ITEM 1. Business.
General
GulfWest is an independent oil and gas company primarily engaged in the acquisition of producing oil and gas properties with Proved Reserves which have the potential for increased value through continued development and the application of enhanced recovery technology. Since June 1993, the Company has substantially increased its reserves through a combination of acquisitions of oil and gas properties and the further exploitation and development of such properties.
As a result of its acquisition, exploitation and development activities, GulfWest has significantly increased its Proved Reserves and average daily production, while increasing its gross margin per BOE. The Company's total Proved Reserves and Present Value increased from 565.3 MBOE (25% crude oil) and $2.3 million (94% Proved Developed), respectively, on December 31, 1993, to 5,709 MBOE (82% crude oil) and $25.5 million (50% Proved Developed) on December 31, 1997, as determined from reserve reports prepared by independent petroleum engineers. GulfWest's average net daily production has increased from approximately 72 BOE for the six months ended December 31, 1993 to approximately 674 BOE for the year ended December 31, 1997. Based on pro forma reserves and production at December 31, 1997, the Company has a reserve life index of 23.2 years. The Company's gross margin has increased from $1.80 per BOE for the six months ended December 31, 1993 to $8.65 per BOE for the year ended December 31, 1997.
At present, substantially all of the Company's properties are located onshore in Texas; however, in the future the Company plans to expand to analogous onshore areas in the continental United States in which it believes attractive acquisition opportunities exist. The operations of the Company are considered to fall within a single industry segment, the acquisition, development and production of natural gas and crude oil. See "Item 2.
ITEM 2. Properties.
The Company holds an average 93% Working Interest in 499 gross productive oil and gas wells and Royalty Interests in 2 additional wells. At December 31, 1997, the properties contained (net to the Company's interest) estimated Proved Reserves of 4,676,427 barrels of oil and 6,195,358 Mcf of natural gas. Substantially all of the Company's reserves are located in Texas, with approximately 69% of the Texas reserves located in the Permian Basin of West Texas and approximately 31% located in East Texas.
Proved Reserves. The following table reflects the estimated Proved Reserves of the Company at December 31 for each of the preceding three years.
(a) The above table does not include reserves for the Company's interests in wells in Louisiana which represents less than 1% of the Company's operations.
Approximately 50% of the Company's total Proved Reserves were classified as Proved Developed at December 31, 1997.
Standardized Measure of Discounted Future Net Cash Flows. The following table sets forth as of December 31 for each of the preceding three years, the estimated future net cash flow from and standardized measure of discounted future net cash flows of the Company's Proved Reserves which were prepared in accordance with the rules and regulations of the SEC. Future net cash flow represents future gross cash flow from the production and sale of Proved Reserves, net of oil and gas production costs (including production taxes, ad valorem taxes and operating expenses) and future development costs. Such calculations are based on current cost and price factors at December 31 for each year. There can be no assurance that the Proved Reserves will all be developed within the periods used in the calculations or that prices and costs will remain constant.
(1) Based upon year end weighted average prices of $23.64 per Bbl and $3.91 per Mcf for the calendar year 1996 and $15.68 per Bbl and $2.28 per Mcf for the calendar year 1997.
Significant Properties. Substantially all of the Company's properties are located in Texas. Summary information on the Company's properties with Proved Reserves is set forth below as of December 31, 1997.
(1) The above table does not include reserves for the Company's interests in wells in Louisiana which represents less than 1% of the Company's operations.
(2) Based upon year end weighted average prices of $15.68 per Bbl and $2.28 per Mcf for the calendar year 1997.
All information set forth herein relating to the Company's Proved Reserves, estimated future net cash flows and Present Values is taken from reports prepared by Ryder Scott Company and H. J. Gruy & Associates (with respect to the Company's West Texas properties), Forrest Garb and Associates, Inc., Eastex Geological Consultants and Thomas R. Kaetzer (with respect to the Company's East Texas properties) and James Engineering, Inc. (with respect to the Company's Oklahoma and Kansas properties), each of which is a firm of independent petroleum engineers. The estimates of these engineers were based upon review of production histories and other geological, economic, ownership and engineering data provided by the Company. No reports on the Company's reserves have been filed with any federal agency. In accordance with the SEC's guidelines, the Company's estimates of Proved Reserves and the future net revenues from which Present Values are derived are made using year end oil and gas sales prices held constant throughout the life of the properties (except to the extent a contract specifically provides otherwise). The prices of oil and gas at December 31, 1996 used to estimate the Company's Proved Reserves and the future net revenues from which Present Value is derived were substantially higher than the prices used in previous years to make such estimates. The closing price on the New York Mercantile Exchange ("NYMEX") for the prompt month futures contract for delivery of West Texas Intermediate Crude Oil on December 31, 1996 and March 24, 1998 was $25.92 and $15.92 per Bbl, respectively. The closing price on the NYMEX for the prompt month futures contract for natural gas delivered at Henry Hub, Louisiana on December 31, 1996 and March 24, 1998 was $2.76 and $2.28 per MMBtu, respectively. The Present Value of the Company's estimated total net Proved Reserves on December 31, 1996, would have been $21.3 million if calculated using $18.00 per Bbl of oil and $2.00 per Mcf of natural gas at that date, which the Company believes is more in line with current and expected future prices. See "Item 2. Properties. Risk Factors-Uncertainty of Estimates of Oil and Gas Reserves." Operating costs, development costs and certain production-related taxes were deducted in arriving at estimated future net revenues, but such costs do not include debt service, general and administrative expenses and income taxes.
There are numerous uncertainties inherent in estimating oil and gas reserves and their values, including many factors beyond the Company's control. The reserve data set forth in this report represents estimates only. Reservoir engineering is a subjective process of estimating the sizes of underground accumulations of oil and gas that cannot be measured in an exact manner. The accuracy of any reserve estimate is a function of the quality of available data, engineering and geological interpretation, and judgment. As a result, estimates of different engineers, including those used by the Company, may vary. In addition, estimates of reserves are subject to revision based upon actual production, results of future development, exploitation and exploration activities, prevailing oil and gas prices, operating costs and other factors, which revisions may be material. Accordingly, reserve estimates are often different from the quantities of oil and gas that are ultimately recovered and are highly dependent upon the accuracy of the assumptions upon which they are based. There can be no assurance that these estimates are accurate predictions of the Company's oil and gas reserves or their values. Estimates with respect to Proved Reserves that may be developed and produced in the future are often based upon volumetric calculations and upon analogy to similar types of reserves rather than actual production history. Estimates based on these methods are generally less reliable than those based on actual production history. Subsequent evaluation of the same reserves based upon production history will result in variations, which may be substantial, in the estimated reserves. See "Item 2. Properties. Risk Factors-Uncertainty of Estimates of Oil and Gas Reserves."
Productive Wells at December 31, 1997:
Developed Acreage at December 31, 1997:
Undeveloped Acreage. The Company did not own any undeveloped acreage at December 31, 1997.
Drilling Results. The Company did not participate in drilling any wells during the years ended December 31, 1995, 1996 and 1997.
Risk Factors
Market Conditions and Prices
The Company's success depends heavily upon its ability to market its oil and gas production at favorable prices, of which there can be no assurance. In recent decades, there have been both periods of worldwide overproduction and underproduction of hydrocarbons and periods of increased and relaxed energy conservation efforts. Such conditions have resulted in periods of excess supply of, and reduced demand for, crude oil on a worldwide basis and for natural gas on a domestic basis; these periods have been followed by periods of short supply of, and increased demand for, crude oil and, to a lesser extent, natural gas. The excess or short supply of oil and gas has placed pressures on prices and has resulted in dramatic price fluctuations.
Historical Operating Losses and Variability of Operating Results
The Company has incurred net losses since its inception and there can be no assurance that the Company will be profitable in the future. In addition, the Company's future operating results may fluctuate significantly depending upon a number of factors, including industry conditions, prices of oil and gas, rates of production, timing of capital expenditures and drilling success. This variability could have a material adverse effect on the Company's business, financial condition and results of operations. See "Item 6. Selected Financial Data" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
Uncertainty of Estimates of Oil and Gas Reserves
This report contains estimates of the Company's proved oil and gas reserves and the estimated future net revenues therefrom that rely upon various assumptions, including assumptions as to oil and gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. The process of estimating oil and gas reserves is complex, requiring significant decisions and assumptions in the evaluation of available geological, geophysical, engineering and economic data for each reservoir. As a result, such estimates are inherently imprecise. Actual future production, oil and gas prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and gas reserves may vary substantially from those estimated in the reports obtained by the Company from reserve engineers. Any significant variance in these assumptions could materially affect the estimated quantities and Present Value of reserves set forth in this
Report. In addition, the Company's Proved Reserves may be subject to downward or upward revision based upon production history, results of future exploration and development, prevailing oil and gas prices and other factors, many of which are beyond the Company's control. Actual production, revenues, taxes, development expenditures and operating expenses with respect to the Company's reserves will likely vary from the estimates used, and such variances may be material.
Approximately 50% of the Company's total estimated Proved Reserves at December 31, 1997 were undeveloped, which are by their nature less certain. Recovery of such reserves will require significant capital expenditures and successful drilling operations. The reserve data set forth in the reserve engineer reports assumes that substantial capital expenditures by the Company will be required to develop such reserves. Although cost and reserve estimates attributable to the Company's oil and gas reserves have been prepared in accordance with industry standards, no assurance can be given that the estimated costs are accurate, that development will occur as scheduled or that the results will be as estimated.
The Present Value referred to in this report should not be construed as the current market value of the estimated oil and gas reserves attributable to the Company's properties. In accordance with applicable requirements of the SEC, the estimated discounted future net cash flows from Proved Reserves are generally based on prices and costs as of the date of the estimate, whereas actual future prices and costs may be materially higher or lower. The estimates at December 31, 1996 of the Company's Proved Reserves and the future net revenues from which Present Value is derived were made using weighted average sales prices of $23.64 per Bbl of oil and $3.91 per Mcf of natural gas at that date, which prices were substantially higher than the prices used in previous years to make such estimates. The closing price on the NYMEX for the prompt month futures contract for delivery of West Texas Intermediate Crude Oil on December 31, 1996 and March 24, 1998 was $25.92 and $15.92 per Bbl, respectively. The closing price on the NYMEX for the prompt month futures contract for natural gas delivered at Henry Hub, Louisiana on December 31, 1996 and March 24, 1998 was $2.76 and $2.28 per MMBtu, respectively. Actual future net cash flows will also be affected by increases or decreases in consumption by oil and gas purchasers and changes in governmental regulations or taxation. The timing of actual future net cash flows from Proved Reserves, and thus their actual Present Value, will be affected by the timing of both the production and the incurring of expenses in connection with development and production of oil and gas properties. In addition, the 10% discount factor, which is required by the SEC to be used in calculating discounted future net cash flows for reporting purposes, is not necessarily the most appropriate discount factor based on interest rates in effect from time to time and risks associated with the Company or the oil and gas industry in general.
Replacement of Reserves
In general, the volume of production from oil and gas properties declines as reserves are depleted. Except to the extent the Company acquires properties containing Proved Reserves or conducts successful development and exploitation activities, or both, the Proved Reserves of the Company will decline as reserves are produced. The Company's future oil and gas production is, therefore, highly dependent upon its level of success in finding or acquiring additional reserves. The business of acquiring, enhancing or developing reserves is capital intensive. To the extent cash flow from operations is reduced and external sources of capital become limited or unavailable, the Company's ability to make the necessary capital investment to maintain or expand its asset base of oil and gas reserves would be impaired. In addition, there can be no assurance that the Company's future acquisition and development activities will result in additional Proved Reserves or that the Company will be able to drill productive wells at acceptable costs.
Reserve Concentration Risk
Substantially all of the Company's reserves are located in Texas, with 69% of the total reserves located in the Permian Basin of West Texas and 31% located in East Texas. Any interruption in the production from these reserves could materially adversely affect the operations of the Company.
Industry Risks
Oil and gas drilling and production activities are subject to numerous risks, many of which are beyond the Company's control. These risks include the risk that no commercially productive oil or gas reservoirs will be encountered, that operations may be curtailed, delayed or canceled, and that title problems, weather conditions, compliance with governmental requirements, mechanical difficulties or shortages or delays in the delivery of drilling rigs and other equipment may limit the Company's ability to develop, produce and market its reserves. There can be no assurance that new wells drilled by the Company will be productive or that the Company will recover all or any portion of its investment. Drilling for oil and gas may involve unprofitable efforts, not only from dry wells but also from wells that are productive but do not produce sufficient net revenues to return a profit after drilling, operating and other costs. In addition, the Company's properties may be susceptible to hydrocarbon drainage from production by other operators on adjacent properties.
Industry operating risks include the risks of fire, explosions, blow-outs, pipe failure, abnormally pressured formations and environmental hazards, such as oil spills, natural gas leaks, ruptures or discharges of toxic gases, the occurrence of any of which could result in substantial losses to the Company due to injury or loss of life, severe damage to or destruction of property, natural resources and equipment, pollution or other environmental damage, clean-up responsibilities, regulatory investigation and penalties and suspension of operations. In accordance with customary industry practice, the Company maintains insurance against some, but not all, of the risks described above. There can be no assurance that any insurance will be adequate to cover losses or liabilities. The Company cannot predict the continued availability of insurance at premium levels that justify its purchase.
Acquisition Risks
The Company's growth has been attributable largely to acquisitions of producing oil and gas properties with Proved Reserves. The successful acquisition of such properties requires an assessment of recoverable reserves, future oil and gas prices, operating costs, potential environmental and other liabilities and other factors beyond the Company's control. Such assessments are necessarily inexact and their accuracy inherently uncertain. In connection with such an assessment, the Company performs a review of the subject properties that it believes to be generally consistent with industry practices. Such a review, however, will not reveal all existing or potential problems, nor will it permit a buyer to become sufficiently familiar with the properties to fully assess their deficiencies and capabilities. Inspections may not always be performed on every well, and structural and environmental problems are not necessarily observable even when an inspection is undertaken. In most cases, the Company is not entitled to contractual indemnification for pre-closing liabilities, including environmental liabilities, and generally acquires interests in the properties on an "as is" basis with limited remedies for breaches of representations and warranties. In those circumstances in which the Company has contractual indemnification rights for pre-closing liabilities, there can be no assurance that the seller will be able to fulfill its contractual obligations. In addition, competition for producing oil and gas properties is intense and many of the Company's competitors have financial and other resources which are substantially greater than those available to the Company. Therefore, no assurance can be given that the Company will be able to acquire producing oil and gas properties which contain economically recoverable reserves or that it will make such acquisitions at acceptable prices.
Substantial Capital Requirements
The Company makes and will continue to make substantial capital expenditures in its exploitation and development projects. The Company intends to finance these capital expenditures with cash flow from operations, existing financing arrangements and equity offerings. Additional financing may be required in the future to fund the Company's developmental and exploitation activities. No assurance can be given as to the availability or terms of any such additional financing that may be required or that financing will continue to be available under the existing or new financing arrangements. If additional capital resources are not available
to the Company, its developmental and other activities may be curtailed and its business, financial condition and results of operations could be materially adversely affected. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Financial Condition and Capital Resources."
Marketability of Production
The marketability of the Company's natural gas production depends in part upon the availability, proximity and capacity of natural gas gathering systems, pipelines and processing facilities. Most of the Company's natural gas is delivered through natural gas gathering systems and natural gas pipelines that are not owned by the Company. Federal, state and local regulation of oil and gas production and transportation, tax and energy policies, changes in supply and demand and general economic conditions all could adversely affect the Company's ability to produce and market its oil and gas. Any dramatic change in market factors could have a material adverse effect on the Company's financial condition and results of operations.
Dependence on Key Personnel
The business of the Company will depend on the continued services of its president and chief executive officer, Marshall A. Smith III. Effective September 9, 1997, the Company entered into an employment agreement with Mr. Smith for a period of 3 years. The loss of the services of Mr. Smith would be particularly detrimental to the Company because of his background and experience in the oil and gas industry.
Competition
The oil and gas industry is highly competitive in all its phases. Competition is particularly intense with respect to the acquisition of desirable Producing Properties, the acquisition of oil and gas Prospects suitable for enhanced production efforts, and the hiring of experienced personnel. The competitors of the Company in oil and gas acquisition, development, and production include the major oil companies in addition to numerous independent oil and gas companies, individual proprietors and drilling programs. Many of these competitors possess and employ financial and personnel resources substantially in excess of those which are available to the Company and may, therefore, be able to pay more for desirable Producing Properties and Prospects and to define, evaluate, bid for, and purchase a greater number of Producing Properties and Prospects than the financial or personnel resources of the Company will permit. The ability of the Company to generate reserves in the future will be dependent on the Company's ability to select and acquire suitable Producing Properties and Prospects in competition with these companies.
Governmental Regulation
Domestic exploration for and production and sale of oil and gas are extensively regulated at both the federal and state levels. 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, are authorized by statute to issue, and have issued, rules and regulations affecting the oil and gas industry which often are difficult and costly to comply with and which carry substantial penalties for noncompliance. State statutes and regulations require permits for drilling operations, drilling bonds, and reports concerning operations. Most states in which the Company will operate also have statutes and regulations governing conservation matters, including the unitization or pooling of properties and the establishment of maximum rates of production from wells. Many state statutes and regulations may limit the rate at which oil and gas could otherwise be produced from acquired properties. Some states have also enacted statutes prescribing ceiling prices for natural gas sold within their states. The Company's operations are also subject to numerous laws and regulations governing plugging and abandonment, the discharge of materials into the environment or otherwise relating to environmental protection. The heavy regulatory burden on the oil and gas industry increases its costs of doing business and consequently affects its profitability. Although the Company believes it is in compliance with such laws, rules and regulations, there can be no assurance that a
change in such laws, rules or regulations, or the interpretation thereof, will not have a material adverse effect on the Company's financial condition or results of operations.
The transportation and sale for resale of natural gas in interstate commerce have historically been regulated by the Federal Regulatory Commission ("the FERC"). While sales of natural gas by producers such as the Company, and all sales of crude oil, condensate and natural gas liquids can currently be made at uncontrolled market prices, the federal government in the past has regulated the prices at which oil and gas could be sold, and Congress could reenact price controls in the future.
The Company's sales of natural gas are affected by the availability, terms and cost of transportation. The price and terms for access to pipeline transportation remain subject to extensive federal and state regulation. Several major regulatory changes have been implemented by Congress and the FERC from 1985 to the present that affect the economics of natural gas production, transportation and sales. In addition, the FERC continues to promulgate revisions to various aspects of the rules and regulations affecting those segments of the natural gas industry, most notably interstate natural gas transmission companies, which remain subject to the FERC's jurisdiction. These initiatives may also affect the intrastate transportation of natural gas under certain circumstances. The stated purpose of many of these regulatory changes is to promote market competition among the various sectors of the natural gas industry and these initiatives generally reflect more light-handed regulation of the natural gas industry. Although the ultimate impact of these complex rules and regulations, many of which are repeatedly subjected to judicial challenge and interpretation, cannot be predicated, the Company does not believe it will be affected by any action taken materially different than other producers with which it competes.
The Company owns certain gas pipelines that it believes meet the standards the FERC has used to establish a pipeline's status as a gatherer not subject to FERC jurisdiction. State regulation of gathering facilities generally includes various safety, environmental, and in some circumstances, nondiscriminatory take requirements. The Texas Railroad Commission has been reviewing changes to its regulations governing transportation and gathering services provided by intrastate pipelines and gatherers, and recently implemented a code of conduct intended to prevent undue discrimination by intrastate pipelines and gatherers in favor of their marketing affiliates.
The natural gas industry historically has been very heavily regulated; therefore, there is no assurance that the less stringent regulatory approach recently pursued by the FERC and Congress will continue.
Operational Risks and Insurance
GulfWest's oil and gas activities are subject to all of the risks normally incident to drilling for and production of oil and gas, including blowouts, cratering and fires, each of which could result in damage to life and property. In accordance with customary industry practices, GulfWest carries insurance against some, but not all, of these risks. Losses and liabilities resulting from such events would reduce revenues and increase costs to GulfWest to the extent not covered by insurance. See "Risk Factors-Industry Risks."
Environmental Matters
The Company is subject to environmental risks normally incident to the operation of oil and gas properties. These environmental risks include uncontrollable flows of natural gas, fluids and other substances into the environment, explosions, fires, pollution and other environmental and safety risks. The following is a discussion of certain environmental and safety concerns related to the Company. It is not intended to constitute a complete discussion of the various federal, state and local statutes, rules, regulations, or orders to which the Company's operations may be subject. Further, the recent trend in environmental legislation and regulations is toward stricter standards, and this will likely continue in the future.
The Company's activities are subject to environmental and safety regulation by federal and state authorities, including, without limitation, the state environmental agencies and the EPA, which can increase the costs of such operations. Such regulation may increase the cost of planning, designing, drilling, operating, and abandoning wells. In most instances, the regulatory requirements relate to the handling and disposal of drilling and production waste products and measures to control water and air pollution.
The Company currently owns or leases properties that for many years have been used for the exploration and production of oil and gas. Although the Company has utilized operating and disposal practices that were standard for the industry at the time, hydrocarbons or other wastes may have been disposed of or released on or under the properties owned or leased by the Company or on or under other locations where such wastes have been taken for disposal. In addition, many of the Company's properties were previously operated by third parties whose treatment and disposal or release of hydrocarbons or other wastes was not under the Company's control. These properties and wastes disposed thereon may be subject to the Comprehensive Environmental Response, Compensation, and Liability Act, the Resource Conservation and Recovery Act, or analogous state laws. Under such laws, the Company could be required to remove or remediate previously disposed wastes (including wastes disposed or released by prior owners or operators) or property contamination (including groundwater contamination) or to perform remedial plugging operations to prevent future contamination.
Environmental laws and regulations may require the acquisition of a permit or other authorization before certain activities may be conducted by the Company. These laws also include fines and penalties for non-compliance. Further, these laws and regulations may limit or prohibit activities on certain lands lying within wilderness areas, wetlands, areas providing habitat for certain species or other protected areas. The Company is also subject to other federal, state, and local laws covering the handling, storage or discharge of materials used by the Company, or otherwise relating to protection of the environment, safety and health. The Company believes that it is in material compliance with all applicable environmental laws and regulations. The Company periodically conducts environmental assessments of its assets and is not aware of any material environmental problems requiring remediation. Because the requirements imposed by environmental laws and regulations frequently change and because the risk of substantial environmental costs is inherent in oil and gas operations, the Company is unable to predict the ultimate costs of compliance with such requirements or whether the incurrence of such costs would have a material adverse effect on the operations of the Company.
ITEM 3.
ITEM 3. Legal Proceedings.
The Company's operating subsidiary, WestCo, is currently involved in a dispute with a company over rental equipment which WestCo contends was faulty and inoperable. At present, neither party has instituted litigation; however, the Company anticipates arbitration to settle the dispute in the near future. Due to the loss of revenues caused by the failure of the equipment to perform properly, the Company believes any claims for back rental would be sufficiently offset by the damages sustained by WestCo. Accordingly, no value has been placed on the other company's claim.
The Company is not a party to any other material legal proceedings.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders.
The Company's annual meeting was held on October 21, 1997. The only matter submitted to a vote of the shareholders was the election of directors. All 7 of the serving directors were re-elected. See Item 10 of this report, which information is incorporated herein by reference.
A special meeting of the shareholders of the Company was held on March 24, 1998 to consider a proposal for the offering, sale and issuance of the Company's Common Stock through a private placement at a price to be determined whereby gross proceeds of at least $500,000 and up to $5.5 million are anticipated to be raised. Of the 1,759,185 outstanding shares of Common Stock entitled to be voted at the meeting, there were, either in person or represented by proxy, 1,024,465 of such shares voted, which was 58% of the outstanding shares entitled to be voted at the meeting and was a sufficient quorum to conduct business. The proposal was approved with 987,691 votes for the proposal, 44,608 votes against and 1,166 abstentions. No other matters were considered at this special meeting.
PART II
ITEM 5.
ITEM 5. Market for Registrant's Common Stock and Related Stockholder Matters.
The Company's Common Stock is traded on The Nasdaq SmallCap Market tier of The Nasdaq Stock Market under the symbol "GULF" (prior to February 27, 1996 the symbol was "GFWO") and listed on the Boston Stock Exchange under the symbol "GFW". The high and low trading prices for the Common Stock for each quarter in 1996, 1997 and 1998 (through March 27, 1998) are set forth below. The trading prices represent prices between dealers, without retail mark-ups, mark-downs, or commissions, and may not necessarily represent actual transactions.
Common Stock
The Company is authorized to issue 20,000,000 shares of Class A Common Stock, par value $.001 per share (the "Common Stock"). As of March 27, 1998, 1,759,185 shares of Class A Common Stock were issued and outstanding and held by approximately 572 beneficial owners. Fidelity Transfer Company, 1800 South West Temple, Suite 301, Box 53, Salt Lake City, Utah 84115, (801)484-7222 is the transfer agent for the Common Stock.
Holders of Common Stock are entitled, among other things, to one vote per share on each matter submitted to a vote of shareholders and, in the event of liquidation, to share ratably in the distribution of assets remaining after payment of liabilities (including preferential distribution and dividend rights of holders of Preferred Stock). Holders of Common Stock have no cumulative rights, and, accordingly, the holders of a majority of the outstanding shares of the Common Stock have the ability to elect all of the directors.
Holders of Common Stock have no preemptive or other rights to subscribe for shares. Holders of Common Stock are entitled to such dividends as may be declared by the Board of Directors out of funds legally available therefor. The Company has never paid cash dividends on the Common Stock and does not anticipate paying any cash dividends in the foreseeable future.
Preferred Stock
The Board of Directors is authorized, without further shareholder action, to issue Preferred Stock in one or more series and to designate the dividend rate, voting rights and other rights, preferences and restrictions of each such series. Currently, there are two classes of Preferred Stock outstanding, Class AA and Class AAA, both immediately convertible into shares of Common Stock.
There were 1,950 shares of Class AA Preferred Stock outstanding at March 27, 1998, with a stated annual dividend rate of $50 per share, payable annually on a cumulative basis as declared, and convertible to 100 shares of Common Stock per share. Currently, dividends on the Class AA Preferred Stock are in arrears by $45,900. The Company may call the Class AA Preferred Stock for redemption, in whole or in part, at $600 per share (120% of the price paid for each share).
There were 3,440 shares of Class AAA Preferred Stock outstanding at March 27, 1998, with a stated annual dividend rate of $45 per share, payable quarterly on a cumulative basis as declared. The Company is attempting to renegotiate the terms of its Class AAA Preferred Stock to (a) change the strike price of the conversion feature of the Preferred Stock from 70% of the 15 day trailing average bid price of GulfWest's Common Stock to 100% of the offering price of the private placement, (b) make the Preferred Stock mandatorily redeemable by the Company beginning one year after the filing of a resale registration statement, subject to certain terms and conditions and (c) to provide the holders of the Preferred Stock a bonus equal to one quarterly dividend payment in satisfaction of any past or future compensation in connection with any delay in the registration of the Common Stock underlying the Preferred Stock and accompanying warrants to which the holders of the Preferred Stock might otherwise have been entitled. If the Company is unable to obtain the approval of all of the holders of the Preferred Stock, the present terms and conditions governing the Preferred Stock will remain in effect. Currently, dividends on the Class AAA Preferred Stock are in arrears approximately $141,400.
Both classes of the Preferred Stock have preference over the Company's Common Stock in payment of dividends and in distributions upon liquidation, dissolution or winding up of the Company. The holders of the Preferred Stock have no preemptive rights. The holders of the Preferred Stock, as a class, have no voting rights (except as required by Texas law or in connection with an amendment to the Certificate of Designation of the Shares to change their rights), other than those resulting from a default in judgment of debt or from a non-payment of dividends for more than six quarters. If the Company has been notified of a default in payment of debt which it is unable to cure or if the dividends on the Preferred Stock are in arrears by more than six quarters, the number of directors of the Company shall be increased to such number that permit the Preferred Shareholders and all such other Preferred Shareholders ("Preferred Class"), voting as a single class, to elect one-fourth of the directors of the Company. The Preferred Stock has transfer restrictions unless such transaction is registered under the Securities Act and applicable state securities laws or is exempt therefrom.
It is not possible to state the actual effects of the issuance of additional Preferred Stock upon the rights of holders of Common Stock until the Board of Directors of the Company determines the specific rights of the holders of such Preferred Stock. However, as in the case of the outstanding shares of Class AA and Class AAA Preferred Stock, such effects might include restricting dividends on the Common Stock, diluting the voting power of the Common Stock, impairing the liquidation rights of the Common Stock and delaying or preventing a change in control of the Company without further action by the shareholders.
Convertible Debentures
On November 18, 1997, the Company completed a private offering of $500,000 of convertible debentures (the "Debentures"). The Debentures bear interest at a rate of 12% payable quarterly and are collateralized by certain assets of the Company. Upon the earlier of the close of a private placement or one year from the issuance date of the Debentures, the principal and any accrued and unpaid interest will become payable upon demand. The holders of such Debentures will have the option, for one year from the due date to convert all or a part of the outstanding principal and any accrued and unpaid interest to GulfWest Common Stock at a strike price equal to 80% of the private placement offering price.
ITEM 6.
ITEM 6. Selected Financial Data.
The following table sets forth selected historical financial data of GulfWest Oil Company as of December 31, 1997, 1996, 1995, 1994 and 1993, and for each of the periods then ended. See "Item 1. Business" and "Item 7.
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Overview
GulfWest is an independent oil and gas company primarily engaged in the acquisition of producing oil and gas properties with Proved Reserves which have the potential for increased value through continued development and the application of enhanced recovery technology. The Company's objective is to significantly increase the production of such properties through workovers of the wells, horizontal drilling from existing wellbores, development drilling or other enhancement operations.
During the fourth quarter of 1996, the Company acquired producing oil properties with Proved Reserves from an unrelated entity in two separate transactions ("Phase I" and "Phase II") for a total purchase price of $10,654,000. The Company's subsidiary, WestCo Oil Company ("WestCo"), is the operator of the acquired properties.
Results of Operations
Comparative results of operations for the periods indicated are discussed below.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenues
Oil and gas sales for 1997 increased 176% to $4,269,000 from $1,549,000 in 1996. This was due to the addition of Working Interests ownership in the Phase I and II properties acquired in the fourth quarter of 1996.
Lease sales revenues in 1997 were $73,000 compared to $252,000 in 1996 with cost of leases sold being $38,000 compared to $92,000 in 1996.
In September 1996, the Company began operating well servicing equipment to perform work on its own properties and under contract to third parties. Operations for third parties produced well servicing revenues of $482,000 less expenses of $279,000 in 1997 compared to $58,900 less expenses of $46,400 for 1996.
Costs and Expenses
Lease operating expenses for 1997 increased by 226% to $2,139,000 from $657,000 in 1996 because of the added Working Interests ownership.
The 249% increase in Depreciation, Depletion and Amortization to $1,625,000 for 1997 from $466,000 in 1996 was due to the added Working Interests ownership in the Phase I and II properties in the fourth quarter of 1996 and economic factors affecting the year end prices of oil and gas.
General and administrative costs for 1997 increased by $419,000 over 1996 due to costs associated with company expansion.
Interest expense increased from $385,000 in 1996 to $1,161,000 in 1997 due to borrowing costs related to the acquisition of additional interests and other debt incurred during the year to finance the Company's operations.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Revenues
Oil and gas sales for 1996 increased 181% to $1,549,000 in 1996 compared to $551,300 in 1995. This was due to the addition of Working Interests ownership in the Phase I and II acquisitions during the fourth quarter of 1996 and to increases in oil and gas prices.
There was no gathering system revenue in 1996 compared to $32,385 in 1995, since the Company exchanged its beneficial ownership in the gathering system for additional Working Interests in wells in the Madisonville Field in August 1995.
Lease sales revenues in 1996 were $252,300 compared to -0- in 1995, with cost of leases sold being $91,800 in 1996 compared to -0- in 1995. The leases sold consisted of 50% ownership in properties which the Company had acquired during the second quarter of 1996.
In September 1996, the Company began operating well servicing equipment to perform work on its own properties and under contract to third parties. Operations for third parties produced well servicing revenues of $58,900 less expenses of $46,400 in 1996.
Revenue from operating overhead (administrative fees for operating oil and gas properties) and other income increased by 63% to $105,700 in 1996 compared to $65,000 in 1995 after commencement of operations by the operating subsidiary in August 1995. The increase was due to a full year's operation of the Madisonville properties and the assumption of operations for properties acquired during the fourth quarter of 1996.
Costs and Expenses
Lease operating expenses for 1996 increased by 58% to $657,000 in 1996 compared to $415,800 in 1995 because of the added Working Interests ownership.
Depreciation, Depletion and Amortization increased 41% to $466,100 in 1996 compared to $331,300 in 1995, due to the acquisition of Working Interests in the fourth quarter of 1996.
Interest expense increased 143% to $420,100 in 1996 compared to $172,600 in 1995, due to borrowing costs related to the acquisition of additional interests and other debt incurred during 1996 to finance the Company's operations.
General and administrative costs for 1996 increased by 16% to $1,058,900 in 1996 compared to $912,300 in 1995, due to added personnel salaries and other costs associated with company expansion.
Financial Condition and Capital Resources
During the fourth quarter of 1996, the Company acquired and assumed operations for $10,654,000 in oil properties in West Texas. In connection with these acquisitions, the Company issued senior debt due
October and December, 1999 in the original principal amount of $7,400,000. In a subsequent event, on March 20, 1998, the Company obtained a loan from a banking institution for $10,237,000, which included $7,632,000 for refinancing oil properties in West Texas purchased in October and December, 1996 (the "Acquired Properties") and $2,605,000 for payment toward the acquisition of certain other oil properties in West Texas (the "Additional Properties"), with a purchase price of $2,976,000. The Company has entered into a purchase and sale agreement for certain other oil properties in West Texas (the "Remaining Properties") for a purchase price of $1,450,000, with $1,000,000 in bank financing and $450,000 in seller financing to be closed, subject to various conditions such as title curative matters, not later than May 7, 1998.
On November 18, 1997, the Company completed a private offering of $500,000 of Debentures. The Debentures bear interest at a rate of 12% payable quarterly and are collateralized by certain assets of the Company. Upon the earlier of the close of a private placement or one year from the issuance date of the Debentures, the principal and any accrued and unpaid interest will become payable upon demand. The holders of such Debentures will have the option, for one year from the due date to convert all or a part of the outstanding principal and any accrued and unpaid interest to GulfWest Common Stock at a strike price equal to 80% of the private placement offering price.
On January 7, 1997, the Company established a $2,000,000 revolving line-of-credit with Southwest Bank of Texas, with part of the proceeds to be used for payment of short-term notes incurred for acquisitions made during the fourth quarter of 1996. On July 2, 1997, the Company's revolving line-of-credit was increased to $2,750,000 with the additional funds to be used for acquisitions and further enhancements of the Company's West Texas properties. The line-of-credit is guaranteed by Mr. J. Virgil Waggoner, a director of the Company. On March 30, 1998, the line-of-credit of $2,750,000 was renewed with a maturity date of April 10, 2000 and the demand feature of the note was removed.
On December 15, 1997, the Company obtained a loan from Mr. J. Virgil Waggoner, a director of the Company, in the amount of $1,000,000 to drill seventeen developmental wells in the Vaughn Field. On March 25, 1998, Mr. Waggoner agreed to extend the due date of the note to June 30, 1999 and, at the Company's option, to convert the outstanding principal amount of the note to Common Stock of the Company.
On March 3, 1998, the Company established a $500,000 revolving-line-of-credit with Compass Bank of Dallas, with the proceeds to be used for equipment purchases and working capital for its subsidiary, VanCo Well Service, Inc. ("VanCo"). The line of credit was guaranteed by J. Virgil Waggoner, a director, Marshall A. Smith, III, President of the Company and Jay Waggoner, an officer of VanCo.
At a special meeting of the shareholders of the Company on March 24, 1998, the shareholders approved the offering, sale and issuance of shares of the Company's Common Stock through a private placement at a price to be determined whereby gross proceeds of at least $500,000 and up to $5.5 million are anticipated to be raised. If fully subscribed, the Company expects to use the proceeds from the offering for working capital and general corporate purposes. These general purposes may include (i) approximately $2.75 million for payment of the current balance of a revolving credit facility with a financial institution and personally guaranteed by J. Virgil Waggoner, a director (this credit facility would continue to be available to the Company for acquisition, development and enhancement of oil and gas properties); (ii) approximately $1 million for repayment of a drilling loan from J. Virgil Waggoner (as noted above, Mr. Waggoner has agreed to convert the outstanding principal amount of the note to Common Stock, at the option of the Company); and (iii) approximately $600,000 for placement agent fees and expenses of the offering. The use of proceeds is subject to change, however, based upon the number of shares of Common Stock sold in the offering, the amount of net proceeds to the Company, competitive developments and the availability to the Company of other methods of financing.
In January 1998, the Company commenced a program to drill seventeen (17) infield wells in the Vaughn Field, Crockett County, Texas. If successful, upon completion of the drilling program, the Company will have increased its Proved Producing oil reserves in the Vaughn Field from approximately 700,000 barrels to an estimated 1.7 million barrels.
Management is seeking a partner to assist in the horizontal development of wells on its Madisonville properties. Management has identified 7 wells for re-entry using its horizontal technique which has proved up an additional 400,000 barrels of oil equivalent. The partner would be required to provide sufficient funds to pay down the existing debt on the property and fund the drilling and completion of the horizontal wells in exchange for a substantial operating interest in those wells.
Management's acquisition strategy is for the Company to be an aggressive consolidator of small, under-capitalized operators with Undeveloped Properties and oil and gas properties that may be non-core to larger independent and major oil and gas companies.
Although management believes the above actions will ultimately provide the Company with the means to become profitable, there is no guarantee these actions can be effectively implemented. Adverse changes in prices of oil and gas and/or the inability of the Company to continue to raise the money necessary to develop existing reserves or acquire new reserves would have a severe impact on the Company.
Inflation and Changes in Prices
While the general level of inflation affects certain costs associated with the petroleum industry, factors unique to the industry result in independent price fluctuations. Such price changes have had, and will continue to have a material effect; however, the fluctuations cannot be predicted by the Company. The following table indicates the average oil and gas prices received over the last three years by quarter. Average prices per equivalent barrel indicate the composite impact of changes in oil and gas prices. Natural gas production is converted to oil equivalents at the rate of 6 Mcf per barrel.
Year 2000 Issue
To date, the Company has not made an assessment of the effects, if any, on its business, operations or operating systems of the widely reported year 2000 computer problem.
Recent Accounting Pronouncements
During June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130 "Reporting Comprehensive Income" and Statement of Financial Accounting Standards No. 131 "Disclosure About Segments of an Enterprise and Related Information". During February 1998, the FASB issued Statement of Financial Accounting Standards No. 132 "Employers' Disclosure about Pensions and other Post Retirement Benefits". Preliminary analysis of these new standards by the Company indicates that the standards will not have a material impact on the Company. The standards are effective for financial statements for fiscal years beginning after December 15, 1997.
Actual Results May Differ From Forward-Looking Statements
Statements in this Form 10-K that reflect projections or expectations of future financial or economic performance of the Company, and statements of the Company's plans and objectives for future operations are "forward-looking" statements within the meaning of Section 27A of the Securities and Exchange Act of 1993, as amended. No assurance can be given that actual results or events will not differ materially from those projected, estimated, assumed or anticipated in any such forward looking statements. Important factors (the "Cautionary Disclosures") that could result in such differences include: general economic conditions in the Company's markets, including inflation, recession, interest rates and other economic factors; the availability of qualified personnel; the level of competition experienced by the Company; the Company's ability to implement its business strategies and to manage its growth; and other factors that affect businesses generally. Subsequent written and oral "forward-looking" statements attributable to the Company or persons acting on its behalf are expressly qualified by the Cautionary Disclosures.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data.
Information with respect to this Item 8 is contained in the Company's financial statements beginning on Page of this Annual Report.
ITEM 9.
ITEM 9. Changes In and Disagreements With Accountants and Accounting and Financial Disclosure.
None
PART III
ITEM 10.
ITEM 10. Directors and Executive Officers of the Registrant.
The directors and executive officers of the Company are as follows:
All directors will hold office until the next annual meeting of shareholders or until their successors are elected and qualified. Officers are elected annually by the Company's board of directors and serve for a one- year period and until their successors are elected. There is no family relationship between any of the named individuals above.
John E. Loehr was elected chairman of the board on September 1, 1993 and appointed Chief Financial Officer, effective November 22, 1996. Mr. Loehr is also currently president and sole shareholder of ST Advisory Corporation, an investment company, and vice-president of Star-Tex Trading Company, also an investment company. Mr. Loehr was formerly president of Star-Tex Asset Management, a commodity trading advisor, a position he held from 1988 until 1992, when he sold his ownership interest. Mr. Loehr is a CPA and is a member of the American Institute of Certified Public Accountants and Texas Society of Certified Public Accountants.
Marshall A. Smith III has served as an officer and a director of the Company since July 1989. From July, 1989 to November 20, 1992, he served as president and chairman of the board of directors. On November 20, 1992, he resigned as president but continued as chief executive officer and chairman of the
board. On September 1, 1993, Mr. Smith reassumed the duties of president and resigned as chairman of the board. Prior to joining the Company, Mr. Smith served in various capacities in a number of family controlled companies.
Jim C. Bigham has served as Executive Vice President of the Company since 1996 and as a director since 1991. Mr. Bigham joined the Company in 1991 as secretary. Prior to joining the Company in 1991, Mr. Bigham held management and sales positions in the real estate and printing industries. Mr. Bigham is also a retired United States Air Force Major. During his career, he served in both command and staff officer positions in the operational, intelligence and planning areas.
A. Van Nguyen has served as Vice President of Operations of the Company since 1996. Prior to joining the Company, he was Senior Vice President of OGP Operating, Inc., and a principal of Oil and Gas Producers, Inc., from 1992 to 1995. OGP Operating, Inc. was the operating company for Fuel Resources, Inc., a wholly-owned subsidiary of Brooklyn Union Gas Company. Prior to that, he was a senior petroleum engineer at Deminex U.S. Oil Company, where he was employed from 1981 to 1992. Mr. Nguyen is a Registered Professional Engineer in the State of Texas. Mr. Nguyen is a petroleum engineer with extensive background and experience in oil and gas property evaluation, drilling and completion, field operations and enhancement recovery technology.
Ned W. Fowler has served as a director of the Company since 1990. He also currently serves as a special advisor to OGERD Corporation, a company engaged in the marketing of equipment and supplies to the petroleum and petrochemical industries worldwide. In December, 1994, Mr. Fowler retired as executive vice president and a director of IRI International, Inc., positions he had held since 1985. IRI International, Inc. manufactures, markets, and services oil well drilling rigs nationally and internationally. The company was formed in 1985 as a merger of the Ideco Division of Dresser Industries and Ingersoll-Rand Oil Field Products Company. Mr. Fowler was president of Ideco-Dresser from 1982 until the merger with Ingersoll- Rand.
Charles D. Ledford has served as a director since August 5, 1996. Mr. Ledford served as chairman of the board, chief executive officer and president of ECO2, Inc., a rubber tire recycling company, from its inception in 1991 until February, 1997. Since 1976, Mr. Ledford has been active in research and development and the study of the application of pyrolysis in business. In 1992, Mr. Ledford patented a process converting scrap rubber tires into carbon black and fuel oil through the use of pyrolysis.
Henri M. Nevels has served as a director of the Company since August 22, 1996. Mr. Nevels also serves as an advisor to a private European investor group with international holdings, including those in the United States and China. Mr. Nevels has held this position for the past seven years.
James L. Crowson has served as a director of the Company since July 7, 1997. Mr. Crowson also is Deputy Chancellor for Texas Tech University and Texas Tech University Health Sciences Center, a position he assumed in 1996. Mr. Crowson is responsible for activities of the Board of Regents and is the direct administrator over the Vice Chancellors for institutional advancement, governmental relations, legal affairs, and fiscal affairs. From 1987 to 1995, Mr. Crowson was employed by the Lomas Financial Group as Senior Vice President and General Counsel until 1994 and as Executive Vice President in 1994-1995. Mr. Crowson served in various positions from 1970 to 1980 in the University of Texas system.
Anthony P. Towell has served as a director of the Company since November 13, 1997. Mr. Towell also is a director of a number of public companies, both in the United Kingdom and the United States, in the safety, environmental and computer network industries. Mr. Towell has been in the petroleum business since
1957 and has held executive positions with various public oil and gas companies including the Royal Dutch Shell group companies and Pacific Resources, Inc.
J. Virgil Waggoner has served as a director of the Company since December 1, 1997. Mr. Waggoner's career in the petrochemical industry began in 1950 and included senior management positions with Monsanto Company and El Paso Products Company, the petrochemical and plastics unit of El Paso Company. Mr. Waggoner served as president and chief executive officer of Sterling Chemicals, Inc. from the firm's inception in 1986 until its sale and his retirement in 1996. Mr. Waggoner continues to serve as non-executive vice chairman of the Board of Directors of Sterling Chemicals, Inc. Mr. Waggoner is on the Board of Directors of Kirby Corporation and is an advisory board director of First Commercial Bank of Little Rock, Arkansas. He is currently president and chief executive officer of JVW Investments, Ltd., a private company.
ITEM 11.
ITEM 11. Executive Compensation
Information with respect to executive compensation is incorporated herein by reference to the Proxy Statement.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
Information with respect to security ownership of certain beneficial owners and management is incorporated herein by reference to the Proxy Statement.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions
Information with respect to certain relationships and related transactions is incorporated herein by reference to the Proxy Statement.
DEFINITIONS
The following are definitions of certain terms used in this Form 10-K.
Bbl. Barrel.
BOE. Barrel of oil equivalent, based on a ratio of 6,000 cubic feet of natural gas for each barrel of oil.
Grossacres or gross wells. The total acres or wells, as the case may be, in which a Working Interests is owned.
Horizontal Drilling. High angle directional drilling with lateral penetration of one or more productive Reservoirs.
Mcf. One thousand cubic feet.
Net acres or net wells. The sum of the fractional Working Interests owned in gross acres or gross wells.
Net oil and gas sales. Oil and natural gas sales less oil and natural gas production expenses.
Overriding Royalty Interest. The right to a share of production from a well free of all costs and expenses except transportation, in addition to other Royalties reserved by the lessor by the property.
Present Value. The pre-tax present value, discounted at 10%, of future net cash flows froom estimated proved reserves, calculated holding prices and costs constant at amounts in effect on the date of the report (unless such prices or costs are subject to change pursuant to contractural provisions) and otherwise in accordance with the Commission's rules for inclusion of oil and gas reserve information in financial statements filed with the Commission.
Proceeds of Production. Money received (usually monthly) from the sale of oil and gas produced from Producing Properties.
Producing Properties. Properties that contain one or more wells that produce oil and/or gas in paying quantities (i.e., a well for which proceeds from production exceed operating expenses).
Productive well. A well that is producing oil or gas or that is capable of production.
Prospect. A lease or group of leases containing possible reserves, capable of producing crude oil, natural gas, or natural gas liquids in commercial quantities, either at the time of acquisition, or after vertical or horizontal drilling, completion of workovers, Recompletions, or operational modifications.
Proved Reserves. Estimated quantities of crude oil, natural gas, and natural gas liquids that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known Reservoirs under existing economic conditions; i.e., prices and costs as of the date the estimate is made. Reservoirs are considered proved if economic producibility is supported by either actual production or a conclusive formation test. The area of a Reservoir considered proved includes:
a. That portion delineated by drilling and defining by gas-oil or oil-water contacts, if any; and
b. The immediately adjoining portions not yet drilled but which can be reasonably judged as economically productive on the basis of available geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir.
Reserves which can be produced economically through application of improved recovery techniques (such as fluid injection) are included in the "proved" classification when successful testing by a pilot project, or the operation of an installed program in the reservoir, provides support for the engineering analysis on which the project or program was based.
Proved Reserves do not include:
a. Oil that may become available from known Reservoirs but is classified separately as "indicated additional reserves";
b. Crude oil, natural gas, and natural gas liquids, the recovery of which is subject to reasonable doubt because of uncertainty as to geology, Reservoir characteristics, or economic factors;
c. Crude oil, natural gas, and natural gas liquids that may occur in undrilled Prospects; and
d. Crude oil, natural gas, and natural gas liquids that may be recovered from oil shales and other sources.
Proved Developed Reserves. Reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery should be included as "proved developed" only after testing by a pilot project or after operation of an installed program has confirmed through production response that increased recovery will be achieved.
Proved Undeveloped Reserves. Reserves that are expected to be recovered from new wells on undrilled acreage of from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage shall be limited to those drilling units offsetting productive units that are reasonably certain of production when drilled. Proved reserves for other units that have not been drilled can be claimed only where it can be demonstrated with certainty that there is continuity of production from the existing productive formation. Under no circumstances should estimates for Proved Undeveloped Reserves be attributable to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proven effective by actual tests in the area and in the same Reservoir.
Recompletion. The completion for production of an existing wellbore in another formation from that in which the well has previously been completed.
Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil or gas that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs.
Royalty. The right to a share of production from a well free of all costs and expenses.
Royalty Interest. An interest in an oil and gas property entitling the owner to a share of oil and natural gas production free of costs of production.
Standardized Measure. The present value, discounted at 10%, of future net cash flows from estimated proved reserves, after income taxes, calculated holding prices and costs constant at amounts in effect on the date of the report (unless such prices or costs are subject to change pursuant to contractual provisions) and otherwise in accordance with the Commission's rules for inclusion of oil and gas reserve information in financial statements filed with the Commission.
Working Interest. The operating interest under a lease, the owner of which has the right to explore for and produce oil and gas covered by such lease. The full working interest bears 100 percent of the costs of exploration, development, production, and operation, and is entitled to the portion of gross revenue from the proceeds of production which remains after proceeds allocable to Royalty and Overriding Royalty Interests or other lease burdens have been deducted.
PART IV
ITEM 14.
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) The following documents are filed as part of this Report:
(1) Financial Statements:
Consolidated Balance Sheets at December 31, 1997, and 1996.
Consolidated Statements of Operations for the years ended December 31, 1997, 1996, and 1995.
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996, and 1995.
Notes to Consolidated Financial Statements, December 31, 1997, 1996 and 1995.
(2) Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts
(3) Exhibits:
Number Description ------ -----------
X2.1 Restructuring Agreement Regarding Madisonville Prospect, dated April 18, 1995.
X2.2 Unanimous Consent to First Amendment to Regulations of S.G.C. Transmission, L.L.C., dated July 17, 1995.
X2.3 Security Agreement RE: Subsequently Acquired Interests, dated July 17, 1995.
+2.4 Purchase and Sale Agreement, with amendments, between Pharaoh Oil and Gas, Inc, as Seller, and WestCo Producing Company, as Purchaser, dated June 12, 1996.
+2.5 Addendum of Purchase and Sale Agreement by and between Gary O. Bolen, Individually and d/b/a Badger Oil Company, Pharaoh Oil and Gas, Inc., and GulfWest Texas Company.
+2.6 Assignment of Purchase and Sale Agreement by and between Gary O. Bolen, Individually and d/b/a Badger Oil Company, Pharaoh Oil and Gas, Inc., GulfWest Texas Company and WestCo Producing Company.
+2.7 Assignment and Bill of Sale by and between Gary O. Bolen, Individually and d/b/a Badger Oil Company and Pharaoh Oil and Gas, Inc. as Assignor and GulfWest Texas Company as Assignee.
&2.8 Purchase and Sale Agreement between Pharaoh Oil and Gas, Inc., Taylor Link Operating Co. and Gary O. Bolen, Individually and d/b/a Badger Oil Company (collectively, "Pharaoh"), as Seller, and WestCo Producing Company, as Purchaser, dated November 6, 1996.
&2.9 Addendum of Purchase and Sale Agreement between Pharaoh and WestCo Producing Company, dated December 5, 1996.
&2.10Assignment of Purchase and Sale Agreement by and between Pharaoh, GulfWest Permian Company and WestCo Producing Company, dated December 5, 1996.
&2.11Form of Assignment and Bill of Sale by and between Pharaoh as Assignor and GulfWest Permian Company as Assignee.
*3.1 Articles of Incorporation of the Registrant and Amendments thereto.
*3.2 Bylaws of the Registrant.
+3.3 Statement of Resolution Establishing and Designating the Company's Class AA Preferred Stock, filed with the Secretary of State of Texas as an amendment to the Company's Articles of Incorporation on September 23, 1996.
+3.4 Statement of Resolution Establishing and Designating the Company's Class AAA Preferred Stock, filed with the Secretary of State of Texas as an amendment to the Company's Articles of Incorporation on September 23, 1996.
^ 4.1 Form of Note Purchase and Sale Agreement for the Company's 1995 Series A 9.5% Subordinated Notes, undated.
^4.2 Subscription and Registration Rights Agreement for the Purchase of Preferred Stock Between the Company and Eco2, Inc. dated March 13, 1996.
+4.3 Term note in the amount of $1,500,000.00 payable to the order of Pharaoh Oil and Gas, Inc. and to be executed by GulfWest Texas Company.
&4.4 Term note in the amount of $5,900,000.00 payable to the order of Pharaoh Oil and Gas, Inc. and executed by GulfWest Permian Company, dated December 5, 1996.
&4.5 Term note in the amount of $1,604,000.00 payable to the order of Pharaoh Oil and Gas, Inc. and executed by GulfWest Permian Company, dated December 5, 1996.
@10.2GulfWest Oil Company 1994 Stock Option Plan, approved by the Board of Directors on February 11, 1994.
@10.3Form of Nonqualified Stock Option Agreement, dated February 11, 1994 between the Company and certain officers, directors and advisors of the Company.
#10.4Letter Agreement between the Company and Madisonville Project, Limited, dated December 28, 1993 and amendment dated March 28, 1994.
#10.5Investment Letter Subscription Agreement of the Madisonville Project, Limited, executed by the Company on July 31, 1994.
#10.6The Madisonville Project, Limited Agreement of Limited Partnership, dated July 31, 1994.
@10.7Warrant Agreement between the Company and Jackson & Walker, L.L.P., dated December 21, 1994.
^10.8Stock Option Agreement between the Company and John E. Loehr, dated May 11, 1995.
^10.9Stock Option Agreement between the Company and Marshall A. Smith III, dated May 11, 1995.
^10.10 Employment Agreement between the Company and Marshall A Smith III, dated July 1, 1995.
^10.11 Employment Agreement between the Company and Jim C. Bigham, dated July 1, 1995.
"16 Letter from Arthur Andersen, L.L.P., dated December 28, 1995 agreeing with the statements contained in Item 4 of the Form 8-KA report.
?20.1 Letter to Shareholders dated August 12, 1996.
25 Power of Attorney (included on signature page of this Annual Report).
%27.1 Financial Data Schedule.
_______________
& Previously filed with the Company's Form 8-K, Current Report dated December 5, 1996, filed with the Commission on December 17, 1996.
+ Previously filed with the Company's Form 8-K, Current Report dated October 10, 1996, filed with the Commission on October 25, 1996.
? Previously filed with the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1996, filed with the Commission on August 14, 1996.
^ Previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1995, filed with the Commission on April 12, 1996.
" Previously filed with the Company's Form 8-K/A, Current Report dated December 12, 1995, filed with the Commission on December 29, 1995.
X Previously filed with the Company's Form 8-K, Current Report dated July 17, 1995, filed with the Commission on July 31, 1995.
@ Previously filed with the Company's Annual Report on Form 10-K for the year ended December 31, 1994, filed with the Commission on April 14, 1995.
# Previously filed with the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1994, filed with the Commission on August 14, 1994.
* Previously filed with the Company's Registration Statement (on Form S-1, Reg. No. 33-53526), filed with the Commission on October 21, 1992.
% Filed herewith.
S I G N A T U R E S
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.
GULFWEST OIL COMPANY
Date: March 31, 1998 By:\s\ Marshall A. Smith III ------------------------ Marshall A. Smith III President
POWER OF ATTORNEY
Know all men by these presents, that each person whose signature appears below constitutes and appoints Marshall A. Smith III as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place, and stead, in any and all capacities to sign any and all amendments or supplements to this Annual Report on Form 10-K, and to file the same, and with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney- in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
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.
GULFWEST OIL COMPANY
FINANCIAL REPORT
DECEMBER 31, 1997
C O N T E N T S
Page ----
INDEPENDENT AUDITOR'S REPORT ON THE FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
Consolidated balance sheets
Consolidated statements of operations
Consolidated statements of stockholders' equity
Consolidated statements of cash flows
Notes to consolidated financial statements
INDEPENDENT AUDITOR' REPORT ON THE FINANCIAL STATEMENT SCHEDULE
FINANCIAL STATEMENT SCHEDULE
Schedule II - Valuation and Qualifying Accounts
All other Financial Statement Schedules have been omitted because they are either inapplicable or the information required is included in the financial statements or the notes thereto.
INDEPENDENT AUDITOR'S REPORT
Stockholders and Board of Directors GULFWEST OIL COMPANY
We have audited the accompanying consolidated balance sheets of GulfWest Oil Company (a Texas Corporation) and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of GulfWest Oil Company and Subsidiaries as of December 31, 1997 and 1996 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
\s\WEAVER AND TIDWELL, L.L.P WEAVER AND TIDWELL, L.L.P. Dallas, Texas March 25, 1998
The Notes to Consolidated Financial Statements are an integral part of these statements.
The Notes to Consolidated Financial Statements are an integral part of these statements.
The Notes to Consolidated Financial Statements are an integral part of these statements.
The Notes to Consolidated Financial Statements are an integral part of these statements.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
The following is a summary of the significant accounting policies consistently applied by management in the preparation of the accompanying financial statements.
Organization/Concentration of Credit Risk
GulfWest Oil Company and subsidiaries (the "Company") intends to pursue the acquisition of quality oil and gas prospects which have proved developed and undeveloped reserves and the development of prospects with third party industry partners.
The accompanying financial statements include the Company and its wholly-owned subsidiaries: WestCo Producing Company (WestCo), formed in 1995; Vanco Well Service, Inc. ("Vanco"), GulfWest Texas Company ("GWT") and GulfWest Permian Company ("GWP") all formed in 1996; and DutchWest Oil Company formed in 1997. All material intercompany transactions and balances are eliminated upon consolidation.
The Company grants credit to independent and major oil and gas companies for the sale of crude oil and natural gas. In addition, the Company grants credit to joint owners of oil and gas properties which the Company, through WestCo, operates. Such amounts are secured by the underlying ownership interests in the properties. The Company also grants credit to various third parties through Vanco for well servicing operations.
The Company maintains cash on deposit in interest and non-interest bearing accounts which, at times, exceed federally insured limits. The Company has not experienced any losses on such accounts and believes it is not exposed to any significant credit risk on cash and equivalents.
Statement of Cash Flows
The Company considers all highly liquid investment instruments purchased with remaining maturities of three months or less to be cash equivalents for purposes of the consolidated statements of cash flows.
Non-Cash Investing and Financing Activities:
In 1997, the Company acquired other property and equipment through the issuance of debt totaling $130,875. Additionally, the Company exchanged a related party note receivable of $73,782 for oil and gas properties. 51,250 shares of common stock were issued to related parties upon the exercise of warrants and paid for by conversion of accrued expenses to such parties of $26,250.
In 1996, a $150,000 note payable was converted to preferred stock. In addition, the Company acquired oil and gas properties and other property and equipment through the issuance of debt totaling $9,291,864 and $348,486, respectively. A $500,000 note payable was converted to common stock in 1996.
In 1995, the Company acquired oil and gas properties through the assumption and issuance of debt totaling $720,508. Additionally, the Company financed $50,061 towards the purchase of other property and equipment.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies - continued
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Oil and Gas Properties
The Company uses the successful efforts method of accounting for oil and gas producing activities. Costs to acquire mineral interests in oil and gas properties, to drill and equip exploratory wells that find proved reserves, and to drill and equip development wells are capitalized. Costs to drill exploratory wells that do not find proved reserves, and geological and geophysical costs are expensed.
As the Company acquires significant oil and gas properties, any unproved property that is considered individually significant is periodically assessed for impairment of value, and a loss is recognized at the time of impairment by providing an impairment allowance. Capitalized costs of producing oil and gas properties and support equipment, after considering estimated dismantlement and abandonment costs and estimated salvage values, are depreciated and depleted by the unit-of-production method.
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 has 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. On the sale of an entire or partial interest in a proved property, gain or loss is recognized, based upon the fair values of the interests sold and retained.
Depreciation and Amortization
The Company provides for depreciation and amortization using the straight-line method over the following estimated useful lives of the respective assets:
Automobiles 3 - 5 years Office equipment 7 years Gathering system 10 years Well servicing equipment 10 years
Oil and Gas Revenues
The Company recognizes oil and gas revenues on the sales method as oil and gas production is sold. Differences between sales and production volumes during the years ended December 31, 1997, 1996, and 1995 were not significant.
Fair Value of Financial Instruments
At December 31, 1997 and 1996, the Company's financial instruments consist of notes receivable from related parties, notes payable and long-term debt. The Company believes that the recorded values approximate fair value.
GULFWEST OIL COMPANY AMD SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies - continued
Earnings (Loss) Per Share
Earnings (loss) per share are calculated based upon the weighted-average number of outstanding common shares. Diluted earnings (loss) per share are calculated based upon the weighted-average number of outstanding common shares, plus the effect of dilutive stock options, warrants, convertible preferred stock and convertible debentures.
The Company has adopted Statement of financial Accounting Standards (SFAS) No. 128 "Earnings Per Share", which requires that both basic earnings (loss) per share and diluted earnings (loss) per share be presented on the face of the statement of operations. All per-share amounts are presented in a diluted basis, that is, based upon the weighted-average number of outstanding common shares and the effect of all potentially diluted common shares. Implementation of SFAS No. 128 had no effect on previously reported loss per share amounts.
Reclassifications
Some amounts on the 1996 and 1995 financial statements have been reclassified to conform to 1997 presentation. Such reclassifications had no effect on results of operations for 1996 and 1995.
Impairments
Impairments, measured using fair market value, are recognized whenever events or changes in circumstances indicate that the carrying amount of long-lived assets (other than unproved oil and gas properties discussed above) may not be recoverable and the future undiscounted cash flows attributable to the asset are less than its carrying value.
Stock Based Compensation
In October 1995, SFAS No. 123, "Stock Based Compensation," (SFAS 123) was issued. This statement requires the Company to choose between two different methods of accounting for stock options and warrants. The statement defines a fair-value-based method of accounting for stock options and warrants but allows an entity to continue to measure compensation cost for stock options and warrants using the accounting prescribed by APB Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees." Use of the APB 25 accounting method results in no compensation cost being recognized if options are granted at an exercise price at the current market value of the stock or higher. The Company will continue to use the intrinsic value method under APB 25 but are required by SFAS 123 to make pro forma disclosures of net income and earnings per share as if the fair value method had been applied in its 1997 and 1996 financial statements. See Note 6 to the consolidated financial statements for further information.
Implementation of New Financial Accounting Standards
In June 1997, SFAS No. 130, "Reporting Comprehensive Income", was issued. The statement must be adopted by the Company in the first quarter of 1998. Under provisions of this statement, the Company will be required to include a financial statements presentation of comprehensive income and its components to conform to these new requirements. Implementation of this disclosure standard is not expected to affect the Company's financial position or results of operations.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 2. Operations and Management Plans
At December 31, 1997, the Company had suffered recurring operating losses, had cash on hand of approximately $626,500 and its current liabilities exceeded its current assets by $1,342,860. Subsequent to year end, the Company purchased an additional 27 oil wells in Pecos County, Texas for $2.6 million and refinanced its outstanding senior debt of approximately $7.4 million plus accrued interest of approximately $200,000 with Chase of Texas, N.A. with a note totaling $10.2 million. The note bears interest at the prime rate for the first 6 months and the prime rate plus one-half percent for the subsequent 6 months, with the principal due March 20, 1999. The Company also paid $300,000 cash in connection with the purchase ($200,000 is included as deposits on oil and gas properties on the balance sheet), $170,000 in workover costs on the properties (included in accounts receivable on the balance sheet) and issued the seller a $162,675 note payable with interest at 8% due September 20, 1998. Subject to obtaining clear title, the Company intends to purchase additional properties from the same seller for $1,450,000 by increasing the aforementioned bank note and seller note $1,000,000 and $450,000, respectively.
The Company's revolving line of credit of $2.75 million, bearing interest at the prime rate, was extended to April 10, 2000 and a $1 million note, bearing interest at the prime rate, from a director, was extended to June 30, 1999. The director further agreed that, at the Company's option, the loan may be exchanged for common stock of the Company. Also, in March, 1997, the Company obtained a $500,000 line of credit from a bank, interest at prime, due April, 1999.
Subsequent to year end, the shareholders approved the offering, sale and issuance of shares of the Company's common stock through a private placement at a price to be determined whereby gross proceeds of at least $500,000 and up to $5.5 million are anticipated to be raised. If fully subscribed, the Company expects to use the proceeds from the offering for working capital and general corporate purposes. These general purposes may include (i) approximately $2.75 million for payment of the current balance of a revolving credit facility with a financial institution and personally guaranteed by a director (this credit facility would continue to be available to the Company for acquisition, development and enhancement of oil and gas properties); (ii) approximately $1 million for repayment of a drilling loan from a director (as noted above, the director has agreed to convert the outstanding principal amount of the note to common stock, at the option of the Company); and (iii) approximately $600,000 for placement agent fees and expenses of the offering. The use of proceeds is subject to change, however, based upon the number of shares of common stock sold in the offering, the amount of net proceeds to the Company, competitive developments and the availability to the Company of other methods of financing.
In January 1998, the Company commenced a program to drill 17 infield wells in the Vaughn Field, Crockett County, Texas. If successful, upon completion of the drilling program, the Company estimates it will increase its proved producing oil reserves in the Such Field from approximately 700,000 barrels to an estimated 1.7 million barrels.
Management is seeking a partner to assist in the horizontal development of wells on its Madisonville properties. Management has identified 7 wells for re-entry using its horizontal technique which has proved up an additional 400,000 barrels of oil equivalent. The partner would be required to provide sufficient funds to pay down the existing debt on the property and fund the drilling and completion of the horizontal wells in exchange for a substantial operating interest in those wells.
Management's acquisition strategy is for the Company to be an aggressive consolidator of small, under-capitalized operators with undeveloped properties and oil and gas properties that may be non-core to larger independent and major oil and gas companies.
Although management believes the above actions will ultimately provide the Company with the means to become profitable, there is no guarantee these actions can be effectively implemented. Adverse changes in prices of oil and gas and/or the inability of the Company to continue to raise the money necessary to develop existing reserves or acquire new reserves would have a severe impact on the Company.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3. Cost of Oil and Gas Properties
The following tables set forth certain information with respect to the Company's oil and gas producing activities for the periods presented:
On July 3, 1994, the Company exercised its option under the Investment Letter and Subscription Agreement with Madisonville Project, Ltd. (the "Partnership"), an unrelated party, to convert $500,000 of the note receivable from the Partnership into 100 Partnership units. At December 31, 1994, the Company's 100 units represent an interest of 32.46% of the Partnership. Per the agreement with the Partnership, income and expenses are to be distributed between partners based on the weighted average interest in the partnership during the year. As a result of the investment in the Partnership, the balance sheet of the Partnership as of December 31, 1997 and 1996, and its results of operations for the years ended December 31, 1997, 1996 and 1995 have been proportionately consolidated with the accompanying balance sheets, statements of operations and cash flows of the Company. All material intercompany transactions and balances have been eliminated in consolidation.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3. Cost of Oil and Gas Properties - continued
Costs Incurred in Oil and Gas Producing Activities: - continued
On July 17, 1995, the Company acquired from SPI beneficial ownership of an additional 42-1/2% of the working interests in 31 proved producing oil and gas properties located in Madison and Grimes Counties, Texas. The acquisition was made pursuant to a Restructuring Agreement (the "Agreement") dated April 18, 1995 which also provided for the assumption of operations of the properties and gathering system by WestCo, a wholly owned subsidiary of the Company. The Agreement was entered into by and between the Company, SPI, Sikes Operating, Inc. ("SOI"), an unrelated party, WestCo, S.G.C. Transmission, L.L.C. ("SGC") a Texas limited liability company of which the Company is a member, and the Partnership, of which the Company is a limited partner. The Company gave SPI its 37-1/2% ownership of the gas pipeline gathering system and assumed a $640,000 nonrecourse note from the Partnership as payment for the working interests.
The Company also agreed to purchase certain working interest subsequently acquired by SPI for a purchase price of $100,000, with $20,000 paid in cash at closing and a promissory note for $80,000, payable on or before 120 days from the date of the closing with interest at 10% per annum. This note was paid in full in March, 1996.
In 1996, the Company acquired significant oil and gas reserves from an unrelated entity in two separate transactions. In the first transaction ("Phase I"), the Company acquired various properties for $3,000,000. $1,500,000 was paid at closing and a $1,500,000 note payable was issued. In the second transaction ("Phase II"), the Company acquired various properties for $7,654,000. $150,000 was paid at closing and two notes payable totaling $7,504,000 were issued. In connection with the Phase I and Phase II transactions, the Company incurred $150,000 in commissions to a related party.
In 1997, the Company acquired an oil and gas property in satisfaction of a $73,782 note receivable from a related party. In connection with two other property acquisitions in 1997, the Company incurred a total of $62,500 in commissions to a related party.
Supplemental unaudited pro forma information presenting the results of operations for the years ended December 31, 1996 and 1995, as if the Phase I and Phase II transactions had occurred as of January 1, 1996 and 1995:
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4. Accrued Expenses
Note 5. Notes Payable and Long-Term Debt
Repayment on the nonrecourse debt to the Partnership is to be made from 75% of the operating cash flow from the acquired wells, with payments applied first to interest, then to principal. In addition, the lender received a 15% net profits interest, as defined in the purchase agreement, in amounts realized from the acquired properties.
Subsequent to December 31, 1997, the following refinancing of long-term debt occurred:
* The $2,729,515 line of credit due date was extended to April 10, 2000 and the demand feature removed.
* The $1,000,000 promissory note to a director due date was extended to June 30, 1999.
* The notes payable to acquire oil and gas properties totaling $7,431,986 were refinanced with a bank, as well as accrued interest of $201,717 and the financing of $2,603,512 in additional oil and gas properties on March 20, 1998. The new note ($10,237,215) is due in a lump sum amount on March 20, 1999. Interest is payable at prime rate quarterly through September 20, 1998; prime plus .5% quarterly thereafter.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 5. Notes Payable and Long-Term Debt - continued
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 6. Stockholders' Equity - continued
Class AA and AAA preferred shareholders have liquidation preference over common shareholders of $500 per preferred share, plus accrued dividends. Dividends in arrears at December 31, 1997 were approximately $187,400 ($141,400 - - Class AAA; $45,900 - Class AA). There was no dividends in arrears at December 31, 1996.
Stock Options
The Company maintains a Non-Qualified Stock Option Plan (the "Plan") which authorizes the grant of options of up to 200,000 shares of common stock. Under the Plan, options may be granted to any of the Company's key employees (including officers), directors, or advisors. The Plan is administered by the Stock Option Committee of the Board of Directors. All options granted under the Plan have been granted at an option price of $3,00 per share. In addition, the Company has granted stock options to outside parties, including 500,000 options to a director related to the issuance and quarantee of Company debt. Following is a schedule by year of the activity related to stock options, including weighted-average ("WTD AVG") exercise prices of options in each category.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 6. Stockholders' Equity - continued
Included in the "warrants exercised/expired" column in 1997 were 51,250 $.50 warrants exercised by related parties. The remaining 90,000 warrants expired. Included in the "warrants issued" and "warrants exercised/expired" columns in 1996 are 121,000 warrants issued in 1995 whose expiration dates were extended in 1996. The remaining 31,000 warrants expired.
Warrants outstanding to officers, directors and employees of the Company at December 31, 1997and 1996 were approximately 1,300,000 and 1,160,000, respectively. The exercise prices on these warrants range from $.475 to $6.00 and expire various dates through 2006.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 6. Stockholders' Equity - continued
Other Stock Based Compensation Disclosures
During 1997 and 1996, the Company issued options and warrants totaling 85,000 (25,000 exercisable) and 653,000 (all exercisable), respectively, to employees as compensation. No compensatory equity instruments were issed to employees in 1995. As disclosed in Note 1, the Company continues to use the intrinsic value based method of APB 25 to measure stock based compensation. If the Company had used the fair value method required by SFAS 123, the Company's net loss and per share information would approximate the following amounts:
The effects of applying SFAS 123 as disclosed above are not indicative of future amounts. The Company anticipates making additional stock based employee compensation awards in the future.
The Company utilized the Black-Sholes option pricing model to estimate the fair value of the options and warrants on the grant date. A 60% discount off the NASDAQ market price at the measurement date was utilized because of (1) the restricted nature of the stock underlying the options/warrants and (2) the dilutive effect of the substantial number of options/warrants issued and outstanding. Accordingly, the exercise price of all stock options and warrants issued in 1997 and 1996 exceeded the discounted market price at the measurement date. Other significant assumptions include (1) 5.75% risk free interest rate; (2) weighted average expected life of 1997 - 3 years; 1996 - 4.95 years; (3) expected volatility of 1997 - 77.68%; 1996 - 81.89% and (4) no expected dividends.
Note 7. Loss Per Common Share
Potential dilutive securities (1997 - stock options, stock warrants, convertible preferred stock and convertible debentures; 1996 - stock options, stock warrants and convertible preferred stock; 1995 - stock options and stock warrants) have not been considered since the Company reported a net loss and, accordingly, their effects would be antidilutive.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8. Related Party Transactions
On December 1, 1992, Ray Holifield and Associates, Inc. executed an unsecured promissory note to the Company for $118,645 with interest at 10% per annum, due on October 1, 1993. At December 31, 1993, the note was still outstanding. During 1994, the Company entered into an agreement with the Holifield Trust in which Holifield will make payments on the past due note from future oil and gas revenue. During 1995, $10,995 of interest payments were received. No principal payments were received during 1997 or 1996. At December 31, 1997 the unsecured promissory note has been fully reserved.
On December 1, 1992, Parkway Petroleum Company, a Ray Holifield related company, executed an unsecured promissory note to the Company for $54,616 with interest at 10% per annum, due on October 1, 1993. The note was issued for amounts due from contract drilling services provided by the Company. At December 31, 1993, the note was still outstanding. During 1994, the Company entered into an agreement with the Holifield Trust in which Holifield will make payments on the past due note from future oil and gas revenue. During 1995, $6,250 of interest payments were received. No principal payments were received during 1997 or 1996. At December 31, 1997, the unsecured promissory note has been fully reserved.
On January 10, 1994, the Company entered into a consulting agreement with Williams whereby the Company would provide management and accounting services for $25,000 per month for a period of one year. The Company accrued the consulting fees with an offset to deferred income until payment of the fees are actually received. During 1994, $172,140 was recorded as consulting fee income. Beginning in the second quarter 1994, the Company began recognizing consulting income only as cash payments were received. Prior to the second quarter, $75,000 in consulting fee revenue was accrued. The Company has received $97,140 in consulting fee payments. As of December 31, 1994, the receivable from Williams of $202,860 for consulting fees has been offset by deferred income of $127,860 and a provision for doubtful accounts of $75,000. Effective January 1, 1995, the Company received a promissory note from Williams in the amount of $202,860, bearing interest at the rate of 10% per annum, and payable in quarterly installments of principal and interest of $15,538.87. During 1997 and 1996, the Company received no payments on this note. At December 31, 1997, the unsecured promissory note has been fully reserved.
As of December 31, 1995, the Company had accrued compensation for two officers of the Company totaling $54,123. On March 27, 1996, notes due April 1, 1997 were issued to these two officers for this amount. Additionally, the Company has accrued consulting fees to ST Advisory Corp., a related party owned by a director of the Company, totaling $12,500 for services performed in connection with economic evaluations and nonrecourse financing arrangements for future acquisitions of oil and gas properties and other corporate development opportunities. As of December 31, 1996, accrued compensation to one officer totaled $10,500. At December 31, 1997, accrued compensation to three officers totaled approximately $75,000.
Interest expensed on related party notes totaled approximately $49,000, $26,000 and $19,000 for the years December 31, 1997, 1996 and 1995, respectively.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 9. Income Taxes
As of December 31, 1997 and 1996, the Company did not believe it was more likely than not that the net operating loss carryforwards would be realizable through generation of future taxable income; therefore, they were fully reserved.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 10. Commitments and Contingencies
Lease Obligations
The Company leases office space at two locations. Both lease agreements are maintained on a month-to- month basis. The Company also leases four compressors used in the production of oil and gas revenue.
Year 2000 Computer Issues
To date, the Company has not made an assessment of the effects, if any, on its business, operations or operating systems of the widely reported year 2000 computer problem.
Litigation
The Company is involved in other litigation and disputes. Management believes such claims are without merit with respect to the Company or are adequately covered by insurance and has concluded the ultimate resolution of such disputes will not have a material effect on the Company's consolidated financial statements.
Note 11. Oil and Gas Reserves Information (Unaudited)
The estimates of proved oil and gas reserves utilized in the preparation of the financial statements are estimated in accordance with guidelines established by the Securities and Exchange Commission and the Financial Accounting Standards Board, which require that reserve estimates be prepared under existing economic and operating conditions with no provision for price and cost escalations over prices and costs existing at year end except by contractual arrangements.
The Company emphasizes that reserve estimates are inherently imprecise. Accordingly, the estimates are expected to change as more current information becomes available. The Company's policy is to amortize capitalized oil and gas costs on the unit of production method, based upon these reserve estimates. It is reasonably possible that, because of changes in market conditions or the inherent imprecision of these reserve estimates, that the estimates of future cash inflows, future gross revenues, the amount of oil and gas reserves, the remaining estimated lives of the oil and gas properties, or any combination of the above may be increased or reduced in the near term. If reduced, the carrying amount of capitalized oil and gas properties may be reduced materially in the near term.
GULFWEST OIL COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 11. Oil and Gas Reserves Information (Unaudited) - continued
INDEPENDENT AUDITOR'S REPORT
Stockholders and Board of Directors GULFWEST OIL COMPANY
Our report on the consolidated financial statements of GulfWest Oil Company as of December 31, 1997 and 1996 and for each of the three years in the period ended December 31, 1997, is included on page. In connection with our audit of such financial statements, we have also audited the related financial statement schedule for the years ended December 31, 1997, 1996 and 1995 on page.
In our opinion, the financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.
\s\ WEAVER AND TIDWELL, L.L.P. WEAVER AND TIDWELL, L.L.P.
Dallas, Texas March 25, 1998
GULFWEST OIL COMPANY AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995