ITEM 1. AND ITEM 2.
ITEM 3.
LEGAL PROCEEDINGS
There are currently no pending material legal proceedings to which we are a party.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company’s shareholders during the fourth quarter of 2004.
PART II
ITEM 5.
ITEM 5.
MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Principal Market and Price Range of Common Stock
Infinity’s Common Stock began trading on the Nasdaq Small-Cap Market on June 29, 1994, under the symbol “IFNY.” The following table sets forth the high and low closing sale prices for Infinity’s Common Stock as reported by the Nasdaq Stock Market. The closing price of the Common Stock on March 23, 2005 was $10.45 per share.
Approximate Number of Holders of Common Stock
At March 23, 2005, there were 235 record holders of Infinity’s $0.0001 par value Common Stock.
Dividends
Holders of common stock are entitled to receive such dividends as may be declared by Infinity’s Board of Directors. Infinity has not declared nor paid and does not anticipate declaring or paying any dividends on its common stock in the near future. Any future determination as to the declaration and payment of dividends will be at the discretion of Infinity’s board of directors and will depend on then-existing conditions, including Infinity’s financial condition, results of operations, contractual restrictions, capital requirements, business prospects and such other factors as the board deems relevant. Pursuant to the terms of its Senior Secured Notes Facility, Infinity is prohibited from paying dividends.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The selected consolidated financial information presented below for the years ended December 31, 2004, 2003 and 2002, and March 31, 2001, and the nine month transition period ended December 31, 2001 is derived from the audited consolidated financial statements of Infinity. Infinity changed its fiscal year end to December 31 fiscal year end from a March 31 fiscal year end effective December 31, 2001. Certain reclassifications have been made to prior financial data to conform to the current presentation. The table gives effect to the two-for-one split of Infinity’s common stock effective May 13, 2002 for all periods presented.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following information should be read in conjunction with the Consolidated Financial Statements and Notes presented elsewhere in this Form 10-K. Infinity follows the full-cost method of accounting for oil and gas properties. See “Organization and Summary of Significant Accounting Policies,” included in Note 1 to the Consolidated Financial Statements.
Infinity and its operating subsidiaries Infinity-Texas, Infinity-Wyoming and Consolidated are engaged in identifying and acquiring oil and gas acreage, exploring and developing acquired acreage, oil and gas production, and providing oilfield services. Infinity’s primary focuses are on: (i) the acquisition, exploration and development of and production from its properties in the Fort Worth Basin of North Central Texas and Greater Green River, Sand Wash and Piceance Basins of Southwest Wyoming and Northwest Colorado; and (ii) providing oilfield services in the Mid-Continent region and the Powder River Basin of Northeast Wyoming. Infinity has also been awarded a 1.4 million acre concession offshore Nicaragua in the Caribbean Sea which it intends to explore over the next few years subject to consummation of the long-term exploration and production contract governing such activity.
Overview of Oil and Gas Exploration and Production Activity
Infinity, through Infinity-Texas, expanded its exploration and production operations into the Fort Worth Basin of Texas during the year ended December 31, 2004. The opportunity to operate in Texas was attractive to Infinity due to year-round access to exploration and development locations, ease of permitting, better weather, and less restrictive government and environmental laws and regulations. In addition, early results for other operators in the Fort Worth Basin were encouraging to Infinity-Texas, and its minority joint interest partners, who were experienced in other successful parts of the basin. Meanwhile, Infinity-Wyoming continued to explore and develop the various projects and prospects in the Rocky Mountains, but was hampered by weather, governmental and environmental restrictions and regulations, as well as various operational issues at the Labarge Field and Pipeline Field. Infinity-Wyoming began initial exploration efforts for coalbed methane in the Sand Wash and Piceance Basins, and also commenced development drilling for oil at its Sand Wash Prospect.
Infinity expects to continue to explore and develop its Fort Worth Basin acreage and its Rocky Mountain projects and prospects. Infinity expects its Rocky Mountain projects to proceed more slowly, due in part to governmental restrictions. In addition to reducing and refinancing indebtedness, Infinity raised equity and debt capital during 2004 (and early 2005) to fund its exploration and production operations. Infinity expects to be able to continue to raise capital during 2005 and beyond to fund its exploration and production operations, although the timing, cost and amounts, if any, will depend upon general energy and capital markets conditions and the success of the Company’s operations.
Infinity-Wyoming has selected Netherland, Sewell and Associates, Inc. to prepare its December 31, 2004 and 2003 third party reserve evaluations. Results of these evaluations are disclosed in the “Supplemental Oil and Gas Disclosures” in Infinity’s Consolidated Financial Reports and in the “Oil and Natural Gas Reserves” section of Item 1. and Item 2. Business and Properties. Another engineering firm prepared the reserve evaluation as of December 31, 2002.
Overview of Oilfield Service Operations
Consolidated continued to develop its business relationships as the largest oilfield service provider in Eastern Kansas and Northeast Oklahoma by serving approximately 475 customers during 2004. The continued strong price of natural gas and crude oil and the focus on development of the coal bed methane
potential of the Cherokee basin in Eastern Kansas and Northeast Oklahoma contributed to the overall increase in activity for Consolidated. During 2004 Consolidated achieved several operational milestones:
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revenue of $14.7 million;
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subsidiary level earnings before interest, taxes, depreciation and amortization of approximately $6.5 million;
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provided services to approximately 475 customers;
•
subsidiary level income before taxes of approximately $4.7 million; and
•
the acquisition of a Kansas oilfield service provider and the divestiture of relatively low-margin assets and operations to a customer.
Consolidated is actively seeking opportunities through acquisitions or mergers to expand its service area, increase its market share or enhance the services it provides to its customers.
Subsequent Events
Senior Secured Notes Facility
On January 13, 2005, we entered into a securities purchase agreement (the “Senior Secured Notes Facility”) with affiliates of Promethean Asset Management, LLC and Angelo, Gordon & Co., L.P. (collectively, the “Buyers”), pursuant to which Infinity sold, and the Buyers purchased $30 million aggregate principal amount of senior secured notes (the “Notes”) due January 13, 2009 and five-year warrants to purchase 924,194 shares of common stock at an exercise price of $9.09 per share and 732,046 shares of common stock at an exercise price of $11.06 per share (collectively, the “Warrants”). The Notes have an initial maturity of 48 months subject to extension for an additional twelve months upon the mutual agreement of Infinity and the Buyers. The Notes bear interest at 3-month LIBOR (London Interbank Offered Rate) plus 675 basis points, adjusted the first business day of each calendar quarter. The Notes are secured by essentially all of the assets of Infinity and its subsidiaries and are guaranteed by each of Infinity’s active subsidiaries. The Notes are redeemable by Infinity for cash at any time during the first year at 105% of par value, declining by 1% per year thereafter (101% during any extended maturity period), together with any accrued and unpaid interest. Under certain circumstances, Infinity has the option to repay the Notes with direct issuances of shares of registered common stock in lieu of cash.
At quarterly intervals and over a three-year period, commencing in the third quarter of 2005, Infinity has the option to sell additional notes (the “Additional Notes”), along with additional warrants, in amounts of up to $15 million in any rolling twelve-month period and up to a maximum of $45 million. The Additional Notes would have an initial maturity of 42 months (54 months if the maturity of the Initial Notes is extended). The issuance of Additional Notes is subject to Infinity’s future satisfaction of various closing conditions. The ability to issue Additional Notes or requirement to prepay Notes prior to maturity will depend upon a maximum Notes balance calculated quarterly based generally upon a combination of financial performance of Consolidated and (ii) the SEC after-tax PV-10% value of our proved reserves.
Infinity used approximately $9.2 million of the proceeds from the sale of Notes and Warrants to repay all amounts outstanding pursuant to a Loan and Security Agreement between LaSalle Bank N.A. and Consolidated, a Credit Agreement between U.S. Bank National Association and Infinity-Wyoming, and certain other secured lending agreements, and those credit agreements have been terminated. Infinity is using the remainder of the proceeds to pay costs and expenses related to the sale of the Notes and Warrants and to fund its oil and gas exploration and development activities.
Acquisition of Additional Acreage in the Fort Worth Basin
In February 2005, we entered into a definitive agreement for the acquisition of approximately 24,500 gross and net acres in Comanche County in the Fort Worth Basin of Texas, subject to customary closing conditions. The agreement, as amended, also provides for a right of first refusal on all acres acquired by
the seller in Comanche County. We expect to close the Comanche transaction on or before April 19, 2005. Upon closing, including acreage previously owned, Infinity-Texas will own and operate approximately 67,500 gross acres (approximately 56,300 acres net to Infinity’s interest) of leasehold in Erath, Hamilton and Comanche Counties, Texas. We believe the Comanche County acreage offers prospective vertical and horizontal drilling and production opportunities, targeting the Barnett Shale and Lower Marble Falls formations. The leased properties are located approximately 30 miles southwest of Infinity-Texas’ existing acreage in Erath and Hamilton Counties, Texas. Infinity-Texas agreed to drill at least one test well on the Comanche acreage during the next twelve months.
Redemption of All Subordinated Convertible Debt
Pursuant to requirements of the Senior Secured Notes Facility, on January 13, 2005, Infinity called for redemption the remaining $2.5 million of 8% Subordinated Convertible Notes due 2006 outstanding on February 28, 2005. During January and February 2005, the holders of all of the 8% subordinated convertible notes converted the debt and accrued interest into 517,296 shares of the Company’s common stock.
Based on the volume weighted average stock price for Infinity’s common stock from February 18, 2005 to February 24, 2005 and pursuant to requirements of the Senior Secured Notes Facility, on February 25, 2005, Infinity called for redemption the remaining $8.2 million of 7% Subordinated Convertible Notes due 2007 outstanding on April 22, 2005 at a redemption price of 102.8% plus accrued and unpaid interest. During 2005, through March 23, the holders of $5,950,538 of 7% subordinated convertible notes have converted the debt and accrued interest into 783,779 shares of the Company’s common stock. Approximately $5.6 million of principal amount remains outstanding as of March 23, 2005. The Company has cash on deposit in excess of the amount outstanding at March 23, 2005, should the remaining 7% notes not be presented for conversion prior to the redemption date.
2005 Operational and Financial Objectives
Exploration and Production
Infinity-Wyoming plans to focus on increasing production through development of acreage. Infinity-Wyoming anticipates capital expenditures will be approximately $10 million to drill approximately eight wells, and complete four wells in progress at December 31, 2004, and conduct additional geological and geophysical analysis on its acreage positions.
Infinity-Texas will focus on increasing its acreage position and commencing production in the Fort Worth Basin of central Texas. Infinity-Texas anticipates its capital expenditures will be approximately $30 million to acquire additional acreage, drill approximately fifteen wells, complete three wells in progress at December 31, 2004, and conduct additional geological and geophysical analysis on its acreage positions.
The ability of Infinity-Wyoming and Infinity-Texas to complete these activities is dependent on a number of factors including, but not limited to:
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The availability of the capital resources required to fund the activity. Infinity-Wyoming expects to generate approximately $4 million in cash flow from operations in 2005. Infinity-Texas expects to generate cash flow from operations in 2005 subsequent to the hook up of its initial wells in the Fort Worth basin; however management is currently unable to predict with accuracy an estimate of this amount;
•
The availability of third party contractors for drilling rigs and completion services;
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The completion of environmental studies by the Bureau of Land Management covering federal acreage in the Pipeline and Labarge fields; and
•
The approval by regulatory agencies of applications for permits to drill in a timely manner.
Oilfield Services
Consolidated expects to increase its oilfield service revenue during 2005 due to the increase in the number of wells being drilled and completed by property owners in our service areas and through strategic acquisitions. These acquisitions would be done in order to:
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expand the services that are provided;
•
expand the area that is serviced; and
•
gain market share by providing complementary services to our existing services.
Revenues from oilfield services are expected to be between $14 million and $15 million. Management expects that it could make acquisitions that will cost between $10 million and $20 million during 2005 and expects to fund the acquisitions through the issuance of subordinated debt or common stock. Excluding acquisitions and related capital expenditures, Consolidated also expects to have capital expenditures of about $2 million related to equipment and facilities. These capital expenditures would be financed through cash flow and cash on hand.
Corporate Activities
Infinity continues to negotiate the final exploration and production agreement with INE for the Perlas and Tyra blocks offshore Nicaragua. Management expects to complete the negotiations and execute the agreement in 2005. Upon execution, Infinity would be required to post a performance bond of approximately $0.7 million for the initial work on the leases which will include an environmental study and the development of geological information developed from additional seismic evaluation. Infinity expects to incur additional costs to complete the negotiations and finalize the leases of approximately $0.1 million.
Results of operations for the year ended December 31, 2004 compared to the year ended December 31, 2003
Infinity incurred a net loss after taxes of $4.6 million, or $0.49 per diluted share, in 2004 compared to a net loss after taxes of $9.9 million, or $1.23 per diluted share, in 2003.
Infinity achieved total revenue of $21.0 million in 2004 compared to $18.2 million in 2003. The $2.8 million increase in revenue was attributable to a $3.1 million increase in oilfield service operations, partially offset by a $0.3 million decrease in oil and gas production revenue. Infinity earned a gross profit of $10.5 million during 2004, a $1.4 million, or 15% increase in gross profit from $9.1 million in 2003. Gross profit from exploration and production was $3.6 million during both 2004 and 2003.
General and administrative expenses for the year ended December 31, 2004 increased $0.2 million from $5.3 million in 2003 to $5.5 million in 2004. In 2003, Infinity incurred approximately $0.6 million in expenses associated with the detailed negotiations relating to a potential merger and the process leading up to negotiations in which Infinity solicited and reviewed strategic alternatives. Infinity and its subsidiaries also recognized additional depreciation, depletion and amortization (“DD&A”) expense of approximately $2.1 million during 2004, an increase to approximately $5.2 million compared to DD&A of approximately $3.1 million for 2003. The increase in DD&A was due to the increase in the depletion rate on and increased investment in oil and gas producing properties and the increase in the investment in Consolidated’s fleet in 2004. During 2004, Infinity-Wyoming also recognized a $4.1 million ceiling write-down of its oil and gas properties based on the full cost ceiling test for oil and gas properties subject to depletion, as compared to $3.0 million in 2003. As a result, Infinity recognized an operating loss of $4.3 million for 2004, compared to an operating loss of $2.3 million for 2003.
Interest expense and finance charges and amortization of loan costs decreased by $4.5 million to $3.3 million for 2004 compared to $7.8 million for 2003. The decrease was primarily due to the recognition in 2003 of $5.6 million of amortization of loan costs associated with the value of warrants and options granted in conjunction with obtaining new debt financing and the amortization of $0.6 million of cash loan costs paid when those same loans were obtained, compared to $2.1 million of amortization of loan costs in 2004. Infinity
also experienced a $0.3 million decrease in interest expense in 2004 compared to 2003 due to a decrease in average debt outstanding, lower interest rates on certain indebtedness and an increase in interest capitalized to undeveloped properties.
Exploration and Production
The following table provides statistical information for the year ended December 31, 2004, 2003 and 2002 (due to rounding and other operating expenses the sum of the individual amounts presented may not equal the totals):
During 2004, Infinity-Wyoming recorded approximately $1.4 million in revenue on the sale of 33,668 barrels of oil, (201,828 Mcfe) and approximately $4.9 million in revenue on gas sales of 953,428 Mcf from its Pipeline and Labarge projects. Infinity-Wyoming incurred $1.9 million in oil and gas production expenses and $0.7 million in production taxes to produce oil and gas during the year ended December 31, 2004. The total production expenses and production taxes of approximately $2.6 million equate to approximately $2.28 in lifting costs on total production of 1,155,436 Mcfe. The 19% decrease in equivalent production in 2004 as compared to 2003 was primarily a result natural declines in production rates for wells in the Pipeline field.
Infinity-Wyoming also incurred $0.7 million in general and administrative costs and $3.6 million in DD&A expense, or depletion expense of $3.06 per Mcf equivalent for 2004 compared to $0.92 per Mcf equivalent for 2003. DD&A costs for 2004 increased by $2.1 million due to the increased depletion rate associated with the increased investment in developed oil and gas properties without a corresponding increase in proved reserve quantities. The higher depletion rate in 2004 was partially offset by lower oil and gas production in 2004 compared to 2003.
Under full cost accounting rules, Infinity reviews, on a quarterly basis, the carrying value of its oil and gas properties. Under these rules, capitalized costs of proved oil and gas properties, may not exceed the present value of estimated future revenue at the un-escalated prices in effect as of the end of each fiscal quarter, and a write-down for accounting purposes is required if the ceiling is exceeded. Infinity-Wyoming is also required to evaluate the value of its unproved oil and gas properties and adjust the value to the lower of the cost or market value of the properties.
At December 31, 2004, the carrying amount of oil and gas properties subject to amortization exceeded the full cost ceiling limitation by approximately $8.9 million based upon a natural gas price of approximately $6.07 per Mcf and an oil price of approximately $40.25 per barrel in effect at that date. However, due to significant subsequent price increases to approximately $6.53 per Mcf of gas and $54.55 per barrel of oil at the March 15, 2005 measurement date, Infinity was required to record a ceiling writedown of $4.1 million in the quarter and year ended December 31, 2004. In 2003, the Company recorded a ceiling writedown of approximately $3.0 million.
During 2003 Infinity recorded $1.8 million in revenue on the sale of 57,654 barrels of oil, (345,924 Mcf equivalent) and $4.8 million in revenue on the sale of 1,080,456 Mcf of natural gas from its Pipeline and Labarge projects. Infinity-Wyoming incurred approximately $2.2 million in production expenses and $0.8 million in production taxes to produce the oil and gas during 2003. The total production expenses and production taxes of approximately $2.9 million equate to $2.05 in lifting costs on total Mcf equivalents of 1,426,380. Infinity-Wyoming also incurred approximately $0.8 million in general and administrative costs and $1.6 million in DD&A expense.
Oilfield Services
Sales for 2004 increased 27% to $14.7 million from $11.6 million in 2003. Sales of cementing services increased by approximately $1.7 million due to the acquisition of Blue Star Acid Services in April 2004 and by approximately $0.7 million due to an increase of 200 jobs at the Gillette, Wyoming camp. In 2004, the Chanute, Kansas camp cemented an additional 160 wells and generated an additional $0.7 million in revenue compared to its 2003 activity, prior to its sale in September 2004. The following table details the increase in gross revenue in millions of dollars, before discounts and inter-company eliminations, for the years shown, based on the number and type of core service jobs performed (due to rounding the sum of the individual amounts presented may not equal the totals):
Oilfield Service Statistics
The increase in the number of cementing jobs performed reflects the increase in the number of wells being drilled in Eastern Kansas and Northeast Oklahoma as well as in Northeast Wyoming. As well testing is completed on the newly drilled wells, completion and stimulation activities such as acidizing and fracturing should increase. Management believes that the increase in the number of wells cemented by Consolidated during the year and the continued high prices for oil and natural gas are good indicators of future increases in its acidizing and fracturing activities as well.
The additional activity also led to a 27% increase in the cost of goods sold of approximately $1.7 million. The increase in cost of goods sold was primarily due to the increase in materials of approximately $0.9 million, labor expense of approximately $0.4 million, and an increase in equipment operating costs and maintenance of approximately $0.4 million. General and administrative expenses for oilfield services of $2.8 million for 2004 was comparable to the same period in 2003.
Corporate Activities
Infinity and its subsidiaries incurred approximately $2.1 million in expenses associated with corporate activities during 2004 and 2003.
Other Income and Expenses
Other income and expense was a net expense of $0.3 million for 2004 compared to $7.6 million for 2003. Infinity recognized a $4.5 million decrease in interest expense of which $4.2 million was associated with the amortization of financing costs. There was also a $0.3 million decrease in interest expense in 2004 compared to 2003 period due to a decrease in average debt outstanding, lower interest rates on certain indebtedness and an increase in the amount of interest capitalized to undeveloped properties.
Income Tax
Infinity reflected no net tax benefit or expense in 2004 and 2003. The net operating losses generated in 2004 and 2003 increased Infinity’s net deferred tax asset. Due to uncertainty as to the ultimate utilization of the net operating losses, the net deferred tax asset has been fully reserved by a valuation allowance as described in Note 11 of the consolidated financial statements.
Results of operations for the year ended December 31, 2003 compared to the year ended December 31, 2002
Infinity incurred a net loss after taxes of $9.9 million, or $1.23 per fully diluted share, in 2003 compared to a net loss after taxes of $1.6 million, or $0.22 per fully diluted share in 2002.
Infinity achieved a $4.6 million increase in gross profit to $9.1 million in 2003 from $4.5 million for 2002. The increase in gross profit during 2003 compared to 2002 was the result of a $3.0 million, or approximately 36%, increase in oilfield service revenue to $11.6 million from $8.6 million. The increase in revenue was partially offset by a $1.6 million, or 35%, increase in oilfield service cost of services provided (see “Oilfield Services” discussion below). Oilfield service revenue for 2002 was reduced by the elimination of $2.1 million of oilfield service sales that were provided to Infinity-Wyoming by Consolidated for the development of its oil and gas properties and the cost of services provided was reduced by $1.1 million for the cost of those services provided to Infinity-Wyoming. The oilfield service subsidiary provided minimal services to Infinity-Wyoming in 2003. Additionally, gross profit comparisons were affected by a $4.2 million, or approximately 178%, increase in sales of oil and gas from $2.4 million for 2002 to $6.6 million in 2003 with a corresponding increase of $0.6 million in oil and gas production costs and $0.5 million increase in production taxes in 2003 (see “Oil and Gas Production” discussion below).
General and administrative expenses for 2003 increased $0.7 million from $4.6 million in 2002 to $5.3 million in 2003. In 2003, Infinity incurred approximately $0.6 million in expenses associated with the detailed negotiations relating to a potential merger, which negotiations were terminated in April 2003, and the process leading up to those negotiations in which Infinity solicited and reviewed strategic alternatives. Infinity and its subsidiaries also recognized additional DD&A expense of approximately $1.3 million during 2003, an increase to approximately $3.1 million for the period compared to DD&A of approximately $1.8 million for 2002. The increase in DD&A was due to the increase in the investment in Consolidated’s fleet in 2002 and the increase in the depletion rate on the oil and gas producing properties. Infinity-Wyoming also recognized a $3.0 million ceiling write-down of its oil and gas properties based on the full cost ceiling test for oil and gas properties subject to depletion. As a result, Infinity recognized an operating loss of $2.3 million for 2003, compared to an operating loss of $1.9 million for 2002.
Interest expense and finance charges increased by $7.0 million to $7.8 million for 2003 compared to $0.8 million for 2002. The increase was primarily due to the recognition of $5.6 million of amortization of loan costs associated with the value of warrants and options granted in conjunction with obtaining debt financing and the amortization of $0.6 million of cash loan costs paid when those same loans were obtained. Infinity also experienced a $0.9 million increase in interest expense in 2003 period compared to 2002 due to the increase in debt outstanding, higher interest rates on certain notes issued in 2003 and a decrease in the amount of interest that was capitalized to undeveloped properties as Infinity experienced a period of development inactivity during a significant portion of 2003.
Infinity recognized a deferred income tax benefit of $1.1 million in 2002. The net operating losses generated in 2003 increased Infinity’s net deferred tax asset. Due to uncertainty as to the ultimate utilization of the net operating losses, the net deferred tax asset has been fully reserved by a valuation allowance as discussed in Note 11 of the consolidated financial statements. Therefore, Infinity has reflected no net tax expense or benefit for 2003.
Exploration and Production
See the table above for statistical information for 2003 and 2002 (due to rounding and other operating expenses the sum of the individual amounts presented may not equal the totals).
During 2003, Infinity-Wyoming recorded approximately $1.8 million in revenue on the sale of 57,654 barrels of oil, (345,924 Mcf equivalents) and approximately $4.8 million in revenue on the gas sales of 1,080,456 Mcf from its Pipeline and Labarge projects. Infinity-Wyoming incurred $2.1 million in production expenses and $0.8 million in production taxes to produce the oil and gas during 2003. The total production expenses and production taxes of approximately $2.9 million equate to approximately $2.04 in lifting costs on total Mcf equivalents of 1,426,380. Infinity-Wyoming also incurred $0.8 million in general and administrative costs and $1.6 million in DD&A expense, or approximately $1.63 per Mcf equivalent for the period. The general and administrative expense included approximately $0.2 million in costs associated with the detailed negotiations relating to a potential merger, which negotiations were terminated in May 2003, and the process leading up to those negotiations in which Infinity solicited and reviewed strategic alternatives. Excluding these costs, general and administrative expenses for Infinity-Wyoming were unchanged when compared to the prior year period. DD&A costs for the period increased by $1.3 million due to the increased depletion rate associated with the investment in developed oil and gas properties. The higher rate was the result of the increase in oil and gas production and the decrease in the proved reserves from 2002 to 2003.
Infinity also recognized in 2003 a ceiling write-down of its oil and gas properties under the full cost ceiling test of approximately $3.0 million. Due to the limited availability of capital for development of its properties, the decision not to re-new a portion of Infinity-Wyoming’s leases during 2004, and the condemnation of leases due to geological and geophysical evaluation, Infinity-Wyoming re-classified approximately $5.0 million of its investment in oil and gas properties not subject to depletion to subject to amortization.
During 2002 Infinity-Wyoming recorded $0.9 million in revenue on the sale of 42,525 barrels of oil, (255,150 Mcf equivalent) and $1.3 million in revenue on the sale of 648,160 Mcf of natural gas from its Pipeline and Labarge projects. Infinity-Wyoming incurred approximately $1.1 million in lease operating expenses, $0.2 million in production taxes and $0.3 million in transportation fees to produce the oil and gas during 2002. The total production expenses and production taxes of approximately $1.6 million equate to $1.79 in lifting costs on total Mcf equivalents of 903,310. Infinity-Wyoming also incurred approximately $0.7 million in general and administrative costs and $0.2 million in DD&A expense, or approximately $1.00 per Mcf equivalent for the period.
The increase in production was primarily a result of the increased production time for wells in each period. Several wells began production in the third and fourth quarters of 2002. These wells produced for all of 2003 while producing for only a short period and at lower volumes during 2002.
Infinity-Kansas recorded net revenue of $0.2 million from its Kansas properties and operating expenses and production taxes of $0.2 million during 2002. Effective May 1, 2002 Infinity-Kansas sold its interest in the Owl Creek and Manson properties to West Central Oil, LLC for cash and a note receivable. Under the full cost method of accounting for oil and gas properties, Infinity and its subsidiaries did not recognize a gain or loss on the sale of its oil and gas properties since the sale did not have a material impact on the relationship between the oil and gas property values and the value of the reserves associated with those properties. Infinity reduced its investment in the remaining oil and gas properties by approximately $244,000 on the sale of the property.
During 2003, production, oil and gas prices, operating expenses and development expenditures for Infinity-Wyoming’s Labarge and Pipeline projects varied from those estimated in reserve reports at December 31, 2002 and additional geological, geophysical, and engineering data became available and was analyzed. Production at Labarge continued to be uneconomic, possibly due in part to down-hole operational problems. Quantities of proved oil and gas reserves as evaluated by Netherland Sewell and Associates at December 31, 2003 were substantially less than our previous estimates which in turn resulted in a higher depletion rate for the last part of 2003.
The 58% increase in production during 2003 combined with the significant reduction in proved reserves at January 1, 2004 resulted in a $1.2 million increase in depletion of developed oil and gas properties in 2003 compared to the 2002 period.
Infinity-Wyoming experienced a $0.3 million increase in administrative expenses in 2003 compared to 2002. This increase in administrative expense was primarily legal, accounting, and consulting fees associated with the detailed negotiations relating to a potential merger, which negotiations were terminated in May 2003, and the process leading up to those negotiations in which Infinity solicited and reviewed strategic alternatives.
Oilfield Services
Sales for 2003 increased to $11.6 million from $8.6 million, net of inter-company eliminations, in 2002. Infinity eliminated oilfield services sales of $2.1 million from revenues for sales of services to Infinity-Wyoming during 2002. There were no material inter-company sales in 2003. Sales of cementing services from Consolidated’s Bartlesville, Oklahoma camp increased by approximately $0.8 million and revenue from fracturing services from that camp increased by approximately $1.3 million in 2003 compared to 2002. The increase in revenue was primarily due to an increase in development activity during the second and third quarters of 2003 as customers moved from the evaluation of their prospects to the full scale development of their prospects in areas serviced from the Bartlesville facility. Revenue from cementing services provided from Consolidated’s Gillette, Wyoming facility increased by approximately $1.3 million, due to increased coalbed methane development activity in the Powder River Basin of Wyoming. Crews from the Gillette facility cemented over 400 wells in 2003 compared to 78 in 2002. The following table details the increase in gross revenue in millions of dollars, before discounts and inter-company eliminations, for the periods, based on the number and type of core service jobs performed (due to rounding the sum of the individual amounts presented may not equal the totals):
Oilfield Service Statistics
The increase in the number of cementing jobs performed reflects the increase in the number of wells being drilled in Eastern Kansas and Northeast Oklahoma as well as in Wyoming. The additional activity also led to an increase in the cost of goods sold of approximately $1.6 million. The increase in cost of goods sold was primarily due to the increase in materials of approximately $0.7 million, labor expense of approximately $0.4 million, and an increase in equipment operating costs and maintenance of approximately $0.3 million. General and administrative expenses for oilfield services for 2003 were comparable to 2002.
Corporate Activities
Infinity and its subsidiaries incurred approximately $2.1 million in expenses associated with corporate activities during 2003 compared to approximately $1.9 million in 2002. Included in the $0.2 million increase was approximately $0.3 million in legal, accounting, and consulting fees associated with the detailed negotiations relating to a potential merger, which negotiations were terminated in May 2003, and the process leading up to those negotiations in which Infinity solicited and reviewed strategic alternatives.
Other Income and Expenses
Other income and expense was a net expense of $7.6 million for 2003 compared to $0.8 million for 2002. Infinity recognized a $7.0 million increase in interest expense of which $6.0 million was associated with the amortization of financing costs. $5.4 million of the increase in amortization of loan costs related to options and warrants granted in conjunction with obtaining new debt financing and the remainder of the increase was related to cash loan costs paid when those same loans were obtained. There was also a $0.9 million increase in interest expense in 2003 compared to 2002 due to the increase in debt outstanding, higher interest rates on notes issued in 2003 and a decrease in the amount of interest that was capitalized to undeveloped properties as Infinity experienced a period of development inactivity during a significant portion of 2003.
Income Tax
Infinity recognized a deferred tax benefit of approximately $1.1 million in 2002. The net operating losses generated in 2003 increased Infinity’s net deferred tax asset. Due to uncertainty as to the ultimate utilization of the net operating losses, the net deferred tax asset has been fully reserved by a valuation allowance as described in Note 11 of the consolidated financial statements. Therefore, Infinity has reflected no net tax expense or benefit for 2003.
Liquidity and Capital Resources
Infinity’s primary sources of liquidity are cash provided by operations and debt and equity financing. Infinity’s primary needs for cash are for the operation, development, production, exploration and acquisition of oil and gas properties, for fulfillment of working capital obligations, and for the operation and development through acquisitions of oilfield service businesses.
As of December 31, 2004, the Company had working capital of $0.3 million, compared to a working capital deficit of $2.2 million at December 31, 2003. Working capital increased by approximately $2.5 million due to an approximate $5.9 million increase in current assets due primarily to (i) a $2.3 million increase in cash; (ii) a $1.7 million increase in net accounts receivable; and (iii) an approximate $1.6 million increase in the current portion of a note receivable, offset by an approximate $3.4 million increase in current liabilities due to (i) a $1.5 million increase in accounts payable and (ii) a $3.5 million increase in accrued liabilities; offset by (iii) a $1.4 million decrease in current portion of long-term debt.
During the year ended December 31, 2004, cash provided by operating activities was $5.5 million, compared to $2.8 million in 2003. The increase in cash provided by operating activities of $2.7 million was primarily due to the $5.3 million decrease in net loss.
During 2004, Infinity used $9.9 million in investing activities, compared to $6.9 million used in 2003. The increase in cash used in investing activities of $3.0 million was primarily attributable to a $6.0 million increase in exploration and production capital expenditures and a $1.7 million increase in oilfield services capital expenditures, partially offset by a $4.6 million increase in proceeds of sale of fixed assets.
During 2004, Infinity financing activities provided $6.8 million, compared to $3.9 million from financing activities during 2003. The increase in cash provided by financing activities of $2.9 million was due to an $8.5 million increase in proceeds from equity issuances, net of issuance costs, offset by a $5.3 million decrease in proceeds from borrowings and a $0.3 million increase in debt repayments.
Effective June 13, 2001, Infinity sold $6,475,000 in 8% Subordinated Convertible Notes in a private placement. During the year ended December 31, 2004, $308,276 of the notes and interest accrued on those notes was converted into 63,179 shares of common stock, leaving an outstanding balance on the notes of $2,493,000 at December 31, 2004. The remaining notes and accrued interest were converted in their entirety by February 28, 2005 into 517,296 shares of the Company’s common stock.
Effective April 17, 2002, Infinity sold $12,540,000 in 7% Subordinated Convertible Notes in a private placement. Infinity issued $391,000 in additional notes for the payment of accrued interest due April 15, 2004 and $404,000 in additional notes for the payment of accrued interest due October 15, 2004. In addition, during
the year ended December 31, 2004, $487,472 of the notes and interest accrued on notes were converted into 62,685 shares of common stock, leaving an outstanding balance on the notes of $11,516,698 at December 31, 2004. During 2005, through March 23, the holders of $5,950,538 of 7% have converted the debt and accrued interest into 783,779 shares of the Company’s common stock. The remaining notes are currently subject to redemption by Infinity on April 22, 2005 and the outstanding balance of the notes on March 23, 2005 was approximately $5.6 million. Infinity has cash available to redeem the remaining 7% notes should they not be presented for conversion prior to the redemption date.
Effective November 25, 2002, Infinity issued $3,000,000 in notes to a stockholder. These notes were secured with a first or second priority security interest in certain gas properties and accrued interest at 7% per annum. On January 15, 2004, Infinity issued 125,000 shares of common stock valued at $4.00 per share and paid $750,000 in cash, as partial payment on the $3,000,000 bridge note. As a result of the private placement of common stock on November 15, 2004, the note was repaid in full during November 2004.
In January 2002, Consolidated established a term loan collateralized by substantially all of its oilfield service equipment, a revolving line of credit secured by the eligible receivables of Consolidated and a $1.0 million capital expenditures line of credit with LaSalle Bank, N.A. (“LaSalle Bank”). Effective July 9, 2004, Consolidated borrowed $5.4 million under this facility. As a result of the closing of the Senior Secured Notes Facility, the indebtedness under the LaSalle facility was repaid in full on January 13, 2005.
In September 2003, Infinity-Wyoming established a Secured Revolving Borrowing Base Credit Facility with U.S. Bank National Association (“U.S. Bank”). The facility provided for funding of up to $25.0 million, and the initial amount made available under the facility and drawn by the Company was $5.5 million. At December 31, 2004 $5.0 million of debt under the U.S. Bank facility is reflected as long-term debt as it was repaid using the long-term credit facility. As a result of the closing of the Senior Secured Notes Facility, the indebtedness under the U.S. Bank facility was repaid in full on January 13, 2005.
Infinity issued 1,000,000 shares of common stock in January 2004 in a private placement for which it received net proceeds after offering costs of approximately $3.9 million. The net proceeds of this offering, after making a $750,000 payment on notes, were used to pay costs associated with the completion of the Pipeline Field wells drilled in the fourth quarter of 2003, to pay for the Labarge Field well completion activities, and for working capital.
Infinity issued 1,027,000 shares of common stock in November 2004 in a private placement for which it received net proceeds after offering costs of approximately $4.9 million. The net proceeds of this offering, after making a $1,750,000 payment on notes, were used to pay costs associated with the initial drilling of the Fort Worth Basin wells drilled in the fourth quarter of 2004 and for working capital.
Outlook for 2005
Depending on the availability of capital resources, the availability of third party contractors for drilling and completion services, and satisfaction of regulatory activities, Infinity could incur capital expenditures of approximately $42 million during 2005. Capital expenditures by operating entity would be approximately $30 million by Infinity-Texas; $10 million by Infinity-Wyoming; and $2 million by Consolidated. The Company could also make capital expenditures for acquisitions in excess of these amounts should appropriate opportunities arise.
Following the sale of the Senior Secured Notes and Warrants to Buyers in January 2005, Infinity used approximately $9.2 million of the proceeds to repay all amounts outstanding pursuant to the Loan and Security Agreement between LaSalle Bank N.A. and Consolidated, the Credit Agreement with U.S. Bank National Association and Infinity-Wyoming, and certain other secured lending agreements, and those credit agreements have been terminated. No principal on the Notes is due until 2009. Following the repayment of debt and transaction expenses of approximately $2.3 million, Infinity had approximately $18.5 million available for oil and gas exploration and development expenditures. In addition, at quarterly intervals and over a three year period, commencing in the third quarter of 2005, Infinity has the option to sell additional notes, along with warrants, in amounts up to $15 million in any rolling twelve-month period. The ability to issue
Additional Notes will depend upon a maximum Notes balance calculated quarterly based generally upon a combination of financial performance of Consolidated and the SEC after-tax PV-10% value of our proved reserves. Management of the Company is of the opinion that it is reasonably likely that the Company will be eligible to sell $15 million in additional Notes and Warrants during the second half of 2005.
In January 2005, Infinity called for the redemption of the remaining 8% Subordinated Convertible Notes due 2006 outstanding on February 28, 2005. All $2.5 million outstanding on the 8% notes converted into common stock prior to the redemption date.
In February 2005, Infinity has called for redemption of the remaining 7% Subordinated Convertible Notes due 2007 outstanding on April 22, 2005. Approximately $5.6 million of principal remains outstanding as of March 23, 2005. The Company has cash on deposit in excess of the amount outstanding at March 23, 2005, should the remaining 7% notes not be presented for conversion prior to the redemption date.
Depending on the market price for crude oil and natural gas during 2005, production levels from wells not yet placed on line, and continued demand for and acceptance of our oilfield service operations in the geographic areas we serve, Infinity would expect to generate at least $10 million from operating activities during 2005.
Through March 23, 2005, Infinity has received approximately $4 million in proceeds from the exercise of options and warrants. Management expects to receive proceeds from additional exercises during 2005, but is unable to predict the amount or timing of such proceeds.
In summary, Infinity believes that it will have approximately $47.5 million available to it in 2005 from the net proceeds from the sale of Notes ($18.5 million), the sale of Additional Notes ($15.0 million), cash from operating activities (at least $10.0 million), and proceeds from the exercise of options and warrants (at least $4.0 million), to fund its planned capital expenditures of approximately $42 million and redeem the 7% notes should none of the balance outstanding at March 23, 2005 be presented for conversion.
Should Infinity identify acquisition opportunities, or if it wishes to accelerate the exploration and development of its oil and gas properties beyond that currently anticipated, or if cash flow from operating activities is not at levels anticipated, or if Infinity is unable to sell additional notes and warrants under the Senior Secured Notes Facility, Infinity may seek the forward sale of oil and gas production, partnerships or strategic alliances for the development of its undeveloped acreage, the public or private offering of common or preferred equity or subordinated debt, asset sales, or other joint interest or joint venture opportunities to fund any cash shortfalls.
Critical Accounting Policies and Estimates
Infinity believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.
Reserve Estimates
Infinity’s estimated quantities of proved reserves at December 31, 2004 and 2003 were prepared by independent petroleum engineers Netherland, Sewell and Associates, Inc. and at December 31, 2002 were prepared by independent petroleum engineers Wells Chappell and Company, Inc. Infinity’s estimates of oil and natural gas reserves, by necessity, are projections based on geologic and engineering data, and there are uncertainties inherent in the interpretation of such data as well as the projection of future rates of production and the timing of development expenditures. Reserve engineering is a subjective process of estimating underground accumulation of oil and natural gas that are difficult to measure. The accuracy of any reserve estimate is a function of the quality of available data, engineering and geological interpretation and judgment. Estimates of economically recoverable oil and natural gas reserves and future net cash flows necessarily depend upon a number of variable factors and assumptions, such as historical production from the area compared with production from other producing areas, the assumed effects of regulations by governmental agencies and assumptions governing future oil and natural gas prices, future operating costs, severance, ad valorem and excise taxes, development costs and work-over and remedial costs, all of which may in fact vary
considerably from actual results. For these reasons, estimates of the economically recoverable quantities of oil and natural gas attributable to any particular group of properties, classifications of such reserves based on risk of recovery, and estimates of the future net cash flows expected there from may vary substantially. Any significant variance in the assumptions could materially affect the estimated quantity and value of the reserves, which could affect the carrying value of Infinity’s oil and gas properties and the rate of depletion of the oil and gas properties. Actual production, revenues and expenditures with respect to Infinity’s reserves will likely vary from estimates, and such variances may be material.
Oil and Gas Properties, Depreciation and Full Cost Ceiling Test
Infinity follows the full cost method of accounting for oil and gas properties. Under this method, all productive and nonproductive costs incurred in connection with the exploration for and development of oil and gas reserves are capitalized. Such capitalized costs include lease acquisition, geological and geophysical work, delay rentals, drilling, completing and equipping oil and gas wells, and salaries, benefits and other internal salary related costs directly attributable to these activities. The capitalized costs are amortized over the life of the reserves associated with the assets with the amortization being expensed as depletion in the period that the reserves are produced. This depletion expense is calculated by dividing the period’s production volumes by the estimated volume of reserves associated with the investment and multiplying the calculated percentage by the capitalized investment. Costs associated with production and general corporate activities are expensed in the period incurred. Interest costs related to unproved properties and properties under development are also capitalized to oil and gas properties.
If the net investment in oil and gas properties less asset retirement obligations, exceeds an amount equal to the sum of (1) the standardized measure of discounted future net cash flows from proved reserves including the effect of cash flow hedges, and (2) the lower of cost or fair market value of properties in process of development and unexplored acreage, the excess is charged to expense as additional depletion. Infinity is required to review the carrying value of its oil and gas properties each quarter under the full cost accounting rules of the Securities and Exchange Commission. Under these rules, capitalized costs of proved oil and gas properties, excluding the future cash outflows associated with settling asset retirement obligations that have been accrued in the full cost pool, less accumulated amortization and related deferred taxes, may not exceed an amount equal to the sum of the present value of estimated future net revenues from proved reserves, discounted at 10%. Application of the ceiling test generally requires pricing future revenue at the un-escalated prices in effect as of the last day of the quarter, including the effects of cash flow hedges, and requires a write down for accounting purposes if the ceiling is exceeded. Unproved oil and gas properties are not amortized, but are assessed for impairment either individually or on an aggregated basis using a comparison of the carrying values of the unproved properties to net future cash flows.
At December 31, 2004, the carrying amount of oil and gas properties subject to amortization exceeded the full cost ceiling limitation by approximately $8,900,000 based upon a natural gas price of approximately $6.07 per Mcf and an oil price of approximately $40.25 per barrel in effect at that date. However, due to significant subsequent price increases to approximately $6.53 per Mcf of gas and $54.55 per barrel of oil at the March 15, 2005 measurement date, the Company was only required to record a ceiling writedown of $4,100,000 in the quarter and year ended December 31, 2004. In 2003, the Company recorded a ceiling writedown of $2,975,000.
A decline in prices received for oil and gas sales or an increase in operating costs subsequent to the measurement date or reductions in estimated economically recoverable quantities could result in a requirement that Infinity recognize an additional ceiling write-down of oil and gas properties in a future period. Normal dispositions of oil and gas properties are accounted for as adjustments of capitalized costs, with no gain or loss recognized.
Property, Equipment and Depreciation
Equipment utilized in the oilfield service business and to support operations on Infinity’s oil and gas properties is stated at cost. This equipment is depreciated using the straight line method over the estimated useful lives of the assets of three to 30 years.
Valuation of Tax Asset
The deferred tax assets and liabilities represent the future tax return consequences of those temporary differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that are not expected to be realized based on available evidence that is more likely than not to be realized in the form of a deferred tax valuations allowance.
Off-Balance Sheet Arrangements
Infinity has no material off-balance sheet arrangements.
Contractual Obligations
Infinity’s contractual obligations, including those of its consolidated subsidiaries, include long-term debt, equipment and operating leases and other non-current obligations. The following table lists Infinity’s significant contractual obligations at December 31, 2004.
For purposes of this table, Infinity is assuming that the holders of the 7% and 8% subordinated convertible notes will not exercise the conversion feature. In addition periodic interest payments required under the credit facilities and the 7% and 8% subordinated convertible notes are not reflected in the table. In January 2005, the Company repaid the revolving credit facility and term loans using proceeds from the Senior Secured Notes facility. However, the table above reflects the original maturity of the debt.
This table does not reflect the obligations associated with the gas gathering contract related to the Pipeline property. That contract is subject to certain delivery commitments that Infinity-Wyoming has not met. However, the gas gatherer has also not been able to supply the additional system capacity to allow Infinity-Wyoming to meet its delivery obligations and, Infinity-Wyoming expects that the contract will be amended to reflect volume requirements that are consistent with deliveries.
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS No. 123(R) is effective for public companies for interim or annual periods beginning after June 15, 2005, supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employee’s,” and amends SFAS No. 95, “Statement of Cash Flows.” SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values, beginning with the first interim or annual
period after June 15, 2005, with early adoption encouraged. The pro forma disclosures, previously permitted under SFAS No. 123, no longer will be an alternative to financial statement recognition. SFAS No. 123(R) also requires the tax benefits in excess of recognized compensation expenses to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement may serve to reduce the Company’s future cash provided by operating activities and increase future cash provided by financing activities, to the extent of associated tax benefits that may be realized in the future.
The Company is required to adopt SFAS No. 123(R) in its third quarter of fiscal 2005, beginning July 1, 2005. Under SFAS No. 123(R), Infinity must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost, and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive options, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS No. 123(R); the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. Infinity is evaluating the requirements of SFAS No. 123(R), and expects that the adoption of SFAS No. 123(R) will not have a material impact on consolidated results of operations and earnings per share as all outstanding options are fully vested.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions” (“SFAS 153”). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for the fiscal periods beginning after June 15, 2005. The Company is currently evaluating the effect that the adoption of SFAS 153 will have on consolidated results of operations and financial condition but does not expect it to have a material impact.
Staff Accounting Bulletin (“SAB”) 106 was released in September 2004. SAB 106 expresses the SEC staff’s views on the interaction of SFAS No. 143 and the full cost method and provides guidance on computing the full cost ceiling as well as depreciation, depletion and amortization. SAB 106 also requires additional disclosures regarding how the application of SFAS No. 143 has affected the ceiling test and depreciation, depletion and amortization. The Company adopted SAB 106 during the fourth quarter of 2004 and experienced no significant impact on its depletion or ceiling test calculation.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Infinity’s major market risk exposure is in the pricing applicable to its oil and gas production. Realized pricing is primarily driven by the prevailing price for crude oil and spot prices applicable to Infinity’s crude oil and natural gas production. Historically, prices received for gas production have been volatile and unpredictable. Pricing volatility is expected to continue. Gas price realizations ranged from a low of $4.17 to a high of $6.98 per Mcf during the year ended December 31, 2004. Oil price realizations ranged from a low of $33.35 per barrel to a high of $52.58 per barrel during the period.
Infinity periodically enters into fixed price contracts or hedging activities on a portion of its projected natural gas production in accordance with its Energy Risk Management Policy. These activities are intended to support cash flow at certain levels by reducing the exposure to oil and gas price fluctuations. Realized gains or losses from Infinity’s cash flow risk management activities are recognized in production revenues. In the year ended December 31, 2004, the effect of Infinity-Wyoming hedging its gas production compared to if it had sold the gas on the spot market was a decrease in revenue of approximately $0.6 million.
The Securities Purchase Agreement dated as of January 13, 2005 by and among Infinity and the Buyers of the Notes includes a covenant that at each date that is the end of a quarterly or annual period covered by a quarterly report on Form 10-Q or annual report on Form 10-K (a “Determination Date”), at least 20% of the Company’s estimate of its oil and gas production for the 12-month period commencing immediately after such
Determination Date shall be protected from price fluctuations using derivatives, fixed price agreements and/or volumetric production payments. It is the opinion of management that the Company would have been in compliance with this hedging requirement at December 31, 2004, had the Notes been issued and outstanding on that date.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS.
The consolidated financial statements and supplementary information filed as part of this Item 8 are listed under Part IV, Item 15, “Exhibits, Financial Statement Schedules, and Reports on Form 8-K” and contained in this Form 10-K at page.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports under the Securities Exchange Act of 1934, as amended (“Exchange Act”) are communicated, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. At the end of the Company’s fourth quarter of 2004, as required by Rules 13a-15 and 15d-15 of the Exchange Act, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Principal Financial and Accounting Officer, of the effectiveness of the design and operation of disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon that evaluation, the Chief Executive Officer and the Principal Financial and Accounting Officer concluded that the design and operation of these disclosure controls and procedures were effective as of that date. No changes in internal controls over financial reporting identified in connection with its evaluation (as required by Rules 13a-15(d) and 15d-15(d) of the Exchange Act) occurred during the fourth quarter of 2004 that affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting.
Although the evaluation did not detect any material weaknesses or significant deficiencies in the Company’s system of internal accounting controls over financial reporting, management has identified certain deficiencies in its reconciliation procedures, level of staffing, and inherent limitations in its electronic data processing software. The Company has added additional accounting staff during the first quarter of 2005 and intends to add additional accounting personnel during the second quarter of 2005 to address these deficiencies. The Company will also assess the viability of replacing or enhancing its electronic data processing software in 2005.
PART III
ITEM 10:
ITEM 10:
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors of Infinity is incorporated by reference to the section entitled “Election of Directors” in our definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A in connection with the 2004 annual meeting of shareholders (the “Proxy Statement”).
ITEM 11:
ITEM 11:
EXECUTIVE COMPENSATION
Reference is made to the information set forth under the caption “Executive Compensation and Other Information” in the Proxy Statement, which information (except for the report of the board of directors on executive compensation and the performance graph) is incorporated by reference in this report on Form 10-K.
ITEM 12:
ITEM 12:
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is made to the information set forth under the caption “Security Ownership of Principal Shareholders and Management” in the Proxy Statement, which information is incorporated by reference in this report on Form 10-K.
ITEM 13:
ITEM 13:
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is made to the information contained under the caption “Certain Transactions” contained in the Proxy Statement, which information is incorporated by reference in this report on Form 10-K.
ITEM 14:
ITEM 14:
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Reference is made to the information contained under the caption “Appointment of Independent Accountant” contained in the Proxy Statement, which information is incorporated by reference in this report on Form 10-K.
PART IV
ITEM 15:
ITEM 15:
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as part of this report on Form 10-K or incorporated by reference.
(1) Our consolidated financial statements are listed on the “Index to Consolidated Financial Statements” on Page to this report.
(2) Financial Statement Schedules (omitted because not applicable or not required. Information is disclosed in the notes to the financial statements).
(3) The following exhibits are filed with this report on Form 10-K or incorporated by reference.
EXHIBITS
(1)
Incorporated by reference to our Registration Statement (No. 33-17416-D).
(2)
Incorporated by reference to our Annual Report on Form 10-KSB for the fiscal year ended March 31, 2000.
(3)
Incorporated by reference to our Registration Statement on Form S-3 (File No. 333-69292).
(4)
Incorporated by reference to our Registration Statement on Form S-3 (File No. 333-96671).
(5)
Incorporated by reference to our Current Report on Form 8-K, filed with the SEC on January 21, 2004.
(6)
Incorporated by reference to our Current Report on Form 8-K, filed with the SEC on November 16, 2004.
(7)
Incorporated by reference to our Current Report on Form 8-K, filed with the SEC on January 14, 2005.
(8)
Incorporated by reference to our Annual Report on Form 10-KSB for the fiscal year ended March 31, 2001.
(9)
Incorporated by reference to our Annual Report on Form 10-KSB for the transition period ended December 31, 2001.
(10)
Incorporated by reference to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2002.
(11)
Incorporated by reference to our Registration Statement on Form S-8 (File No. 333-117390).
(12)
Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2004.
(13)
Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2004.
(14)
Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2003.
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Infinity has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
INFINITY, INC.
By:
/s/ Stanton E. Ross
Stanton E. Ross
President and Chief Executive Officer
Dated: March 30, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Infinity and in the capacities and on the dates indicated:
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Infinity, Inc. and Subsidiaries
Chanute, Kansas
We have audited the consolidated balance sheets of Infinity, Inc. and Subsidiaries as of December 31, 2004 and 2003 and the consolidated statements of operations, changes in stockholders’ equity and cash flows for the years ended December 31, 2004, 2003 and 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with 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 consolidated 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 includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated 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 condition of Infinity, Inc. and Subsidiaries, as of December 31, 2004 and 2003, and the results of their operations and their cash flows for the years ended December 31, 2004, 2003 and 2002, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 2003, the Company changed its method of accounting for asset retirement obligations.
/s/ Ehrhardt Keefe Steiner & Hottman PC
March 13, 2005, except for Notes 7, 8 and 16
which are as of March 23, 2005
Denver, Colorado
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF OPERATIONS
See Notes to Consolidated Financial Statements
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For the years ended December 31, 2004, 2003 and 2002
See Notes to Consolidated Financial Statements
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For the year ended December 31, 2004, 2003 and 2002
See Notes to Consolidated Financial Statements
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CASH FLOWS
See Notes to Consolidated Financial Statements
INFINITY, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
See Notes to Consolidated Financial Statements
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 -
Organization and Summary of Significant Accounting Policies
The Company and its subsidiaries are engaged in the acquisition, exploration, development and production of natural gas and crude oil in the United States and also in Nicaragua. In addition, the Company provides oilfield services in the Mid-Continent region and in Northeast Wyoming.
Basis of Presentation
The consolidated financial statements include the accounts of Infinity, Inc. and its wholly-owned subsidiaries, Consolidated Oil Well Services, Inc., Infinity Oil and Gas of Wyoming, Inc., Infinity Oil and Gas of Texas, Inc., Infinity Oil and Gas of Kansas, Inc., CIS - Oklahoma, Inc., Infinity Research and Development, Inc., L.D.C. Food Systems, Inc., Consolidated Pipeline Company, Inc., CIS Oil and Gas, Inc., Infinity Nicaragua, Ltd., and Infinity Nicaragua Offshore, Ltd. Infinity Nicaragua, Ltd., and Infinity Nicaragua Offshore, Ltd. own a 98.2% interest in Rio Grande Resources, SA, which is also consolidated. All significant intercompany balances and transactions have been eliminated in consolidation.
Reclassifications
Certain amounts in the accompanying consolidated financial statements for prior periods have been reclassified to conform to the current year presentation.
Accounts Receivable
Revenue producing activities are conducted primarily in Kansas, Oklahoma, and Wyoming. The Company grants credit to all qualified customers which potentially subjects the Company to credit risk resulting from, among other factors, adverse changes in the industries in which the Company operates and the financial condition of its customers. We continuously monitor collections and payments from our customers and maintain an allowance for doubtful accounts based upon our historical experience and any specific customer collection issues that we have identified.
Hedging Activities
The Company accounts for derivative instruments or hedging activities under the provisions of Statement of Financial Accounting Standards No 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”). SFAS No. 133 requires the Company to record derivative instruments at their fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income (loss) and are recognized in the statement of operations when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges, if any, are recognized in earnings.
The Company periodically enters into fixed price delivery contracts to manage price risk with regard to a portion of its natural gas production. Fixed price delivery contracts that do not meet certain requirements are accounted for using cash flow hedge accounting. Under this method, realized gains and losses on qualifying hedges are recognized in gas revenues when the associated revenue stream occurs and the resulting cash flows are reported as cash flows from operations. To qualify as a hedge, these contracts must be designated as a cash flow hedge and changes in their value must correlate with changes in the price of anticipated future production such that the Company’s exposure to the effects of commodity price is reduced. If the contract is not a hedge, changes in the fair value are recorded in the Company’s statement of operations currently. If a derivative financial instrument, such as the contracts discussed above, is settled before the date of the anticipated
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
transaction, the Company carries forward the accumulated change in value of the contract and includes it in the measurement of the related transaction.
During the years ended December 31, 2004, 2003 and 2002, the Company had fixed price delivery contracts that were designated as cash flow hedges as follows:
During 2004, 2003 and 2002, the Company reclassified out of other comprehensive income, income of approximately $155,000, income of approximately $133,000 and losses of approximately $32,000, respectively, on the contracts, which have been included in natural gas revenues in the accompanying consolidated statement of operations and in cash provided by operating activities in the accompanying consolidated statement of cash flows. The fair value of the fixed price delivery contracts was calculated using the twelve month forecasted sales price for the Henry Hub gas delivery point less a historical differential for the actual delivery point and the quantities and prices fixed in the contracts.
During 2004, the Company entered into fixed price delivery contracts for 2,000 MMBtu per day from April 1, 2004 until March 31, 2006. The price for the period April 1, 2004 until March 31, 2005 is $4.40 per MMBtu and the price for the period April 1, 2005 until March 31, 2006 is $4.15 per MMBtu. Sales under these fixed price contracts are accounted for as normal sales agreements under the exemption in SFAS No. 133.
Revenue Recognition
The Company recognizes sales of oil when the product is delivered and recognizes enhancement service revenue when the services are performed. The Company uses the sales method for recording natural gas sales. This method allows for recognition of revenue which may be more or less than the Company’s share of pro-rata production from certain wells. During 2004, 2003 and 2002, there were no material natural gas imbalances.
Environmental Costs
The Company expenses, on a current basis, recurring costs associated with managing hazardous substances and pollution in ongoing operations. The Company also accrues for costs associated with the remediation of environmental pollution when it becomes probable that a liability has been incurred and its proportionate share of the amount can be reasonably estimated.
Management Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates with regard to the consolidated financial statements include the estimated carrying value of unproved properties, the estimate of proved oil and gas reserve volumes and the related present value of estimated future net cash flows and the ceiling test applied to capitalized oil and gas properties and the realization of deferred tax assets.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Inventories
Inventories, consisting primarily of cement mix, sand, fuel and chemicals, are stated at the lower of cost or market. Cost has been determined on the first-in, first-out method.
Property and Equipment
Depreciation and amortization are computed using the straight-line method over the following estimated useful lives:
Oil and Gas Properties
The Company follows the full cost method of accounting for oil and gas properties. Accordingly, all costs associated with property acquisition, exploration, and development activities are capitalized. Exploration and development costs include dry hole costs, geological and geophysical costs, direct overhead related to exploration and development activities, estimated future costs of site restoration, dismantlement and abandonment activities, and other costs incurred for the purpose of finding oil and gas reserves. Salaries and benefits paid to employees involved in the acquisition, exploration and development of properties, as well as other internal costs that can be directly identified with acquisition, exploration and development activities, are also capitalized. The Company capitalized $652,038, $49,221, and $1,444,238 of internal costs during 2004, 2003 and 2002, respectively. Costs associated with production and general corporate activities are expensed in the period incurred.
The Company performs an impairment analysis whenever events or changes in circumstances indicate an asset’s carrying amount may not be recoverable. Cash flows used in this impairment analysis are determined based upon estimates of proved oil and gas reserves, current prices, and the costs to extract those reserves. Downward revisions in estimated reserve quantities, increases in future cost estimates, depressed oil and gas prices, or the reclassification of unevaluated costs to costs subject to amortization without a corresponding increase in proved reserves could cause the Company to reduce the carrying amounts of our properties. Under full cost accounting rules, capitalized costs, excluding the future cash outflows associated with settling asset retirement obligations that have been accrued in the full cost pool, less accumulated amortization and related deferred income taxes, may not exceed an amount equal to the sum of the present value discounted at ten percent of estimated future net revenue less estimated future expenditures to be incurred in developing and producing the proved reserves, less any related income tax effects. If capitalized costs exceed the limit, the excess must be charged to expense. This is referred to as the “full cost ceiling limitation.” The expense may not be reversed in future periods. At the end of each quarter, a full cost ceiling limitation calculation is made.
At December 31, 2004, the carrying amount of oil and gas properties subject to amortization exceeded the full cost ceiling limitation by approximately $8,900,000 based upon a natural gas price of approximately $6.07 per Mcf and an oil price of approximately $40.25 per barrel in effect at that date. However, due to significant subsequent price increases to approximately $6.53 per Mcf of gas and $54.55 per barrel of oil at the March 15, 2005 measurement date, the Company was only required to record a ceiling writedown of $4,100,000 in the quarter and year ended December 31, 2004. In 2003, the Company recorded a ceiling writedown of $2,975,000.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Depletion of proved oil and gas properties is computed on the units-of-production method, with oil and gas being converted to a common unit of measure based on their relative energy content, whereby capitalized costs, as adjusted for future development costs and asset retirement obligations, are amortized over the total estimated proved reserve quantities. The costs of wells in progress and unevaluated properties, including any related capitalized interest, are not being amortized. On a quarterly basis, such costs are evaluated for inclusion in the costs to be amortized resulting from the determination of proved reserves, impairments, or reductions in value. To the extent that the evaluation indicates these properties are impaired, the amount of the impairment is added to the capitalized costs to be amortized. Abandonment of unproved properties are accounted for as an adjustment to capitalized costs related to proved oil and gas properties, with no losses recognized. See Note 17 for additional discussion of unevaluated properties.
Proceeds from the sales of oil and gas properties are accounted for as adjustments to capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas, in which case the gain or loss is recognized in income. Expenditures for maintenance and repairs are charged to production expense in the period incurred.
The Securities and Exchange Commission’s full cost accounting rules prohibit recognition of income in current operations for services performed by the Company on oil and natural gas properties in which the Company has an interest, but rather require amounts to be treated as a reimbursement of costs with any excess of fees over costs credited to the full cost pool and recognized through lower cost amortization only as production occurs.
Capitalized Interest
The Company capitalizes interest costs to oil and gas properties on expenditures made in connection with exploration and development projects that are not subject to current depletion. Interest is capitalized only for the period that activities are in progress to bring these projects to their intended use. Total interest costs incurred in 2004, 2003 and 2002 were $1,866,104, $1,976,001, and $1,612,469, respectively. Interest costs capitalized were $634,589, $382,236, and $1,010,119 for 2004, 2003 and 2002, respectively.
Long-Lived Assets
Long-lived assets to be held and used in the Company’s business are reviewed for impairment whenever events or changes in circumstances indicate that the related carrying amount may not be recoverable. When the carrying amounts of long-lived assets exceed the discounted expected future cash flows, the Company records an impairment. No impairment was recorded during 2004, 2003 or 2002.
Transportation Costs
The Company accounts for transportation costs under Emerging Issues Task Force (“EITF”) 00-10, “Accounting for Shipping and Handling Fees and Costs,” whereby amounts paid for transportation costs are classified as an operating expense and not netted against natural gas revenues.
Intangible Assets
The Company adopted SFAS No. 142 “Goodwill and Other Intangible Assets,” effective January 1, 2001. As a result, the Company does not amortize goodwill, but instead, reviews goodwill for impairment on at least an annual basis.
Other intangibles are recorded at cost and are amortized on the straight-line basis over the contractual or estimated useful life of the asset, which ranges from one to five years using the effective interest method.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Amortization of loan costs associated with debt obtained in connection with exploration and development projects that are not subject to current amortization are capitalized to oil and gas properties. Amortization of loan costs are capitalized only for the period activities are in progress to bring these projects to their intended use. Total loan amortization costs capitalized for 2004, 2003 and 2002 were $555,375, $2,714,974, and $2,023,373, respectively (see Note 4 for total loan costs classified as intangibles).
Per Share Information
Basic earnings (loss) per common share are computed as net income (loss) divided by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share are computed as net income (loss) divided by the weighted average number of common shares and potential common shares, using the treasury stock method, outstanding during the period.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash generally consists of cash on hand and demand deposits with financial institutions. At times, the Company maintains deposits in financial institutions in excess of federally insured limits. Management monitors the soundness of the financial institutions and believes the Company’s risk is negligible.
The Company considers all highly liquid investments with an original maturity of three months or less to be a cash equivalent.
Stock Options
The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its stock option plans. Accordingly, no compensation cost has been recognized for options granted to employees under the stock option plans because the fair value of the stock equaled or was less than the option exercise price at the date of grant. Had compensation costs for employee stock options under the Company’s plan been determined based upon the fair value at the grant date for awards under the plan consistent with the methodology prescribed under SFAS No. 123, “Accounting for Stock-Based Compensation”, the Company’s net loss and loss per share would have been as follows (see Note 10):
For options granted during 2004, 2003 and 2002, the estimated fair value of the options granted utilizing the Black-Scholes pricing model under the Company’s plan was based on a weighted average risk-free interest rate of 1.5%, expected option life of 10 years for 2004 and 5 years for 2003 and 2002, expected volatility of approximately 147%, 131%, and 117%, and no expected dividends.
The Company has adopted the disclosure requirements of SFAS No. 148, “Accounting for Stock-Based Compensation Transition Disclosure” in its consolidated financial statements. This statement amends
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SFAS No. 123, “Accounting for Stock-Based Compensation” to provide alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based compensation. In addition, SFAS No. 148 amends the disclosure provision of SFAS No. 123 to require more prominent disclosure about the effects of an entity’s accounting policy decisions with respect to stock-based employee compensation on reported net income.
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, “Share-Based Payment”, which amends SFAS No. 123 and requires companies to recognize in the statement of operations the grant date fair value of stock options and other equity-based compensation to employees for fiscal periods after June 15, 2005.
Comprehensive Income (Loss)
The Company has elected to report comprehensive income (loss) in the consolidated statement of stockholders’ equity. Comprehensive income (loss) is composed of net income (loss) and all changes to stockholders’ equity, except those due to investments by stockholders, changes in additional paid-in capital and distributions to stockholders.
Income Taxes
Income taxes are provided for the tax effects of the transactions reported in the consolidated financial statements and consist of taxes currently due plus deferred taxes related primarily to temporary differences between the tax and financial basis of property and equipment and other assets, oil and gas properties, and net operating loss carry-forwards using enacted tax rates in effect for the year in which the differences are expected to reverse.
The deferred tax assets and liabilities represent the future tax return consequences of those temporary differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that are not expected to be realized based on available evidence that it is more likely than not to be realized in the form of a deferred tax valuations allowance.
Asset Retirement Obligations
Effective January 1, 2003, the Company adopted the provisions of SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 requires the Company to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the Company capitalizes cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted each period towards its future value, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, the Company reports a gain or loss upon settlement to the extent the actual costs differ from the recorded liability. Upon adoption of SFAS No. 143, the Company recorded a discounted liability of approximately $447,000 for future retirement obligations and increased net oil and gas properties by the same amount. The adoption of SFAS No. 143 had no material effect on earnings in all periods presented. The majority of the asset retirement obligation to be recognized relates to the projected costs to plug and abandon oil and gas wells. Liabilities are also recorded for compressor and field facilities.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table reflects the components of the change in the carrying amount of the asset retirement obligation.
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS No. 123(R) is effective for public companies for interim or annual periods beginning after June 15, 2005, supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employee’s,” and amends SFAS No. 95, “Statement of Cash Flows.” SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values, beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures, previously permitted under SFAS No. 123, no longer will be an alternative to financial statement recognition. SFAS No. 123(R) also requires the tax benefits in excess of recognized compensation expenses to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement may serve to reduce the Company’s future cash provided by operating activities and increase future cash provided by financing activities, to the extent of associated tax benefits that may be realized in the future.
The Company is required to adopt SFAS No. 123(R) in its third quarter of fiscal 2005, beginning July 1, 2005. Under SFAS No. 123(R), Infinity must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost, and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive options, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS No. 123(R); the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. Infinity is evaluating the requirements of SFAS No. 123(R), and expects that the adoption of SFAS No. 123(R) will not have a material impact on consolidated results of operations and earnings per share as all outstanding options are fully vested.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions”. SFAS No. 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for the fiscal periods beginning after June 15, 2005. The Company is currently evaluating the effect that the adoption of SFAS No. 153 will have on consolidated results of operations and financial condition but does not expect it to have a material impact.
Staff Accounting Bulletin (“SAB”) 106 was released in September 2004. SAB 106 expresses the SEC staff’s views on the interaction of SFAS No. 143 and the full cost method and provides guidance on computing the full cost ceiling as well as depreciation, depletion and amortization. SAB 106 also requires additional
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
disclosures regarding how the application of SFAS No. 143 has affected the ceiling test and depreciation, depletion and amortization. The Company adopted SAB 106 during the fourth quarter of 2004 and experienced no significant impact on its depletion or ceiling test calculation.
Note 2 -
Accounts Receivable
Accounts receivable consists of the following:
Note 3 -
Property and Equipment
Property and equipment consists of the following:
Note 4 -
Intangibles
Intangibles consist of the following:
During 2004, 2003 and 2002, the Company recorded amortization expense related to intangibles, excluding amounts capitalized, of $2,100,351, $6,210,738, and $241,272, respectively. Of the total amortization expense
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
related to intangibles, the Company recorded amortization of loan costs of $2,097,329, $6,200,633, and $234,680, respectively.
Loan costs consist of the following at December 31, 2004:
Substantially all of the net book value of loan costs at December 31, 2004 will expensed in 2005 as a result of debt repayments or conversion.
Note 5 - Notes Receivable
The Company received a three year note for $1,620,000 when it sold its Kansas producing properties in May 2002. The note had an outstanding balance as of December 31, 2004 and 2003 of approximately $1,581,000 and $1,597,000, respectively. Interest accrues on the note at 8% per annum with quarterly payments, based on a 30 year amortization, of $35,000, including interest, due on the first day of November, February, May and August with a balloon payment due May 1, 2005. The note is collateralized by the oil producing properties that were sold.
Note 6 - Accrued Liabilities
Accrued liabilities consist of:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Note 7 - Long-Term Debt and Convertible Notes Payable
Long term debt consists of the following:
Maturities of long-term debt are as follows:
Certain subordinated notes have converted in 2005, as discussed below. However, the table above reflects the maturity of the convertible notes and the note payable to seller in accordance with their stated terms. All other borrowings under secured credit facilities and revolving and term loans were paid in full in January 2005 with proceeds from the Senior Secured Notes Facility discussed in Note 16 and the maturities for that debt have been presented in the financial statements in accordance with the terms of the Notes due January 13, 2009.
Convertible Subordinated Notes
8% Convertible Subordinated Notes
Effective June 13, 2001, the Company sold $6,475,000 in 8% Subordinated Convertible Notes in a private placement in which C.E. Unterberg, Towbin acted as the placement agent. A director of the Company was an officer with C.E. Unterberg, Towbin. Interest on the notes accrued at a rate of 8% per annum and was payable
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
in arrears on each December 15 and June 15. The notes were originally convertible to one share of common stock at $5 per share and matured on June 13, 2006.
The Company incurred costs of $501,906 associated with the placement, which has been capitalized as loan costs and is being amortized using the effective interest method. The Company also issued warrants to purchase 220,000 shares of common stock at $5.99. The Company capitalized additional loan costs of $924,717 related to the fair value of the warrants as determined using the Black-Scholes pricing model assuming a five year life, weighted average risk-free interest rate of 8%, expected volatility of 80.66% and no expected dividend yield.
As the conversion feature of the convertible notes was below the market value of the stock on the date of issue, the Company recorded a discount of $1,165,500 related to the intrinsic value of the beneficial conversion feature. The notes were immediately convertible and therefore, the discount was immediately amortized. The Company capitalized the amortization of the beneficial conversion feature into oil and gas properties not subject to amortization as the debt was issued in order to continue exploration and development of projects that were not currently subject to amortization, and was not used for general operating purposes.
During 2004, 2003 and 2002, the holders of $300,000, $1,450,000 and $2,232,000 of 8% subordinated convertible notes converted the debt and accrued interest into 63,179, 295,689 and 454,974 shares of the Company’s common stock, respectively.
On January 13, 2005, the Company called for redemption all of the remaining 8% subordinated convertible notes outstanding on February 28, 2005. During January and February 2005, the holders of all $2,493,000 of 8% subordinated convertible notes converted the debt and accrued interest into 517,296 shares of the Company’s common stock.
7% Convertible Subordinated Notes
Effective April 22, 2002, the Company sold $12,540,000 in 7% Subordinated Convertible Notes in a private placement in which C.E. Unterberg, Towbin acted as the placement agent. A director of the Company was an officer with C.E. Unterberg, Towbin. In addition, to the extent a holder of the Company’s 8% Subordinated Convertible Notes converted any of their notes and the accrued interest to stock, and purchased 7% Subordinated Convertible Notes, these parties would be related parties. Interest on the 7% subordinated notes accrues at a rate of 7% per annum and is payable in arrears on each April 15 and October 15. The Company can elect to pay the accrued interest in cash or in the form of additional notes issued in increments of $1,000 with residual interest due in cash. In 2004 and 2003, the Company issued $795,000 and $379,000 in new notes as payment for interest due. The notes were originally convertible to one share of common stock at $8.625 per share and mature on April 22, 2007. The loan indenture for the 7% notes contains anti-dilution provisions that require the Company to adjust the conversion price of the notes if stock is sold at a price less than the conversion price. At December 31, 2004, the conversion price was $7.766 per share. In connection with the adjustment of the conversion price, the Company recorded a charge of approximately $354,000 related to the additional shares issuable at the new conversion price.
The notes are subordinated to substantially all the Company’s other existing or future notes payable, capital leases, debentures, bonds or other such securities.
The Company incurred costs of $865,505 associated with the issuance of the 7% convertible notes, which have been capitalized as loan costs and are being amortized using the effective interest method. The Company also issued warrants to purchase 200,000 shares of common stock at $9.058. The Company capitalized additional loan costs of $1,386,044 related to the fair value of the warrants as determined using the Black-Scholes pricing model assuming a five year life, weighed average risk-free interest rate of 7%, expected volatility of 98.30% and no expected dividend yield.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During 2004 and 2003, the holders of $462,302 and $1,735,000 of the 7% subordinated convertible notes converted the debt and accrued interest into 62,685 and 203,712 shares of the Company’s common stock.
On February 25, 2005, the Company called for redemption all of the remaining 7% subordinated convertible notes outstanding on April 22, 2005 at a redemption price of 102.8% plus accrued and unpaid interest. During 2005, through March 23, the holders of $5,950,538 of 7% subordinated convertible notes at December 31, 2004 have converted the debt and accrued interest into 783,779 shares of the Company’s common stock.
$25,000,000 Development Credit Facility
In September 2003, the Company established a Secured Revolving Borrowing Base Credit Facility (“Facility”) with a bank. Interest on the amounts outstanding accrued at prime rate plus 1.0%. The Company incurred $110,000 in loan costs and approximately $57,000 in legal costs to establish the facility. These costs were capitalized as loan costs and amortized using the effective interest method. The facility was repaid in full with proceeds from the Senior Secured Notes Facility discussed in Note 16 to the Consolidated Financial Statements and terminated on January 13, 2005.
Bridge Loan and Related Agreements - Related Party
On November 25, 2002, the Company obtained a $3,000,000 one year bridge loan from a related party with an annual interest rate at Wall Street prime plus 1.0%. In March 2003, the note was extended to January 2004. In May 2003, the note was amended to extend the maturity to January 30, 2005. In June 2003, the loan agreement was amended to waive a portion of the accelerated payment requirements and to increase the interest rate to 7%. The Company also entered into a consulting agreement with the related party in June 2003 under which the related party would facilitate a $3,850,000 bridge loan that was obtained and repaid in 2003 and other future financings, if any.
The table below sets forth information about options that were granted in conjunction with these transactions. All of the options issued were valued using the Black-Scholes pricing model assuming a five year life, weighted average risk free interest rate of 1.5%, expected volatility rates between 125% and 132% and no expected dividend yield. The option value was capitalized as loan costs and was amortized using the effective interest method. The amortization is treated as interest in the Company’s consolidated statement of operations with a portion capitalized to the non-producing properties developed with the proceeds of the loan.
The following is a summary of the options granted in connection with the loan and related agreements:
During 2004, the Company repaid the loan balance outstanding with $2,500,000 in cash and the issuance of 125,000 shares of common stock valued at $4.00 per share.
Revolving Credit and Term Loans
Effective July 9, 2004, Consolidated borrowed $5,400,000 under an amended credit facility with LaSalle Bank. The amended facility required monthly payments of $113,493 plus interest through November 2007,
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
with a final payment of the remaining balance of the note due December 31, 2007. Amounts outstanding accrued interest at the prime rate plus 1.25% per annum. The credit facility was repaid in full with proceeds from the Senior Secured Notes Facility discussed in Note 16 to the Consolidated Financial Statements and terminated on January 13, 2005.
2003 Debt Paid in Full
In 2003, the Company issued 201,000 five year options and 462,500 five year warrants to purchase common stock at $8.75 per share and granted a 4% over-riding royalty in certain producing properties when it obtained three bridge loans totaling $5,900,000 with interest rates ranging from 2% per month to 12% per year. The Company capitalized loan costs of $3,297,390 for the options and warrants and $1,250,000 based on the estimated fair value for the 4% over-riding royalty conveyed. The Company used the Black-Scholes pricing model assuming a five year life, weighted average risk-free interest rates of 1.5% to 4%, expected volatility between 126.11% and 131.96% and no expected dividend yield to calculate the fair value of the options and warrants at the date of grant. The Company repaid all of the loans during 2003 and all of the loan costs were fully amortized during the year.
Note 8 - Stockholders’ Equity
Stock Split
In May 2002, the Company effected a 2:1 stock split effective May 13, 2002. All shares and per share amounts have been restated to give effect to the stock split.
Private Institutional Placements of Equity
In January 2004, the Company issued 1,000,000 shares of common stock in exchange for $4,000,000. In November 2004, the Company issued 1,027,000 shares of common stock in exchange for $5,237,700. Costs associated with the issuances totaled $319,644.
Warrants and Options to Non-Employees
The Company, in conjunction with a public stock offering in September 1988, issued Class A and Class B warrants to purchase 425,918 shares of common stock. The 223,496 Class A warrants have expired. During 2002, 163,264 shares of common stock were issued upon the exercise of Class B warrants for proceeds of $977,911. The remaining 39,158 Class B warrants expired in June 2002.
During 2001, in connection with the sale of $6,475,000 8% subordinated convertible notes; the Company granted 220,000 warrants to purchase the Company’s common stock at $5.99 per share. During February 2005, all of these warrants were exercised.
During 2002, in connection with the sale of $12,540,000, 7% subordinated convertible notes; the Company granted 200,000 warrants to purchase the Company’s common stock at $9.058 per share. The warrants expire in April 2007 (see Note 7).
In connection with obtaining $5,000,000 of bridge loans in March and November 2002, the Company granted five year options to purchase the Company’s common stock; 250,000 at $7.34 and 320,000 at $8.75 per share (see Note 7). Subsequent to December 31, 2004 and through March 23, 2005, 77,850 of the $7.34 options and 191,000 of $8.75 options were exercised.
During 2003, in connection with the issuance of $1,000,000 of bridge notes, which were paid in full in 2003, the Company granted 212,500 warrants to purchase the Company’s common stock at $8.75 per share. The warrants expire in April 2008 (see Note 7). During February 2005, warrants on 8,000 shares were exercised under cashless exercise provisions resulting in the issuance of 2,257 shares of common stock.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During 2003, in connection with the issuance of $3,850,000 in bridge notes which were paid in full in 2003, the Company granted 250,000 warrants to purchase the Company’s common stock at $8.75 per share. The warrant agreement contains anti-dilution provisions that require the Company to adjust the exercise price and change the number of warrants outstanding if the Company sells stock at less than the exercise price. During January and November 2004, the warrants were increased by 27,746, to 277,746 warrants with an exercise price of $7.88 per share and the associated value of approximately $120,000 was recorded as offering costs. The warrants expire July 2, 2008 (see Note 7).
In connection with obtaining $1,050,000 of bridge loans in January and April of 2003 (which were paid in full during 2003), the amendments of an existing $3,000,000 loan agreement, and a consulting contract to assist with the facilitation of a $3,850,000 loan agreement, the Company granted options to purchase the Company’s common shares at $8.75 per share (see Note 7).
A summary of warrant and option activity with non-employees is as follows:
The following is the weighted average fair value of warrants and options granted to non-employees:
Options Under Employee Option Plans
The Company has adopted stock option plans containing both incentive and non-statutory stock options. All options allow for the purchase of common stock at prices not less than the fair market value of such stock
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
at the date of grant. If the optionee owns more than 10% of the total combined voting power of all classes of the Company’s stock, the exercise price can not be less than 110% of the fair market value of such stock at the date of grant.
Options granted under the plans become exercisable immediately or as directed by the Board of Directors and generally expire five or ten years after the date of grant, unless the employee owns more than 10% of the total combined voting power of all classes of the Company’s stock, in which case they must be exercised within five years of the date of grant. Pursuant to the plans, an aggregate of 2,338,047 options were available for grant. The Company granted 403,750, 10,000, and 345,000 options to employees under the Plans during 2004, 2003 and 2002, respectively. At December 31, 2004, there were 195,881 shares remaining available under the plans. During February 2005, the Company granted ten-year options on 165,000 shares at an exercise price of $8.50 per share.
A summary of stock option activity is as follows:
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following is the weighted average fair value of warrants and options granted to employees:
Subsequent to December 31, 2004, and through March 23, 2005, options on 62,700 shares were exercised for proceeds of approximately $222,000.
Options
The Company granted 177,500 options to employees outside its stock option plans prior to March 31, 2001 with exercise prices ranging from $1.55 to $4.00 and a weighted average price per share of $2.76. These options were exercised during 2002.
Note 9 - Income Taxes
The provision for income taxes consists of the following:
The effective income tax rate varies from the statutory federal income tax rate as follows:
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The significant temporary differences and carry-forwards and their related deferred tax asset (liability) and deferred tax asset valuation allowance balances are as follows:
For income tax purposes, the Company has approximately $26,979,000 of net operating loss carry-forwards expiring from 2015 through 2024.
During 2004, 2003 and 2002, the Company realized certain tax benefits related to stock option plans in the amounts of $172,000, $164,000 and $232,000, respectively. Such benefits were recorded as a deferred tax asset as they increased the Company’s net operating losses and an increase in additional paid in capital. The recognition of the valuation allowance offset the impact of this benefit.
The Company has provided for a valuation allowance of $5,825,000 due to the uncertainty of realizing the tax benefits from its net operating loss carry-forwards.
Note 10 - Commitments and Contingencies
Gas Gathering Contract
In June 2001, the Company entered into a long-term gas gathering contract, which expires in December 2008. This contract was amended April 4, 2003. Under the amended contract, the Company will pay gas gathering fees per thousand cubic feet (“Mcf”) delivered. The Company is obligated to pay a fee of $.40 per Mcf on the first 7,500,000 Mcf and $.25 per Mcf thereafter. Additionally, the Company has an annual volume commitments starting September 1, 2001. The Company’s minimum volume for (i) Year one 600,000 Mcf, (ii) Year two 1,600,000 Mcf, (iii) Year three 2,000,000 Mcf, (iv) Year four 1,800,000 Mcf, and (v) Year five 1,500,000 Mcf. If the Company exceeds the minimum in any year, the excess reduces the following year’s commitment. If the Company does not meet the minimum in any year, the shortfall is added to the following years and at the end of the three years, the Company was to pay for any shortfall. Through December 31, 2004, the Company had delivered approximately 3,137,000 Mcf. While the Company has failed to deliver the volumes required under the contract, the pipeline operator has also not provided the compression and gathering capabilities it was required to provide under the contract. Management has received a verbal commitment from the operator that the volume commitments will be adjusted and management does not believe there will be a contract shortfall under the renegotiated volumes and therefore, anticipates no additional costs under the contract.
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Lease Agreements
We have certain lease agreements for the use of office space. The terms of the various leases extend through September 2009. The following is a schedule by year of future minimum lease obligations under operating lease arrangements at December 31, 2004:
Rental expense for these and other leases was $133,524, $142,926 and $103,824 for the years ended December 31, 2004, 2003 and 2002, respectively.
Financial Consulting Agreement
In July 2003 the Company entered into an eighteen month financial consulting agreement with a related party. The Company issued options to purchase 125,000 shares of common stock that were valued at approximately $1,094,000 using the Black-Scholes valuation model, as compensation for entering into the agreement (see Note 7.) The related party helped facilitate the $3,850,000 bridge loan that was obtained in July 2003.
Regulations
The Company’s oil and gas operations are subject to various Federal, state and local laws and regulations. The Company could incur significant expense to comply with new or existing laws and non-compliance could have a material adverse effect on the Company’s operations.
Environmental
The Company uses injection wells to dispose of water into underground rock formations. If future wells produce water of lesser quality than allowed under state laws or if water is produced at rates greater than can be injected, the Company could incur additional costs to dispose of its water.
Fixed Price Delivery Contracts
The Company entered into fixed price delivery contracts for natural gas from April 1, 2004 through March 31, 2006. See Note 1.
Note 11 - Retirement Plan
The Company has a 401(k) plan covering substantially all of the employees of the oil field services subsidiary. There were no Company contributions made to the plan during 2003 and 2002. Effective January 1, 2004, the Company began matching, dollar for dollar, employee contributions up to 4% of gross pay. The Company expensed $111,739 of such contributions during 2004.
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Note 12 - Industry Segments
The Company reports segment information in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”, which requires disclosure of information related to certain operating segments of the Company.
The Company’s operations have been classified into two industry segments: (i) Oil Field Services; and (ii) Oil and Gas Production. The Oil Field Services segment of the Company is directed at services associated with the drilling and completion of oil and gas wells, including cementing, acidizing, fracturing, nitrogen pumping and water hauling and has operations in Kansas, Oklahoma, and Wyoming. The Oil and Gas Production segment of the Company is engaged in the acquisition, exploration, development and production of natural gas and crude oil in Colorado, Texas and Wyoming.
The Oil Field Services segment had eliminated inter-company sales of approximately $2,100,000 in 2002 and less than $20,000 during 2003. There were no such sales in 2004.
Note 13 - Significant Customers
During 2004, the Company had oil field service sales to three unrelated third parties of approximately $4,980,000, representing approximately 34% of net sales. In addition, during 2004, the Company sold approximately $6,209,000 or 99% of its oil and gas revenue to two unrelated customers.
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During 2003, the Company had oil field service sales to one unrelated third party of approximately $1,150,000, representing approximately 10% of net sales. In addition, during 2003, the Company sold approximately $6,453,000 or 98% of its oil and gas revenue, to two unrelated customers.
During 2002, the Company had oil field service sales to one unrelated third party of approximately $1,569,000, representing approximately 14% of net sales. In addition, during 2002, the Company sold approximately $2,107,000 or 89% of its oil and gas revenue to three unrelated companies.
Receivables outstanding at December 31, 2004 and 2003 from significant customer sales were approximately $1,879,000 and $529,000, or 53% and 30% of total accounts receivable at such date, respectively.
Note 14 -
Fair Value of Financial Instruments
The carrying value of the Company’s cash balance, accounts receivable, accounts payable and accrued liabilities represents the fair value of the accounts. The fair value of the Company’s long-term debt with financial institutions and equipment financing companies approximates the carrying value because (i) interest rates are variable or (ii) the debt instruments were executed at rates comparable to current rates for similar notes. The fair value of the Company’s other long-term debt obligations cannot be determined due to the nature of the transactions which created the debt, and comparable market value information is not readily determinable without incurring excessive costs. See Note 7 for the terms of the long-term debt obligations.
Note 15 -
Earnings Per Share
For the years ended December 31, 2004, 2003 and 2002, all potential Company shares of common stock are anti-dilutive.
As of December 31, 2004, 2003, and 2002, the impact of 5,320,892, 4,991,746, and 4,473,413, respectively, of potential shares of common stock were not included because their effect was anti-dilutive.
See Note 8 and Note 16 regarding options and warrants issued in 2005.
Note 16 -
Subsequent Event
Senior Secured Notes Facility
On January 13, 2005, the Company entered into a securities purchase agreement (the “Senior Secured Notes Facility”) with affiliates of Promethean Asset Management, LLC and Angelo, Gordon & Co., L.P. (collectively, the “Buyers”), pursuant to which Infinity sold, and the Buyers purchased, $30 million aggregate principal amount of senior secured notes (the “Notes”) due January 13, 2009 and five-year warrants to purchase 924,194 shares of common stock at an exercise price of $9.09 per share and 732,046 shares of common stock at an exercise price of $11.06 per share (collectively, the “Warrants”). The Notes have an initial maturity of 48 months subject to extension for an additional twelve months upon the mutual agreement of Infinity and the Buyers. The Notes bear interest at 3-month LIBOR (London Interbank Offered Rate) plus 675 basis points, adjusted the first business day of each calendar quarter. The Notes are secured by essentially all of the assets of Infinity and its subsidiaries and are guaranteed by each of Infinity’s active subsidiaries. The Notes are redeemable by Infinity for cash at any time during the first year at 105% of par value, declining by 1% per year thereafter (101% during any extended maturity period), together with any accrued and unpaid interest. Under certain circumstances, Infinity has the option to repay the Notes with direct issuances of shares of registered common stock in lieu of cash.
At quarterly intervals and over a three-year period, commencing in the third quarter of 2005, Infinity has the option to sell additional notes (the “Additional Notes”), along with additional warrants, in amounts of up to $15 million in any rolling twelve-month period and up to a maximum of $45 million. The Additional Notes would have an initial maturity of 42 months (54 months if the maturity of the initial Notes is extended). The
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
issuance of Additional Notes is subject to Infinity’s future satisfaction of various closing conditions. The ability to issue Additional Notes or the requirement to prepay Notes prior to maturity will depend upon a maximum Notes balance calculated quarterly based generally upon a combination of the financial performance of Consolidated Oil Well Services, Inc. and the SEC after-tax PV-10% value of the Company’s proved reserves.
In connection with the issuance of the Notes and Warrants, Infinity also entered into a registrations rights agreement with the Buyers pursuant to which Infinity agreed to file a shelf registration statement covering resales of the ordinary shares issuable upon exercise of the Warrants.
The Securities Purchase Agreement dated as of January 13, 2005 by and among Infinity and the Buyers of the Notes includes a covenant that at each date that is the end of a quarterly or annual period covered by a quarterly report on Form 10-Q or annual report on Form 10-K (a “Determination Date”), at least 20% of the Company’s estimate of its oil and gas production for the 12-month period commencing immediately after such Determination Date shall be protected from price fluctuations using derivatives, fixed price agreements and/or volumetric production payments.
Infinity used approximately $9.2 million of the proceeds from the sale of the Notes and Warrants to repay all amounts outstanding pursuant to a Loan and Security Agreement between LaSalle Bank N.A. and Consolidated, a Credit Agreement between U.S. Bank National Association and Infinity-Wyoming, and certain other secured lending agreements, and those credit agreements have been terminated. See Note 7 to the Consolidated Financial Statements. Infinity is using the remainder of the proceeds to pay costs and expenses related to the sale of the Notes and Warrants and to fund its oil and gas exploration and development activities.
Note 17 -
Supplemental Oil and Gas Information
Proved Oil and Gas Reserves (Unaudited)
The following information was developed from reserve reports prepared by independent reserve engineers:
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The 2003 revision to the previous estimate of reserves is due primarily to the following factors:
•
operational issues at the existing Labarge wells;
•
a lack of financial resources to rectify the operational issues on a timely basis or to complete exploration on other wells; and
•
geological studies that indicate the producing Pipeline wells were producing from the sands rather than the coals thus leading the Company to change the classification of Pipeline from a coal play to a sand play.
Proved reserves are estimated quantities of crude oil, natural gas and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions.
There are uncertainties inherent in estimating quantities of proved oil and gas reserves, projecting future production rates, and timing of development expenditures. Accordingly, reserve estimates are often different from the quantities of oil and gas that are ultimately recovered.
All proved reserves are located in the United States.
Proved Developed Oil and Gas Reserves (Unaudited)
The following information sets forth the estimated quantities of proved developed oil and gas reserves of the Company as of the end of each year.
Costs Incurred in Oil and Gas Activities
Costs incurred in connection with the Company’s oil and gas acquisition, exploration and development activities are shown below.
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Aggregate Capitalized Costs
Aggregate capitalized costs relating to the Company’s oil and gas producing activities, and related accumulated depreciation, depletion, amortization and ceiling write-down are as follows:
Costs Not Being Amortized
Oil and gas property costs not being amortized at December 31, 2004, by year that the costs were incurred are as follows:
Unevaluated costs include $6,063,000 relating to our prospect in the Fort Worth Basin of North Central Texas. During 2004, the Company acquired interests in approximately 32,000 acres in the Fort Worth Basin of North Central Texas. In October 2004, the Company commenced the drilling of several exploratory gas wells. Approximately $3,600,000 associated with wells in progress is expected to be classified as evaluated during 2005.
Unevaluated costs include $6,933,000 relating to our Labarge prospect in Southwest Wyoming. Substantially all of the acreage in the prospect is subject to an ongoing Bureau of Land Management environmental impact statement (“EIS”). The EIS must be completed before the Company can continue development. Approximately $2,100,000 associated with wells in progress is expected to be classified as evaluated during 2005.
Unevaluated costs include approximately $925,000 relating to our concessions offshore Nicaragua. The Company expects to execute a definitive exploration and production contract covering the approximate 1,400,000 acres during 2005.
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Capitalized Financing Costs
From inception through December 31, 2004 the Company has capitalized the following financing costs related to properties not subject to amortization. As these properties are developed, the costs are transferred to properties subject to amortization:
Oil and Gas Operations
Aggregate results of operations in connection with the Company’s oil producing activities are shown below:
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves (Unaudited)
The following information is based on the Company’s best estimate of the required data for the Standardized Measure of Discounted Future Net Cash Flows as of December 31, 2004, 2003, and 2002, as required by SFAS No. 69. The Statement requires the use of a 10 percent discount rate. This information does not represent the fair market value nor the expected present value of future cash flows of the Company’s proved oil and gas reserves.
Future cash inflows are computed by applying a year-end spot market gas price and oil price for the areas of production. The following table shows the prices that have been used for each period:
A subsequent decline in prices received for oil and gas sales from those used to compute cash inflows ($6.53 per Mcf and $54.55 per barrel at March 15, 2005) could result in a requirement that the Company recognize a ceiling write-down to oil and gas properties in a future period. See also Note 1 to the Consolidated Financial Statements.
Future production and development costs are computed by estimating the expenditures to be incurred in developing and producing the Company’s proved oil and gas reserves at December 31, 2004, 2003 and 2002 assuming continuation of existing economic conditions.
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following reconciles the change in the standardized measure of discounted future net cash flow:
Future income tax expenses are computed by applying the appropriate period-end statutory tax rates to the future pretax net cash flow relating to the Company’s proved oil and gas reserves, less the tax basis of the properties involved. The future income tax expenses do not give effect to tax credits, allowances, or the impact of general and administrative costs of ongoing operations relating to the Company’s proved oil and gas reserves.
Note 18 - Quarterly Consolidated Financial Information (Unaudited)
The following table provides selected quarterly consolidated financial results for the years ended December 31, 2004 and 2003.
INFINITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company recorded full cost ceiling writedowns during the fourth quarters of 2004 and 2003, of $4,100,000 and $2,975,000, respectively.
Note 19 - Schedule of Condensed Financial Information
The oil and gas production subsidiary of the Company that owns more than 25% of the net assets of the Company was restricted from distributing more than $300,000 to the parent at December 31, 2004 under the $25,000,000 development credit facility executed in September 2003. However as such credit facility was repaid in full and terminated on January 13, 2005; the restriction is no longer applicable. Accordingly, the condensed balance sheet, statement of operations and cash flow statement for the parent have not been provided as of and for the period ended December 31, 2004.
EXHIBIT INDEX