Item 1. Description of Business
Business Development
We are an exploration and production company engaged in oil and gas exploration, drilling and development. We currently have oil and gas interests in Anderson County, Freestone County, and Jones County, Texas. Our strategy is to develop our current low risk, high probability prospects and to lease out deeper zones of our properties for royalty interests. Due to our lack of adequate resources we are seeking joint ventures or farm-outs to develop our properties. Our oil and gas activities are currently conducted solely in the United States. We do not own any interests in any mining properties.
In July 2006, as part of the P.D.C. Ball mineral property and Barnico Drilling, Inc. (“Barnico”) acquisition, we purchased a 90% interest in approximately 27,557 gross acres (approximately 22,682 net acres) of oil and gas fee mineral rights known as the “P.D.C. Ball mineral property” owned by Roboco Energy, Inc. in Anderson County, Freestone County and Jones County, Texas for $31.9 million, which included cash and issuance of our stock. Funding for the acquisition was through the issuance of $32.4 million of senior secured convertible notes.
Barnico was an East Texas-based drilling contractor with two drilling rigs. We acquired Barnico to help us control drilling costs and meet drilling schedules. During 2007, the drilling revenues from third parties declined significantly because Barnico’s largest customer ceased its drilling in Barnico’s service area. Due to a lack of capital we were unable to utilize Barnico’s resources to drill our own properties. During 2008 we sold all of the outstanding shares of Barnico and discontinued all drilling activities. In late 2008, the purchaser defaulted on the note and we repossessed the drilling and related equipment. We reported the drilling operations as discontinued and the assets as held for sale in our 2008 financial statements. In June 2009 we sold the remaining assets through an auction.
On November 1, 2006, we signed two three-year Oil, Gas & Mineral Leases and a Joint Operating Agreement with Marathon Oil Company and its affiliate (together, “Marathon”) granting Marathon the right to explore and develop approximately 9,200 acres of our mineral property in Freestone County, Texas. The agreements give Marathon the right to drill oil and gas wells and develop the property. We retain a 21.5% royalty interest in any revenue generated from property located in zones below approximately 8,500 feet. The lease will expire in April 30, 2010. Barrow-Shaver Resources holds a lease in zones above approximately 8,500 feet and we retained a 25% royalty interest in any revenue generated from property. This lease expires on November 1, 2011.
Marathon began drilling its first deep well (M-1) of approximately 15,000 feet during the latter part of the third quarter of 2008. Drilling of M-1 was completed during December 2008 and there was 23 feet of pay on the well log. The well has not been perforated for production and no reserve value is given to this well at this time.
Business of Issuer
Competitive Business Conditions
We are a small exploration and development oil and gas company, and a substantial number of our competitors have longer operating histories and substantially greater financial and personnel resources than we do. We do not hold a significant competitive position in the oil and gas industry.
The oil and gas business is highly competitive. We compete with private and public companies in all facets of the oil and gas business, including suppliers of energy and fuel to industrial, commercial and individual customers. Numerous independent oil and gas companies, oil and gas syndicates and major oil and gas companies actively seek out and bid for oil and gas prospects and properties. Many of these companies not only explore for, produce and market oil and natural gas, but also carry out refining operations and market the resultant products on a worldwide basis. Such companies may be able to pay more for prospective oil and gas properties, and such competitive disadvantages could adversely affect our ability to acquire new properties or develop existing properties. Additionally, such companies may be able to evaluate, bid for and purchase a greater number of properties and prospects than our financial and human resources permit.
Competitive conditions may be substantially affected by energy legislation and regulation considered from time to time by the governments of the United States and the State of Texas, as well as factors that we cannot control, including international political conditions, overall levels of supply and demand for oil and gas, and the markets for synthetic fuels and alternative energy sources. Intense competition also occurs with respect to marketing, particularly of natural gas.
Regulations
Various United States and federal regulations affect the production and sale of oil and natural gas. States in which we conduct activities impose restrictions on the drilling, production, transportation and sale of oil and natural gas. These regulations include requiring permits for drilling wells; maintaining prevention plans; submitting notification and receiving permits in relation to the presence, use and release of certain materials incidental to oil and gas operations; and regulating the location of wells, the method of drilling and casing wells, the use, transportation, storage and disposal of fluids and materials used in connection with drilling and production activities, surface plugging and abandoning of wells and the transporting of production. Legislation affecting the oil and gas industry is under constant review for amendment or expansion, frequently increasing the regulatory burden. Also, numerous departments and agencies, both federal and state, have issued rules and regulations binding on the oil and gas industry and its individual members, compliance with which is often difficult and costly, and some of which carry substantial penalties for failure to comply. Inasmuch as new legislation affecting the oil and gas industry is commonplace, and existing laws and regulations are frequently amended or reinterpreted, we are unable to predict the future cost or impact of complying with these laws and regulations.
These laws and regulations have a significant impact on oil and gas drilling, gas processing plants and production activities, increase the cost of doing business and, consequently, affect profitability. We consider the cost of environmental protection a necessary and manageable part of our business. We have been able to plan for and comply with new environmental initiatives without materially altering our operating strategies.
State statutes and regulations require permits for drilling operations, drilling bonds and reports concerning wells. The State of Texas has statutes and regulations governing conservation matters, including the unitization or pooling of oil and gas properties and establishment of maximum rates of production from oil and gas wells.
Our operations are also subject to extensive and developing federal, state and local laws and regulations relating to environmental, health and safety matters; petroleum; chemical products and materials; and waste management. Permits, registrations or other authorizations are required for the operation of certain of our facilities and for our oil and gas exploration and future production activities. These permits, registrations or authorizations are subject to revocation, modification and renewal. Governmental authorities have the power to enforce compliance with these regulatory requirements, the provisions of required permits, registrations or other authorizations, and lease conditions, and violators are subject to civil and criminal penalties, including fines, injunctions or both. Failure to obtain or maintain a required permit may also result in the imposition of civil and criminal penalties. Third parties may have the right to sue to enforce compliance.
Our operations are also subject to various conservation matters, including the number of wells which may be drilled in a unit, and the unitization or pooling of oil and gas properties. In this regard, some states allow the forced pooling or integration of tracts to facilitate exploration, while other states rely on voluntary pooling of lands and leases. This may make it more difficult to develop oil and gas properties. In addition, state conservation laws establish maximum rates of production for oil and gas wells, generally limit the venting or flaring of gas, and impose certain requirements regarding the ratable purchase of production. The effect of these regulations is to limit the amounts of oil and gas we can produce from our wells and to limit the number of wells or the locations at which we can drill.
Our operations, as is the case in the petroleum industry generally, are significantly affected by federal tax laws. Federal, as well as state, tax laws have many provisions applicable to corporations which could affect our future tax liability.
Environmental Matters
Our exploration, development, and future production of oil and gas, including our operation of saltwater injection and disposal wells, are subject to various federal, state and local environmental laws and regulations discussed below. Such laws and regulations can increase the costs of planning, designing, installing and operating oil and gas wells. We consider the cost of environmental protection a necessary and manageable part of our business. We have been able to plan for and comply with new environmental initiatives without materially altering our operating strategies.
Our activities are subject to a variety of environmental laws and regulations, including but not limited to, the Oil Pollution Act of 1990 (“OPA”), the Clean Water Act (“CWA”), the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), the Resource Conservation and Recovery Act (“RCRA”), the Clean Air Act (“CAA”), and the Safe Drinking Water Act (“SDWA”), as well as state regulations promulgated under comparable state statutes. We are also subject to regulations governing the handling, transportation, storage, and disposal of naturally occurring radioactive materials that are found in our oil and gas operations. Civil and criminal fines and penalties may be imposed for non-compliance with these environmental laws and regulations. Additionally, these laws and regulations require the acquisition of permits or other governmental authorizations before undertaking certain activities, limit or prohibit other activities because of protected areas or species, and impose substantial liabilities for cleanup of pollution.
Under the OPA, a release of oil into water or other areas designated by the statute could result in us being held responsible for the costs of remediating such a release, certain OPA specified damages, and natural resource damages. The extent of that liability could be extensive, as set out in the statute, depending on the nature of the release. A release of oil in harmful quantities or other materials into water or other specified areas could also result in us being held responsible under the CWA for the costs of remediation, and civil and criminal fines and penalties.
CERCLA and comparable state statutes, also known as “Superfund” laws, can impose joint and several and retroactive liability, without regard to fault or the legality of the original conduct, on certain classes of persons for the release of a “hazardous substance” into the environment. In practice, cleanup costs are usually allocated among various responsible parties. Potentially liable parties include site owners or operators, past owners or operators under certain conditions, and entities that arrange for the disposal or treatment of, or transport hazardous substances found at the site. Although CERCLA, as amended, currently exempts petroleum, including but not limited to, crude oil, gas and natural gas liquids from the definition of hazardous substance, our operations may involve the use or handling of other materials that may be classified as hazardous substances under CERCLA. Furthermore, there can be no assurance that the exemption will be preserved in future amendments of the act, if any.
RCRA and comparable state and local requirements impose standards for the management, including treatment, storage, and disposal of both hazardous and non-hazardous solid wastes. We generate hazardous and non-hazardous solid waste in connection with our routine operations. From time to time, proposals have been made that would reclassify certain oil and gas wastes, including wastes generated during drilling, production and pipeline operations, as “hazardous wastes” under RCRA which would make such solid wastes subject to much more stringent handling, transportation, storage, disposal, and clean-up requirements. This development could have a significant impact on our operating costs. While state laws vary on this issue, state initiatives to further regulate oil and gas wastes could have a similar impact.
Because oil and gas exploration and production, and possibly other activities, have been conducted at some of our properties by previous owners and operators, materials from these operations remain on some of the properties and in some instances require remediation. In addition, from time to time we may agree to indemnify sellers of producing properties from which we acquire properties against certain liabilities for environmental claims associated with such properties. While we do not believe that costs to be incurred by us for compliance and remediating previously or currently owned or operated properties will be material, there can be no guarantee that such costs will not result in material expenditures.
Additionally, in the course of our routine oil and gas operations, surface spills and leaks, including casing leaks of oil or other materials occur, and we incur costs for waste handling and environmental compliance. Moreover, we are able to control directly the operations of only those wells for which we act as the operator. We believe that we are in substantial compliance with applicable environmental laws and regulations.
We do not anticipate being required in the near future to expend amounts that are material in relation to our total capital expenditures program by reason of environmental laws and regulations, but inasmuch as such laws and regulations are frequently changed, we are unable to predict the ultimate cost of compliance. There can be no assurance that more stringent laws and regulations protecting the environment will not be adopted or that we will not otherwise incur material expenses in connection with environmental laws and regulations in the future.
We are also subject to laws and regulations concerning occupational safety and health. Due to the continued changes in these laws and regulations, and the judicial construction of many of them, we are unable to predict with any reasonable degree of certainty our future costs of complying with these laws and regulations. We consider the cost of safety and health compliance a necessary and manageable part of our business. We have been able to plan for and comply with new initiatives without materially altering our operating strategies.
We are subject to certain laws and regulations relating to environmental remediation activities associated with past operations, such as CERCLA and similar state statutes. In response to liabilities associated with these activities, accruals are established from time to time when reasonable estimates are possible. Estimated and accrued environmental remediation costs as of December 31, 2009 and 2008, respectively, were approximately $0.1 million and $0.1 million. These accruals represent the estimated costs associated with plugging abandoned wells by cementing the borehole, removing casing and other equipment, and leveling and replanting the surface. We use discounting to present value in determining our accrued liabilities for environmental remediation or well closure, but no material claims for possible recovery from third party insurers or other parties related to environmental costs have been recognized in our financial statements. We will adjust remediation accruals when new remediation responsibilities are discovered and probable costs become estimable, or when current remediation estimates must be adjusted to reflect new information.
We believe that the operator of the properties in which we have an interest are in substantial compliance with applicable laws, rules and regulations relating to the control of air emissions at all facilities on those properties. Although we maintain insurance against some, but not all of the risks described above, including insuring the costs of clean-up operations, public liability and physical damage, there is no assurance that our insurance will be adequate to cover all such costs, that the insurance will continue to be available in the future or that the insurance will be available at premium levels that justify our purchase. The occurrence of a significant event not fully insured or indemnified against could have a material adverse effect on our financial condition and operations. Compliance with environmental requirements, including financial assurance requirements and the costs associated with the cleanup of any spill, could have a material adverse effect on our capital expenditures, earnings or competitive position. We do believe, however, that our operators are in substantial compliance with current applicable environmental laws and regulations. Nevertheless, changes in environmental laws have the potential to adversely affect operations. At this time, we have no plans to make any material capital expenditures for environmental control facilities.
Research and Development
We are not currently conducting any research and development activities, other than property explorations and assessments.
Employees
We currently have three employees, consisting of a Chief Executive Officer, Chief Financial Officer, and a Secretary and Treasurer. In addition, we engage consultants on an as-needed basis for legal, accounting, technical, consulting, oil field, geological and administrative services. None of our employees are represented by a union. We believe that our employee relationships are satisfactory.
Oil and Gas Operations
The following table summarizes our oil and gas production revenue and costs, our productive wells and acreage, undeveloped acreage and drilling activities for each of the last three years ended December 31.
Production
Average sales price per barrel oil equivalent
$ 21.24
$ 48.66
$ 63.86
Average production cost per barrel of equivalent
$ 7.18
$ 6.01
$ 21.71
Net oil production (barrels)
1,781
1,106
Net gas production (mcf)
135,304
130,589
138,136
Productive wells - oil
Gross
Net
Productive wells - gas
Gross
Net
Developed acreage - oil
Gross acreage
Net acreage
Developed acreage - gas
Gross acreage
8,537
8,537
8,537
Net acreage
Undeveloped acreage - oil
Gross
Nil
Nil
Nil
Net
Nil
Nil
Nil
Undeveloped acreage - gas
Gross
19,100
19,100
19,100
Net
14,150
14,150
14,150
Drilling activity
Net productive exploratory wells drilled
Net dry exploratory wells drilled
We are not obligated to provide oil or gas in fixed quantities or at fixed prices under existing contracts.
Item 1A.
Item 1A. Risk Factors
Risk Factors
You should carefully consider the risks described below, together with all other information contained in this Annual Report in evaluating our business and prospects. The risks and uncertainties described below are not the only ones we face. If any of the following risks and uncertainties occur they may adversely affect our business, operating results or financial condition. Additional risks and uncertainties, other than those we describe below, that are not presently known to us or that we may currently believe are immaterial, may also impair our business operations. You should refer to the other information contained in this Annual Report, including the consolidated financial statements and notes thereto of our company, before deciding to invest in our common stock.
Risks Related To Our Business
We have a limited operating history and have incurred losses since we began operations. We must generate greater revenue to achieve profitability.
We commenced our current operations in 2005 and have incurred losses before and after we began our operations. In addition, as discussed in the accompanying financial statements, our accumulated deficit and the need to achieve and sustain profitability, our default on outstanding senior secured convertible notes and convertible debentures, and our reliance on the financing discussed in this Annual Report, have caused our independent accountants to raise substantial doubt about our ability to continue as a going concern. At December 31, 2008, we had an accumulated deficit of $91,855,311. This deficit has increased to $101,933,888 at December 31, 2009 due to interest expense on our debt. Our current cash flows alone are insufficient to fund our interest expense and therefore there are no excess funds available to fund our business plan, necessitating further growth and funding for implementation. We may be unable to achieve the needed growth to attain profitability and may fail to obtain the funding that we need when it is required. Our future financial results depend largely on the following factors: (1) discovery of adequate levels of hydrocarbons on our properties and the economic feasibility for their recovery; (2) access to additional equity and/or debt funding to develop and exploit our properties; (3) finding a joint venture partner to farm-in and develop our properties; and (4) obtaining a forbearance and deferral of interest payments from our senior secured convertible note holders and our convertible debenture holders. There can be no assurance that we will be successful in any of these matters, that the prices for our production will be at a profitable level or that we will achieve or sustain profitability or positive cash flows from our operating activities.
Our auditor has raised substantial doubts about our ability to continue as a going concern. If we are unable to continue our business, our common stock may have little or no value.
As discussed in the accompanying financial statements, our accumulated deficit and the need to achieve and sustain profitability, our default on outstanding debt issues, and our reliance on the financing discussed in this Annual Report have caused our auditor to raise substantial doubt about our ability to continue as a going concern. There can be no assurance that future operations will be profitable. Revenues and profits, if any, will depend upon various factors, including whether we will be able to continue expansion of our revenue. We may not achieve our business objectives and the failure to achieve such goals may render us unable to continue our business, which would result in our common stock having little or no value.
If we are not able to successfully identify, acquire and develop oil and gas properties, it could have a material adverse effect on our business.
Our future performance depends upon our ability to acquire and develop oil and gas reserves that are economically recoverable. Without successful exploration, exploitation or acquisition activities, we will not be able to develop reserves or generate revenues. We might not be able to acquire or develop reserves on acceptable terms, or if we do acquire or develop reserves, that such reserves will yield commercial quantities of oil and gas deposits.
Information in this Annual Report on Form 10-K regarding our future exploration projects reflects our current intent and is subject to change.
Our current exploration and development plans are described in this Annual Report on Form 10-K. Whether we ultimately undertake an exploration project will depend on the following factors:
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availability and cost of capital;
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receipt of additional seismic data or the reprocessing of existing data;
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current and projected oil or natural gas prices;
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the costs and availability of drilling rigs and other equipment supplies and personnel necessary to conduct operations on the property;
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success or failure of activities in similar areas;
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changes in the estimates of the costs to complete the project;
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our ability to attract other industry partners to acquire a portion of the working interest to reduce costs and exposure to risks;
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finding a suitable joint working interest partners;
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decisions made by our joint venture partners; and
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receiving forbearance on the debt defaults.
We will continue to gather data about our projects, and it is possible that additional information will cause us to alter our schedule or determine that a project should not be pursued at all. Our plans regarding our projects are subject to change.
Development of our reserves will require significant capital expenditures for which we may be unable to provide sufficient financing. Our need for additional capital may harm our financial condition.
We will be required to make substantial capital expenditures beyond our existing capital resources to continue our development and operational plans. Historically, we have relied, and continue to rely, on external sources of financing to meet our capital requirements to implement our corporate development and investment strategies. We have, in the past, relied upon equity and debt capital as our principal source of funding. In the event we do not achieve positive cash flow, we will need to obtain future funding through debt and equity markets, but we may not be able to obtain additional funding when it is required and additional funding may not be available on commercially acceptable terms. The instruments covering our debt obligations place restrictions on our ability to issue additional debt and additional equity, which places additional restrictions on our ability to obtain additional funding. If we fail to obtain the funding that we need when it is required, we may have to forego or delay potentially valuable opportunities, which may significantly affect our financial condition and ability to effectively implement the proposed business plans.
We have limited control over activities on properties we do not operate, which could reduce our production and revenues.
If we do not operate the properties in which we own an interest, we do not have control over normal operating procedures, expenditures or future development of underlying properties. The failure of an operator of our wells to adequately perform operations or an operator's breach of the applicable agreements could reduce our production and revenues. The success and timing of our drilling and development activities on properties operated by others, therefore, depends upon a number of factors outside of our control, including the operator's timing and amount of capital expenditures, expertise and financial resources, inclusion of other participants in drilling wells and use of technology.
Certain of our directors and officers have potential conflicts of interest because they are the beneficiaries of mineral interests in the Company's properties.
David Steward, our chief executive officer and a director, and Michael Studdard, a director, are the beneficiaries of mineral interests in properties owned by us. These economic interests may create conflicts of interest in determining the course of action to be taken by us in developing those properties.
Our internal controls over financial reporting have been determined to not be effective. Failure to remedy this deficiency may reduce our ability to accurately report our financial results or prevent fraud.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results could be harmed. Our management has identified material weaknesses in our internal control over financial reporting, as defined in the standards established by the Public Company Accounting Oversight Board. The Company’s financial reporting includes various highly complex technical accounting issues such as derivatives, stock-based compensation expense, and standardized measure of discounted future cash flows calculations. During the fiscal year 2009, we did not have adequate personnel who were knowledgeable of the application of appropriate accounting and financial reporting principles for highly technical accounting issues that may arise. In addition, there was a lack of monitoring of the financial reporting process by management and we lacked an independent audit committee. If we fail to develop or maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential stockholders and the market in general could lose confidence in our financial reporting, which loss of confidence could harm our business and the trading price of our common stock. Our internal control over financial reporting has been modified during our most recent year by adding additional advisors to address deficiencies in the financial closing, review and analysis process, which has improved our internal control over financial reporting. On January 15, 2010 we also hired a new Chief Financial Officer to alleviate our material weaknesses.
If our independent contractors are characterized as employees, we would be subject to employment and withholding liabilities, past taxes and penalties.
We have structured some of our relationships with our consulting service providers in a manner that we believe results in an independent contractor relationship as opposed to an employer-employee relationship. If regulatory authorities or state, federal or foreign courts were to determine that our consulting service providers (or their owners or principals) are employees and not independent contractors, we would be required to withhold income taxes, to withhold and pay social security, Medicare and similar taxes and to pay unemployment and other related payroll taxes. We would also be liable for unpaid taxes that would have been incurred had the consulting services providers been properly characterized as employees and subject to penalties.
We may not be able to finance future needs or adapt our business plan to changes because of restrictions placed on us by the instruments governing our debt.
Our agreements with the investors who purchased our senior secured convertible notes and convertible debentures contain various covenants that limit our ability to:
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pay dividends on our common stock, redeem or repurchase our common stock or other equity securities;
·
issue our common stock or other equity securities;
·
incur additional indebtedness;
·
sell, lease or purchase assets; and
·
issue any securities that rank equivalent or senior to the senior secured convertible notes that we issued to those investors.
Additionally, our debt agreements contain numerous affirmative covenants, including covenants regarding reporting requirements and compliance with applicable laws and regulations. Any additional debt we incur in the future may subject us to future covenants.
We are in default under our debt instruments therefore our lenders are entitled to control the Company and the value of our common stock may decline.
We were unable to make our scheduled interest payments due October 1, 2008, January 1, 2009, and April 1, 2009 on our senior secured convertible notes and we were unable to make our scheduled principal and interest payment due January 11, 2009 on our convertible debentures. Therefore we are in default on the terms of those instruments. The holders of the senior secured convertible notes and convertible debentures have not waived the defaults. At this time, those holders have not accelerated payment of the debt nor have they proceeded against our collateral.
Our failure to pay interest when due under our senior secured convertible notes and to pay interest and principal when due under our convertible debentures and to comply with other covenants contained in those debt instruments, if such defaults are not cured or waived, could result in acceleration of debt under those and other debt instruments that contain cross-acceleration or cross-default provisions. Such acceleration could require us to repay or repurchase debt, together with accrued interest and charges and other amounts owing in respect thereof, prior to the date it otherwise is due and could adversely affect our financial condition. Upon a default or cross-default, the debt holders could also proceed against the collateral.
The senior secured convertible notes contain a variety of events of default which are typical for transactions of this type, as well as the following events:
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suspension from trading or failure of the stock to be listed for trading for more than five consecutive trading days or more than an aggregate of 10 trading days in any 365-day period;
·
failure to issue shares upon conversion of the amended and restated senior secured convertible notes for more than 10 business days after the relevant conversion date or notice to any holder of our intent not to comply with a conversion request pursuant to the amended and restated senior secured convertible notes;
·
failure for 10 consecutive business days to have reserved for issuance the full number of shares issuable upon conversion of the senior secured convertible notes;
·
failure to pay to any holder any amount of principal, redemption price, interest, late charges or other amounts when due under the amended and restated senior secured convertible notes, except that we shall have a five-day grace period to pay any interest, late charges or other amounts under the amended and restated senior secured convertible notes;
·
any default under, redemption or acceleration prior to maturity of any of our, or any of our subsidiaries’, indebtedness which exceeds $250,000;
·
a final judgment or judgments for payment of money in excess of $250,000 are rendered against us or our subsidiaries which are not bonded, discharged or stayed pending appeal within 60 days of their entry; provided, however any judgment covered by insurance or an indemnity for which we will receive proceeds within 30 days is not included in calculating the $250,000;
·
the breach or failure to comply with certain affirmative or negative covenants in the amended and restated senior secured convertible notes, other than a breach of or failure to comply with the covenant not to permit liens, in the case of liens for an amount less than $20,000 on our property or assets where the lien is removed within 30 days; and
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the SEC commences a formal investigation or enforcement action against us or any of our current officers or directors.
After the occurrence of an event of default, the holders of the senior secured convertible notes have the right to require us to redeem the senior secured convertible notes at a price of up to 200% of the principal amount of the senior secured convertible notes being redeemed, depending upon the nature of the event of default.
In the event of default, the exercise price of the warrants may also be recalculated based upon the market price for shares of our common stock.
The convertible debentures contain a variety of events of default which are typical for transactions of this type, as well as the following events:
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suspension from trading or failure of the stock to be listed for trading for more than five consecutive trading days;
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failure to make payment of the principal amount of, or interest on or other charges in respect to the amended and restated secured convertible debentures when due and payable;
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failure to deliver the payment in cash pursuant to a “Buy-In” within three days after notice is delivered;
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breach of any representation, warranty, covenant or other term or condition of any transaction document, except, in the case of a breach of a covenant or other term or condition of any transaction document which is curable, only if such breach continues for a period of at least ten consecutive business days;
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an event of default shall have occurred and be continuing under the amended and restated senior secured convertible notes;
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we are party to any “Change of Control Transaction”;
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we or any of our subsidiaries default in any of our obligations under any other debenture or any mortgage, credit agreement or other facility, indenture agreement, factoring agreement or other instrument under which there may be issued, or by which there may be secured or evidenced any indebtedness for borrowed money or money due under any long term leasing or factoring arrangement of us or any of our subsidiaries in an amount exceeding $500,000 (other than the senior secured convertible notes), whether such indebtedness now exists or shall hereafter be created and such default shall result in such indebtedness becoming or being declared due and payable prior to the date on which it would otherwise become due and payable.
After the occurrence of an event of default, YA Global, the holder of the convertible debentures, has the right to require us to redeem the full principal amount of the convertible debentures, together with interest and other amounts owing in respect thereof, immediately in payment of cash; provided however, that the debenture holder may request payment of such amounts in common stock.
Risks Related To Our Industry
The competition in the oil and gas industry is high, which may adversely affect our ability to succeed.
The oil and gas industry is highly competitive, and many of these competitors are large, well-established companies and have substantially larger operating staffs and greater capital resources than we do. Many of these companies not only explore for and produce oil and natural gas, but also carry on refining operations and market petroleum and other products on a regional, national or worldwide basis. These companies may be able to pay more for productive oil and natural gas properties and exploratory prospects or define, evaluate, bid for and purchase a greater number of properties and prospects than our financial or human resources permit. In addition, these companies may have a greater ability to continue exploration activities during periods of low oil and natural gas market prices. Our larger competitors may be able to absorb the burden of present and future federal, state, local and other laws and regulations more easily than we can, which would adversely affect our competitive position. Our ability to acquire additional properties and to discover reserves in the future will be dependent upon our ability to evaluate and select suitable properties and to consummate transactions in a highly competitive environment. In addition, because we have fewer financial and human resources than many companies in our industry, we may be at a disadvantage in bidding for exploratory prospects and producing oil and natural gas properties.
Oil and natural gas prices are volatile and a decline in oil and natural gas prices can significantly affect our financial results and impede our growth.
Oil and natural gas are commodities whose prices are determined based on world demand, supply and other factors, all of which are beyond our control. World prices for oil and natural gas have fluctuated widely in recent years, and decreases in the prices of oil and natural gas may have a material adverse effect on our financial condition, the future results of our operations and quantities of reserves recoverable on an economic basis.
Lower oil and natural gas prices may not only decrease our revenues on a per unit basis, but also may reduce the amount of oil and natural gas that we can produce economically. This may result in our having to make substantial downward adjustments to our estimated proved reserves. If this occurs or if our estimates of development costs increase, production data factors change or our exploration or development results deteriorate, successful efforts accounting rules may require us to write down, as a non-cash charge to earnings, the carrying value of our oil and natural gas properties for impairments. We are required to perform impairment tests on our assets whenever events or changes in circumstances lead to a reduction of the estimated useful life or estimated future cash flows that would indicate that the carrying amount may not be recoverable or whenever management's plans change with respect to those assets. We may incur impairment charges in the future, which could have a material adverse effect on our results of operations in the period taken.
Our estimated reserves are based on many assumptions that may turn out to be inaccurate. Any material inaccuracies in these assumptions will materially affect the quantities of our reserves.
No one can measure underground accumulations of oil and natural gas in an exact way. Oil and natural gas reserve engineering requires estimates of underground accumulations of oil and natural gas and assumptions concerning future oil and natural gas prices, production levels, and operating and development costs. As a result, estimated quantities of proved reserves and projections of future production rates and the timing of development expenditures may be incorrect.
Drilling for and producing oil and natural gas are high risk activities with many uncertainties that could adversely affect our business, financial condition or results of operations.
Any drilling activities we or joint venture partners may undertake are subject to many risks, including the risk that we will not discover commercially productive reservoirs. Drilling for oil and natural gas can be unprofitable, not only from dry holes, but from productive wells that do not produce sufficient revenues to return a profit. In addition, drilling and producing operations may be curtailed, delayed or canceled as a result of other factors, including:
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unusual or unexpected geological formations;
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pressures;
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fires and/or blowouts;
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loss of drilling fluid circulation;
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title problems;
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facility or equipment malfunctions;
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unexpected operational events;
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shortages or delays in the availability of chemicals, drilling rigs, equipment and services;
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compliance with environmental and other governmental requirements and related lawsuits; and
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adverse weather conditions.
The occurrence of these events also could impact third parties, including persons living near our operations, our employees and employees of our contractors, leading to injuries or death or property damage. As a result, we face the possibility of liabilities from these events that could adversely affect our business, financial condition or results of operations.
Any of these risks can cause substantial losses, including personal injury or loss of life, damage to or destruction of property, natural resources and equipment, pollution, environmental contamination or loss of wells and other regulatory penalties.
We ordinarily maintain insurance against various losses and liabilities arising from our operations; however, insurance against all operational risks is not available to us. Additionally, we may elect not to obtain insurance if we believe that the cost of available insurance is excessive relative to the perceived risks presented. Thus, losses could occur for uninsurable or uninsured risks or in amounts in excess of existing insurance coverage. The occurrence of an event that is not fully covered by insurance could have a material adverse impact on our business activities, financial condition and results of operations.
We are subject to environmental and other government laws and regulations in all jurisdictions in which we operate, and compliance with these laws and regulations could cause us to incur significant costs.
Our operations are governed by numerous U.S. laws and regulations at the state and federal levels. These laws and regulations govern the operation and maintenance of our facilities, the discharge of materials into the environment and other environmental protection issues. The laws and regulations may:
·
require that we obtain permits before commencing drilling;
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restrict the substances that can be released into the environment in connection with drilling and production activities;
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limit or prohibit drilling activities on protected areas, such as wetlands or wilderness areas;
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require that reclamation measures be taken to prevent pollution from former operations;
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require remedial measures to mitigate pollution from former operations, such as plugging abandoned wells and remediating contaminated soil and groundwater; and
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require remedial measures to be taken with respect to property designated as a contaminated site, for which we are a responsible person.
Under these laws and regulations, we could be liable for personal injury, clean-up costs and other environmental and property damages, as well as administrative, civil and criminal penalties. We do not have insurance coverage relating to liability for environmental damage because we do not believe that insurance coverage for the full potential liability of environmental damages is available at a reasonable cost. Accordingly, we could be liable, or could be required to cease production on properties, if environmental damage exists or occurs.
Environmental laws and regulations could change in the future and result in stricter standards and enforcement, larger fines and liability, and increased capital expenditures and operating costs, any of which could have a material adverse effect on our financial condition or results of operations. The costs of complying with environmental laws and regulations in the future may require us to cease production on some or all of our properties.
Equipment that is essential to any development activities might not be available.
Oil and natural gas exploitation and development activities depend upon the availability of drilling and related equipment in the particular areas where those activities will be conducted, and our access to these facilities may be limited. Demand for that equipment or access restrictions may affect the availability of that equipment to us and delay any exploitation and development activities. Shortages and/or the unavailability of necessary equipment or other facilities would impair any such activities, either by delaying our activities, increasing our costs or otherwise.
Unless we replace our oil and natural gas reserves, our reserves and production will decline, which would adversely affect our business, financial condition and results of operations.
Producing oil and natural gas reservoirs generally are characterized by declining production rates that vary depending upon reservoir characteristics and other factors. Because total estimated proved reserves include our proved undeveloped reserves, production will decline even if those proved undeveloped reserves are developed and the wells produce as expected. The rate of decline will change if production from our existing wells declines in a different manner than we have estimated and can change under other circumstances. Thus, our future oil and natural gas reserves and production and, therefore, our cash flow and income are highly dependent upon our success in efficiently developing and exploiting our current reserves and economically finding or acquiring additional recoverable reserves. We may not be able to develop, find or acquire additional reserves to replace our current and future production at acceptable costs.
Risks Related To Our Capital Structure
The additional shares of our common stock that may be sold upon conversion of our senior secured convertible notes, convertible debentures and related warrants may create downward pressure on the trading price of our common stock and adversely affect the liquidity of our common stock.
The Company increased the number of shares of its capital stock in October 2006 to 300,000,000 shares of common stock and 2,000,000 shares of preferred stock. The secondary resale of these shares into the public markets, as well as future sales of securities by the Company could have an adverse effect on the market price of our common stock and make it more difficult for us to sell our equity securities in the future at prices which we deem appropriate or for holders of our common stock to have liquidity in their investment. Due to the significance of the number of shares that may be issued upon conversion of our senior secured convertible notes, convertible debentures and related warrants, the entry of those shares into the public market, or the mere expectation of the entry of those shares into the market, could depress the market price and adversely affect liquidity of our common stock and could impair our ability to obtain capital through securities offerings or the ability of investors to sell shares at a favorable price or at all.
The continuously adjustable conversion price feature of our convertible debentures could require us to issue a substantially greater number of shares, which could cause dilution to our existing stockholders.
The conversion price of our convertible debenture was fixed until April 30, 2008. However, the number of shares of common stock issuable upon conversion of our convertible debentures has increased after April 30, 2008 since the market price of our stock remains below $0.65, which will cause dilution to our existing stockholders. Our obligation to issue shares upon conversion of our convertible debentures is essentially limitless if the trading price per common share declines towards zero because the debentures are convertible into common stock after April 30, 2008 based on the trading price per common share of our Company.
Certain terms of our senior secured convertible notes and convertible debentures could prevent or deter a third party from acquiring us.
Our entering into or being party to any "Change of Control Transaction," as defined in the convertible debentures, would be an event of default under those debentures. Upon such a default, the holders may require that convertible debentures be redeemed for their full principal amount. Change of Control Transactions include (a) an acquisition by an individual or group of effective control (whether through legal or beneficial ownership of capital stock of the Obligor, by contract or otherwise) of in excess of fifty percent (50%) of the outstanding shares of voting stock of the Company, (b) a replacement at one time or over time of more than one-half of the members of the board of directors of the Company which is not approved by a majority of those individuals who are current members of the board of directors, (c) the merger, consolidation or sale of fifty percent (50%) or more of the assets of the Company or any subsidiary, or (d) the execution by the Company of an agreement providing for any of the events set forth above in (a), (b) or (c).
Additionally we cannot enter into or be party to any "Fundamental Transaction" as defined in the senior secured convertible notes unless the successor entity assumes in writing all of our obligations under the senior secured convertible notes and convertible debentures. Upon certain "Fundamental Transactions" the holders of the senior secured convertible notes may require that the senior secured convertible notes be redeemed for a price of 120% or more of the principal amount of the senior secured convertible notes. These transactions include (i) mergers, (ii) dispositions of all or substantially all of our assets, (iii) purchases, tender or exchange offers, stock purchase agreements or other business combinations by third parties whereby such third parties acquire more than 50% of the outstanding shares of voting stock of the Company, and (iv) reorganizations, recapitalizations or reclassifications of our common stock.
Even if a transaction described in the two paragraphs above would be beneficial to the Company or its shareholders, these restrictions and triggers may prevent or deter our board of directors or a third party from pursuing it.
Because the holders of certain warrants have cashless exercise rights, we may not receive proceeds from their exercise, and the low exercise price of certain warrants may create downward pressure on the trading price of our common stock and adversely affect the liquidity of our stock.
The holders of certain of our warrants have cashless exercise rights, which provide them with the ability to exercise the warrants and, in lieu of making the cash payment of the exercise price, elect instead to receive the number of shares that could have been purchased with what would have been the net proceeds if the warrant holder had exercised the warrants with a cash payment of the exercise price and then immediately sold such shares at the then-current closing price. To the extent that the holders of the warrants exercise this right, we will not receive proceeds from such exercise. Furthermore, as discussed in this Annual Report on Form 10-K, the exercise price of our warrants to purchase 51,500,743 shares is $0.001 per share. This low exercise price and the cashless exercise option discussed above may encourage warrant holders to exercise their warrants. The entry of those shares into the public market, or the mere expectation of the entry of those shares into the market, could depress the market price and adversely affect liquidity of our common stock and could impair our ability to obtain capital through securities offerings or the ability of investors to sell shares at a favorable price or at all.
The holders of the Senior Secured Convertible Notes and Convertible Debentures may convert the Senior Secured Convertible Notes and Convertible Debentures or Exercise the Warrants for shares of our Common Stock, which may cause dilution of the shares of Common Stock held by then-existing investors.
The conversion of the senior secured convertible notes and convertible debentures into common stock, and the exercise of the warrants will result in dilution to the interests of current holders of our common stock, since the number of shares held by current stockholders will then represent a smaller percentage of all outstanding shares of common stock and the equity received from the conversion of the senior secured convertible notes and convertible debentures and exercise of the amended and restated Series A warrants, the new Series A warrant and the other new Series A warrants will be less than the current value of the common stock. In addition, significant dilution of current stockholders’ common stock may depress the market value and price for such shares.
The convertible debentures are convertible into our common stock, at a price per share equal to the lesser of (a) $0.65, or (b) an amount equal to 85% of the lowest volume weighted average price of our common stock for the 15 trading days immediately preceding the conversion date as quoted by Bloomberg, LP, subject to certain anti-dilution adjustments that could reduce the conversion price to any lower price at which we issue or become obligated to issue any common stock. During the years ended December 31, 2009, and 2008 the Company issued 36,538,319 and 7,617,804 shares respectively upon the conversion of $147,800 and $107,700 respectively of principal of the debentures. Additional conversions will result in substantial dilution to our current shareholders.
The senior secured convertible notes are convertible at the option of the holders into shares of our common stock at an initial conversion price of $0.65 per share, subject to certain anti-dilution adjustments that could reduce the conversion price to any lower price at which we issue or become obligated to issue any common stock. Assuming again that conversion of the senior secured convertible notes took place on December 31, 2009 at a conversion price of $0.65, at which time there were 87,384,135 shares outstanding, the 82,733,188 shares of common stock issuable upon such conversion would represent 48.6% of the common stock outstanding after conversion, without regard to any limitations on conversion.
Although the senior secured convertible notes and convertible debentures contain limitations on the percentage of outstanding shares of the Company that may be held by a holder (and its affiliates) at any time, the ability of holders to convert the notes and debentures, sell all or a portion of their shares, and then convert additional notes or debentures, will allow the dilution to existing shareholders to occur over an extended period of time.
The continuously adjustable conversion price feature of our convertible debentures may encourage investors to make short sales in our common stock, which could have a depressive effect on the price of our common stock.
The convertible debentures are convertible into common stock at any time by dividing the dollar amount being converted by $0.65, or at any time after April 30, 2008, by the lower of $0.65 or 85% of the lowest volume weighted average price of the Company’s common stock for the 15 trading days immediately preceding the conversion date as quoted by Bloomberg, LP. The interest on the convertible debentures accrues on the outstanding principal balance at a rate of 10% per year commencing on October 31, 2007. Each holder of the convertible debentures (together with its affiliates) may only convert up to 4.9% of our then-issued and outstanding shares on the conversion date. The significant downward pressure on the price of the common stock as a debenture holder converts and sells material amounts of common stock could encourage short sales by investors. This could place further downward pressure on the price of the common stock. A debenture holder could sell common stock into the market in anticipation of covering the short sale by converting their securities, which could cause the further downward pressure on the stock price. In addition, not only the sale of shares issued upon conversion of convertible debentures, but also the mere perception that these sales could occur, may adversely affect the market price of the common stock of our Company.
Shares reserved for issuance under our 2007 stock incentive plan may create potential conflicts of interest for our management and may dilute or diminish the value of our common stock.
We reserved up to 2,378,249 shares of common stock for future issuance under our 2007 Stock Incentive Plan. According to the Plan, the number and class of shares of common stock subject to each outstanding option or stock award, the option exercise price, and the annual limits on and the aggregate number and class of shares of common stock for which awards thereafter, and any adjustments thereto, are determined by a committee consisting of members of our board of directors. Some of our directors and, therefore, committee members, also serve as officers of the Company and are eligible to receive options and stock awards under the Plan, which could create, or appear to create, a conflict of interest when such committee members are presented with decisions regarding awards under the Plan. Furthermore, the eventual exercise of those options will dilute the holdings of the current stockholders, and significant sales of stock issued upon the exercise of options could have a negative effect on our stock price and impede our ability to raise future capital.
There is currently a limited market for our common stock, which may result in stockholders being unable to sell their shares in a timely manner and at the price they desire to sell.
Our common stock is currently quoted on the OTC Bulletin Board, which is characterized by low trading volume. Because of this limited liquidity, stockholders may be unable to sell their shares. The trading price of our shares has from time to time fluctuated widely and may be subject to similar fluctuations in the future. The trading price of our common stock may be affected by a number of factors, including events described in the risk factors set forth in this Annual Report on Form 10-K, as well as our operating results, financial condition, announcements of drilling activities, general conditions in the oil and gas exploration and development industry, and other events or factors. In recent years, broad stock market indices, in general, and smaller capitalization companies, in particular, have experienced substantial price fluctuations. In a volatile market, we may experience wide fluctuations in the market price of our common stock. These fluctuations may have a negative effect on the market price of our common stock.
Our common stock is subject to the "Penny Stock" rules of the Securities and Exchange Commission, which makes transactions in our stock cumbersome and may reduce the value of an investment in our stock.
The Securities and Exchange Commission has adopted Rule 15g-9 which establishes the definition of a "penny stock," for the purposes relevant to us, as any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions.
For any transaction involving a penny stock, unless exempt, the rules require:
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that a broker or dealer approve a person's account for transactions in penny stocks; and
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the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased.
In order to approve a person's account for transactions in penny stocks, the broker or dealer must:
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obtain financial information and investment experience objectives of the person; and
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make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the Commission relating to the penny stock market, which, in highlight form:
·
sets forth the basis on which the broker or dealer made the suitability determination; and
·
that the broker or dealer received a signed, written agreement from the investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in securities subject to the "penny stock" rules. This may make it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock.
Disclosure also has to be made about the risks of investing in penny stocks in both public offerings and in secondary trading and about the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and the rights and remedies available to an investor in cases of fraud in penny stock transactions. Finally, monthly statements have to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks.
Item 2.
Item 2. Description of Property
Principal Executive Offices
Our principal executive offices are located at the following address effective January 1, 2009:
800 N. Church Street
Suite #C
Palestine, TX 75801
Our telephone number is (903) 723-0395
Properties
The following discussion regarding our properties should also be read in conjunction with our consolidated financial statements and notes thereto.
Anderson County, Freestone County and Jones County, Texas
In July 2006, we purchased a 90% interest in the mineral rights, royalties and leases known as the P.D.C. Ball Property pertaining to the oil, gas and liquid hydrocarbons, excluding coal and lignite, covering 27,557 gross acres (22,682 net acres) in Anderson, Freestone and Jones Counties in East Texas for $22.7 million cash and 4.3 million shares of our common stock. In 2009, the property generated $52 thousand in royalties. We have been actively seeking industry partners to lease from us the remaining undeveloped parts of our properties. We have met and discussed this opportunity with a number of oil and gas companies.
Of the 10% interest in the mineral rights not owned by the Company, 4% interest is owned by Roboco Energy Inc. (“Roboco”), a private company owned by Michael S. Studdard, George D. Barnes and Tom J. Temples. During 2008, George Barnes resigned as a director and officer and Tom Temples resigned as an officer of Wentworth. Michael Studdard has also retired as the Company’s President, but remained as a director. The remaining 6% interest is owned by Horseshoe Energy, Inc., a private company owned by David Steward (subsequently elected a director in July 2007 and appointed our Chairman and CEO in December 2007) and his family. The P.D.C Ball Property also bears overriding royalty interests totaling 5%, distributed as follows: 3% to Roboco and 2% to Barnes Drilling and Exploration, Inc. Prior to the purchase of the P.D.C Ball Property, none of these parties were affiliated with us and none of our officers or directors were affiliated with Roboco, Horseshoe Energy, Inc. or Barnes Drilling & Exploration, Inc.
In November 2006, we signed two three-year oil, gas & mineral leases and a joint operating agreement with Marathon to explore approximately 9,200 acres of our P.D.C. Ball Property in Freestone County, Texas. The agreements give Marathon the right to drill deep gas wells on the property (below 8,500 feet) and the opportunity to partner with us on drilling upper zones (above 8,500 feet) on a 50/50 basis. We retained a 21.5% royalty interest in any revenue generated from the property below 8,500. As previously discussed, in June 2009, Marathon assigned the upper zones (above 8,500 feet) back to Wentworth and the deep-well leases were extended until April 30, 2010.
Marathon, together with Barrow-Shaver, completed the drilling of its first deep well (M-1) of approximately 15,000 feet during December 2008. We were recently advised that there is damage in the casing and production will be further delayed. The timing for the repair and ultimate production is unknown as this time. No reserve value is given to this well due to its current status.
On the remaining approximately 18,000 gross acres of the P.D.C. Ball Property, we are continuing to seek partners to jointly develop the property. Several companies have expressed an interest in participating in a similar arrangement as the Marathon lease described above. Management has met with many interested parties over the past several months however we are currently not engaged in negotiation with any party.
Freestone County, Texas Bracken Well 1 and 2
In September 2006, we acquired from an unrelated party a mineral lease of approximately 193 acres which is surrounded by the P.D.C. Ball Property. The acquisition was to fill a “hole” in the P.D.C. Ball mineral block and it represents what our geologists have determined to possess low risk and high probability drilling locations. During January 2007, Bracken #1 was successfully drilled and commenced production in February 2007. We have a 100% working interest and a net revenue interest of 76.25% in this well. Through December 2007, this well produced 93 MMCF of natural gas. Production was shut down in January 2008 for remedial work due to an excessive amount of water produced and equipment problems. The excessive water associated with gas production persisted and we have shut-in this well until an economical method to dispose of the water is available. Bracken #2 was drilled during March 2007 and was a dry hole.
Freestone County, Texas Shiloh Well #1 and #3
The Shiloh #1 and #3 wells were existing wells and have produced natural gas since the 1970s. They are located on 640 acres within the perimeter of the P.D.C. Ball Property. During January 2007, we purchased a 50% working interest in both wells from an unrelated party for the sum of $200,000. By this acquisition, we increased our net revenue interest to 38.75% and 38.50% in Shiloh 1 and 3, respectively and became the operator. Most of the production comes from Shiloh #3, which had an average daily gross production of approximately 750 MCF of gas during 2009. We own a 38.75% and 38.5% net revenue interest in Shiloh #1 and #3, respectively. Effective July 1, 2009, the operation of the working interest wells, including the Shiloh #1 and #3, was contracted to Barrow-Shaver Resources Company, a local East Texas oil and gas company.
During June, 2009 we successfully negotiated a six-month lease extension with Marathon Oil Company and its affiliate (together, “Marathon” or the “Lessee”) on a 9,200-acre deep-well lease (see “Mineral Lease and Joint Operating Agreement” below). The Lessee’s current lease on the property was to expire November 1, 2009. The extension will give the Lessee until April 30, 2010 to drill additional deep Bossier/Haynesville formation wells on the western portion (approximately 4,000 acre) of the 9,200-acre lease. In return for the six-month extension, the Lessee assigned 100% of its working interest (with a 75% net revenue interest) in the Lessee’s shallow leases on the mineral block to us. The shallow leases are from the surface down to approximately 8,500 feet and include additional rights to explore the Pettit formation.
During August, 2009 we entered into a two-year Exploration Agreement with Barrow-Shaver Resources Company to conduct exploration operations, including the drilling of exploratory and development wells and the recompletion of existing wells. This is to be carried out within the parcel of land consisting mainly of the above mentioned 9,200 acres of shallow leases assigned to Barrow-Shaver from Marathon plus approximately 220 acres of the adjacent mineral leases. Barrow-Shaver will be the operator and bear 100% of the exploration and development costs, and in return, Wentworth will receive 25% in royalties and up to a 12.5% carried working interest to casing point in each shallow well. In addition, Barrow-Shaver is to pay Wentworth $500 per acre for each unit formed around any new producing well drilled.
On September 1, 2009, Barrow-Shaver and Wentworth (collectively, the “Grantors”) entered into a one-year development agreement with Dominion Production Company LLC and DHI (collectively, the “Grantees”) to conduct joint development operations including the re-entry of development wells previously shut-in due to excessive water production. The Grantees bear 100% of the development costs and receive a 75% net revenue interest. The Grantors retain a carried working interest of 25%, with the option of acquiring an additional 35% working interest when the Grantees have received $450,000 in revenue from each well developed. Further, for any formation above the Woodbine Formation that the Grantees and Grantors wish to re-complete for production, the Grantees will receive 60% participation and the Grantors will receive 40% participation.
On September 10, 2009 we re-entered an existing well (Brackens #1) that was previously shut-in due to excessive water production using a down-hole pump system wherein water produced is re-injected into the lower portion of the formation. Preliminary results indicate the well is capable of producing 300 to 400 MCF of gas per day. Production is expected to commence when the permit from Railroad Commission is received. Based on this, Barrow-Shaver is planning to re-enter other shut-in wells using similar methods over the ensuing months. In addition, Barrow-Shaver is planning to drill up to two new wells in 2010. However, we can provide no assurance of the success of recompletion of other shut-in wells and drilling of new wells.
In 2008, our former wholly-owned subsidiary, Barnico Drilling, Inc., was sold to CamTex Energy, Inc., a corporation in which George Barnes, our former Vice President of Operations, is an officer. In August 2008, CamTex Energy, Inc. defaulted on the terms of the sale and we repossessed the Barnico drilling rigs and related equipment during March 2009. The repossessed assets were sold for the net amount of approximately $0.9 million by auction on June 18, 2009 resulting in a loss of $1.2 million, which is reported in our Consolidated Statement of Operations for the year ended December 31, 2009.
We have not paid any of the quarterly interest payments on our senior secured convertible notes of approximately $12.2 million as of the year ended December 31, 2009. Payments of interest were due to the holders of our senior secured convertible notes on October 1, 2008, January 1, 2009, April 1, 2009, July 1, 2009, and October 1, 2009. We do not have sufficient funds to make these payments. With respect to the senior secured convertible notes, we were granted a forbearance and deferral of interest payment until January 1, 2009. Since January 1, 2009 the note holders have declined to grant further waivers of default and deferrals of the quarterly interest payments and accordingly, we are in default of the terms of the notes.
An event of default under the terms of our convertible notes constitutes a default under the terms of our outstanding convertible debentures. We were also unable to make the principal and interest payment on the convertible debentures which was due on January 11, 2009. The senior secured convertible note holders and the convertible debenture holder have not commenced collection actions against the Company. However, there is no assurance that they will not do so in the future.
Due to our inability to make the payments required on the convertible debentures and the senior secured convertible notes, we are in default of these agreements effective as of October 1, 2008. Under the terms of the senior secured convertible notes, the interest rate escalated to 15% upon default. Interest on the convertible debentures continues to accrue interest at 10%. The principal amount of both the senior secured convertible notes and the convertible debentures are reported as current liabilities in our financial statements due to the defaults.
In the short term, management continues to reduce administrative overhead and operate within the revenue generated from the Shiloh #1 and Shiloh #3 wells and royalty interests from other wells.
Delivery Commitments
We are not obligated to provide oil or gas in fixed quantities or at fixed prices under existing contracts.
Item 3.
Item 3. Legal Proceedings
We are not aware of any proceedings contemplated by a governmental authority. We are party to litigation as follows:
On December 19, 2008, the Company commenced a lawsuit against our former subsidiary, Barnico Drilling, Inc., our former Vice President, Georges Barnes, and CamTex Energy, Inc. (of which George Barnes is an officer), in the District Court of Anderson County, Texas. The lawsuit relates to the Company’s attempt to repossess certain items from George Barnes and CamTex Energy, Inc. in accordance with a court ruling on September 9, 2008. George Barnes had refused to turn over these items claiming that the items were not owned by Barnico but were actually owned by George Barnes and his family. This case was heard in the District Court of Anderson County, Texas on March 12, 2009 and Mr. Barnes was ordered to immediately relinquish to Wentworth possession of the items. Mr. Barnes was also held in contempt of court for his failure to relinquish possession of the items and Wentworth was awarded its attorney fees and costs incurred in preparing the motion.
On August 27, 2009, the Company filed an amended petition to its original lawsuit in an attempt to recover approximately $25,000 the Company believes is owed to it by George Barnes for the use of Barnico drilling rigs for a period of time between February 2008 and May 2009 and approximately $11,000 for overrides improperly paid to George Barnes and certain of his family. In its amended petition, the Company has also alleged fraud relating to the misrepresentation of the quality of the Barnico drilling rigs and equipment in the March 2006 Stock Purchase Agreement under which the Company initially acquired its stock in Barnico. The Company has also filed a claim against a third party relating to payments made by that third party to Barnico in 2009 despite receiving notice of the Company’s security interest in Barnico’s accounts receivable.
We may also be a party to various legal actions that arise in the ordinary course of our business. Based in part on consultation with legal counsel, we believe that (i) the liability, if any, under these claims will not have a material adverse effect on us, and (ii) the likelihood that the liability, if any, under these claims is material is remote.
Item 4.
Item 4. REMOVED AND RESERVED
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock is quoted on the OTC Bulletin Board under the symbol “WNWG.” Prior to January 4, 2006, our common stock was quoted on the Pink Sheets. The following table sets forth the high and low bid information for our common stock for each quarter within the last two fiscal years.
Quarter Ended
High Bid Price 1
Low Bid Price 1
March 31, 2008
$0.33
$0.12
June 30, 2008
$0.175
$0.055
September 30, 2008
$0.099
$0.025
December 31, 2008
$0.055
$0.008
March 31, 2009
$0.016
$0.002
June 30, 2009
$0.011
$0.0035
September 30, 2009
$0.01
$0.003
December 31, 2009
$0.006
$0.0016
1Source: http://quotes.nasdaq.com. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
Holders
As of March 22, 2010, we had 84 stockholders of record, and an unknown number of additional holders whose stock is held in “street name.”
Dividends
No dividends have been declared or paid on our securities, and we do not anticipate that any dividends will be declared or paid in the foreseeable future. Under the terms of the senior secured convertible notes, we are not permitted to pay any cash dividend or make any distribution with respect to our capital stock without the prior written consent of a majority of the holders of the senior secured convertible notes.
Recent Sales of Unregistered Securities
The following table describes all securities we issued within the past year without registering the securities under the Securities Act and that were not otherwise disclosed on our quarterly reports on Form 10-Q or our current reports on Form 8-K filed during the year ended December 31, 2009.
Date
Description
Number
Purchaser
Proceeds
($)
Consideration
Exemption
(A)
Oct. 12, 2009
Common Stock
3,806,452
YA Global Investments, L.P. (f/k/a Cornell Capital, L.P.)
Nil
Issuance of common stock upon conversion of $11,800 of convertible debentures
Sec. 4(2)
Nov. 3, 2009
Common Stock
3,961,538
YA Global Investments, L.P. (f/k/a Cornell Capital, L.P.)
Nil
Issuance of common stock upon conversion of $10,300 of convertible debentures
Sec. 4(2)
Dec. 11, 2009
Common Stock
1,823,529
YA Global Investments, L.P. (f/k/a Cornell Capital, L.P.)
Nil
Issuance of common stock upon conversion of $3,100 of convertible debentures
Sec. 4(2)
(A)
With respect to sales designated by “Sec. 4(2),” these shares were issued pursuant to the exemption from registration contained in to Section 4(2) of the Securities Act of 1933 as privately negotiated, isolated, non-recurring transactions not involving any public offer or solicitation. Each purchaser represented that such purchaser’s intention to acquire the shares for investment only and not with a view toward distribution. We requested our stock transfer agent to affix appropriate legends to the stock certificate issued to each purchaser and the transfer agent affixed the appropriate legends. Each purchaser was given adequate access to sufficient information about us to make an informed investment decision. None of the securities were sold through an underwriter and accordingly, there were no underwriting discounts or commissions involved.
Item 6.
Item 6. Selected Financial Data
As a “smaller reporting company”, we are not required to provide the information required by this Item.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with our Consolidated Financial Statements and notes thereto referred to in Item 8, the “Cautionary Notice Regarding Forward-Looking Statements,” “Items 1. Description of Business,” and “Item 2. Description of Properties” in this Annual Report on Form 10-K.
Overview and Plan of Operations
We are an exploration and production company engaged in oil and gas exploration, drilling and development. We currently have oil and gas interests in Anderson County, Freestone County, and Jones County, Texas. Our strategy is to develop our current low risk, high probability prospects and to lease out deeper zones of our properties for royalty interests. Due to our lack of adequate financial resources, we are seeking joint ventures or farm-outs to develop our properties.
Our financial position is critically dependent upon the following: (1) successful discovery and economical recovery of adequate hydrocarbons on our properties; (2) access to additional equity and/or other forms of funding; (3) finding a joint venture partner to farm-in and develop our properties and (4) obtaining a forbearance and deferral of interest and principal payments from the holders of our senior secured convertible notes and convertible debentures. There can be no assurance that we will be successful in any of these matters.
Our current production is derived principally from two wells, Shiloh #1 and #3 in Freestone County, acquired from an unrelated party. These wells have a combined gross production of approximately 860 MCF per day. We have been actively seeking industry partners to lease from us the remaining undeveloped parts of our properties.
During the second quarter of 2008, we sold all outstanding shares of Barnico for $3,500,000 to CamTex Energy, Inc, a corporation in which George Barnes, our former Vice President of Operation, is an officer. We received $50,000 on the closing of the sale and a promissory note in the amount of $3,450,000. In August 2008, CamTex Energy, Inc. defaulted on the note by failing to make the agreed quarterly principal payment of $345,000 plus interest. We repossessed the drilling rigs and related equipment, which were sold during June 2009 for $0.9 million.
In the short term, management continues to reduce administrative overhead and operate within the revenue generated from the Shiloh #1 and Shiloh #3 wells and royalty interest from other wells.
Notwithstanding the above, management continues to explore other opportunities including joint ventures, mergers and sale of property.
Results of Operations
Year ended December 31, 2009 Compared to Year Ended December 31, 2008:
Revenues
Revenue from oil and gas sales was $.5 million in 2009 compared to $1.1 million in 2008 Although our production increased slightly from 22,523 BOE in 2008 to 24,332 BOE in 2009, our prices declined from $49.40 per BOE in 2008 to $21.24 per BOE in 2009.
The Company has no significant gas imbalances. Therefore, gas imbalances have no effect on the Company’s operations or liquidity.
Operating Expenses
Our operating costs totaled .5 million for 2009 compared to $8.2 million for 2008. We recorded a $7.9 million impairment charge related to the company’s oil and gas properties for the year ended December 31, 2008, but had no impairment charges in 2009.
General and Administrative
Total general and administrative costs were $1.1 million for 2009 compared to $2.9 million for 2008. This decrease is due to a change in bookkeeping firms as well as a decrease in audit fees.
Finance and Interest Costs
Finance and interest costs were $7.5 million in 2009, down from $49.0 million in 2008. Due to our default on the senior secured convertible notes and the convertible debentures in 2008, we expensed all deferred financing costs and debt discount related to these instruments at the date of default
Unrealized Gain (Loss) on Derivative Contracts
For the year ended December 31, 2009 we had non-cash unrealized loss on derivative contracts of $0.1 million compared to a non-cash unrealized gain of $19.2 million for the year ended December 31, 2008 The change in 2008 was due to the price of the stock falling below the exercise price of most of the warrants and options. There was little change in the value of the derivative contracts in 2009 because the stock price stayed below the exercise price of most options and warrants.
Loss from Discontinued Operations
Barnico Drilling, Inc. was purchased by us during 2006 and represented our drilling segment. Due to a decline in drilling activity and the absence of funds to drill our own wells we sold Barnico’s stock and discontinued our drilling operations in 2008.
Liquidity and Capital Resources
Our primary sources of liquidity during the year were $.5 million of oil and gas revenues. For 2008 we had $1.1 million of operating revenues.
We have incurred significant losses from operations and are in default of our senior secured convertible notes and convertible debentures since October 1, 2008. These factors have raised substantial doubt about the Company’s ability to continue as a going concern. Our financial position is critically dependent upon the following: (1) successful discovery and economical recovery of adequate hydrocarbons on our properties; (2) access to additional equity and/or other forms of funding; (3) finding a joint venture partner to farm-in and develop our properties and (4) obtaining a forbearance and deferral of principal and interest payments from our senior secured convertible note holders and our convertible debenture holders. There can be no assurance that we will be successful in any of these matters. As the Company has no debt or equity funding commitments, we will need to rely upon best efforts financings. There can be no assurance that the Company will be successful in raising the required capital. The failure to raise sufficient capital through future debt or equity financings or otherwise may cause the Company to curtail operations, sell assets, or result in the failure of our business.
Our short-term liquidity requirements for the next twelve months include interest payments, penalties and maturities (discussed further in “Financing Activities” below), cash requirements for our oil and gas production expenses, and capital expenditures. Our long-term liquidity requirements are substantially similar to our short-term liquidity requirements. We are reliant on obtaining adequate financing for our operations and capital needs. These factors raise substantial doubt about our ability to continue as a going concern.
Operating Activities
During 2009 and 2008, we used $0.8 million and $2.9 million respectively, of cash in our operating activities. Our cash used in operating activities was primarily attributable to our property operations and general and administrative costs such as professional fees, investor relations and management fees.
Investing Activities
In 2009, we generated $0.9 million of cash from the sale of equipment. During 2008, investing activities used $0.1 million in cash related to capitalized cost on our oil and gas properties.
Financing Activities
During 2009 we had on costs related to financing activities and during 2008 we used approximately $50,000 to pay advances from related parties.
Off-Balance Sheet Arrangements
As of December 31, 2009 and 2008, we had no off-balance sheet arrangements reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Material Commitments
Critical Accounting Policies and Estimates
We prepare our consolidated and combined financial statements in this report using accounting principles that are generally accepted in the United States (“GAAP”). GAAP represents a comprehensive set of accounting and disclosure rules and requirements. We must make judgments, estimates, and in certain circumstances, choices between acceptable GAAP alternatives as we apply these rules and requirements. The most critical estimate we make is the engineering estimate of proved oil and gas reserves. This estimate affects the application of the successful efforts method of accounting, the calculation of depreciation, depletion, and amortization of oil and gas properties and the estimate of the impairment of our oil and gas properties. It also affects the estimated lives used to determine asset retirement obligations. In addition, the estimates of proved oil and gas reserves are the basis for the related standardized measure of discounted future net cash flows.
Estimated Oil and Gas Reserves
The evaluation of our oil and gas reserves is critical to management of our operations and ultimately our economic success. Decisions such as whether development of a property should proceed and what technical methods are available for development are based on an evaluation of reserves. These oil and gas reserve quantities are also used as the basis of calculating the unit-of-production rates for depreciation, evaluating impairment and estimating the life of our producing oil and gas properties in our asset retirement obligations. Our proved reserves are classified as either proved developed or proved undeveloped. Proved developed reserves are those reserves which can be expected to be recovered through existing wells with existing equipment and operating methods. Proved undeveloped reserves include reserves expected to be recovered from new wells from undrilled proven reservoirs or from existing wells where a significant major expenditure is required for completion and production. We also report probable reserves and possible reserves, each of which reflects a lower degree of certainty of realization than proved reserves.
Independent reserve engineers prepare the estimates of our oil and gas reserves presented in this report based on guidelines promulgated under GAAP and in accordance with the rules and regulations of the Securities and Exchange Commission. The evaluation of our reserves by the independent reserve engineers involves their rigorous examination of our technical evaluation and extrapolations of well information such as flow rates and reservoir pressure declines as well as other technical information and measurements. Reservoir engineers interpret these data to determine the nature of the reservoir and ultimately the quantity of proved, probable and possible oil and gas reserves attributable to a specific property. Our proved reserves in this report include only quantities that we expect to recover commercially using current prices, costs, existing regulatory practices and technology. While we are reasonably certain that the proved reserves will be produced, the timing and ultimate recovery can be effected by a number of factors including completion of development projects, reservoir performance, regulatory approvals and changes in projections of long-term oil and gas prices. Revisions can include upward or downward changes in the previously estimated volumes of proved reserves for existing fields due to evaluation of (1) already available geologic, reservoir, or production data or (2) new geologic or reservoir data obtained from wells. Revisions can also include changes associated with significant changes in development strategy, oil and gas prices, or production equipment/facility capacity.
Standardized measure of discounted future net cash flows
The standardized measure of discounted future net cash flows relies on these estimates of oil and gas reserves using commodity prices and costs. Effective for the year ending December 31, 2009 and later, commodity prices are based on the average prices as measure on the first day of each of the last twelve calendar months. In our 2009 year-end reserve report, we used an average Light Crude price of $61.18 per Bbl, and a Henry Hub price of $3.87 per MMbtu adjusted by property for energy content, quality, transportation fees, and regional price differentials. While we believe that future operating costs can be reasonably estimated, future prices are difficult to estimate since the market prices are influenced by events beyond our control. Future global economic and political events will most likely result in significant fluctuations in future oil and gas prices. Application of the new reserve rules resulted in the use of lower prices at December 31, 2009 for both oil and gas than would have resulted under the previous rules.
Revenue Recognition
We recognize oil and gas revenue from interests in producing wells as the oil and gas is sold. Revenue from the purchase, transportation, and sale of natural gas is recognized upon completion of the sale and when transported volumes are delivered. We recognize revenue related to gas balancing agreements based on the entitlement method. Our net imbalance position at December 31, 2009, was immaterial.
Oil and Gas Exploration and Development
Oil and gas exploration and development costs are accounted for using the successful efforts method of accounting.
Property Acquisition Costs
Oil and gas leasehold acquisition costs are capitalized and included in the balance sheet caption properties, plants and equipment. Leasehold impairment is recognized based on exploratory experience and management’s judgment. Upon achievement of all conditions necessary for the classification of reserves as proved, the associated leasehold costs are reclassified to proved properties.
Exploratory Costs
Geological and geophysical costs and the costs of carrying and retaining undeveloped properties are expensed as incurred. Exploratory well costs are capitalized, or “suspended,” on the balance sheet pending further evaluation of whether economically recoverable reserves have been found. If economically recoverable reserves are not found, exploratory well costs are expensed as dry holes. If exploratory wells encounter potentially economic quantities of oil and gas, the well costs remain capitalized on the balance sheet as long as sufficient progress assessing the reserves and the economic and operating viability of the project is being made. For complex exploratory discoveries, it is not unusual to have exploratory wells remain suspended on the balance sheet for several years while we perform additional appraisal drilling and seismic work on the potential oil and gas field, or while we seek government or co-venturer approval of development plans or seek environmental permitting. Once all required approvals and permits have been obtained, the projects are moved into the development phase, and the oil and gas reserves are designated as proved reserves.
Development Costs
Costs incurred to drill and equip development wells, including unsuccessful development wells, are capitalized.
Depletion and Amortization
Leasehold costs of producing properties are depleted using the unit-of-production method based on estimated proved oil and gas reserves. Amortization of intangible development costs is based on the unit-of-production method using estimated proved developed oil and gas reserves.
Depreciation of Other Property and Equipment
Furniture, fixtures, equipment, and other are depreciated using the straight-line method over the estimated useful lives of the assets. The estimated life of these assets range from three to five years.
Impairment of Property and Equipment
Property and equipment used in operations are assessed for impairment whenever changes in facts and circumstances indicate a possible significant deterioration in the future cash flows expected to be generated by an asset group. If, upon review, the sum of the undiscounted pretax cash flows is less than the carrying value of the asset group, the carrying value is written down to estimated fair value through additional amortization or depreciation provisions and reported as impairments in the periods in which the determination of the impairment is made. Individual assets are grouped for impairment purposes at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets-generally on a field-by-field basis for exploration and production assets, at an entire complex level for refining assets or at a site level for retail stores. Because there usually is a lack of quoted market prices for long-lived assets, the fair value of impaired assets is determined based on the present values of expected future cash flows using discount rates commensurate with the risks involved in the asset group or based on a multiple of operating cash flow validated with historical market transactions of similar assets where possible. Long-lived assets committed by management for disposal within one year are accounted for at the lower of amortized cost or fair value, less cost to sell.
The expected future cash flows used for impairment reviews and related fair value calculations are based on estimated future production volumes, prices and costs, considering all available evidence at the date of review. If the future production price risk has been hedged, the hedged price is used in the calculations for the period and quantities hedged. The impairment review includes cash flows from proved developed and undeveloped reserves, including any development expenditures necessary to achieve that production. Additionally, when probable reserves exist, an appropriate risk-adjusted amount of these reserves may be included in the impairment calculation. The price and cost outlook assumptions used in impairment reviews differ from the assumptions used in the Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserve Quantities. In that disclosure, ASC 932-235, “Disclosures about Oil and Gas Producing Activities,” requires inclusion of only proved reserves and the use of prices and costs at the balance sheet date, with no projection for future changes in assumptions. Based on this analysis, we recorded impairment charges related to capitalized costs of oil and gas properties of $3.2 million for the year ended December 31, 2008. No impairment was recognized for the year ended December 31, 2009.
We have our unproved properties appraised by an independent appraiser. The most recent appraisal indicated a value of $8.3 million for these properties at December 31, 2009. Since this appraised value was in excess of the carrying amount of the unproved properties no impairment was recognized, however, an impairment charge of $4.6 million was recorded in 2008 because at that time the carrying value exceeded the appraised value.
Derivative Instruments
In accordance with the interpretive guidance in ASC 815-15, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” we valued the conversion feature of the separate issuances of secured convertible debentures and warrants in January and July 2006 as derivative liabilities. We must make certain periodic assumptions and estimates to value the derivative liability. Factors affecting the amount of this liability include changes in our stock price and the computed volatility of our stock price. The change in value is reflected in our statements of operations as non-cash income or expense, and the changes in the carrying value of derivatives may have a material impact on our financial statements. For the years ended December 31, 2009 and December 31, 2008, we recorded a non-cash charge of $104,000 and non-cash income of $19.2 million, respectively, upon revaluation of the instruments that are subject to this accounting treatment. The derivative liability associated with these instruments is reflected on our balance sheet as a short-term liability. This liability will remain until the secured convertible debentures are converted, exercised or repaid, and until the warrants are exercised, expire, or other events occur to cause the termination of the derivative accounting, the timing of which may be outside our control.
Our senior secured convertible notes and our convertible debentures contain embedded conversion features, pursuant to which all or part of the debt owed to the holder may be converted into shares of our common stock at an initial price of $0.65 per share, subject to certain adjustments, and the warrants we issued provide the holder with the right to purchase our common stock at prices ranging from $0.001 to $0.65 per share. As a result of the terms of our agreement to register the resale of the shares of our common stock issuable upon conversion or exercise of these instruments or warrants, we are required under applicable accounting rules to treat the conversion feature of the notes and debentures and the related warrants as liabilities, rather than as equity instruments. This classification as liabilities also requires that we account for them at fair value and include changes in fair value as a component of other income (expense) for so long as the warrants and the conversion feature of the notes and debentures remain classified as liabilities. Changes in fair value are based upon the market price of our common stock and are calculated using the Black-Scholes method of valuation. As a result, as the market price of our common stock increases, our other expense increases, and as the market price of our common stock decreases, our other income increases. This accounting treatment could result in wide swings of our other income (expense) and net income in the future.
Stock-Based Compensation
Effective January 1, 2006, we adopted ASC 718, “Share-Based Payment”. ASC 718 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. The pro forma disclosures previously permitted under SFAS 123 are no longer an alternative to financial statement recognition. We adopted ASC 718 using the modified prospective method which requires the application of the accounting standard as of January 1, 2006. The consolidated and combined financial statements for the years ended December 31, 2009 and 2008 reflect the impact of adopting ASC 718.
Capitalized Interest
Interest is capitalized as part of the historical cost of developing and constructing assets for significant projects. Significant oil and gas investments in unproved properties, significant exploration and development projects for which DD&A expense is not currently recognized, and exploration or development activities that are in progress qualify for interest capitalization. Interest is capitalized until the asset is ready for service. Capitalized interest is determined by multiplying the Company’s weighted-average borrowing cost on debt by the average amount of qualifying costs incurred. Once an asset subject to interest capitalization is completed and placed in service, the associated capitalized interest is expensed through depreciation or impairment, along with other capitalized costs related to that asset.
Asset Retirement Obligations
An asset retirement obligation associated with the retirement of a tangible long-lived asset is recognized as a liability in the period incurred, with an associated increase in the carrying amount of the related long-lived asset. The cost of the tangible asset, including the asset retirement cost, is depreciated over the useful life of the asset. The asset retirement obligation is recorded at its estimated fair value, measured by reference to the expected future cash outflows required to satisfy the retirement obligation discounted at the Company’s credit-adjusted risk-free interest rate. Accretion expense is recognized over time as the discounted liability is accreted to its expected settlement value. If the estimated future cost of the asset retirement obligation changes, an adjustment is recorded to both the asset retirement obligation and the long-lived asset. Revisions to estimated asset retirement obligations can result from changes in retirement cost estimates, revisions to estimated inflation rates and changes in the estimated timing of abandonment.
Income Taxes
Deferred income taxes are based on the difference between the financial reporting and tax basis of assets and liabilities. The deferred income tax provision represents the change during the reporting period in the deferred tax assets and deferred tax liabilities, net of the effect of acquisitions and dispositions. Deferred income tax assets include tax loss and credit carryforwards and are reduced by a valuation allowance if, based on available evidence, it is more likely than not that some portion of all of the deferred tax assets will be not be realized. Significant judgment is required in assessing the timing and amounts of deductible and taxable items. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions may be challenged and potentially disallowed. When facts and circumstances change, we adjust these reserves through our provision for income taxes.
To the extent interest and penalties may be assessed by taxing authorities on any underpayment of income tax, such amounts have been accrued and are classified as a component of income tax expense in our Statement of Operations.
We adopted the provisions of ASC 740, “Accounting for Uncertainty in Income Taxes” on January 1, 2007. The adoption did not result in a material adjustment to the Company’s tax liability for unrecognized income tax benefits. If applicable, we would recognize interest and penalties related to uncertain tax positions in interest expense. As of December 31, 2009, we had not accrued interest or penalties related to uncertain tax positions. The tax years 2006-2009 remain open to examination for federal income tax purposes and by the other major taxing jurisdictions to which we are subject.
In July 2006, the FASB issued FASB ASC 740 - Income Taxes effective for years beginning after December 15, 2006. The statement establishes a more-likely-than-not threshold for recognizing the benefits of tax return positions in the financial statements. Also, the statement implements a process for measuring those tax positions which meet the recognition threshold of being ultimately sustained upon examination by the taxing authorities. There are no uncertain tax positions taken by the Company on its tax returns and the adoption of the statement had no material impact to the Company’s consolidated financial statements. The Company files tax returns in the US and states in which it has operations and is subject to taxation. Tax years subsequent to 2005 remain open to examination by U.S. federal and state tax jurisdictions.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data
The Report of Independent Registered Public Accounting Firm and Consolidated Financial Statements are set forth beginning on page 51 of this Annual Report on Form 10-K and are incorporated herein.
The financial statement schedules have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or the Notes to the Consolidated Financial Statements.
Item 9.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
On September 9, 2008, Hein & Associates LLP, Certified Public Accountants of Dallas, Texas resigned as Wentworth Energy, Inc.’s principal independent accountants and MaloneBailey, LLP, Certified Public Accountants of Houston, Texas were appointed in their place.
The former principal accountants’ reports on the financial statements for the years ended December 31, 2006 and December 31, 2007 contained no adverse opinions, disclaimers of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principles, except that their report for each such year expressed substantial doubt about the Company’s ability to continue as a going concern.
The appointment of the new accountants, MaloneBailey, LLP, was recommended by the Company’s audit committee and approved by its board of directors on September 9, 2008.
During the years ended December 31, 2006 and December 31, 2007 and the interim period preceding their resignation, there were no disagreements with the former accountants on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of the former accountants, would have caused them to make reference to the subject matter of the disagreements in connection with their reports.
During the years ended December 31, 2006 and 2007, and any subsequent period through September 9, 2008, the Company did not consult with MaloneBailey, LLP regarding either (i) the application of accounting principles to a specific completed or contemplated transaction, or the type of audit opinion that might be rendered on the Company’s financial statements or (ii) any matter that was either the subject of disagreement or event identified in response to (a)(1)(iv) of Item 304 of Regulation S-K.
Item 9A.
Item 9A. Controls and Procedures
Management’s Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures have been designed to ensure that information required to be disclosed by the Company is collected and communicated to management to allow timely decisions regarding required disclosures. The Chief Executive Officer and the Chief Financial Officer have concluded, based on their evaluation as of December 31, 2009 that, as a result of the material weaknesses described below, disclosure controls and procedures were ineffective in providing reasonable assurance that material information is made known to them by others within the Company.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles (“GAAP”). Management has assessed the effectiveness of internal control over financial reporting based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework . A material weakness, as defined by SEC rules, is a control deficiency, or combination of control deficiencies, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses in internal control over financial reporting that were identified are:
a)
We did not maintain sufficient personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of GAAP commensurate with our complexity and our financial accounting and reporting requirements. We have limited experience in the areas of financial reporting and disclosure controls and procedures. Also, we do not have an independent audit committee. As a result, there is a lack of monitoring of the financial reporting process and there is a reasonable possibility that material misstatements of the consolidated financial statements, including disclosures, will not be prevented or detected on a timely basis; and
b)
Due to our small size, we do not have a proper segregation of duties in certain areas of our financial reporting process. The areas where we have a lack of segregation of duties include cash receipts and disbursements, approval of purchases and approval of accounts payable invoices for payment. This control deficiency, which is pervasive in nature, results in a reasonable possibility that material misstatements of the financial statements will not be prevented or detected on a timely basis.
As a result of the existence of these material weaknesses as of December 31, 2009, management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2009, based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to temporary rules of the SEC that permit the company to provide only management's report in this annual report.
Changes to Internal Controls and Procedures over Financial Reporting
Our internal control over financial reporting has been modified during our most recent year by adding additional advisors to address deficiencies in the financial closing, review and analysis process, which has improved our internal control over financial reporting. On January 15, 2010 we hired a new Chief Financial Officer to further strengthen our internal controls.
Management’s Remediation Plans
We will look to increase our personnel resources and technical accounting expertise within the accounting function as funds become available. Management believes that hiring additional knowledgeable personnel with technical accounting expertise will remedy the following material weakness: insufficient personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of GAAP commensurate with our complexity and our financial accounting and reporting requirements.
Item 9B.
Item 9B. Other Information
There was no material information during the fourth quarter of 2009 not previously reported.
PART III
Item 10.
Item 10. Directors, Executive Officers, and Corporate Governance
Management and Board of Directors
The following table sets forth the name, age and position of each of our directors and executive officers as of the date of this Annual Report:
Name
Age
Position(s) With the Company
Position Held
Since
Director
Since/During
David Steward
Chief Executive Officer, Chairman of the Board and Director
December 13, 2007
July 26, 2007
Allen McGee
Chief Financial Officer and Director
January 15, 2010
January 15, 2010
Felicia Williamson
Secretary and Treasurer
January 15, 2010
N/A
Jack B. Evans
Director
February 18, 2010
February 18, 2010
Michael S. Studdard
Director
August 21, 2006
August 21, 2006
Our directors are elected during annual stockholders’ meeting with terms ranging from one to three years. Officers will hold their positions at the pleasure of the board of directors. There is no arrangement or understanding between our directors and officers and any other person under which any director or officer was or is to be selected as a director or officer.
The following is a brief description of the business experience during the past five years of each of the above-named persons:
David Steward
Mr. Steward was appointed our chief executive officer and chairman of the board of directors in December 2007. Mr. Steward has been a landman for almost four decades and is a member of the American Association of Professional Landmen and the Society of Exploration Geophysicists. He is a 25% owner, director and Vice President of Horseshoe Energy, Inc., a private oil and gas company, is a partner in Steward Oil and Gas, LLC and Sierra Mineral & Royalty, and remains active in the family oil and gas business. Mr. Steward also owns Steward Estates, which owns a commercial office building near Conroe, Texas. Mr. Steward received a BBA degree from Texas A&I University, which is a part of the Texas A&M University system. Mr. Steward devotes 90% of his time to the Company. Mr. Steward’s leadership abilities and oil and gas experience, among other factors, led the board of directors to conclude that he should serve as a director of the Company.
Allen McGee
Mr. McGee was appointed our chief financial officer and elected as a director on January 15, 2010. Mr. McGee has served as president of Allen Roberts McGee, P.C., an accounting firm, since January 1989. Mr. McGee also served as chief financial officer for Petro Resources Corporation (now Magnum Hunter Resources Corp.) from April 2005 to May 2007, and as its chief accounting officer from June 2007 to June 2009. Mr. McGee’s accounting and financial experience as well as his service as an executive officer of another public company, among other factors, led the Board to conclude that he should serve as a director of the Company.
Felicia Williamson
Ms. Williams was appointed our secretary and treasurer on January 15, 2010, and has been a non-executive employee of the company since December 2006. From 1999 to November 2006, Ms. Williamson was employed as a probation officer in Dallas County, Texas.
Jack B. Evans
Mr. Evans was elected as a director on February 18, 2010. Mr. Evans has over 30 years of financial and accounting experience with both public and private companies. Mr. Evans, a Certified Public Accountant, has operated a private accounting practice since 1983. Mr. Evans also holds a B.A. from the University of Houston. Mr. Evan’s accounting and financial experience, among other factors, led the board of directors to conclude that he should serve as a director of the Company.
Michael S. Studdard
Michael Studdard was our President and director from August 2006 until November 2008. He has continued as a director since his retirement as President in November 2008. Mr. Studdard is a member of the American Association of Professional Landmen and the Society of Exploration Geophysicists. From 1992 to July 2006, he was an independent landman and founded Michael S. Studdard & Associates, a small, private company specializing in seismic permitting and exploration ventures. Mr. Studdard founded Signature Geophysical, where he was responsible for hiring and supervising landmen, field crews, sales, and marketing. From 1989 to 1992, he was Regional Director of Sales for GFS Company, where he was responsible for coordinating and managing sales and marketing activities and developing relationships with oil and gas companies including Mobil, Texaco, Exxon and Chevron in addition to independent exploration companies. From 1986 to 1992, he was the National Sales Director with TGC Industries. From 1976 to 1986, he was co-owner of Ward Exploration, where he was Manager of Public Relations and sales responsible for personnel and budgets as well as manager of field crew operations. Prior thereto, Mr. Studdard served in various capacities with SPS Services, Inc. Mr. Studdard’s oil and gas experience, among other factors, led the board of directors to conclude that he should serve as a director of the Company.
Audit Committee and Audit Committee Financial Expert
We have an audit committee currently comprising only one director at the present time - Jack B. Evans. Our board of directors has determined that Mr. Evans, is a financial expert, as that term is defined under applicable securities regulations.
The board of directors has determined that Mr. Evans is an “independent” director as defined by applicable laws, rules, and listing standards including, without limitation, the standards for independent directors established by The New York Stock Exchange, Inc., The NASDAQ National Market, and the Securities and Exchange Commission. Subject to some exceptions, these standards generally provide that a director will not be independent if (a) the director is, or in the past three years has been, an employee of ours; (b) a member of the director’s immediate family is, or in the past three years has been, an executive officer of ours; (c) the director or a member of the director’s immediate family has received more than $120,000 per year in direct compensation from us other than for service as a director (or for a family member, as a non-executive employee); (d) the director or a member of the director’s immediate family is, or in the past three years has been, employed in a professional capacity by our independent public accountants, or has worked for such firm in any capacity on our audit; (e) the director or a member of the director’s immediate family is, or in the past three years has been, employed as an executive officer of a company where one of our executive officers serves on the compensation committee; or (f) the director or a member of the director’s immediate family is an executive officer of a company that makes payments to, or receives payments from, us in an amount which, in any twelve-month period during the past three years, exceeds the greater of $1,000,000 or two percent of that other company’s consolidated gross revenues.
Board Leadership Structure
The Company's board of directors is currently chaired by the chief executive officer of the Company, Mr. Steward. The Company believes that combining the positions of chief executive officer and board chair helps to ensure that the board of directors and management act with a common purpose. In the Company's view, separating the positions of chief executive officer and board chair has the potential to give rise to divided leadership, which could interfere with good decision-making or weaken the Company's ability to develop and implement strategy. Instead, the Company believes that combining the positions of chief executive officer and board chair provides a single, clear chain of command to execute the Company's strategic initiatives and business plans. In addition, the Company believes that a combined chief executive officer/board chair is better positioned to act as a bridge between management and the board of directors, facilitating the regular flow of information. The Company also believes that it is advantageous to have a board chair with an extensive history with and knowledge of the Company (as is the case with the Company's chief executive officer) as compared to a relatively less informed independent board chair.
Role of the Board in Risk Oversight
One of the board’s key functions is informed oversight of the Company's risk management process. The board administers this oversight function directly through the board as a whole, as well as through the board's standing committees that address risks inherent in their respective areas of oversight. In particular, our board is responsible for monitoring and assessing strategic risk exposure, including a determination of the nature and level of risk appropriate for the Company. Our Audit Committee has the responsibility to consider and discuss our major financial risk exposures and the steps our management has taken to monitor and control these exposures, including guidelines and policies to govern the process by which risk assessment and management is undertaken. The Audit Committee also monitors compliance with legal and regulatory requirements, in addition to oversight of the performance of our audit function.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our executive officers and directors, and persons who beneficially own more than 10% of our common stock, to file initial reports of ownership and reports of changes in ownership with the SEC. Executive officers, directors and greater than 10% beneficial owners are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. To the Company’s knowledge, based solely on a review of the copies of such reports furnished to the Company and written representations that no other reports were required, as of the date of this report, all Section 16(a) filing requirements applicable to its officers, directors and greater than ten percent beneficial owners are complied with.
Code of Ethics
We have adopted a code of ethics which applies to all our directors, officers and employees. A copy of our “Code of Ethics and Business Conduct for Officers, Directors and Employees” was filed with the Securities and Exchange Commission as Exhibit 14.1 to our Annual Report on Form 10-KSB for the year ended December 31, 2005 filed on April 17, 2006 and incorporated herewith by reference.
Item 11.
Item 11. Executive Compensation
Summary Compensation Table
The following table sets forth the compensation awarded to, earned by or paid to our Chief Executive Officer, to our most highly compensated executive officers who were serving as an executive officer at December 31, 2009, other than our Chief Executive Officer, and up to two additional individuals for whom disclosure would have been required but for the fact that the individuals were not serving as executive officers at December 31, 2009 (collectively, the “Named Executed Officers”).
1. Francis Ling resigned as chief financial officer and director of the Company effective January 1, 2010.
The Company has entered into various consulting agreements and employment agreements in connection with services rendered to the Company by management. The material terms of such agreements are as follows:
David Steward
On March 25, 2009, the Company agreed to extend the term of Mr. Steward’s consulting agreement dated November 16, 2007 (the “Consulting Agreement”) for a period of one year that ended on ended on October 31, 2009.
Under the extended Consulting Agreement, Mr. Steward received as compensation for his services, $15,000 per month and an annual bonus based on the Company’s financial results, oil and gas production and the performance of the Company’s stock. Mr. Steward may terminate the Consulting Agreement at any time by giving the Company sixty days advance written notice. The Company may terminate the Consulting Agreement at any time without cause.
On March 25, 2009, the Company also issued an option (the “Option”) to purchase 500,000 shares of the Company’s common stock to Mr. Steward. The Option is immediately exercisable, with an exercise price of $0.03 per share, subject to antidilution provisions, and expires on March 24, 2014. The Option was issued pursuant to the Company’s 2007 Stock Incentive Plan.
Recent Change of our Chief Financial Officer
Francis Ling resigned as the Company’s chief financial officer and director effective January 1, 2010. Allen McGee was appointed as the Company’s new chief financial officer and elected as a director on January 15, 2010. In 2009, Mr. McGee provided accountant services to the Company as an independent contractor, pursuant to which he was paid an aggregate of $18,000 for services rendered. Mr. McGee will be paid an annualized salary of $72,000 per year in connection with his service as the Company’s chief financial officer. The Company has agreed to make such salary payments directly to Mr. McGee’s accounting firm, Allen Roberts McGee, P.C.
Outstanding Equity Awards at Fiscal Year End
The following tables set forth information concerning unexercised options, stock that has not vested, and equity incentive awards outstanding as of December 31, 2009 for each of the Named Executive Officers.
1.
The stock options granted to Francis Ling originally vested at a rate of 100,000 options per calendar quarter commencing December 31, 2005. Pursuant to the stock option amendment on November 14, 2007, these options were accelerated into 2007.
2.
On November 14, 2007, these stock option agreements were amended to extend the option expiration dates from February 28, 2008 to February 28, 2011 and from April 2, 2010 to April 2, 2013.
The material terms of our agreements with our Named Executive Officers relating to the payment of retirement benefits, and payments in connection with their resignation, termination or change in responsibilities following a change of control are described in “Summary Compensation Table” above.
Copies of each of the option agreements, and any amendments thereto, listed below are included in the exhibit list that is part of the 2007 Annual Report on Form 10-KSB/A - Amendment No. 2.
Compensation of Directors
The following table sets forth information concerning the compensation of our directors, excluding Named Executive Officers who are also directors, for the year ended December 31, 2009:
Directors Compensation
Name
Fees Earned or Paid in Cash
($)
Stock Awards
($)
Option Awards
($)
Non-Equity Incentive Plan Compensation
($)
Non-Qualified Deferred Compensation Earnings
($)
All Other Compensation
($)
Total
($)
Roger D. Williams
12,500
-
-
-
-
-
12,500
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2008 with respect to compensation plans (including individual compensation arrangements) under which our equity securities are authorized for issuance:
Plan Category
Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights
(a)
Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights
(b)
Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))
(c)
Equity compensation plans approved by security holders
1,800,000
$0.55
578,249
Equity compensation plans not approved by security holders
15,096,000
$0.63
n/a
Total
16,396,000
$0.64
578,249
On July 26, 2007, the Company’s stockholders approved a stock incentive plan (the “Stock Incentive Plan”) for employees, directors, officers, consultants, and advisors of the Company to provide a means to motivate, attract and retain the services of such individuals in order to promote the success of the Company. The 2007 Plan reserved 2,378,249 shares of common stock for issuance by the Company either directly as stock awards or underlying stock options. At December 31, 2009, 578,249 shares were available under the Plan for future issuance.
Prior to the implementation of the Stock Incentive Plan and the Directors’ Stock Option Plan, we did not have a formal equity compensation plan and our Board of Directors granted stock options on an ad hoc basis to directors, officers, employees and consultants.
Security Ownership of Certain Beneficial Owners
The following table provides information regarding our shares of outstanding Common Stock beneficially owned as of the date hereof by (a) each person who is known to us to be the beneficial owner of more than 5% of any class of our outstanding voting securities, (b) each of our directors, (c) each of our Named Executive Officers, and (d) all of our directors and executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and includes a voting and investment power with respect to shares. Unless otherwise indicated, the persons named in the table have sole voting and sole investment control with respect to all shares beneficially owned, subject to community property laws where applicable. Shares of Common Stock subject to options and warrants currently exercisable or convertible, or exercisable or convertible within 60 days of the date of this Annual Report on Form 10-K, are deemed beneficially owned and outstanding from computing the percentage of the person holding such securities, but are not considered outstanding for computing the percentage of any other person, except with respect to group totals.
Name and Address of Beneficial Owner 1
Title of Class
Amount and Nature of Beneficial Ownership
% of
Class
Named Executive Officers and Directors
David W. Steward
420 E. Reunion
Fairfield, Texas 75840
Common
767,300 2
*
Francis K. Ling
Suite 98, 2603 - 162nd Street, Surrey, BC, Canada
Common
1,407,500 3
1.0%
Allen McGee
4265 San Felipe, #1040
Houston, Texas 77027
Common
*
Jack B. Evans
3 Riverway Ste 125
Houston, Texas 77056
Common
2,775,0004
2.07%
Michael S. Studdard
5110 Anderson County Road 2206,
Palestine, Texas 75801
Common
2,870,838 5
2.12%
All Directors and Executive Officers as a Group
Common
7,820,638
5.84%
*
Less than 1%.
1.
The terms of our senior secured convertible notes and related warrants restrict the noteholder from converting or exercising the senior secured convertible notes or related warrants if the senior secured convertible noteholder (and its affiliates) would beneficially own in excess of 4.99% of the number of shares of common stock outstanding immediately after giving effect to such conversion or exercise. The terms of our convertible debentures and related warrants restrict the debentureholder from (a) converting the convertible notes if the convertible debentureholder (and its affiliates) would beneficially own in excess of 4.9% of the number of shares of common stock outstanding immediately after giving effect to such conversion and (b) exercising the related warrants if the convertible debentureholder (and its affiliates) would beneficially own in excess of 4.9% of the number of shares of common stock outstanding immediately after giving effect to such exercise. Due to the ownership restriction in the senior secured convertible notes, convertible debentures and warrants, we did not list any of the holders of the notes, debentures or warrants from the January 2006, July 2006 or October 2007 private placement as 5% or greater beneficial owners in this table.
2.
Represents 267,300 shares of common stock owned of David W. Steward and Pam Steward, as joint tenants and 500,000 shares of common stock issuable upon exercise of options exercisable within 60 days held by Mr. Steward.
3.
Represents 61,500 shares of common stock owned of record by Mr. Ling and 1,346,000 shares of common stock issuable upon exercise of options exercisable within 60 days held by Mr. Ling.
4.
Represents (i) 1,000,000 shares of common stock owned by record of Mr. Evans, (ii) 1,000,000 shares of common stock owned by record of the Jack B. Evans SEP, and (iii) 750,000 shares of common stock owned by record of Claire G. Evans, the mother of Mr. Evan. Mr. Evans shares voting and investment power with respect to the shares held by Claire G. Evans.
5.
Represents 1,500,000 shares of common stock owned by Roboco Energy, Inc. of which Mr. Studdard owns 1/3 of the issued and outstanding shares and 1,370,838 shares of common stock issuable upon exercise of options exercisable within 60 days held by Mr. Studdard.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Except for transactions set forth under the heading “Executive Compensation” and as described below, there have been no transactions or proposed transactions since the beginning of our last fiscal year requiring disclosure pursuant to Item 404 of Regulation S-K.
The Company paid management and consulting fees to its directors, persons related to directors or entities controlled by directors. The total expense for these fees for the year ended December 31, 2009 was $348,260.
As of December 31, 2009, the Company had an account receivable of $13,050 due from an entity owned by a former President and current director of the Company. During the fourth quarter of 2008, the Company determined that it was overpaying overriding royalties to Roboco Energy, Inc., a corporation owned by Mike Studdard, the Company’s former President and a current director. As a result, the Company recorded an account receivable for the overpayment. This overpayment will be deducted from future overriding royalties.
The Company paid overriding royalties to a corporation controlled by a director and/or a director’s family member. The total overriding royalties paid to these parties for the year ended September 30, 2009 was $6,597.
Director Independence
We have determined that the following individuals who currently serve as a director or served as a director during any part of the last completed fiscal year are not independent, as that term is defined in Item 407 to Regulation S-K:
Name
Committee Membership
Jack Evans
Audit Committee
Roger Williams1
None
1 Resigned during November 2009
We have determined that the following individuals who currently serve as a director or served as a director during any part of the last completed fiscal year are not independent, as that term is defined in Item 407 to Regulation S-K:
Name
Committee Membership
David Steward
None
Francis K. Ling1
Audit Committee
Allen McGee
None
Michael Studdard
None
1 Resigned during January 2010
Indemnification of Officers and Directors
The Oklahoma Statutes provide that we may indemnify our officers and directors for costs and expenses incurred in connection with the defense of actions, suits, or proceedings where the officer or director acted in good faith and in a manner he reasonably believed to be in our best interest and is a party by reason of his status as an officer or director, absent a finding of negligence or misconduct in the performance of duty.
Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or persons controlling the Company under the foregoing provisions, we have been informed that, in the opinion of the Securities and Exchange Commission, this indemnification is against public policy as expressed in that Act and is, therefore, unenforceable.
Conflicts of Interest
There will be occasions when the time requirements of our business conflict with the demands of the officers’ other business and investment activities. These conflicts may require that we attempt to employ additional personnel. There is no assurance that the services of additional personnel will be available or that they can be obtained upon terms favorable to us.
Some of our officers and directors also are officers, directors, or both of other corporations. These companies may be in direct competition with us for available opportunities.
Our Chairman and Chief Executive Officer, David W. Steward, is a director and Vice President of Horseshoe Energy, Inc. David Steward owns a 3% undivided interest in the P.D.C. Ball mineral property. Mr. Steward is also a partner along with his wife and son’s of Sierra Minerals & Royalty, which holds the producing royalty interest on the P.D.C. ball mineral property. In addition, he is a partner in Steward Oil and Gas, LLC which owns interests in oil and gas properties, or provides services to companies who own interests in oil and has properties throughout Texas.
Our former President, Michael S. Studdard, is an officer, director or owner of the following companies who own interests in oil and gas properties, or provide services to companies who own interests in oil and gas properties, in East Texas: Mike Studdard & Associates, PMS Leasing, Bayou Interests, Roboco Energy, Inc., Rock Bottom Oil Company, GP, LLC, and South Buffalo Partners.
Mr. Steward and Mr. Studdard have agreed to not accept any work, enter into a contract or accept any obligation that is inconsistent or incompatible with their positions with us, but their fiduciary obligations to these companies may, from time to time, conflict with their obligations to us. The determination of whether a contract or obligation is inconsistent or incompatible with the positions of these individuals with the Company will be within the control of each individual and if any of these individuals have conflicting fiduciary duties to us and to any other entity, we have no assurance that the Company will be given a priority over any other entity in resolving a conflict in fiduciary duties.
Our Code of Ethics requires all our officers and directors to avoid any action that may involve, or may appear to involve, a conflict of interests with us. However, our directors and officers may, in the future, become affiliated with other companies in businesses similar to ours. As such, they will have fiduciary duties to these other companies. To the extent that a director or officer identifies business opportunities that may be suitable for companies with whom they are affiliated, they will honor those fiduciary obligations. Accordingly, they may not present opportunities to us that otherwise may be attractive to us unless the other companies have declined to accept such opportunities.
Our Code of Ethics requires all officers or directors to disclose to us any situation that presents the possibility of a conflict of interests. To the extent that conflicts of interest arise, such conflicts will be resolved in accordance with the provisions of the Oklahoma General Corporation Act (the “OGCA”). Under the OGCA, a transaction between a corporation and an interested director or officer may be protected against challenges based solely on the conflict of interest if (a) the material facts of the interested relationship are disclosed or known and the transaction is approved in good faith by vote of either the majority of the disinterested directors, or the shareholders; or (b) the transaction is fair to the company at the time it is approved. We will endeavor to resolve such conflicts amicably.
Item 14.
Item 14. Principal Accountant Fees and Services
Audit Fees
The fees to MaloneBailey, LLP for the audit of our annual statements and review of the quarterly reports for the fiscal year ended December 31, 2009 are estimated at $70,200. The fees for the audit of the annual statements for the fiscal year ended December 31, 2008 totaled $96,000.
PART IV
Item 15.
Item 15. Exhibits
The following exhibits are attached hereto or are incorporated by reference:
* Filed herewith
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: April 15, 2010
WENTWORTH ENERGY, INC.
(Registrant)
/s/ DAVID STEWARD
David Steward
Chief Executive Officer
(Principal Executive Officer)
/s/ ALLEN MCGEE
Allen McGee
Chief Financial Officer
(Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Capacity
Date
/s/ DAVID STEWARD
David Steward
Chief Executive Officer, Chairman of the Board and Director
April 15, 2010
/s/ ALLEN MCGEE
Allen McGee
Chief Financial Officer and Director
April 15, 2010
/s/ JACK B. EVANS
Jack B. Evans
Director
April 15, 2010
/s/ MICHAEL STUDDARD
Michael Studdard
Director
April 15, 2010
Wentworth Energy, Inc.
Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders’ (Deficit)
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
Supplemental Information (Unaudited)
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Wentworth Energy, Inc.
Palestine, Texas
We have audited the accompanying consolidated balance sheets of Wentworth Energy, Inc. as of December 31, 2009 and 2008 and the related consolidated statements of operations, shareholders’ deficit, and cash flows for the years then ended. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Wentworth Energy, Inc. as of December 31, 2009 and 2008 and the results of operations and cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company suffered losses from operations and has a working capital deficiency, which raises substantial doubt about its ability to continue as a going concern. Management’s plans regarding those matters also are described in Note 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ MaloneBailey, LLP
www.malone-bailey.com
Houston, Texas
April 14, 2010
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
Wentworth Energy, Inc.
Notes to the Consolidated Financial Statements
1. Nature of Operations
Wentworth Energy, Inc. (“Wentworth” or the “Company”) is an exploration and production company engaged in oil and gas exploration and production primarily in the East Texas area. The Company’s strategy is to lease all of its property in exchange for royalty interest and working interest participation in shallow zones.
2. Significant Accounting Policies
a) Consolidation
These consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Barnico Drilling, Inc. Barnico Drilling, Inc. was sold in 2008. All significant inter-company transactions have been eliminated in consolidation.
b) Oil and gas activities
The Company follows the successful efforts method under which lease acquisition costs and intangible drilling and development costs on successful wells, development dry holes and asset retirement costs are capitalized. Costs of drilling exploratory wells are initially capitalized, but charged to expense if and when a well is determined to be unsuccessful.
Geological and geophysical costs and the costs of carrying and retaining undeveloped properties are expensed as incurred. Exploratory well costs are capitalized on the balance sheet pending further evaluation of whether economically recoverable reserves have been found. If economically recoverable reserves are not found, exploratory well costs are expensed as dry holes. If exploratory wells encounter potentially economic quantities of oil and gas, the well costs remain capitalized on the balance sheet as long as sufficient progress assessing the reserves and the economic and operating viability of the project is being made. Costs incurred to drill and equip development wells, including unsuccessful development wells, are capitalized.
Costs directly associated with the acquisition and evaluation of unproved properties is excluded from the amortization base until proved reserves are discovered. Once proved reserves are discovered, the costs are reclassified to proved properties. Unproved oil and gas properties that are individually significant are assessed at least annually for impairment of value, and a loss is recognized at the time of impairment by providing an impairment allowance. Capitalized costs of proved oil and gas properties are depreciated and depleted on a field basis by the units-of-production method based on proved reserves as estimated by an independent petroleum engineering firm. Support equipment and other property and equipment are depreciated over their estimated useful lives.
The Company evaluates the carrying value of its long-lived assets when indicators of impairment are present and the undiscounted future cash flows estimated to be generated by those assets are less than the assets' carrying amount. If such assets are impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying value or fair value, less costs to sell. For the years ended December 31, 2009 and 2008, the Company recognized impairment losses of $0.4 million and $0.8 million on its assets held for sale which is included in the Loss from discontinued operations in the Consolidated Statements of Operations. (see also Note 16)
The Company performs a review for impairment of proved oil and gas properties on a field basis. Undiscounted future net cash flows and fair value of a proved field are determined using the undiscounted and discounted future net revenue calculations, respectively, provided by an independent petroleum engineering firm. Based on this analysis, the Company recorded impairment charges related to capitalized costs of oil and gas properties of $3.2 million for the year ended December 31, 2008. No impairment was recognized for the year ended December 31, 2009.
The Company’s unproved properties were appraised by an independent appraiser as of December 31, 2009 and 2008 and the appraisal indicated a value of $8.3 million and $5.7 million, respectively. As of December 31, 2009, since the appraised value was in excess of the carrying amount of the unproved properties, no impairment was recognized. However, an impairment charge of $4.6 million was recorded in 2008 because at that time the carrying value exceeded the appraised value. Oil and gas prices were severely depressed at December 31, 2008, which led to the impairment.
On the sale or retirement of a complete unit of a proved property, the cost and related accumulated depreciation, depletion, and amortization are eliminated from the property accounts, and the resultant gain or loss is recognized. On the retirement or sale of a partial unit of proved property, the cost is charged to accumulated depreciation, depletion, and amortization with a resulting gain or loss recognized in income.
On the sale of an entire interest in an unproved property, gain or loss on the sale is recognized, taking into consideration the amount of any recorded impairment if the property had been assessed individually. If a partial interest in an unproved property is sold, the amount received is treated as a reduction of the cost of the interest retained.
All of the Company’s working interests (divided and undivided) are reported in the Company’s consolidated financial statements with proportionate share of the Company’s revenue and expenses in each major revenue and expense caption on the consolidated statement of operations and proportionate share of assets and liabilities separately in each major asset and liability caption on the consolidated balance sheets.
c) Cash and cash equivalents
For the purpose of reporting cash flows, the Company considers all short-term investments with an original maturity of three months or less to be cash equivalents.
d) Restricted cash
Restricted cash represents amounts maintained to guarantee our letters of credit.
e) Accounts receivable
As of December 31, 2009 and 2008 the Company’s accounts receivable primarily consisted of oil and natural gas proceeds receivable. The Company requires no collateral for such receivables, nor does it charge interest on past due balances. Management periodically reviews accounts receivable for collectability and reduces the carrying amount of the accounts receivable by an allowance. No such allowance was necessary at December 31, 2009 or December 31, 2008.
f) Revenue recognition
Revenues associated with sales of crude oil, natural gas, natural gas liquids and petroleum products, and other items are recognized using the sales method, which is when title and risk of ownership passes to the purchaser and physical delivery of goods occurs, either immediately or within a fixed delivery schedule that is reasonable and customary in the industry.
Revenues from the production of natural gas and crude oil properties, in which we have an interest with other producers, are recognized based on the actual volumes we sold during the period. Any differences between volumes sold and entitlement volumes, based on our net working interest, which are deemed to be non-recoverable through remaining production, are recognized as accounts receivable or accounts payable, as appropriate. Cumulative differences between volumes sold and entitlement volumes are generally not significant.
g) Concentration of credit risk
The Company maintains its deposits primarily in one financial institution, which at times may exceed amounts covered by insurance provided by the U.S. Federal Deposit Insurance Corporation (“FDIC”) of $250,000. At December 31, 2009 and 2008, the Company had approximately $282,000 and $351,000 of uninsured deposits, respectively. During 2008 the Company had a sweep account in which the balance was invested daily in high-interest earning Eurodollar deposit accounts. The balance for the sweep account was approximately $66,000 at December 31, 2008. The Eurodollar deposits were not insured by the FDIC. The Company did not experience any losses with respect to uninsured balances. As of December 31, 2009, the Company no longer maintained a sweep account.
h) Property and equipment
Property and equipment are stated at cost, less accumulated depreciation. Depreciation for financial reporting purposes is computed using the straight-line method over the estimated useful lives of assets, which range from five to seven years. Gains and losses on sales and retirements of property and equipment are reflected in income. Depreciation expense was $23,113 and $23,858 for the years ended December 31, 2009 and 2008, respectively.
i) Deferred financing costs
Financing costs with respect to the 10% convertible debentures totaling $0.3 million were recorded and were being expensed using the effective interest method over the remaining months until maturity of the debentures on January 11, 2009. The Company also recorded a discount for the convertible debentures, as described in Note 9. Due to the default on the debentures, as also described in Note 9, the remaining unamortized finance costs and discount were charged to expense at the date of the default. Amortization expense for the years ended December 31, 2009 and 2008 was $ 0 and $870,000, respectively.
Financing costs with respect to the 9.15% senior secured convertible notes totaling $11.2 million were originally recorded and were being expensed using the effective interest method over the remaining months until maturity of the notes. The maturity date of the convertible notes was extended from July 2009 until October 2010 as a result of the debt restructuring described in Note 9. The Company also recorded a discount for the senior secured convertible notes as described in Note 9. Due to the default on the notes, as also described in Note 9, the remaining unamortized finance costs and discount were charged to expense. Amortization expense for the years ended December 31, 2009 and 2008 was $0 and $35.3 million, respectively.
j) Use of estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements, and the reported amounts of revenues and expenditures during the reporting period. Significant areas requiring the use of management estimates relate to the determination of impairment of oil and gas property costs, stock based compensation and derivative contract liabilities. By their nature, these estimates are subject to measurement uncertainty and the effect on the financial statements of changes in such estimates in future periods could be significant. Actual results could differ materially from those reported.
k) Stock based compensation
The Company accounts for stock based compensation issued to employees and non-employees in accordance with the guidance on share-based payments. Accordingly, the cost of services received in exchange for equity instruments is measured at fair value at the grant date. For the years ended December 31, 2009 and 2008, the Company recognized stock compensation expense of $4,222 and $0, respectively.
l) Income taxes
The Company recognizes deferred tax assets and liabilities based on differences between the financial reporting and tax bases of assets and liabilities using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered. The Company provides a valuation allowance for deferred tax assets for which it does not consider realization of such assets to be more likely than not.
The Company evaluates tax positions taken or expected to be taken in the course of preparing its tax returns using a two-step process. The first step is a recognition process to determine whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more likely than not recognition threshold, it is presumed that the position will be examined by the appropriate taxing authority with full knowledge of all relevant information. The second step is a measurement process whereby a tax position that meets the more likely than not recognition threshold is calculated to determine the amount of benefit/expense to recognize in the financial statements. The tax position is measured at the largest amount of benefit/expense that is more likely than not of being realized upon ultimate settlement. No liability for unrecognized tax benefits was recorded as of December 31, 2009 and 2008.
m) Asset retirement obligations
An asset retirement obligation associated with the retirement of a tangible long-lived asset is recognized as a liability in the period incurred, with an associated increase in the carrying amount of the related long-lived asset. The cost of the tangible asset, including the asset retirement cost, is depreciated over the useful life of the asset. The asset retirement obligation is recorded at its estimated fair value, measured by reference to the expected future cash outflows required to satisfy the retirement obligation discounted at the Company’s credit-adjusted risk-free interest rate. Accretion expense is recognized over time as the discounted liability is accreted to its expected settlement value. If the estimated future cost of the asset retirement obligation changes, an adjustment is recorded to both the asset retirement obligation and the long-lived asset. Revisions to estimated asset retirement obligations can result from changes in retirement cost estimates, revisions to estimated inflation rates and changes in the estimated timing of abandonment.
n) Fair value of financial instruments
All significant financial assets, financial liabilities and equity instruments of the Company are either recognized or disclosed in the financial statements together with other information relevant for making a reasonable assessment of future cash flows, interest rate risk and credit risk. The Company’s financial instruments consist primarily of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, convertible debt and derivative liabilities. The carrying values of these instruments, except for the derivative liabilities, are considered to approximate their respective fair values because of the short maturity of these instruments. The fair value of the derivative liabilities was determined using the Black-Scholes option pricing model.
o) Embedded derivatives
The Company evaluates embedded derivatives in accordance with ASC Topic 815-15 and 815-40 to determine whether the embedded feature should be bifurcated from the host instrument and accounted for as a derivative at fair value with changes in fair value recorded in earnings. If an embedded conversion feature does not require derivative treatment under the above guidance, the instrument is evaluated for consideration of any beneficial conversion feature.
The valuation of the Company’s embedded derivatives and warrant derivatives are determined primarily by the Black-Scholes option pricing model. To determine the fair value of the embedded derivatives, management evaluates assumptions regarding the probability of certain future events. Other factors used to determine fair value include the Company’s period end stock price, historical stock volatility, risk free interest rate and derivative term. The fair value recorded for the derivative liability varies from period to period. This variability may result in the actual derivative liability for a period either above or below the estimates recorded in the consolidated financial statements, resulting in significant fluctuations in other income (expense) because of the corresponding non-cash gain or loss recorded.
p) Subsequent Events
In accordance with applicable accounting standards for the disclosure of events that occur after the balance sheet date but before the financial statements are issued, the Company evaluated all events or transactions that occurred after December 31, 2009 up through the date the financial statements were issued.
q) Recently adopted accounting standards
In August 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-05, Fair Value Measurements and Disclosures (ASU 2009-05). ASU 2009-05 amends Subtopic 820-10, Fair Value Measurements and Disclosures , to provide guidance on the fair value measurement of liabilities. ASU 2009-05 provides clarification for circumstances in which a quoted price in an active market for the identical liability is not available. ASU 2009-05 is effective for interim and annual periods beginning after August 26, 2009. The Company adopted the provisions of ASU 2009-05 for the period ended December 31, 2009. There was no impact on the Company’s operating results, financial position or cash flows.
In June 2009, the FASB issued ASU No. 2009-01, Generally Accepted Accounting Principles (ASU 2009-01). ASU 2009-01 establishes “The FASB Accounting Standards Codification,” or Codification, which became the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. On the effective date, the Codification superseded all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification will become nonauthoritative. ASU 2009-01 is effective for interim and annual periods ending after September 15, 2009. The Company adopted the provisions of ASU 2009-01 for the period ended September 30, 2009. There was no impact on the Company’s operating results, financial position or cash flows.
In May 2009, the FASB issued SFAS No. 165, Subsequent Events (ASC 855) to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855 is effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted the provisions of ASC 855 for the period ended June 30, 2009. There was no impact on the Company’s operating results, financial position or cash flows.
In April 2009, the FASB issued FASB Staff Position (FSP) No. FAS 107-1 and Accounting Principles Board (APB) 28-1, Interim Disclosures about Fair Value of Financial Instruments (ASC 825-10-65) to change the reporting requirements on certain fair value disclosures of financial instruments to include interim reporting periods. The Company adopted ASC 825-10-65 in the second quarter of 2009. There was no impact on the Company’s operating results, financial position or cash flows; however additional disclosures were added to the accompanying notes to the consolidated financial statements for the Company’s fair value of financial instruments. See Note 5 “Embedded Derivative Liabilities and Fair Value Measurements” for more details.
In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, (ASC 320-10-65), to expand other-than-temporary impairment guidance for debt securities to enhance the application of the guidance and improve the presentation and disclosure of other-than temporary impairments on debt and equity securities within the financial statements. The adoption of ASC 320-10-65 in the second quarter of 2009 did not have a significant impact on the Company’s operating results, financial position or cash flows.
In April 2009, the FASB issued FSP No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, (ASC 820-10-65) to provide additional guidance for estimating fair value when the volume and level of activity for an asset or liability has significantly decreased. In addition, ASC 820-10-65 includes guidance on identifying circumstances that indicate a transaction is not orderly. The adoption of ASC 820-10-65 in the second quarter of 2009 did not have a significant impact on the Company’s operating results, financial position or cash flows.
In December 2008, the SEC issued Release No. 33-8995, Modernization of Oil and Gas Reporting (ASC 2010-3), which amends the oil and gas disclosures for oil and gas producers contained in Regulations S-K and S-X, as well as adding a section to Regulation S-K (Subpart 1200) to codify the revised disclosure requirements in Securities Act Industry Guide 2, which is being eliminated. The goal of Release No. 33-8995 is to provide investors with a more meaningful and comprehensive understanding of oil and gas reserves. Energy companies affected by Release No. 33-8995 are now required to price proved oil and gas reserves using the unweighted arithmetic average of the price on the first day of each month within the 12-month period prior to the end of the reporting period, unless prices are defined by contractual arrangements, excluding escalations based on future conditions. SEC Release No. 33-8995 is effective beginning for financial statements for fiscal years ending on or after December 31, 2009. The impact on the Company’s operating results, financial position and cash flows has been recorded in the financial statements; additional disclosures were added to the accompanying notes to the consolidated financial statements for the Company’s supplemental oil and gas disclosure. See Supplemental Oil and Gas Information for more details.
In January 2010, the FASB issued FASB Accounting Standards Update (ASU) No. 2010-03 Oil and Gas Estimations and Disclosures (ASU 2010-03). This update aligns the current oil and natural gas reserve estimation and disclosure requirements of the Extractive Industries Oil and Gas topic of the FASB Accounting Standards Codification (ASC Topic 932) with the changes required by the SEC final rule ASC 2010-3, as discussed above, ASU 2010-03 expands the disclosures required for equity method investments, revises the definition of oil- and natural gas-producing activities to include nontraditional resources in reserves unless not intended to be upgraded into synthetic oil or natural gas, amends the definition of proved oil and natural gas reserves to require 12-month average pricing in estimating reserves, amends and adds definitions in the Master Glossary that is used in estimating proved oil and natural gas quantities and provides guidance on geographic area with respect to disclosure of information about significant reserves. ASU 2010-03 must be applied prospectively as a change in accounting principle that is inseparable from a change in accounting estimate and is effective for entities with annual reporting periods ending on or after a change in accounting estimate and is effective for entities with annual reporting periods ending on or after December 31, 2009. The Company adopted ASU 2010-03 effective December 31, 2009. See Supplemental Oil and Gas Information for more details.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133 (ASC 815-10-65). ASC 815-10-65 requires entities that utilize derivative contracts to provide qualitative disclosures about their objectives and strategies for using such instruments, as well as any details of credit-risk-related contingent features contained within derivatives. ASC 815-10-65 also requires entities to disclose additional information about the amounts and location of derivatives located within the financial statements, how the provisions of ASC 815 have been applied, and the impact that hedges have on an entity’s operating results, financial position or cash flows. The Company adopted ASC 815-10-65 on January 1, 2009. There was no impact on the Company’s operating results, financial position or cash flows; however additional disclosures were added to the accompanying notes to the consolidated financial statements for the Company’s derivative contracts. See Note 5 “ Embedded Derivatives Liabilities and Fair Value Measurements ” for more details.
In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations (ASC 805), and SFAS No. 160, Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51 (ASC 810-10-65). ASC 805 and ASC 810-10-65 significantly change the accounting for and reporting of business combination transactions and noncontrolling (minority) interests within the financial statements. ASC 805 provides additional definitions, such as the definition of the acquirer in a purchase and improvements in the application of how the acquisition method is applied. ASC 810-65 changes the accounting and reporting for minority interests, which are re-characterized as non-controlling interests, and classified as a component of equity. The Company adopted ASC 805 and ASC 810-10-65 on January 1, 2009. There was no impact on the Company’s operating results, financial position or cash flows; however if the Company enters into future business combinations, certain transaction related expenses may be recorded within the Company’s operating results which could reduce its current period net income or increase its net loss. Additionally, valuation of certain assets may be different than under the old accounting standards.
Effective January 1, 2009, the Company adopted FSP No. FAS 157-2, Effective Date of FASB Statement No. 157 (ASC 820-10-55). ASC 820-10-55 delayed the effective date of ASC 820 for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of fiscal 2009. These include goodwill and other non-amortizable intangible assets. The adoption of ASC 820-10-55 did not have a significant impact on the Company’s operating results, financial position or cash flows.
In June 2008, the FASB issued Emerging Issues Task Force (EITF) 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (ASC 260). ASC 260 clarifies that share-based payment awards that entitle their holders to receive non-forfeitable dividends or dividend equivalents before vesting should be considered participating securities. The adoption of ASC 260 on January 1, 2009 did not have a significant impact on the Company’s operating results, financial position or cash flows.
r) Reclassifications
Certain reclassifications have been made to the prior year financial statements in order for them to be in conformity with the current year presentation.
3. Going concern
The accompanying consolidated financial statements have been prepared on the basis of accounting principles applicable to a going concern. Accordingly, they do not give effect to adjustments that would be necessary should the Company be unable to continue as a going concern, and therefore be required to realize its assets and retire its liabilities in other than the normal course of business and at amounts different from those in the accompanying financial statements. However, the Company has incurred significant losses from operations, has a working capital deficiency, and is in default on their senior secured convertible notes and convertible debentures. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The Company’s ability to continue as a going concern is dependent upon achieving profitable operations, receiving deferrals on the interest payments due and waivers on the default of the amended debt agreements from its senior secured convertible note holders and injection of additional capital. The outcome of these matters cannot be predicted at this time. Management of the Company is actively seeking potential partners who possess the necessary resources to assist the Company in developing its remaining properties in order to secure additional funds through lease bonuses and overriding royalty interests.
4. Earnings (loss) per share
Basic net loss per share is computed on the basis of weighted average number of shares of common shares outstanding during the period . Diluted net loss per share is computed using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents, consisting of shares that would be issued upon exercise of common stock options and warrants and from the conversion of the Company’s convertible notes and debentures.
Common stock equivalents pertaining to stock options, warrants and convertible debt were not included in the computation of diluted loss per share because the effect would have been anti-dilutive due to the net losses for the years ended December 31, 2009 and 2008.
5. Embedded Derivative Liabilities and Fair Value Measurements
Embedded Derivative Liabilities
As of December 31, 2009 and 2008, the Company had the following derivative liabilities outstanding:
The Company’s convertible debentures and notes have a conversion feature that is based on the market value of the stock at the date of conversion. The conversion feature was evaluated under ASC Topic 815-15 and 815-40 and was determined to have characteristics of a liability and is therefore a derivative liability under the above guidance. The conversion price is variable which caused the Company to conclude it is possible to have an insufficient number of common shares available to share-settle the convertible debentures, the senior secured convertible notes, and the related warrants. As a result, the embedded conversion feature of the convertible debt was bifurcated and recorded as a derivative liability at its fair value. Similarly, the fair value of the warrants is recorded as a derivative liability. Each reporting period, the above derivative liabilities are fair valued with the non-cash gain or loss recorded in the period as a gain or loss on derivatives. The above derivative instruments are not designated as hedging instruments.
The valuation of the Company’s embedded derivatives and warrant derivatives are determined primarily using the Black-Scholes option pricing model. To determine the fair value of the derivatives, the Company evaluates assumptions regarding the probability of certain future events. No dividends were assumed due to the nature of the Company’s current business strategy. The fair values of the derivatives were estimated using the following assumptions of management:
Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. A fair value hierarchy is used which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are described as follows:
Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
Level 2 - Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
Level 3 - Unobservable inputs reflect the Company’s judgments about the assumptions market participants would use in pricing the asset of liability since limited market data exists. These inputs are developed based on the best information available, using internal and external data.
The following table sets forth by level, within the fair value hierarchy, the Company’s financial assets and liabilities that were accounted for at fair value as of December 31, 2009.
6. Royalty Interests
The Company owns oil and gas royalty interests in Freestone County, Anderson County and Jones County, Texas. These royalty interests were purchased as part of the Company’s 27,557 gross acres of oil and gas fee mineral rights. The royalty interests were recorded at their initial estimated relative fair value of $0.4 million. Depletion of approximately $23,000 and $43,000 has been recorded for the years ended December 31, 2009 and 2008, respectively on these royalty interests.
7. Joint Operating Agreement
In November 2006, the Company signed two three-year Oil & Gas Mineral Leases and a Joint Operating Agreement with Marathon Oil Company and its affiliate (together, “Marathon”) to explore approximately 9,200 acres of the P.D.C. Ball mineral property in Freestone County, Texas. The agreements give Marathon the right to drill deep gas wells on the property (below 8,500 feet) and the opportunity, but not obligation, to partner with the Company on drilling upper zones (above 8,500 feet) on a 50/50 basis. The Company retained a 21.5% royalty interest in any revenue generated from the property below 8,500 feet and a 23% royalty interest in any revenue generated from the property above 8,500 feet. As part of the agreement, the Company acquired a seismic license giving it access to all seismic data collected during Marathon’s lease term. As of December 31, 2009, no revenues have been generated.
8. Equipment
Property and equipment consist of the following:
Cost
Accumulated
Depreciation
Allowance for
Impairment
December 31, 2009
Net Book Value
Office equipment and furniture
$ 49,485
$ 26,206
$ -
$ 23,279
Compressor station
107,014
31,646
-
75,368
$156,499
$57,852
$ -
$98,647
Cost
Accumulated
Depreciation
Allowance for
Impairment
December 31, 2008
Net Book Value
Assets held for sale - equipment
$6,400,939
$640,384
$3,432,344
$2,328,211
Vehicles
-
-
-
-
Office equipment and furniture
50,350
18,380
-
31,970
Compressor station
107,014
16,358
-
90,656
$ 6,558,303
$675,122
$3,432,344
$2,450,837
9. Debt
Senior Secured Convertible Notes
General terms
On July 25, 2006, the Company issued an aggregate $32.4 million of senior secured Convertible Notes (the “Convertible Notes”) were due in five equal installments beginning July 2007. The Convertible Notes carry a 9.15% annual interest rate, which is payable quarterly, and may, at the Company’s option if certain “Equity Conditions” are satisfied, be paid by the issuance of the Company’s common stock. Any shares of common stock used to pay interest will be valued at the lower of (1) the then applicable conversion price of the Convertible Notes and (2) 82.5% of the arithmetic average of the weighted average price of the common stock for the five trading days preceding the interest payment date. At December 31, 2009 and 2008, accrued interest totaled $11.9 million and $4.5 million, respectively.
The Convertible Notes were amended in October 2007 and have a maturity date of October 31, 2010, subject to the right of the holders to extend the maturity date to a date that is not later than October 31, 2012. The Company’s obligations under the Convertible Notes are secured by a security interest in substantially all of the assets of the Company and its wholly-owned subsidiary, Barnico Drilling, Inc. The amendment was accounted for prospectively as a modification of terms in a troubled debt restructuring resulting in additional debt proceeds of $5 million and interest and fees of $16.4 million, which was added to the original loan balance. As a result, the outstanding principal on the Convertible Notes increased from $32.4 million to $53.8 million, which was the principal balance outstanding at December 31, 2009 and 2009, respectively
The Convertible Notes are convertible into common stock at the holders’ option at an initial rate of $1.40 per share, which was reduced to $0.65 per share upon the restructuring of the notes in October 2007.
The convertible notes contain various covenants including, among other things, covenants limiting the incurrence of indebtedness or liens, limiting capital expenditures, limiting the payment of dividends, reserving shares equal to 130% of the number of shares of common stock issuable upon conversion of the convertible notes, as well as provisions governing change of control transactions. Upon a change of control transaction, holders of the convertible notes may require the Company to repurchase the convertible notes at a purchase price of 120% or more of the principal amount of the convertible notes being redeemed.
On October 1, 2008, a quarterly interest payment of approximately $1.23 million was due and payable to the holders of the convertible notes. The Company did not have sufficient funds to meet this payment. However, the note holders agreed to waive the default and granted a deferral of the quarterly interest payment to January 1, 2009. On that date both the original October 1, 2008 and the January 1, 2009 payments were due. The Company was unable to make the payment due on January 1, 2009 and the note holders denied further waiver of the default and deferral of the interest payments. Therefore the Convertible Notes were deemed to be in default effective October 1, 2008. Per terms of the note, the interest rate escalated to 15% effective on the default date of October 1, 2008. The principal of the Convertible Notes is reported as a current liability in the Consolidated Balance Sheets due to the default.
In connection with these Convertible Notes the Company recorded a $36.1 million debt discount due to the value of the derivative associated with the warrants and the embedded conversion feature. The debt discount is being amortized using the interest method over the life of the related debentures and $7.2 million was expensed during year ended December 31, 2008. As noted above, the Company defaulted on the Convertible Notes resulting in the accelerated recognition of unamortized discount totaling $28.1 million. Please also see Note 5 “Embedded Derivative Liabilities and Fair Value Measurements” for details on the embedded conversion feature.
Warrants
In connection with the issuance and amendment of the Convertible Notes, the Company issued an aggregate 67,589,664 Series A warrants to purchase common stock with a strike price of $0.001 per share and an aggregate 17,925,524 Series B warrants to purchase common stock with a strike price of $0.65 per share. As of December 31, 2009 and 2008, there were 51,500,743 Series A warrants and 17,925,524 Series B warrants outstanding.
Convertible Debentures Payable
General terms
On January 12, 2006, the Company issued 10% secured convertible debentures (the “debentures”) with a principal amount of $1.5 million. The debentures were due and payable on January 11, 2009, and principal and accrued interest could, at the option of the holder during the term of the debentures, be converted into shares of the Company’s common stock at a rate of the lesser of $0.65 per share or 85% of the lowest volume-weighted average price of the Company’s common stock during the 15 trading days preceding the conversion date, subject to anti-dilution adjustments. The investor agreed to restrict its ability to convert the debentures to an amount less than 5% of the then-issued shares of common stock in the Company. In addition, the investor will not convert more than $150,000 of the principal in any 30-day period. The Company’s obligations under the debentures are secured by a security interest in substantially all of the Company’s assets; however, that security interest is subordinated to the security interest created under the security agreement in favor of the holders of the senior secured Convertible Notes.
During the years ended December 31, 2009, and 2008 the Company issued 36,538,319 and 7,617,804 shares respectively upon the conversion of $147,800 and $107,700 respectively of principal of the debentures.
In connection with these debentures the Company recorded a $1.5 million debt discount due to the value of the derivative associated with the warrants and the embedded conversion feature. The debt discount is being amortized using the interest method over the life of the related debentures and $0.8 million was expensed during year ended December 31, 2008. As noted above, the Company defaulted on the Convertible Notes. An event of default under the Convertible Notes constitutes a default on the debentures. In addition, the Company was unable to make the principal and interest payment on the debentures which was due on January 11, 2009. Interest on the debentures continues to accrue at 10%. As a result of the default, the remaining unamortized discount totaling $0.1 million was fully expensed and the principal balance of the debentures is reported as a current liability in the Consolidated Balance Sheets . As of December 31, 2009 and 2008, accrued interest totaled approximately $275,000 and $154,000, respectively. Please also see Note 5 “Embedded Derivative Liabilities and Fair Value Measurements” for details on the embedded conversion feature.
10. Related Party Transactions
The Company entered into transactions with related parties as follows. These amounts have been recorded at the exchange amount, being the amount agreed to by the parties:
Year ended December 31, 2009
a) The Company paid management and consulting fees to its directors, persons related to directors or entities controlled by directors. The total expense for these fees for the year ended December 31, 2009 was $348,260.
b) As of December 31, 2009, the Company had an account receivable of $13,050 due from an entity owned by a former President and current director of the Company. During the fourth quarter of 2008, the Company determined that it was overpaying overriding royalties to Roboco Energy, Inc., a corporation owned by Mike Studdard, the Company’s former President and a current director. As a result, the Company recorded an account receivable for the overpayment. This overpayment will be deducted from future overriding royalties.
c) The Company paid overriding royalties to a corporation controlled by a director and/or a director’s family
member. The total overriding royalties paid to these parties for the year ended September 30, 2009 was $6,597.
Year ended December 31, 2008
a) The Company paid management and consulting fees to its Directors, persons related to Directors or entities controlled by Directors. The total expense for these fees during 2008 was $590,870. As of December 31, 2008, there was $120,000 accrued for these fees.
b) On October 31, 2008, the Company wrote off a $0.2 million promissory note receivable related to the sale in December 2006 of properties to Exterra Energy, Inc (formerly Green Gold, Inc.), of which the Company’s former CEO and director, John Punzo was appointed CEO and Chairman on July 8, 2008. Further, one of the Company’s former directors, Gordon C. McDougall, was a director of Exterra until June 23, 2008. The note was originally due in full November 1, 2007 but was subsequently extended to July 2008. The Company wrote off the note on October 31, 2008 due to the fact that no payment had been received since December 2007 and it was deemed to be uncollectible.
c) During the fourth quarter 2008 it was found that the Company was paying Roboco Energy more overriding royalties then they were entitled to. Roboco Energy is owned by Mike Studdard, the Company’s former President and a current director. The Company set up a receivable of $13,050 as of December 31, 2008 for the amount overpaid. The payment of this receivable will be reimbursed from future payments for overriding royalties until the amount due is paid.
d) During the fourth quarter 2008 it was found that the Company should be paying overriding royalties to Horseshoe Energy, Inc. Horseshoe Energy, Inc is owned by David Steward, the Company’s current CEO. The Company set up a payable of $5,275 as of December 31, 2008 for the amount owed which is included in the total Accounts Payable reported on the consolidated Balance Sheet.
11. Asset Retirement Obligation
The following table summarizes the changes in the Company’s asset retirement obligation during the years ended December 31, 2009 and 2008.
Asset retirement obligation, January 1
$ 136,174
$ 140,115
Asset retirement obligations incurred in the current period
-
-
Asset retirement obligations settled in the current period
-
-
Accretion expense
12,461
12,820
Revisions in accounting estimate
(63,145)
-
Revisions in estimated cash flows
-
(16,761)
Asset retirement obligation, December 31
$ 85,490
$ 136,174
12. Warrants Outstanding
A summary of warrants issued during the years ended December 31, 2009 and 2008 is as follows:
Warrants
Weighted Average Exercise Price
Outstanding at December 31, 2007
89,951,276
$ 0.24
Warrants expired
(193,230)
.95
Warrants exercised
(16,588,921)
0.001
Outstanding at December 31, 2008
73,169,125
0.28
Warrants issued
-
-
Warrants exercised
-
-
Warrants expired
-
-
Outstanding at December 31, 2009
73,169,125
$ 0.28
The intrinsic value of the warrants outstanding at December 31, 2009 and 2008 was $103,001 and $463,507, respectively. The decline in the intrinsic value of the warrants at December 31, 2009 is due to a lower stock price ($0.003) applied to the outstanding shares in 2009 as compared to 2008 ($0.1).
The following table summarizes information about warrants outstanding at December 31, 2009:
Exercise Prices
Number Outstanding
Average remaining life in years
Private placement of common stock
$ 4.00
125,000
1.47
Private placement of common stock
1.40
746,429
1.55
Issuance of senior secured convertible notes
0.001
51,500,743
4.84
Issuance of senior secured convertible notes
0.65
17,925,524
4.84
Placement agent, investment banking and consulting agreements in connection with the issuance of senior secured convertible notes
1.40
2,121,429
1.56
Agreement in connection with the Company’s purchase of Barnico Drilling, Inc. and the P.D.C. Ball oil and gas mineral interest
5.00
400,000
1.56
Agreement in connection with the Company’s purchase of Barnico Drilling, Inc. and the P.D.C. Ball oil and gas mineral interest
8.00
350,000
1.56
73,169,125
13. Stock-Based Compensation
On February 15, 2007, the Company adopted its 2007 Stock Incentive Plan (the “2007 Plan”) for employees, directors, officers, consultants, and advisors of the Company to provide a means to motivate, attract and retain the services of such individuals in order to promote the success of the Company. The 2007 Plan reserved 2,378,249 shares of common stock for issuance by the Company either directly as stock awards or underlying stock options. At December 31, 2009 578,249 shares were available under the Plan for future issuance.
During 2009, options to purchase 500,000 shares of Company common stock were granted to our Chief Executive Officer pursuant to the Plan. No stock options were granted to key employees, directors, officers and consultants during 2008 to 2009 outside the Plan.
A summary of activity for stock options for the years ended December 31, 2009 and 2008 is as follows:
Options
Weighted Average Exercise Price
Weighted Average Grant
Date Fair Value
Outstanding at December 31, 2007
16,243,500
$0.63
-
Options granted
-
-
-
Options expired
(1,447,500)
0.40
-
Options exercised
-
-
-
Outstanding at December 31, 2008
14,796,000
0.65
-
Options granted
500,000
.03
$0.003
Options expired
(200,000)
.50
-
Options exercised
-
-
-
Outstanding at December 31, 2009
15,096,000
$0.63
-
There were no options exercised during the year ended December 31, 2009 and 2008. Based on the Company’s stock prices of $0.003 and $0.01 at December 31, 2009 and 2008, respectively, the options had no intrinsic value at December 31, 2009 and 2008. At December 31, 2009 and 2008, there was no unamortized share-based expense.
The following is a summary of stock options outstanding and exercisable at December 31, 2009:
Exercise Price
No. of options
Weighted Average Remaining Contractual Lives
(Years)
$.03
500,000
4.23
$0.25
1,000,000
1.16
$0.50
3,646,000
1.84
$0.75
9,950,000
2.6
15,096,000
The Company estimates the fair value of stock options using the Black-Scholes option pricing model. Key inputs and assumptions used to estimate the fair value of stock options include the grant price of the award, the expected option term, volatility of the Company’s stock, the risk-free rate and the Company’s dividend yield. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by grantees, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made by the Company.
The fair value of each stock option is estimated on the date of the grant using the Black-Scholes option pricing model. No dividends were assumed due to the nature of the Company’s current business strategy. The following table presents the weighted-average assumptions used for options granted:
14. Income Taxes
A reconciliation of income taxes at statutory rates with the reported taxes is as follows:
Statutory rate
34%
34%
Increase (decrease) in income taxes resulting from:
Increase in valuation allowance
(34%)
(34%)
-
-
The significant components of the Company’s deferred tax liabilities and assets are as follows:
Deferred tax liabilities:
Derivative liabilities and debt discount
$ 14,920,682
$ 14,956,259
Support equipment & drilling equipment
Oil and gas properties
1,021,306
-
762,287
Total
15,941,988
15,718,546
Deferred tax assets:
Oil and gas properties
3,486,314
3,486,314
Non-capital losses available for future periods
9,514,174
8,423,047
Finance costs
23,595,195
21,043,541
Stock compensation
12,308,090
12,308,090
Other
40,800
59,699
Total
48,944,573
45,320,691
Valuation allowance
(33,002,585)
(29,602,145)
Total
15,941,988
15,718,546
Net deferred taxes
$ -
$ -
As of December 31, 2009 and 2008 the Company had available non-capital losses for tax purposes of approximately $27.9 and $24.7 million , respectively, which may be carried forward to apply against future income. These losses may be limited under IRS Section 382. These losses will expire commencing in 2021.
15. Commitments and Contingencies
Lawsuits
On December 19, 2008, the Company commenced a lawsuit against our former subsidiary, Barnico Drilling, Inc., our former Vice President, Georges Barnes, and CamTex Energy, Inc. (of which George Barnes is an officer), in the District Court of Anderson County, Texas. The lawsuit relates to the Company’s attempt to repossess certain items from George Barnes and CamTex Energy, Inc. in accordance with a court ruling on September 9, 2008. George Barnes had refused to turn over these items claiming that the items were not owned by Barnico but were actually owned by George Barnes and his family. This case was heard in the District Court of Anderson County, Texas on March 12, 2009 and Mr. Barnes was ordered to immediately relinquish to Wentworth possession of the items. Mr. Barnes was also held in contempt of court for his failure to relinquish possession of the items and Wentworth was awarded its attorney fees and costs incurred in preparing the motion.
On August 27, 2009, the Company filed an amended petition to its original lawsuit in an attempt to recover approximately $25,000 the Company believes is owed to it by George Barnes for the use of Barnico drilling rigs for a period of time between February 2008 and May 2009 and approximately $11,000 for overrides improperly paid to George Barnes and certain of his family. In its amended petition, the Company has also alleged fraud relating to the misrepresentation of the quality of the Barnico drilling rigs and equipment in the March 2006 Stock Purchase Agreement under which the Company initially acquired its stock in Barnico. The Company has also filed a claim against a third party relating to payments made by that third party to Barnico in 2009 despite receiving notice of the Company’s security interest in Barnico’s accounts receivable.
The Company is a party to legal actions that arise in the ordinary course of its business. Based in part on consultation with legal counsel, management believes that (i) the liability, if any, under these claims will not have a material adverse effect on the Company, and (ii) the likelihood that the liability, if any, under these claims is material is remote.
Leases
The Company entered into various operating lease agreements involving office space, drilling equipment and vehicles. Rental expense for these operating leases was approximately $11,399 and $114,524 for the years ended December 31, 2009 and 2008, respectively. Lease arrangements are currently month-to-month.
Contingent Liabilities
In preparing financial statements at any point in time, management is periodically faced with uncertainties, the outcomes of which are not within its control and will not be known for prolonged periods of time. The Company is involved in actions from time to time, which if determined adversely, could have a material negative impact on its financial position, results of operations and cash flows. Management, with the assistance of counsel, makes estimates, if determinable, of the Company’s probable liabilities and records such amounts in the consolidated financial statements. Such estimates may be the minimum amount of a range of probable loss when no single best estimate is determinable. Disclosure is made, when determinable, of any additional possible amount of loss on these claims, or if such estimate cannot be made, that fact is disclosed.
16. Discontinued Operations
The Company’s former wholly-owned subsidiary, Barnico Drilling Inc., (“Barnico”) was acquired in July 2006. Barnico was an East Texas drilling contractor with two drilling rigs. The contract drilling activities diminished significantly and the venture proved to be unsuccessful. In order to recoup part of its investment, the Company sold all of the outstanding shares of Barnico on May 12, 2008, for $3,500,000 to CamTex Energy, Inc., a corporation in which George Barnes, the Company’s former Vice President of Operations, is an officer. The Company received $50,000 on the closing of the sale transaction, and a promissory note in the amount of $3,450,000. The note was collateralized by the drilling rigs and other equipment included in the sale. In connection with the sale, the Company discontinued all drilling activities but maintained continuing involvement with Barnico through a preferential rights agreement between the Company and the purchaser. In August 2008, the purchaser defaulted on its note and the Company repossessed the drilling and related equipment. The Company does not intend to continue any drilling activities and is currently marketing the drilling rigs and other related equipment. As a result, the Company is reporting these assets as held for sale and discontinued operations related to drilling activities.
The drilling rigs and other equipment held for sale had a net book value after impairment of $3,090,030 as of the original May 12, 2008 sale date. In early 2008, the Company obtained an independent appraisal of the equipment and recognized an impairment charge of approximately $2.7 million in the Company’s December 31, 2007 consolidated balance sheet and its consolidated statement of operations for the year then ended. Another independent appraisal was obtained in early 2009 and an additional impairment charge of approximately $0.8 million was recognized in the Company’s December 31, 2008 consolidated balance sheet and its consolidated statement of operations for the year then ended.
The following schedule details the repossessed equipment held for sale as of December 31, 2008:
Cost
Accumulated
Depreciation
Allowance for
Impairment
December 31, 2008
Net Book Value
Rigs and equipment
$ 5,971,938
$ 572,988
$ 3,432,344
$ 1,966,606
Vehicles
195,500
42,099
-
153,401
Construction equipment
233,500
25,296
-
208,204
$ 6,400,938
$ 640,383
$ 3,432,344
$ 2,328,211
The equipment was sold at auction in June 2009 for total proceeds of $0.9 million. The book value of the equipment at that date was $2.0 million and the selling expenses were $110,000, therefore the Company recognized a loss on the sale of the equipment of $1.2 million at the time of the sale. This loss is reported in the Consolidated Statements of Operations as a Loss from Discontinued Operations. Prior to the sale, the Company recorded an additional impairment charge based on the equipment’s appraised value as of March 20, 2009 which is also reported under Loss from discontinued operations in the Consolidated Statements of Operations.
17. Subsequent Events
Since January 1, 2010, there have been 60,028,910 shares of common stock issued upon the conversion of $88,559 principal amount of convertible debentures.
18. Supplemental Oil and Gas Producing Activities (unaudited)
The tables below set forth supplementary disclosures for oil and gas producing activities in accordance with FASB ASC 932, Extractive Activities - Oil and Gas.
Capitalized Costs Relating to Oil and Gas Producing Activities:
December 31, 2009
December 31, 2008
Unproved oil and gas properties
$ 10,303,706
$ 10,303,706
Proved oil and gas properties
21,820,741
21,882,135
Proved oil and gas royalties
353,888
353,888
Less accumulated depreciation, depletion, amortization and valuation allowances
(12,967,418)
(12,712,127)
Net capitalized costs
$ 19,510,917
$ 19,827,602
Accumulated depreciation, depletion, amortization and valuation allowances include impairment costs of $0 and $7,871,469, respectively for December 31, 2009 and 2008. There are no net capitalized costs from the Company’s share of equity method investees.
Costs Incurred in Oil and Gas Property Acquisition, Exploration and Development Activities:
Results of Operations for Oil and Gas Producing Activities for the Years Ended December 31, 2009 and 2008:
19. Reserve Information
The following estimates of proved oil and gas reserve quantities and related standardized measure of discounted net cash flow are estimates only, and do not purport to reflect realizable values or fair market values of the Company’s reserves. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries are more imprecise than those of producing oil and gas properties. All of the Company’s reserves are located in the United States.
Proved reserves are estimated reserves of crude oil (including condensate and natural gas liquids) and natural gas that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed reserves are those expected to be recovered through existing wells with existing equipment, and operating methods. Due to the inherent uncertainties and the limited nature of reservoir data, such estimates are subject to change as additional information becomes available. The reserves actually recovered and the timing of production of these reserves may be substantially different from the original estimate. Revisions result primarily from new information obtained from development drilling and production history; acquisitions of oil and natural gas properties; and changes in economic factors. Based on historical production and geological information, the Company has significant revisions of previous estimates.
The standardized measure of discounted future net cash flows is computed by applying the average, first-day-of-the-month price during the 12-month period ended December 31, 2009 and the year-end prices of oil and gas (with consideration of price changes only to the extent provided by contractual arrangements) for the period ended December 31, 2008 to the estimated future production of proved oil and gas reserves, less estimated future expenditures (based on year-end costs) to be incurred in developing and producing the proved reserves, less estimated future income tax expenses (based on year-end statutory tax rates, with consideration of future tax rates already legislated) to be incurred on pretax net cash flows less tax basis of the properties and available credits, and assuming continuation of existing economic conditions. The estimated future net cash flows are then discounted using a rate of 10 percent a year to reflect the estimated timing of the future cash flows.
Oil
(Bbls)
Gas
(Mcf)
Proved developed and undeveloped reserves
Balance, December 31, 2007
294,900
18,073,400
Revisions of previous estimates
(165,701)
(7,930,637)
Production (bbls & mcf)
(1,106)
(130,589)
Balance, December 31, 2008
128,093
10,012,174
Revisions of previous estimates
1,902
(231,662)
Production
(1,781)
(135,304)
Balance, December 31, 2009
128,214
9,645,208
Oil
(Bbls)
Gas
(Mcf)
Proved developed reserves
December 31, 2008
6,371
1,512,179
December 31, 2009
6,494
1,145,206