================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended June 30, 2002
Commission file number 000-24971
CONTANGO OIL & GAS COMPANY
(Exact name of small business issuer as specified in its charter)
Delaware 95-4079863
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3700 Buffalo Speedway, Suite 960
Houston, Texas 77098
(Address of principal executive offices)
(713) 960-1901
(Issuer's telephone number)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, Par Value $0.04 American Stock Exchange
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X
-------
No ______
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, or will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB X
-----
Revenues from operations for the fiscal year ended June 30, 2002 were
$28,918,168.
The aggregate market value of the voting common stock held by
non-affiliates based on the closing price at September 20, 2002, was
$17,163,188. As of September 20, 2002, there were 9,043,282 shares of the
issuer's common stock outstanding.
Documents Incorporated by Reference
Items 9, 10, 11 and 12 of Part III have been omitted from this report
since registrant will file with the Securities and Exchange Commission, not
later than 120 days after the close of its fiscal year, a definitive proxy
statement, pursuant to Regulation 14A. The information required by Items 9, 10,
11 and 12 of this report, which will appear in the definitive proxy statement,
is incorporated by reference into this Form 10-KSB.
Transitional Small Business Disclosure Format (check one): Yes ______
No X
-----
================================================================================
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-KSB
FOR THE FISCAL ENDED JUNE 30, 2002
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business
Overview ................................................................ 1
Our Strategy ............................................................ 2
Exploration Alliance with JEX ........................................... 2
Onshore Exploration and Properties....................................... 3
Offshore Exploration Joint Ventures ..................................... 4
Offshore Operations and Properties ...................................... 6
Natural Gas and Oil Prices .............................................. 7
Marketing ............................................................... 7
Governmental Regulations ................................................ 8
Employees ............................................................... 10
Directors and Executive Officers ........................................ 10
Corporate Offices ....................................................... 12
Risk Factors ............................................................ 12
Item 2. Description of Properties
Production, Prices and Operating Expenses ............................... 20
Development, Exploration and Acquisition Capital Expenditures ........... 21
Drilling Activity ....................................................... 21
Exploration and Development Acreage ..................................... 22
Productive Wells ........................................................ 22
Natural Gas and Oil Reserves ............................................ 23
Item 3. Legal Proceedings ............................................................ 24
Item 4. Submission of Matters to a Vote of Security Holders .......................... 24
PART II
Item 5. Market for Common Equity and Related Stockholder Matters ..................... 24
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Introduction ............................................................ 27
Critical Accounting Policies ............................................ 27
MD&A Summary Data ....................................................... 29
Year Ended June 30, 2002 Compared to Year Ended June 30, 2001 ........... 29
Capital Resources and Liquidity ......................................... 30
Credit Facility ......................................................... 31
Quantitative and Qualitative Disclosure About Market Risk ............... 32
Item 7. Financial Statements and Supplementary Data .................................. 33
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure ......................................................... 33
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act ............................ 33
Item 10. Executive Compensation ....................................................... 34
Item 11. Security Ownership of Certain Beneficial Owners and Management ............... 34
Item 12. Certain Relationships and Related Transactions ............................... 34
Item 13. Exhibits and Reports on Form 8-K ............................................. 34
i
Cautionary Statement About Forward-Looking Statements
Some of the statements made in this Form 10-KSB may contain
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. The words and phrases "should be", "will be", "believe", "expect",
"anticipate", "estimate", "forecast", "goal" and similar expressions identify
forward-looking statements and express our expectations about future events.
These include such matters as:
. Our financial position
. Business strategy and budgets
. Anticipated capital expenditures
. Drilling of wells
. Natural gas and oil reserves
. Timing and amount of future production of natural gas and oil
. Operating costs and other expenses
. Cash flow and anticipated liquidity
. Prospect development and property acquisitions
. Hedging results
Although we believe the expectations reflected in such forward-looking
statements are reasonable, we cannot assure you that such expectations will
occur. These forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause our actual results, performance
or achievements to be materially different from actual future results expressed
or implied by the forward-looking statements. These factors include among
others:
. The risks associated with exploration
. Ability to raise capital to fund capital expenditures
. The ability to find, acquire, market, develop and produce new
properties
. Natural gas and oil price volatility
. Uncertainties in the estimation of proved reserves and in the
projection of future rates of production and timing of development
expenditures
. Operating hazards attendant to the natural gas and oil business
. Downhole drilling and completion risks that are generally not
recoverable from third parties or insurance
. Potential mechanical failure or under-performance of significant
wells
. Climatic conditions
. Availability and cost of material and equipment
. Delays in anticipated start-up dates
. Actions or inactions of third-party operators of our properties
. Commodity price movements adversely affecting our hedge position
. Ability to find and retain skilled personnel
. Availability of capital
. Strength and financial resources of competitors
. Regulatory developments
. Environmental risks
. General economic conditions
ii
When you consider these forward-looking statements, you should keep in
mind these risk factors and the other cautionary statements in this Form 10-KSB.
You should not unduly rely on these forward-looking statements in this report,
as they speak only as of the date of this report. Except as required by law, we
undertake no obligation to publicly release any revisions to these
forward-looking statements to reflect events or circumstances occurring after
the date of this report or to reflect the occurrence of unanticipated events.
See the information under the heading "Risk Factors" on page 12 for some of the
important factors that could affect our financial performance or could cause
actual results to differ materially from estimates contained in forward-looking
statements.
iii
All references in this Form 10-KSB to the "company", "Contango", "we",
"us" or "our" are to Contango Oil & Gas Company and Subsidiaries. Unless
otherwise noted, all information in this Form 10-KSB relating to natural gas and
oil reserves and the estimated future net cash flows attributable to those
reserves are based on estimates prepared by independent engineers and are net to
our interest.
PART I
Item 1. Business
Overview
We are an independent natural gas and oil company that explores for,
develops, produces and sells natural gas and crude oil. Our exploration and
production efforts are currently focused onshore on the Gulf Coast and offshore
in the Gulf of Mexico. Our primary source of production is currently in south
Texas where we own an approximate 71% working interest and a 53% net revenue
interest in properties located in our South Texas Exploration Program, or
"STEP". While our STEP interests currently account for nearly all of our
production, we also have interests in producing properties located offshore in
the Gulf of Mexico.
As of June 30, 2002, we owned rights to approximately 27.9 Bcfe of
total proved reserves, an increase of 55% from June 30, 2001. As of June 30,
2002 and 2001, approximately 99% and 87% of total proved reserves were
classified as proved developed producing, respectively. The pre-tax net present
value of our total proved reserves as of June 30, 2002 was approximately $53.3
million.
Total revenues and EBITDAX, which we define as earnings before
interest, income taxes, depreciation, depletion and amortization, impairment
expense and expensed exploration expenditures, including gains or losses from
hedging, were $28.9 million and $22.1 million, respectively, for the year ended
June 30, 2002. For the year ended June 30, 2001, total revenues and EBITDAX were
$24.0 million and $19.0 million, respectively. Average net daily production for
the year ended June 30, 2002 was 19.1 MMcf of natural gas per day and 510
barrels of crude oil per day, compared to 9.8 MMcf of natural gas per day and
335 barrels of crude oil per day for the year ended June 30, 2001.
Our predecessor company was incorporated in the State of Nevada in
August 1986 under the name of Maple Enterprises, Inc. and in 1998 was renamed
MGPX Ventures, Inc. following a sale of substantially all of the company's
assets to MGPX Ventures' management. MGPX Ventures, Inc. subsequently had no
operating business until July 1999 when the company's board voted to enter the
natural gas and oil business, changing the company's name to our current name
and hiring Kenneth R. Peak as our chief executive officer. We did not record any
revenue from our natural gas and oil operations until the fiscal year ended June
30, 2000. In December 2000, we reincorporated in the State of Delaware and
affected a 2 for 1 reverse stock split. Prior to January 2001, our common stock
traded on the Nasdaq over-the-counter bulletin board. In January 2001, we
changed our listing to the American Stock Exchange and adopted the trading
symbol "MCF".
1
Our Strategy
Our strategy is predicated upon two core beliefs: (1) that the only
competitive advantage in the commodity-based natural gas and oil business is to
be among the lowest cost producers and (2) that virtually all the exploration
and production industry's value creation occurs through the drilling of
successful exploratory wells. As a result, our business strategy includes the
following elements:
Funding exploration prospects developed by proven geoscientists. Our
prospect generation and evaluation functions are performed by our alliance
partner, Juneau Exploration Company, L.P., or "JEX". This proven group of four
explorationists with 15 to 20 years of experience each has demonstrated its
ability to find reserves both onshore and offshore in the Gulf of Mexico. In our
experience, only a select group of explorationists are able to consistently and
profitably find natural gas and oil. Our STEP properties were discovered by JEX
and resulted in very competitive finding and development costs of $1.41 per
Mcfe. Our principal exploration strategy is to fund exploration prospects
generated by JEX.
Negotiating acquisitions of proved properties. Since January 1, 2002,
we have spent $26.0 million to acquire 14.0 Bcfe of proved developed producing
reserves of natural gas and oil. We will continue to seek producing property
acquisitions based on our view of the pricing cycles of natural gas and oil and
available exploitation opportunities of probable and possible reserves.
Controlling general and administrative and geological and geophysical
costs. Our goal is to be among the highest in the industry in revenue and profit
per employee and among the lowest in the industry in general and administrative
costs. We plan to continue our program of outsourcing geological, geophysical,
reservoir engineering and land functions, and partnering with cost efficient
operators whenever possible. We currently have three employees.
Structuring transactions to minimize front-end investments. We seek to
maximize returns on capital by minimizing our up-front investments of our own
capital in acreage, seismic data and prospect generation. We want our key
partners to share in both the risk and the rewards of our success.
Seeking new alliance ventures. While our core focus will remain the
domestic exploration and production business, we will also continue to seek
alliance ventures with companies and individuals that offer attractive
investment opportunities. These opportunities may include domestic or foreign
exploration prospects, as well as investments in downstream natural gas assets.
Structuring incentives to drive behavior. We believe that equity
ownership aligns the interests of our partners, employees, and stockholders. Our
directors and executive officers currently hold approximately 19% of our
outstanding common stock. In addition, our alliance agreement with JEX requires
JEX to co-invest on every prospect that it recommends to us.
Exploration Alliance with JEX
Under a September 1999 agreement, JEX evaluates natural gas and oil
prospects and recommends exploration prospect and proved property acquisition
investment opportunities to us. In exchange, we have committed, within various
parameters, to invest along with JEX in the recommended prospects and property
acquisitions. We also issued 200,000 shares of our common
2
stock to JEX and granted JEX options to purchase 400,000 shares of our common
stock. The vesting of those options depends on the success of certain prospects
and reserves in which we have invested under the agreement. As of June 30, 2002,
300,000 options had vested.
With respect to natural gas and oil prospects recommended by JEX, and
subject to a $6.0 million annual limit, we are obligated to purchase a
percentage of the working interests available to JEX. JEX is required to
purchase at least 5% of the available working interests of each prospect in
which we invest. Although our financial obligation is limited during any
calendar year, we have to date invested in the full 95% interest available to
us, and it is our intention, subject to our then existing financial condition,
to continue to fully invest in the interest available to us in each prospect
recommended by JEX.
JEX generally pays the cost of generating and preparing a prospect to
drill ready status. When drilling begins on a prospect, we are obligated to
assign to JEX an overriding royalty interest in our working interest in the
prospect. Our agreement with JEX states that this overriding royalty interest
shall equal 3 1/3% of our working interest in the prospect. In practice, this
royalty interest is assigned to the JEX exploration team and not to JEX itself.
In addition, when our revenues from prospects we invest in under the agreement
during a calendar year, net of taxes, royalties and other expenses equals our
capital expenditure related to the acquisition and development of the prospects
on a well-by-well basis, JEX is entitled to an assignment or automatic reversion
of 25% of our working interest in the well. With respect to reserve
acquisitions, we have the right, but not the obligation, to purchase up to 95%
of the interests available to JEX in proved natural gas and oil reserves.
We may terminate the agreement upon 30 days written notice, and JEX may
terminate the agreement upon 180 days notice. If we are in default under the
agreement, however, JEX may terminate the agreement upon 30 days written notice.
John B. Juneau, one of our directors, is the sole manager of the general partner
of JEX.
Onshore Exploration and Properties
Our onshore exploration strategy is to identify large acreage positions
with available 3-D seismic data and to quickly evaluate, develop and drill
economic prospects. Our first significant onshore drilling program was STEP.
STEP has proven to be an excellent program for Contango, resulting in 31
economically successful wells out of a 40-well exploration program.
The first STEP wells were discovered by JEX in the summer of 2000 after
a review of seismic data covering approximately 100 square miles of territory
located on the STEP properties. JEX entered into a joint exploration agreement
with a limited partnership controlled by the mineral owner of the STEP
properties. This limited partnership acts as the operator of our STEP
properties.
We currently own approximately 71% of the working interests and 53% of
the net revenue interests in the STEP properties. As of June 30, 2002, our
interest in net production from the STEP properties was approximately 19.0 MMcf
of natural gas per day and 480 barrels of oil per day. Due to on-going
geological declines in our anticipated reserves, we expect that our net
production will decrease to approximately 14 MMcf of natural gas per day and 350
barrels of oil per day by the end of calendar year 2002. Over 99% of our net
reserves and net production are from our STEP properties.
3
Although we have completed the drilling of our original STEP prospects,
we are continuing our exploration efforts in the STEP area and are participating
in a 3-D seismic shoot covering approximately 150 square miles in Brooks, Jim
Hogg and Starr Counties, Texas. The cost of our participation is estimated at
approximately $2.3 to $3.0 million. Based on the results of this new seismic, we
hope to have additional drillable prospects identified in early 2003.
Offshore Exploration Joint Ventures
We formed Republic Exploration, L.L.C. and Magnolia Offshore
Exploration, L.L.C. joint ventures with JEX to find and develop natural gas and
oil opportunities in the Gulf of Mexico. Two different private seismic data
companies have licensed the rights to reprocessed 3-D seismic data covering a
total of 2,000 blocks of reprocessed 3-D seismic data covering the Gulf of
Mexico continental shelf to these two joint ventures. Republic Exploration, in
which we have a 33.3% interest, has access to approximately 1,400 of these
blocks of reprocessed 3-D seismic data. Magnolia Offshore Exploration, in which
we have a 50% interest, has access to approximately 600 of these blocks of
reprocessed 3-D seismic data.
To date, Republic Exploration and Magnolia Offshore Exploration have
focused on identifying prospects, purchasing lease blocks at federal and state
lease sales, and selling these leases to third parties, retaining reversionary
interests. In the future, however, we expect that Republic Exploration and
Magnolia Offshore Exploration will seek to acquire and retain working interests
in offshore prospects. Contango may farm-in some of these prospects on terms
generally available to unrelated third party industry partners.
Republic Exploration, L.L.C. We have invested approximately $6.7
million in cash in Republic Exploration since its formation in August 2000 for a
33.3% interest in Republic Exploration's profits. Republic Exploration holds a
non-exclusive license to existing and recently reprocessed 3-D seismic data
covering approximately 1,400 blocks of shallow waters in the Gulf of Mexico
continental shelf. Republic Exploration uses the data to acquire and exploit
natural gas and oil prospects. The other members of Republic Exploration are JEX
and a private seismic data company, which licensed to the venture its 3-D
seismic data. JEX is the managing member of Republic Exploration and decides
which prospects Republic Exploration will acquire, develop, and exploit. The
Republic Exploration operating agreement also states that the JEX exploration
team receives a 3 1/3% overriding royalty interest in each prospect that
Republic Exploration successfully drills.
Since its August 2000 formation, Republic Exploration has acquired 11
offshore leases. Of the 11 blocks acquired since formation, Republic Exploration
has entered into farm-out agreements with respect to six. Three have been
drilled successfully, two resulted in dry holes and two wells are expected to
start drilling prior to year end 2002. Under the farm-out agreements, Republic
Exploration will be carried on exploration and development activities and will
receive a reversionary interest upon payout of each block. In addition, Contango
has an after payout working interest in two of these successful wells. We do not
expect to earn our back-in working interest or to receive any cash flow until
after payout, which is projected to occur sometime in the 2004 time frame. We
expect Republic Exploration to participate in future state and federal offshore
lease sales.
The license to the 3-D seismic data provided to Republic Exploration by
its third member expires in 2025. During Republic Exploration's existence and
for one year after its dissolution, we
4
may not acquire an interest in or derive a benefit from the area covered by the
licensed 3-D seismic data without the approval of Republic Exploration's other
members.
Magnolia Offshore Exploration, L.L.C. We purchased a 50% interest in
Magnolia Offshore Exploration in October 2001 for a $1.0 million initial
contribution and an agreement to pay an additional $4.0 million as needed to
cover capital needs. As of September 3, 2002, we have paid approximately
$600,000 of the $4.0 million. Magnolia Offshore Exploration uses 3-D seismic
data covering approximately 600 blocks in the Gulf of Mexico to explore for
prospects at water depths less than 350 feet.
If we do not promptly pay the remaining $3.4 million that we pledged to
make available to Magnolia Offshore Exploration, when requested by Magnolia
Offshore Exploration, we will forfeit our 50% interest in Magnolia Offshore
Exploration, as well as any right to recover previous contributions. JEX is the
only other member of Magnolia Offshore Exploration and acts as the managing
member, deciding which prospects Magnolia Offshore Exploration may acquire,
develop, and exploit. The seismic company that contributed the 600 blocks of
data receives a net profit interest in any discoveries.
As in the Republic Exploration operating agreement, the Magnolia
Offshore Exploration operating agreement states that the JEX exploration team
receives a 3 1/3% overriding royalty interest in each prospect that Magnolia
Offshore Exploration successfully drills. During Magnolia Offshore Exploration's
existence and for one year after its dissolution, we may not acquire an interest
in or derive a benefit from the area covered by the 3-D seismic data without the
approval of JEX or its transferee.
Since its formation, Magnolia Offshore Exploration has acquired three
blocks offshore Louisiana. We expect Magnolia Offshore Exploration to
participate in future state and federal offshore lease sales.
5
Offshore Operations and Properties
The following table sets forth certain information with respect to the
offshore Gulf of Mexico leasehold interests owned by us and related entities as
of September 3, 2002:
When
Block Location Acquired Status
-------------------- ----------- ------------ ------------------------------------------
Brazos 436 ...................... TX-OCS Jul-00 Producing
Eugene Island 28 ................ LA-OCS Mar-00 Producing
Eugene Island 110 ............... LA-OCS Mar-01 Successfully drilled and awaiting completion
Grand Isle 24 ................... LA-OCS Mar-01 Dry hole, block to be released
Grand Isle 28 ................... LA-OCS Mar-01 Successfully drilled and being completed
E. Cameron 107 .................. LA-OCS Mar-01 Available for farm-out
Eugene Island 113B .............. LA-OCS Mar-01 Subject to farm-out option
High Island 25L ................. TX-State Aug-01 Producing
High Island 53L ................. TX-State Oct-00 Available for farm-out
Galveston 149L .................. TX-State Jul-00 Dry hole, block released
W. Cameron 200 .................. LA-OCS Mar-02 Farmed out
Vermilion 73 .................... LA-OCS May-02 Available for farm-out
W. Delta 36 ..................... LA-OCS Mar-02 Available for farm-out
Ship Shoal 155 .................. LA-OCS Mar-02 Available for farm-out
Viosca Knoll 75 ................. LA-OCS Mar-02 Available for farm-out
Viosca Knoll 211 ................ LA-OCS May-02 Available for farm-out
The following table sets forth the name of the leaseholder together with
the working interest and net revenue interest with respect to the offshore Gulf
of Mexico leasehold interests owned by us and related entities as of September
3, 2002:
Republic Magnolia Offshore
Contango Exploration (1) Exploration (1)
---------------------- ------------------------ --------------------
Block WI NRI WI NRI WI NRI
-------------------------- --------- --------- ----------- ----------- ----------- ------
Brazos 436 .................. 18.12% 14.81% -- -- -- --
Eugene Island 28 ............ 21.38% 15.28% -- -- -- --
Eugene Island 110 (2) ....... 0.00% 0.00% 0.00% 0.00% -- --
Grand Isle 28(3) ............ 0.00% 0.00% 0.00% 0.00% -- --
E. Cameron 107 .............. 33.75% 27.00% 66.25% 53.00% -- --
Eugene Island 113B .......... 33.75% 27.00% 66.25% 53.00% -- --
High Island 25L (3) ......... -- -- 0.00% 0.00% -- --
High Island 53L ............. -- -- 100.00% 74.17% -- --
W. Cameron 200 (4) .......... -- -- 0.00% 0.00% -- --
Vermilion 73 ................ -- -- 100.00% 80.00% -- --
W. Delta 36 ................. -- -- 100.00% 80.00% -- --
Ship Shoal 155 .............. -- -- -- -- 100.00% 80.00%
Viosca Knoll 75 ............. -- -- -- -- 100.00% 80.00%
Viosca Knoll 211 ............ -- -- -- -- 100.00% 80.00%
___________
(1) We have a 33.3% interest in Republic Exploration and a 50% interest in
Magnolia Offshore Exploration.
(2) After payout working interest and net revenue interest for Contango
will be 8.44% and 6.75%, respectively, and for Republic Exploration
will be 16.56% and 13.25%, respectively.
(3) After payout working interest and net revenue interest for Republic
Exploration will be 25% and 19.17%, respectively.
(4) After payout working interest and net revenue interest for Republic
Exploration will be 25% and 20%, respectively.
6
Natural Gas and Oil Prices
Substantially all of our production is sold under various terms and
arrangements at prevailing market prices. Our revenues, profitability and future
growth depend on natural gas and oil prices, thus price decreases would
adversely affect our revenues, profits and the value of our proved reserves.
Historically, the prices received for natural gas and oil have fluctuated
widely. Among the factors that can cause these fluctuations are:
. The domestic and foreign supply of natural gas and oil
. Overall economic conditions
. The level of consumer product demand
. Weather conditions
. The price and availability of alternative fuels
. Political conditions in the Middle East and other natural gas and
oil producing regions
. The price of foreign imports
. Domestic and foreign governmental regulations
. Potential price controls
From time to time, we enter into hedging arrangements to reduce our
exposure to decreases in the prices of natural gas and oil. Hedging arrangements
expose us to risk of significant financial loss in some circumstances including
circumstances where:
. There is a change in the expected differential between the
underlying price in the hedging agreement and actual prices
received
. Production is less than expected
. Payments owed under derivative hedging contracts typically come
due prior to receipt of the hedged months production revenue
. The other party to the hedging contract defaults on its contract
obligations
In addition, hedging arrangements limit the benefit we would receive
from increases in the prices for natural gas and oil. We cannot assure you that
the hedging transactions we enter into will adequately protect us from declines
in the prices of natural gas and oil. On the other hand, we may choose not to
engage in hedging transactions in the future. As a result, we may be more
adversely affected by changes in natural gas and oil prices than our competitors
who engage in hedging transactions.
Our business has been and will continue to be affected by changes in
natural gas and oil prices. No assurance can be given to the trend in, or level
of, future natural gas and oil prices.
Marketing
Our production is marketed to third parties consistent with industry
practices. Typically, natural gas, oil and condensate are sold under daily or
monthly pricing agreements based upon factors normally considered in the
industry.
There are a variety of factors which affect the market for natural gas
and oil, including the extent of domestic production and imports of natural gas
and oil, the proximity and capacity of natural gas pipelines and other
transportation facilities, demand for natural gas and oil, the
7
marketing of competitive fuels and the effects of state and federal regulations
on natural gas and oil production and sales. We have not experienced any
difficulties in marketing our natural gas and oil. The natural gas and oil
industry also competes with other industries in supplying the energy and fuel
requirements of industrial, commercial and individual customers. The
availability of a ready market for our natural gas and oil production depends on
the proximity of reserves to, and the capacity of, natural gas and oil gathering
systems, pipelines and trucking or terminal facilities. We deliver natural gas
through gas gathering systems and gas pipelines that we do not own. Federal and
state regulation of natural gas and oil production and transportation, tax and
energy policies, changes in supply and demand and general economic conditions
all could adversely affect our ability to produce and market our natural gas and
oil. Most of our current production comes from wells drilled in south Texas.
This production is being sold to a single purchaser. Any disruption of our
marketing arrangements or financial difficulties with our purchaser, or
alternative marketing sources, could have an adverse effect on our ability to
market our natural gas and oil production. Additionally, if our purchaser
suffered financial difficulties, we might not be able to collect receivables
from the purchaser. However, we have the option to market our production of
natural gas and oil to other alternative purchasers.
Governmental Regulations
Our operations are affected from time to time in varying degrees by
political developments and governmental laws and regulations. Rates of
production of natural gas and oil have for many years been subject to
governmental conservation laws and regulations, and the petroleum industry has
been subject to federal and state tax laws dealing specifically with it.
Federal Income Tax. Federal income tax laws significantly affect our
operations. The principal provisions affecting us are those that permit us,
subject to certain limitations, to deduct as incurred, rather than to capitalize
and amortize, "intangible drilling and development costs" and to claim depletion
on a portion of our natural gas and oil properties based on the greater of (1)
the lesser of 15% of natural gas and oil gross income or net income or (2) cost
depletion.
Environmental Matters. Domestic natural gas and oil operations are
subject to extensive federal regulation and, with respect to federal leases, to
interruption or termination by governmental authorities on account of
environmental and other considerations including the Comprehensive Environmental
Response, Compensation and Liability Act ("CERCLA") also known as the "Superfund
Law". The recent trend towards stricter standards in environmental legislation
and regulation may continue, and this could increase costs to us and others in
the industry. Natural gas and oil lessees are subject to liability for the costs
of cleanup of pollution resulting from a lessee's operations, and may also be
subject to liability for pollution damages. We maintain insurance against costs
of clean-up operations but are not fully insured against all such risks. A
serious incident of pollution may also result in the Department of the Interior
requiring lessees under federal leases to suspend or cease operation in the
affected area.
The Oil Pollution Act of 1990 (the "OPA") and regulations thereunder
impose a variety of regulations on "responsible parties" related to the
prevention of oil spills and liability for damages resulting from such spills in
United States waters. The OPA assigns liability to each responsible party for
oil removal costs and a variety of public and private damages. While liability
limits apply in some circumstances, a party cannot take advantage of liability
limits if the spill was caused by gross negligence or willful misconduct or
resulted from violation of a federal safety, construction or operating
regulation. Few defenses exist to the liability imposed by the OPA. The OPA also
8
imposes ongoing requirements on responsible parties, including proof of
financial responsibility to cover at least some costs in a potential spill. We
believe that currently we have established adequate proof of financial
responsibility for our offshore facilities. However, we cannot predict whether
these financial responsibility requirements under the OPA amendments will result
in the imposition of substantial additional annual costs to the company in the
future or otherwise materially adversely affect the company. The impact,
however, should not be any more adverse to us than it would be to other
similarly situated owners or operators in the Gulf of Mexico.
Our onshore operations are subject to numerous laws and regulations
controlling the discharge of materials into the environment or otherwise
relating to the protection of the environment, including CERCLA. Such laws and
regulations, among other things, impose absolute liability on the lessee under a
lease for the cost of clean-up of pollution resulting from a lessee's
operations, subject the lessee to liability for pollution damages, may require
suspension or cessation of operations in affected areas, and impose restrictions
on the injection of liquids into subsurface aquifers that may contaminate
groundwater. Such laws could have a significant impact on our operating costs,
as well as the natural gas and oil industry in general. Federal, state and local
initiatives to further regulate the disposal of natural gas and oil wastes are
also pending in certain jurisdictions, and these initiatives could have a
similar impact on us.
Other Laws and Regulations. Various laws and regulations often require
permits for drilling wells and also cover spacing of wells, the prevention of
waste of natural gas and oil, including maintenance of certain natural gas/oil
ratios, rates of production and other matters. The effect of these laws and
regulations, as well as other regulations that could be promulgated by the
jurisdictions in which we have production, could be to limit the number of wells
that could be drilled on our properties and to limit the allowable production
from the successful wells completed on the company's properties, thereby
limiting the company's revenues.
The U.S. Department of Interior's Minerals Management Service ("MMS")
administers the natural gas and oil leases held by us on federal onshore lands
and offshore tracts in the Outer Continental Shelf. The MMS holds a royalty
interest in these federal leases on behalf of the federal government. While the
royalty interest percentage is fixed at the time that the lease is entered into,
from time to time the MMS changes or reinterprets the applicable regulations
governing its royalty interests, and such action can indirectly affect the
actual royalty obligation that we may be required to pay. The MMS is currently
engaged in developing new oil and gas valuation regulations for royalty
purposes. The natural gas rule was published in final form on December 16, 1997.
Industry trade associations challenged portions of the rule, and on March 28,
2000, a district court invalidated the challenged regulations. The MMS has
appealed the court's decision, and the appeal remains pending. The oil rule was
published in final form on March 15, 2000. Portions of this rule have also been
challenged by industry trade associations in court and the case remains pending,
with no resolution expected in the near future. We are not in a position to
predict the outcome of the litigation, but we believe that the impact of the
final rules that emerge from the court review will not impact us to any greater
extent than other similarly situated producers.
The Federal Energy Regulatory Commission (the "FERC") has recently
embarked on wide-ranging regulatory initiatives relating to natural gas
transportation rates and services, including the availability of market-based
and other alternative rate mechanisms to pipelines for transmission and storage
services. In addition, the FERC has announced and implemented a policy allowing
pipelines and transportation customers to negotiate rates above the otherwise
applicable maximum lawful cost-based rates on the condition that the pipelines
alternatively offer so-called recourse rates equal
9
to the maximum lawful cost-based rates. With respect to gathering services, the
FERC has issued orders declaring that certain facilities owned by interstate
pipelines primarily perform a gathering function, and may be transferred to
affiliated and non-affiliated entities that are not subject to the FERC's rate
jurisdiction. We cannot predict the ultimate outcome of these developments, nor
the effect of these developments on transportation rates. Inasmuch as the rates
for these pipeline services can affect the natural gas prices received by us for
the sale of our production, the FERC's actions may have an impact on us.
However, the impact should not be substantially different on us than it will on
other similarly situated natural gas producers and sellers.
Employees
We currently have three employees, all of whom are full time. We use the
services of independent consultants and contractors to perform various
professional services, including reservoir engineering, legal, environmental and
tax planning. We are dependent on our alliance partner, JEX, in the areas of
geological and geophysical services and prospect generation, evaluation and
prospect leasing. In addition, as a working interest owner in drilling wells and
producing properties, we rely on outside operators and also utilize the services
of independent contractors to perform field and on-site drilling and production
operation services.
Directors and Executive Officers
The following table sets forth the names, ages and positions of our
directors and executive officers:
Name Age Position
---------------------------------------- ------- --------------------------------------------------------
Kenneth R. Peak ........................ 57 Chairman, President, Chief Executive Officer,
Chief Financial Officer, Secretary and Director
William H. Gibbons ..................... 59 Vice President and Treasurer
Lesia Bautina .......................... 31 Vice President and Controller
Jay D. Brehmer ......................... 37 Director
John B. Juneau ......................... 42 Director
Joseph J. Romano ....................... 49 Director
Darrell W. Williams .................... 59 Director
Kenneth R. Peak was appointed president, chief executive and financial
officer, secretary and a director of Contango in July 1999. Before joining
Contango, Mr. Peak was the president of Peak Enernomics, Incorporated, a natural
gas and oil consulting firm that he formed in 1990. Mr. Peak began his energy
career in 1973 as a commercial banker in First National Bank of Chicago's energy
group. He became treasurer of Tosco Corporation in 1980 and chief financial
officer of Texas International Company ("TIC") in 1982. His tenure with TIC
included serving as president of TIPCO, the domestic operating subsidiary of
TIC's natural gas and oil operations. Mr. Peak has also served as chief
financial officer of Forest Oil Corporation from 1988 to 1989 and as an
investment banker with Howard Weil from 1989 to 1990. Mr. Peak was an officer in
the U.S. Navy from 1968 to 1971. Mr. Peak received a BS degree in physics from
Ohio University and a MBA from Columbia University. He currently serves as a
director of Patterson-UTI Energy, Inc., a North America provider of onshore
contract drilling services to exploration and production companies and Cellxion,
Inc., a privately owned manufacturing and construction company serving the
cellular telephone industry.
10
William H. Gibbons joined Contango in February 2000 and was appointed
treasurer in March 2000 and vice president and treasurer in November 2000.
Before joining Contango, he was treasurer of Packaged Ice, Inc. from 1998 to
2000. From 1990 to 1998 and from 1983 to 1986, he provided financial consulting
services to domestic and international oil companies, including a five-year
assignment with Walter International, Inc. Mr. Gibbons began his energy career
with Houston Oil & Minerals Corporation, where he served as treasurer from 1975
to 1981. He also was vice president-finance for Guardian Oil Company from 1981
to 1983 and director-acquisitions for Service Corporation International from
1986 to 1990. Mr. Gibbons received a BA degree in business administration from
Duke University and a MBA in finance from Tulane University.
Lesia Bautina joined Contango in November 2001 as controller and was
appointed vice president and controller in August 2002. Prior to joining
Contango, Ms. Bautina worked as an auditor for Arthur Andersen LLP from 1997 to
2001. Her primary experience is accounting and financial reporting for
exploration and production companies. Ms. Bautina received a degree in history
from the University of Lvov in the Ukraine in 1990 and a BBA in accounting in
1996 from Sam Houston State University, where she graduated with honors. Ms.
Bautina is a Certified Public Accountant and member of the Petroleum Accounting
Society of Houston. Ms. Bautina was born in the Ukraine, speaks four languages
fluently and became a United States citizen in February 2000.
Jay D. Brehmer has been a director of Contango since October 2000. He has
been a director-capital & finance of Aquila Energy Capital Corporation since
1998. Prior to joining Aquila, Mr. Brehmer was president and the founder of
Capital Financial Services from 1995 to 1998. From 1990 to 1995, he was vice
president of the Mutual of Omaha's investment banking subsidiary. Mr. Brehmer
holds a BBA degree in business administration from Drake University.
John B. Juneau has been a director of Contango since September 1999. Mr.
Juneau is a private investor and the manager of the general partner of JEX, a
firm that specializes in the generation and evaluation of natural gas and oil
prospects and is Contango's alliance partner. Prior to forming JEX, Mr. Juneau
served as senior vice president of exploration for Zilkha Energy Company from
1987 to 1998. His previous experience included three years as staff petroleum
engineer with Texas International Company, where his principal responsibilities
included reservoir engineering, as well as acquisitions and evaluations. Prior
to that, he was a production engineer with ENSERCH in Oklahoma City. Mr. Juneau
holds a BS degree in petroleum engineering from Louisiana State University and
is a registered professional engineer in the State of Texas.
Joseph J. Romano has been a director of Contango since September 1999. He
has been employed as chief financial officer by MSZ Investments, Inc. since 1998
and has been the president and chief financial officer of Zilkha Renewable
Energy Company since January 2002. In February 1989, Mr. Romano joined Zilkha
Energy Company, where he served as senior vice president and chief financial
officer until 1998. He served as the chief financial officer, treasurer and
controller of Texas International Company from 1986 to 1988 and as its treasurer
and controller from 1982 to 1985. Prior to 1982, Mr. Romano spent five years
working in the Worldwide Energy Group of the First National Bank of Chicago. He
holds a BA degree in economics and political science from the University of
Wisconsin-Eau Claire and a MBA in finance from the University of Northern
Illinois.
Darrell W. Williams has been a director of Contango since September 1999
and currently is engaged in various consulting assignments as president of
Williams & Associates, Inc., a consulting firm formed by him for outside
consulting to oil and natural gas service companies. Mr. Williams served as
president of Deutag Marketing and Technical Services from 1993 to mid 2002 with
the
11
primary responsibility to develop new business with E & P companies having
international drilling departments in North America. During three years of this
time, he lived in Germany as managing director of Deutag International and had
responsibility for all drilling operations outside of Europe. Before joining
Deutag, Mr. Williams held senior executive positions with Nabors Drilling from
1988 to 1993, Pool Company from 1985 to 1988, Baker Oil Tools from 1980 to 1983
and SEDCO from 1970 to 1980. Mr. Williams is past chairman of the Houston
Chapter of the International Association of Drilling Contractors, a past member
of the IADC executive committee and a member of the Society of Petroleum
Engineers. He also serves on the board of SMDC, a Hydril subsidiary. Mr.
Williams graduated from West Virginia University with a degree in petroleum
engineering.
Mr. Juneau and Mr. Romano have each informed us that they intend to
resign from our Board of Directors following election of their replacements,
which is expected to occur at our annual meeting later this year. We have
nominated Michael P. Childers and Joseph S. Compofelice as new director
candidates to be voted upon by our stockholders at the annual meeting. The
biographies of Mr. Childers and Mr. Compofelice will be included in the proxy
statement we will send to our stockholders before the annual meeting.
Directors of Contango serve as members of the board of directors until
the next annual stockholders meeting, until successors are elected and qualified
or until their earlier resignation or removal. Officers of Contango are elected
by the board of directors and hold office until their successors are chosen and
qualified, until their death or until they resign or have been removed from
office. All corporate officers serve at the discretion of the board of
directors. Directors are compensated in the form of both a cash payment and
Company equity. Each outside director receives a $3,000 quarterly payment and a
quarterly stock option grant to purchase 3,000 shares of common stock with an
exercise price of the greater of $2.00 or fair market value. There are no family
relationships between any of our directors or executive officers.
Corporate Offices
We lease our corporate offices at 3700 Buffalo Speedway, Suite 960,
Houston, Texas 77098. Our lease covers 2,850 square feet of space for a monthly
rental of $5,819 per month through October 2003.
Risk Factors
In addition to the other information set forth elsewhere in this Form
10-KSB, you should carefully consider the following factors when evaluating
Contango. As one of our stockholders, your investment will be subject to risks
inherent in our business. The trading price of your shares will be affected by
the performance of our business relative to, among other things, competition,
market conditions and general economic and industry conditions. The value of
your investment may decrease, resulting in a loss. The risk factors listed below
are not all inclusive.
We have no ability to control the prices that we receive for natural
gas and oil. Natural gas and oil prices fluctuate widely, and low prices could
have a material adverse effect on our revenues, profitability and growth. Our
revenues, profitability and future growth will depend significantly on natural
gas and crude oil prices. Prices received also will affect the amount of future
cash flow available for capital expenditures and repayment of indebtedness and
will affect our ability to raise additional capital. Lower prices may also
affect the amount of natural gas and oil that we can economically produce.
12
Prices for natural gas and oil fluctuate widely. For example, natural
gas and oil prices declined significantly in 1998 and, for an extended period of
time, remained below prices that prevailed in previous years. Conversely, in
late 2000 and early 2001, prices, particularly for natural gas, increased to
unprecedented levels only to fall back to levels experienced in the late 1990s.
Factors that can cause price fluctuations include:
. The domestic and foreign supply of natural gas and oil
. Overall economic conditions
. The level of consumer product demand
. Weather conditions
. The price and availability of alternative fuels
. Political conditions in the Middle East and other natural gas and
oil producing regions
. The price of foreign imports
. Domestic and foreign governmental regulations
Because we have a limited operating history in the natural gas and oil
industry, our future operating results are difficult to forecast. We entered the
natural gas and oil exploration and production business in July 1999, and as a
result, we have limited historical financial and operating information available
on which to base your evaluation of our future performance. Additionally,
because we have fewer financial resources than many companies in our industry,
we may be at a disadvantage in bidding for acreage, seismic data and exploratory
prospects and producing natural gas and oil properties.
Our ability to successfully execute our business plan is dependent on
our ability to obtain adequate financing. Our business plan, which includes
participation in an increasing number of exploration prospects, has required and
will require substantial capital expenditures. We anticipate that we will
require additional financing to fund our planned growth. Our ability to raise
additional capital will depend on the results of our operations and the status
of various capital and industry markets at the time we seek such capital.
Accordingly, we cannot be certain that additional financing will be available to
us on acceptable terms, if at all. In particular, our credit facility imposes
limits on our ability to borrow under the facility based on adjustments to the
value of our hydrocarbon reserves, and our credit facility and the terms of our
outstanding preferred stock limit our ability to incur additional indebtedness.
In the event additional capital resources are unavailable, we may be required to
curtail our exploration and development activities or be forced to sell some of
our assets in an untimely fashion or on less than favorable terms.
Hedging our production may result in losses. From time to time, we
enter into hedging arrangements on a portion of our natural gas and oil
production to reduce our exposure to declines in the prices of natural gas and
oil. The value of these arrangements can be volatile and can materially affect
our future reported financial results. Hedging arrangements also expose us to
risk of significant financial loss in some circumstances including the
following:
. There is a change in the expected differential between the
underlying price in the hedging agreement and actual prices
received
. Production is less than expected
. Payments owed under derivative hedging contracts typically come due
prior to receipt of the hedged months production revenues
. The other party to the hedging contract defaults on its contract
obligations
13
In addition, these hedging arrangements can limit the benefit we would
receive from increases in the prices for natural gas and oil. Furthermore, if we
choose not to engage in hedging arrangements in the future, we may be more
adversely affected by changes in natural gas and oil prices than our competitors
who engage in hedging arrangements.
Reserve estimates depend on many assumptions that may turn out to be
inaccurate. Any material inaccuracies in these reserve estimates or underlying
assumptions could materially affect the quantities and present values of our
reserves. The process of estimating natural gas and oil reserves is complex. It
requires interpretations of available technical data and various assumptions,
including assumptions relating to economic factors. Any significant inaccuracies
in these interpretations or assumptions could materially affect the estimated
quantities and present value of reserves shown in this report.
In order to prepare these estimates we must project production rates
and timing of development expenditures. We must also analyze available
geological, geophysical, production and engineering data, and the extent,
quality and reliability of this data can vary. The process also requires
economic assumptions relating to matters such as natural gas and oil prices,
drilling and operating expenses, capital expenditures, taxes and availability of
funds. Therefore, estimates of natural gas and oil reserves are inherently
imprecise.
Actual future production, natural gas and oil prices, revenues, taxes,
development expenditures, operating expenses and quantities of recoverable
natural gas and oil reserves most likely will vary from our estimates. Any
significant variance could materially affect the estimated quantities and
pre-tax net present value of reserves shown in this report. In addition, we may
adjust estimates of proved reserves to reflect production history, results of
exploration and development, prevailing natural gas and oil prices and other
factors, many of which are beyond our control. Moreover, many of the producing
wells included in our reserve report have produced for a relatively short period
of time as of June 30, 2002. Because most of our reserve estimates are not based
on a lengthy production history and are calculated using volumetric analysis,
these estimates are less reliable than estimates based on a lengthy production
history.
You should not assume that the pre-tax net present value of our proved
reserves referred to in this report is the current market value of our estimated
natural gas and oil reserves. We base the pre-tax net present value of future
net cash flows from our proved reserves on prices and costs on the date of the
estimate. Actual future prices, costs, and the volume of produced reserves may
differ materially from those used in the pre-tax net present value estimate.
Natural gas and oil reserves are depleting assets and the failure to
replace our reserves would adversely affect our production and cash flows. Our
future natural gas and oil production depends on our success in finding or
acquiring new reserves. If we fail to replace reserves, our level of production
and cash flows would be adversely impacted. Production from natural gas and oil
properties decline as reserves are depleted, with the rate of decline depending
on reservoir characteristics. Our total proved reserves will decline as reserves
are produced unless we conduct other successful exploration and development
activities or acquire properties containing proved reserves, or both. Further,
substantially all of our reserves are proved developed producing. Accordingly,
we do not have significant opportunities to increase our production from our
existing proved reserves. Our ability to make the necessary capital investment
to maintain or expand our asset base of natural gas and oil reserves would be
impaired to the extent cash flow from operations
14
is reduced and external sources of capital become limited or unavailable. We may
not be successful in exploring for, developing or acquiring additional reserves.
If we are not successful, our future production and revenues will be adversely
affected.
We depend on the services of our president and chief executive officer,
and implementation of our business plan could be seriously harmed if we lost his
services. We depend heavily on the services of Kenneth R. Peak, our president
and chief executive officer. We do not have an employment agreement with Mr.
Peak, and the proceeds from a $10.0 million "key person" life insurance policy
on Mr. Peak may not be adequate to cover our losses in the event of Mr. Peak's
death.
We depend on the technical services provided by JEX and could be
seriously harmed if our alliance agreement with JEX were terminated. Because we
have only three employees, none of whom are geoscientists or engineers, we are
dependent upon alliance partners for the success of our natural gas and oil
exploration projects and expect to remain so for the foreseeable future. In
particular, we have an agreement with JEX to source, screen, generate and
present exploration and acquisition opportunities to us. This agreement is
cancelable by JEX with 180-days notice or 30-days notice if we are in default
under our alliance agreement. Highly qualified explorationists or engineers are
difficult to attract and retain in this industry. As a result, the loss of the
services of JEX could have a material adverse effect on us and could prevent us
from pursuing our business plan. Additionally, JEX's loss of certain
explorationists or engineers could have a material adverse effect on our
operations as well.
We rely on the accuracy of the estimates in the reservoir engineering
reports provided to us by our outside engineers. We have no in house reservoir
engineering capability, and therefore must accept the accuracy of the periodic
reservoir reports provided to use by our outside reservoir engineers. If those
reports prove to be inaccurate, our financial reports could have material
misstatements. Further, we use the reports of our independent reservoir
engineers in our financial planning. If the reports of the outside reservoir
engineers prove to be inaccurate, we may make misjudgments in our financial
planning.
Exploration is a high risk activity, and our participation in drilling
activities may not be successful. Our future success will largely depend on the
success of our exploration drilling program. Participation in exploration
drilling activities involves numerous risks, including the risk that no
commercially productive natural gas or oil reservoirs will be discovered. The
cost of drilling, completing and operating wells is often uncertain, and
drilling operations may be curtailed, delayed or canceled as a result of a
variety of factors, including:
. Unexpected drilling conditions
. Blowouts, fires or explosions with resultant injury, death or
environmental damage
. Pressure or irregularities in formations
. Equipment failures or accidents
. Adverse weather conditions
. Compliance with governmental requirements and laws, present and
future
. Shortages or delays in the availability of drilling rigs and the
delivery of equipment
Even when properly used and interpreted, 3-D seismic data and
visualization techniques are only tools used to assist geoscientists in
identifying subsurface structures and hydrocarbon indicators. They do not allow
the interpreter to know conclusively if hydrocarbons are present or
15
economically producible. Poor results from our drilling activities would
materially and adversely affect our future cash flows and results of operations.
In addition, as a "successful efforts" company, we choose to account
for unsuccessful exploration efforts (the drilling of "dry holes") and seismic
costs as an expense of operations, which immediately impacts our earnings.
Significant expensed exploration charges in any period would materially
adversely affect our earnings for that period and could cause our earnings to be
volatile from period to period.
The natural gas and oil business involves many operating risks that can
cause substantial losses. The natural gas and oil business involves a variety of
operating risks, including:
. Blowouts, fires and explosions
. Surface cratering
. Uncontrollable flows of underground natural gas, oil or formation
water
. Natural disasters
. Pipe and cement failures
. Casing collapses
. Stuck drilling and service tools
. Abnormal pressure formations
. Environmental hazards such as natural gas leaks, oil spills,
pipeline ruptures or discharges of toxic gases
If any of these events occur, we could incur substantial losses as a
result of:
. Injury or loss of life
. Severe damage to and destruction of property, natural resources or
equipment
. Pollution and other environmental damage
. Clean-up responsibilities
. Regulatory investigation and penalties
. Suspension of our operations
. Repairs necessary to resume operations
Offshore operations also are subject to a variety of operating risks
peculiar to the marine environment, such as capsizing, collisions and damage or
loss from hurricanes or other adverse weather conditions. These conditions can
cause substantial damage to facilities and interrupt production. As a result, we
could incur substantial liabilities that could reduce the funds available for
exploration, development or leasehold acquisitions, or result in loss of
properties.
If we were to experience any of these problems, it could affect well
bores, platforms, gathering systems and processing facilities, any one of which
could adversely affect our ability to conduct operations. In accordance with
customary industry practices, we maintain insurance against some, but not all,
of these risks. Losses could occur for uninsurable or uninsured risks or in
amounts in excess of existing insurance coverage. We may not be able to maintain
adequate insurance in the future at rates we consider reasonable, and particular
types of coverage may not be available. An event that is not fully covered by
insurance could have a material adverse effect on our financial position and
results of operations.
16
Our ability to market our natural gas and oil may be impaired by
capacity constraints on the gathering systems and pipelines that transport our
natural gas and oil. Most of our natural gas, and a substantial portion of our
oil, is transported through gathering systems and pipelines, which we do not
own. Transportation capacity on gathering systems and pipelines is occasionally
limited and at times unavailable due to repairs or improvements being made to
these facilities or due to capacity being utilized by other natural gas or oil
shippers that may have priority transportation agreements. If the gathering
systems or our transportation capacity is materially restricted or is
unavailable in the future, our ability to market our natural gas or oil could be
impaired and cash flow from the affected properties could be reduced, which
could have a material adverse effect on our financial condition and results of
operations.
Most of our natural gas and oil production is concentrated in south
Texas and is sold to a single purchaser. Most of our current production comes
from wells drilled in south Texas. This production is being sold on a spot basis
to a single purchaser. Any disruption of our marketing arrangements or financial
difficulties with our purchaser, or alternative marketing sources, could have an
adverse effect on our ability to market our natural gas and oil production.
Additionally, if our purchaser suffered financial difficulties, we might not be
able to collect receivables from the purchaser.
We have no assurance of title to our leased interests. Our practice in
acquiring exploration leases or undivided interests in natural gas and oil
leases is not to incur the expense of retaining lawyers to examine the title to
the mineral interest prior to executing the lease. Instead, we rely upon the
judgment of lease brokers or landmen who perform the field work in examining
records in the appropriate governmental, county or parish clerk's office before
leasing a specific mineral interest. This practice is widely followed in the
industry. Prior to the drilling of an exploration well the operator of the well
will typically obtain a preliminary title review of the drillsite lease and/or
spacing unit within which the proposed well is to be drilled to identify any
obvious deficiencies in title to the well and, if there are deficiencies, to
identify measures necessary to cure those defects to the extent reasonably
possible. We have no assurance, however, that any such deficiencies have been
cured by the operator of any such wells. It does happen, from time to time, that
the examination made by the title lawyers reveals that the lease or leases are
invalid, having been purchased in error from a person who is not the rightful
owner of the mineral interest desired. In these circumstances, we may not be
able to proceed with our exploration and development of the lease site or may
incur costs to remedy a defect. It may also happen, from time to time, that the
operator may elect to proceed with a well despite defects to the title
identified in the preliminary title opinion.
Competition in the natural gas and oil industry is intense, and we are
smaller and have a more limited operating history than most of our competitors.
We compete with a broad range of natural gas and oil companies in our
exploration and property acquisition activities. We also compete for the
equipment and labor required to operate and develop these properties. Most of
our competitors have substantially greater financial resources than we do. These
competitors may be able to pay more for exploratory prospects and productive
natural gas and oil properties. Further, they may be able to define, evaluate,
bid for and purchase a greater number of properties and prospects than we can.
Our ability to explore for natural gas and oil and to acquire additional
properties in the future will depend on our ability to evaluate and select
suitable properties and to consummate transactions in this highly competitive
environment. In addition, most of our competitors have been operating for a much
longer time than we have and have demonstrated the
17
ability to operate through industry cycles. We may not be able to compete
effectively with these companies or in such a highly competitive environment.
We are subject to complex laws and regulations, including environmental
regulations that can adversely affect the cost, manner or feasibility of doing
business. Our operations are subject to numerous laws and regulations governing
the operation and maintenance of our facilities and the discharge of materials
into the environment. Failure to comply with such rules and regulations could
result in substantial penalties and have an adverse effect on us. These laws and
regulations may:
. Require that we obtain permits before commencing drilling
. Restrict the substances that can be released into the environment
in connection with drilling and production activities
. Limit or prohibit drilling activities on protected areas, such as
wetlands or wilderness areas
. Require remedial measures to mitigate pollution from former
operations, such as plugging abandoned wells
Under these laws and regulations, we could be liable for personal
injury and clean-up costs and other environmental and property damages, as well
as administrative, civil and criminal penalties. We maintain only limited
insurance coverage for sudden and accidental environmental damages. We do not
believe that insurance coverage for environmental damages that occur over time
is available at a reasonable cost. Moreover, we do not believe that insurance
coverage for the full potential liability that could be caused by sudden and
accidental environmental damages is available at a reasonable cost. Accordingly,
we may be subject to liability, or we may be required to cease production from
properties in the event of environmental damages. These laws and regulations
have been changed frequently in the past. In general, these changes have imposed
more stringent requirements that increase operating costs or require capital
expenditures in order to remain in compliance. It is also possible that
unanticipated factual developments could cause us to make environmental
expenditures that are significantly different from those we currently expect.
Existing laws and regulations could be changed and any such changes could have
an adverse effect on our business and results of operations.
We cannot control the activities on properties we do not operate. Other
companies operate all of the properties in which we have an interest. As a
result, we have a limited ability to exercise influence over operations for
these properties or their associated costs. Our dependence on the operator and
other working interest owners for these projects and our limited ability to
influence operations and associated costs could materially adversely affect the
realization of our targeted returns on capital in drilling or acquisition
activities. The success and timing of our drilling and development activities on
properties operated by others therefore depend upon a number of factors that are
outside of our control, including:
. Timing and amount of capital expenditures
. The operator's expertise and financial resources
. Approval of other participants in drilling wells
. Selection of technology
Acquisition prospects are difficult to assess and may pose additional
risks to our operations. We expect to evaluate and, where appropriate, pursue
acquisition opportunities on
18
terms our management considers favorable. In particular, we expect to pursue
acquisitions that have the potential to increase our domestic natural gas and
oil reserves. The successful acquisition of natural gas and oil properties
requires an assessment of:
. Recoverable reserves
. Exploration potential
. Future natural gas and oil prices
. Operating costs
. Potential environmental and other liabilities and other factors
. Permitting and other environmental authorizations required for our
operations
In connection with such an assessment, we would expect to perform a
review of the subject properties that we believe to be generally consistent with
industry practices. Nonetheless, the resulting conclusions are necessarily
inexact and their accuracy inherently uncertain, and such an assessment may not
reveal all existing or potential problems, nor will it necessarily permit a
buyer to become sufficiently familiar with the properties to fully assess their
merits and deficiencies. Inspections may not always be performed on every
platform or well, and structural and environmental problems are not necessarily
observable even when an inspection is undertaken.
Future acquisitions could pose numerous additional risks to our
operations and financial results, including:
. Problems integrating the purchased operations, personnel or
technologies
. Unanticipated costs
. Diversion of resources and management attention from our
exploration business
. Entry into regions or markets in which we have limited or no prior
experience
. Potential loss of key employees, particularly those of the
acquired organization
We do not intend to pay dividends on our common stock. We have never
declared or paid a dividend on our common stock and do not expect to do so in
the foreseeable future. We currently intend to retain any future earnings for
funding growth, and, therefore, holders of our common stock will not be able to
receive a return on their investment unless they sell their shares.
Anti-takeover provisions of our certificate of incorporation, bylaws
and Delaware law could adversely effect a potential acquisition by third parties
that may ultimately be in the financial interests of our stockholders. Our
certificate of incorporation, bylaws and the Delaware General Corporation Law
contain provisions that may discourage unsolicited takeover proposals. These
provisions could have the effect of inhibiting fluctuations in the market price
of our common stock that could result from actual or rumored takeover attempts,
preventing changes in our management or limiting the price that investors may be
willing to pay for shares of common stock. These provisions, among other things,
authorize the board of directors to:
. Designate the terms of and issue new series of preferred stock
. Limit the personal liability of directors
. Limit the persons who may call special meetings of stockholders
. Prohibit stockholder action by written consent
. Establish advance notice requirements for nominations for election
of the board of directors and for proposing matters to be acted on
by stockholders at stockholder meetings
19
. Require us to indemnify directors and officers to the fullest
extent permitted by applicable law
. Impose restrictions on business combinations with some interested
parties
Item 2. Description of Properties
Production, Prices and Operating Expenses
The following table presents information regarding the production volumes,
average sales prices received and average production costs associated with our
sales of natural gas and oil for the periods indicated. Oil and condensate are
compared with natural gas in terms of cubic feet of natural gas equivalents. One
barrel of oil or condensate is the energy equivalent of six Mcf of natural gas.
Year Ended June 30,
-------------------------
2002 2001
------------ ------------
Production:
Natural gas (thousand cubic feet) .................................. 6,981,909 3,570,026
Oil and condensate (barrels) ....................................... 186,274 122,093
Total (thousand cubic feet equivalent) ........................... 8,099,553 4,302,584
Natural gas (per thousand cubic feet per day) ...................... 19,129 9,781
Oil and condensate (per barrels per day) ........................... 510 335
Total (per thousand cubic feet equivalent per day) ............... 22,189 11,791
Average sales price:
Natural gas (thousand cubic feet) .................................. $ 2.94 $ 5.92
Oil and condensate (barrels) ....................................... $ 21.44 $ 27.95
Total (thousand cubic feet equivalent) ........................... $ 3.03 $ 5.71
Selected data per Mcfe:
Production and severance taxes ..................................... $ 0.20 $ 0.39
Lease operating expense ............................................ $ 0.28 $ 0.22
General and administrative expense ................................. $ 0.36 $ 0.55
Depreciation, depletion and amortization of
natural gas and oil properties ................................... $ 1.05 $ 0.92
20
Development, Exploration and Acquisition Capital Expenditures
The following table presents information regarding our net costs incurred
in the purchase of proved and unproved properties and in exploration and
development activities for the periods indicated:
Year Ended June 30,
-------------------------
2002 2001
------------ ------------
Property Acquisition Costs:
Unproved .......................................................... $ 1,063,204 $ 1,901,405
Proved ............................................................ 23,449,488 -
Exploration costs .................................................... 7,138,690 20,867,565
------------ ------------
Total costs ....................................................... $ 31,651,382 $ 22,768,970
============ ============
Drilling Activity
The following table shows our drilling activity for the periods indicated.
In the table, "gross" wells refer to wells in which we have a working interest,
and "net" wells refer to gross wells multiplied by our working interest in such
wells.
Year Ended June 30,
---------------------------------------------------
2002 2001
------------------------- -------------------------
Gross Net Gross Net
------------ ------------ ------------ ------------
Exploratory Wells:
Productive ............................... 9 6.5 24 10.2
Non-productive ........................... 3 1.4 7 3.0
------------ ------------ ------------ ------------
Total .................................. 12 7.9 31 13.2
============ ============ ============ ============
We drilled no development wells during the periods indicated.
21
Exploration and Development Acreage
Our principal natural gas and oil properties consist of producing and
non-producing natural gas and oil leases. The following table indicates our
interests in developed and undeveloped acreage as of June 30, 2002:
Developed Undeveloped
Acreage (1)(2) Acreage (1)(3)
-------------------- -------------------
Gross (4) Net (5) Gross (4) Net (5)
--------- --------- --------- ---------
Onshore:
Texas ............................................ 9,133 6,366 - -
Offshore Outer Continental Shelf:
Louisiana ........................................ 1,250 267 10,000 3,375
Texas ............................................ 938 170 - -
--------- --------- --------- ---------
Total .......................................... 11,321 6,803 10,000 3,375
========= ========= ========= =========
___________________
(1) Excludes any interest in acreage in which we have no working interest
before payout.
(2) Developed acreage consists of acres spaced or assignable to productive
wells.
(3) Undeveloped acreage is considered to be those leased acres on which
wells have not been drilled or completed to a point that would permit
the production of commercial quantities of oil and gas, regardless of
whether or not such acreage contains proved reserves.
(4) Gross acres refer to the number of acres in which we own a working
interest.
(5) Net acres represents the number of acres attributable to an owner's
proportionate working interest and/or royalty interest in a lease
(e.g., a 50% working interest in a lease covering 320 acres is
equivalent to 160 net acres).
The above table excludes our 33.3% % interest in 25,714 gross
undeveloped acres (22,339 net undeveloped acres) held by Republic Exploration
and excludes our 50% interest in 16,520 gross undeveloped acres (16,520 net
undeveloped acres) held by Magnolia Offshore Exploration.
Productive Wells
The following table sets forth the number of gross and net productive
natural gas and oil wells in which we owned an interest as of June 30, 2002:
Total Productive
Wells (1)
------------------------
Gross (2) Net (3)
--------- ---------
Natural gas ......................................................... 32 21.2
Oil ................................................................. 1 0.8
--------- ---------
Total ............................................................ 33 22.0
========= =========
___________________
(1) Productive wells are producing wells and wells capable of production.
(2) A gross well is a well in which we own an interest.
(3) The number of net wells is the sum of our fractional working interests
owned in gross wells.
22
Natural Gas and Oil Reserves
The following table presents our estimated net proved natural gas and oil
reserves and the pre-tax net present value of our reserves at June 30, 2002,
based on a reserve report generated by W.D. Von Gonten & Co. The pre-tax net
present value is not intended to represent the current market value of the
estimated natural gas and oil reserves we own.
The pre-tax net present value of future cash flows attributable to our
proved reserves as of June 30, 2002 was determined by the June 28, 2002 prices
of $3.24 per MMbtu for natural gas at the Houston Ship Channel and $26.86 per
barrel of oil at Koch's South Texas Crude Oil Posting, in each case before
adjusting for basis, transportation costs, and Btu content. For further
information concerning the present value of future net cash flows from these
proved reserves, see "Supplemental Oil and Gas Disclosures".
Proved Developed Reserves
as of June 30, 2002
---------------------------------------
Developed Behind Pipe Total
----------- ----------- -----------
Natural gas (MMcf) .................. 24,226.8 171.4 24,398.2
Oil and condensate (Bbls) ........... 590,058 206 590,264
Total proved reserves (MMcfe) ....... 27,767.1 172.6 27,939.7
Pre-tax net present value ........... $52,950,820 $398,387 $53,349,207
The process of estimating natural gas and oil reserves is complex. It
requires various assumptions, including natural gas and oil prices, drilling and
operating expenses, capital expenditures, taxes and availability of funds. We
must project production rates and timing of development expenditures. We analyze
available geological, geophysical, production and engineering data, and the
extent, quality and reliability of this data can vary. Therefore, estimates of
natural gas and oil reserves are inherently imprecise. Actual future production,
natural gas and oil prices, revenues, taxes, development expenditures, operating
expenses and quantities of recoverable natural gas and oil reserves most likely
will vary from estimates. Any significant variance could materially affect the
estimated quantities and net present value of reserves. In addition, we may
adjust estimates of proved reserves to reflect production history, results of
exploration and development, prevailing natural gas and oil prices and other
factors, many of which are beyond our control. Because most of our reserve
estimates are not based on a lengthy production history and are calculated using
volumetric analysis, these estimates are less reliable than estimates based on a
lengthy production history.
It should not be assumed that the pre-tax net present value is the current
market value of our estimated natural gas and oil reserves. In accordance with
requirements of the Securities and Exchange Commission, we base the estimated
discounted future net cash flows from proved reserves on prices and costs on the
date of the estimate. Actual future prices and costs may differ materially from
those used in the present value estimate.
We filed an estimate of proved natural gas and oil reserves as of April 1,
2002 in connection with Form S-1 Registration Statement, as amended, and as
originally filed with the Securities and Exchange Commission on May 15, 2002.
The difference between previously reported proved
23
reserves and proved reserves reported in this Form 10-KSB are less than 5% and
were attributable to production between April 1, 2002 and June 30, 2002.
Item 3. Legal Proceedings
As of the date of this Form 10-KSB, we are not a party to any legal
proceedings, and we are not aware of any proceeding contemplated against us.
Item 4. Submission of Matters to a Vote of Security Holders
During the quarter ended June 30, 2002, no matters were submitted to a vote
of security holders.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
Our common stock was listed on the American Stock Exchange in January 2001
under the symbol "MCF". Prior to that time, our common stock traded on the
Nasdaq over-the-counter market. The table below shows the high and low closing
prices of our common stock for the periods indicated.
High Low
---- ---
Fiscal Year 2001:
Quarter ended September 30, 2000 ..................... $ 7.06 $ 1.50
Quarter ended December 31, 2000 ...................... $ 5.91 $ 3.25
Quarter ended March 31, 2001 ......................... $ 7.50 $ 4.65
Quarter ended June 30, 2001 .......................... $ 5.09 $ 3.72
Fiscal Year 2002:
Quarter ended September 30, 2001 ..................... $ 4.00 $ 2.30
Quarter ended December 31, 2001 ...................... $ 3.04 $ 2.35
Quarter ended March 31, 2002 ......................... $ 3.46 $ 2.55
Quarter ended June 30, 2002 .......................... $ 3.94 $ 2.40
As of September 3, 2002, there were 9,043,282 shares of Contango common
stock outstanding, held by 152 holders of record.
We have not declared or paid any dividends on our shares of common stock
and do not anticipate paying any dividends on our shares of common stock in the
future. Currently, except for the regular dividends that we pay on our Series A
and Series B preferred stock, we intend to retain any future earnings for use in
the operations and expansion of our natural gas and oil business. Our credit
facility currently prohibits us from paying any cash dividends on our common
stock. The credit facility does, however, permit the payment of stock dividends
on our common stock. Any future decision to pay dividends on our common stock
will be at the discretion of our board and will depend upon our financial
condition, results of operations, capital requirements, and other factors our
board may deem relevant.
Between August 16, 1999 and August 24, 1999, we commenced and completed a
private placement of 3,230,000 shares of common stock for $0.20 per share and
warrants to purchase 1,230,000 shares of common stock at $2.00 per share,
raising gross proceeds of $670,600. The
24
issuance of the securities was exempt from registration pursuant to Rule 506
under Regulation D of the Securities Act. There were no underwriting discounts,
commissions or finder's fees paid in connection with the placement.
Pursuant to an agreement we entered into with JEX, effective September 1,
1999 and amended August 14, 2000, JEX received 200,000 shares of common stock as
partial consideration under the agreement. The issuance of the securities was
exempt pursuant to Rule 506 under Regulation D of the Securities Act.
Between September 1, 1999 and September 20, 1999, we commenced and
completed a private placement of 1,890,000 shares of common stock for $0.60 per
share, raising gross proceeds of $1,134,000. The securities were offered and
sold to private investors pursuant to Rule 506 under Regulation D of the
Securities Act, and there were no underwriting discounts, commissions or
finder's fees paid in connection with the placement.
Between October 21, 1999 and January 17, 2000, we commenced and completed a
private placement of 722,000 shares of common stock at a gross price of $1.50
per share (net price of $1.44 per share after commissions) for net proceeds of
$1,035,250. Total commissions paid in the offering were $ 47,750. We also
granted to the purchasers an option for an aggregate total of 31,834 shares of
our common stock at $2.00 per share. All of the purchasers were "accredited
investors" as defined under Rule 501 of Regulation D of the Securities Act, and
the issuance of the securities was exempt from registration pursuant to Rule 506
under Regulation D.
On December 29, 1999, we sold in a private placement 1,851,852 shares of
common stock and a warrant to purchase 185,185 shares of common stock at $2.00
per share to Trust Company of the West for net proceeds after discounts of
$2,500,000, or $1.35 per share. The issuance of the securities to Trust Company
of the West was exempt from registration under Section 4(2) of the Securities
Act, as it did not involve a public offering of securities. There were no
underwriting discounts, commissions or finder's fees paid in connection with the
placement.
Between December 30, 1999 and January 17, 2000, we commenced and completed
a private placement of 47,667 shares of its common stock at a price of $1.50 per
share for total proceeds of $71,500. All of the purchasers were "accredited
investors" as defined in Rule 501 of Regulation D of the Securities Act, and the
issuance of the securities was exempt from registration under Rule 506 of
Regulation D. There were no underwriting discounts, commissions or finder's fees
paid in connection with the placement.
On August 24, 2000, we sold in a private placement transaction 2,500 shares
of its Series A preferred stock and a five-year warrant to purchase 250,000
shares of common stock at an exercise price of $2.00 per share to Trust Company
of the West, as an investment manager and custodian on behalf of a client, for
net proceeds of $2,500,000. The issuance of the securities to Trust Company of
the West was exempt from registration under Section 4(2) of the Securities Act,
as it did not involve a public offering of securities. There were no
underwriting discounts, commissions or finder's fees paid in connection with the
placement.
On August 24, 2000, the Southern Ute Indian Tribe doing business as the
Southern Ute Indian Tribe Growth Fund exercised the option it previously
acquired to purchase 1,250,000 shares of common stock for net proceeds of
$2,500,000. In order to induce the Southern Ute Indian Tribe Growth Fund to
exercise such option, we issued to the Southern Ute Indian Tribe Growth Fund a
25
five-year warrant to purchase 125,000 shares of common stock at an exercise
price of $2.00 per share. The issuance of securities to the Southern Ute Indian
Tribe Growth Fund was exempt from registration under Section 4(2) of the
Securities Act, as it did not involve a public offering of securities.
On August 24, 2000, as part of the formation of Republic Exploration, we
granted to each of JEX and a private company in separate private placement
transactions a five-year warrant to purchase 62,500 shares of common stock at an
exercise price of $2.00 per share. The issuance of these two five-year warrants
was exempt from registration under Section 4(2) of the Securities Act, as it did
not involve a public offering of securities. There were no underwriting
discounts, commissions or finder's fees paid in connection with the placements.
On September 27, 2000, we sold in a private placement transaction 5,000
shares of its Series B preferred stock to Aquila Energy Capital Corporation for
net proceeds of $5,000,000. The issuance of the securities to Aquila Energy
Capital Corporation was exempt from registration under Section 4(2) of the
Securities Act, as it did not involve a public offering of securities. There
were no underwriting discounts, commissions or finder's fees paid in connection
with the placement.
As of November 10, 2000, in consideration of the extension of the
expiration date from December 29, 2000 to March 15, 2001 of our option to
purchase an additional 23.3% of Republic Exploration, we granted to each of JEX
and the other member of Republic Exploration in separate private placement
transactions a five-year warrant to purchase 62,500 shares of common stock at an
exercise price of $4.12 per share. These two five-year warrants were exempt from
registration under Section 4(2) of the Securities Act, as they did not involve
public offerings of securities. There were no underwriting discounts,
commissions or finder's fees paid in connection with the placements.
On March 28, 2002, Contango repurchased 2,575,000 shares of Contango common
stock owned by the SUIT Growth Fund for $6,180,000. This share repurchase
represents a 22% reduction in Contango's outstanding common shares. The SUIT
Growth Fund originally purchased these securities in private placements during
June and August 2000. In addition, the Company cancelled a warrant held by the
SUIT Growth Fund to purchase 125,000 shares of its common stock at $2.00 per
share and options to purchase 17,500 shares of its common stock at prices
between $2.70 and $5.87 per share. In connection with these transactions, Robert
J. Zahradnik, Director of Operations of the SUIT Growth Fund and a Contango
director, tendered his resignation as a director to the Company's Board of
Directors.
During the fiscal year ended June 30, 2001, we issued 11,350 shares of
common stock to two employees and an outside consultant at values ranging from
$3.38 per share to $6.85 per share as consideration for their services. The
issuance of these securities was exempt from registration under Section 4(2) of
the Securities Act, as it did not involve a public offering of securities.
During the fiscal year ended June 30, 2002, we issued 3,900 shares of
common stock to two employees and an outside consultant at values ranging from
$2.45 per share to $3.46 per share as consideration for their services. The
issuance of these securities was exempt from registration under Section 4(2) of
the Securities Act, as it did not involve a public offering of securities.
26
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with the financial
statements and the related notes and other information included elsewhere in
this report.
Introduction
We are an independent natural gas and oil company engaged in the
exploration, production and acquisition of natural gas and oil in the United
States. Our entry into the natural gas and oil business began on July 1, 1999.
The following is a discussion of the results of our operations for the fiscal
year ended June 30, 2002, compared to the fiscal year ended June 30, 2001.
Critical Accounting Policies
The application of generally accepted accounting principles involves
certain assumptions, judgments, choices and estimates that affect reported
amounts of assets, liabilities, revenues and expenses. Thus, the application of
these principles can result in varying results from company to company. Our
critical accounting principles, which we describe below, relate to the
successful efforts method for costs related to natural gas and oil activities,
consolidation principles, accounting for financial instruments and stock
options.
Successful Efforts Method of Accounting. We follow the successful efforts
method of accounting for our natural gas and oil business. Under the successful
efforts method, lease acquisition costs and all development costs are
capitalized. Proved natural gas and oil properties are reviewed when
circumstances suggest the need for such a review and, if required, the proved
properties are written down to their estimated fair value. Unproved properties
are reviewed quarterly to determine if there has been impairment of the carrying
value, and any such impairment is charged to expense in the period. Estimated
fair value includes the estimated present value of all reasonably expected
future production, prices and costs. Exploratory drilling costs are capitalized
until the results are determined. If proved reserves are not discovered, the
exploratory drilling costs are expensed. Other exploratory costs, including 3-D
seismic acquisitions, are expensed as incurred. The provision for depreciation,
depletion and amortization is based on the capitalized costs as determined
above, plus future costs to abandon offshore wells and platforms, and is on a
cost center by cost center basis using the units of production method, with
lease acquisition costs amortized over total proved reserves and other costs
amortized over proved developed reserves. We create cost centers on a
well-by-well basis on all of our natural gas and oil activities.
Consolidation Principles. Our consolidated financial statements include the
accounts of Contango Oil & Gas Company and its subsidiaries and affiliates,
after elimination of all intercompany balances and transactions. Majority-owned
subsidiaries are fully consolidated. Minority-owned natural gas and oil
affiliates, such as 33.3% owned Republic Exploration and 50% owned Magnolia
Offshore Exploration are proportionately consolidated. In the case of
minority-owned affiliates that have disproportionate allocations among the
investors, our share of the affiliate's net income or loss is based on how
increases or decreases in the net assets of the venture will ultimately affect
cash payments to Contango (hypothetical liquidation). Since we are the only
member that contributed cash to Republic Exploration and Magnolia Offshore
Exploration, we
27
consolidate 100% of all activities in a loss position into our financial
statements until we recoup our investment.
Hedge Accounting. In June 1998, the Financial Accounting Standards Board,
or "FASB", issued SFAS 133. In June 2000, the FASB issued SFAS 138, "Accounting
for Derivative Instruments and Hedging Activities, an amendment of FASB
Statement No. 133". SFAS 133, as amended, establishes accounting and reporting
standards requiring that every derivative instrument be recorded in the balance
sheet as either an asset or liability measured at its fair value. The statement
requires that changes in a derivative's fair value be recognized currently in
earnings unless specific hedge criteria are met. Although the derivative
transactions we engage in are designed as economic hedges for a portion of
future natural gas and oil production, we have elected not to designate these as
"hedges" under SFAS No. 133. Accordingly, we recognize the changes in the
derivative's fair value in our income statement under "Gain (loss) from hedging
activities".
Stock Options. We began expensing the cost of all Contango stock options
beginning with stock options granted during the fiscal year ended June 30, 2002.
The Company has adopted the fair value based method of recording stock options
contained in SFAS No. 123, "Accounting for Stock-Based Compensation".
All employee stock option grants will be expensed over each stock option's
vesting period based on the fair value at the date the options are granted. The
fair value of each option is estimated as of the date of grant using the
Black-Scholes options-pricing model. The Company recorded an expense of $29,796
for the fiscal year ended June 30, 2002 from the adoption of this accounting
standard.
28
MD&A Summary Data
The table below sets forth, for the periods indicated, summary information
discussed in Management's Discussion and Analysis of Financial Condition and
Results of Operations below.
Year Ended June 30,
-------------------
2002 2001 Change
---- ---- ------
Natural gas and oil sales ..................... $ 23,901,995 $ 24,548,723 -3%
Gain (loss) from hedging activities ........... $ 5,016,173 $ (557,654) n/a
Production:
Natural gas (thousand cubic feet per day)... 19,129 9,781 96%
Oil and condensate (barrels per day) ....... 510 335 52%
Average sales price:
Natural gas (thousand cubic feet) .......... $ 2.94 $ 5.92 -50%
Oil and condensate (barrels) ............... $ 21.44 $ 27.95 -23%
Operating expenses ............................ $ 3,904,541 $ 2,631,905 48%
Exploration expenses .......................... $ 2,694,425 $ 4,167,427 -35%
Depreciation, depletion and amortization ...... $ 8,593,635 $ 4,023,672 114%
Impairment of natural gas and oil properties... $ 527,150 $ 300,466 75%
General and administrative expense ............ $ 2,901,566 $ 2,356,421 23%
Interest expense ............................... $ 285,159 $ 8,674 n/a
Gain on sale of assets ........................ $ 373,539 $ -- n/a
Income tax expense ............................ $ 4,003,154 $ 3,179,248 26%
Year Ended June 30, 2002 Compared to the Year Ended June 30, 2001
Natural Gas and Oil Sales. We reported natural gas and oil sales of
approximately $23.9 million for the year ended June 30, 2002, down from
approximately $24.5 million for the year ended June 30, 2001. This decrease was
attributable to substantial decreases in natural gas and oil prices that were
offset by production increases from new wells drilled on our STEP properties
plus increased net revenue interests in certain of those wells resulting from
acquisitions made during the six months ended June 30, 2002.
For the year ended June 30, 2002, our net production increased to
approximately 19.1 MMcf of natural gas per day and 510 barrels of oil per day.
For the year ended June 30, 2001, our net production was approximately 9.8 MMcf
of natural gas per day and 335 barrels of oil per day. For the year ended June
30, 2002, our average realized price for natural gas was $2.94 per Mcf and for
oil was $21.44 per barrel, compared with prices for the year ended June 30, 2001
of $5.92 per Mcf of natural gas and $27.95 per barrel of oil.
Gain from Hedging Activities. We reported a gain from hedging activities
for the year ended June 30, 2002 of approximately $5.0 million. This gain
consists of approximately $6.0 million of gains realized on settlements of
swap derivative agreements offset by unrealized losses of approximately $1.0
million. For the year ended June 30, 2001, we recognized a loss from hedging
activities of approximately $557,700.
29
Operating Expenses. Operating expenses, including severance taxes, for the
year ended June 30, 2002 were approximately $3.9 million and were attributable
to production operations both onshore Texas and offshore in the Gulf of Mexico.
Of this amount, approximately $2.2 million was attributable to lease operating
expense and $1.7 million was attributable to production and severance taxes.
Operating expenses, including severance taxes, for the year ended June 30, 2001
were approximately $2.6 million, of which approximately $900,000 was
attributable to lease operating expense and $1.7 million was attributable to
production and severance taxes. The increase in 2002 was primarily due to
increased production.
Exploration Expense. Exploration costs for the year ended June 30, 2002
were approximately $2.7 million. This primarily was attributable to the
expensing of $2.2 million in dry holes drilled on our STEP properties and
approximately $500,000 in seismic costs and delay rentals attributable to
activities offshore in the Gulf of Mexico. For the year ended June 30, 2001, we
reported approximately $4.2 million of exploration expense. Of this amount,
approximately $2.8 million was attributable to dry holes drilled and $1.2
million was the cost of shooting seismic data onshore in south Texas.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization for the year ended June 30, 2002 was approximately $8.6 million.
This primarily was attributable to depletion and amortization related to
increased production from our STEP properties, as well as increased costs of
proved properties resulting from the acquisition of additional interests in our
STEP properties completed during the six months ended June 30, 2002. For the
year ended June 30, 2001, we recorded approximately $4.0 million of
depreciation, depletion and amortization. This primarily was attributable to
depletion and amortization related to production from our STEP properties.
Impairment of natural gas and oil properties. Impairment expense for the
year ended June 30, 2002 was approximately $527,200. This was attributable to
impairment of a lease prospect in south Texas and to an additional impairment of
one of our offshore wells. For the year ended June 30, 2001, impairment expense
was approximately $300,500. This was attributable to the impairment of two of
our offshore wells.
General and Administrative Expense. General and administrative expense for
the year ended June 30, 2002 was approximately $2.9 million, compared to
approximately $2.4 million reported for the year ended June 30, 2001. This
increase was primarily attributable to approximately $540,000 of costs incurred
in connection with a proposed public sale of convertible preferred stock in June
2002.
Interest Expense. We reported interest expense of approximately $285,200
for the year ended June 30, 2002. For the year ended June 30, 2001, we reported
interest expense of approximately $8,700. This increase was attributable to
borrowings under our credit facility during the period of January 2002 and June
2002. We had no bank borrowing prior to January 2002.
Capital Resources and Liquidity
During the year ended June 30, 2002, we funded our activities with cash on
hand, internally generated cash flow and borrowings under our secured, reducing
revolving line of credit with Guaranty Bank, FSB that matures in June 2004. We
reported total revenues for the year ended June 30, 2002 of approximately $28.9
million, which included approximately $5.0 million of net gains
30
from hedging activities. EBITDAX, which we define as earnings before interest,
income taxes, depreciation, depletion and amortization, impairment expense and
expensed exploration expenditures, including gains or losses from hedging, for
the twelve-month period was approximately $22.1 million.
At September 20, 2002, we had approximately $415,000 in cash on hand, $16.3
million borrowed under our credit facility and $6.5 million of funds available
under our credit facility.
During the six months ended June 30, 2002, we increased our ownership
interest in our STEP properties in three separate transactions at a total cost
of approximately $23.4 million. In July 2002, we further increased our ownership
in our STEP properties at a cost of approximately $2.6 million. At anticipated
production levels and current commodity price levels, we expect to have cash
flow of $1.5 to 2.0 million per month through March 2003. Current levels of
production are estimated to decline to about 14 MMcf of natural gas and 350
barrels of oil per day by calendar year end 2002 absent any increases resulting
from future drilling activities.
Although we have completed our original drilling program on our STEP
properties, we are continuing our exploration efforts in the STEP area. We are
participating in a 3-D seismic shoot covering approximately 150 square miles in
Brooks, Jim Hogg and Starr Counties, Texas. The cost of our participation is
estimated at approximately $2.3 to $3.0 million. Based on the results of this
new seismic, we hope to have additional drillable prospects identified by early
2003. Capital expenditures for the fiscal year 2002 totaled approximately $31.7
million. We have identified $5.0 million to $10.0 million in capital
expenditures for the fiscal year 2003 and are actively seeking additional
opportunities and prospects for 2003.
We believe that our cash on hand, our anticipated cash flow from operations
and funds available under our credit facility will be adequate to satisfy
planned capital expenditures over the next 12 months. We may seek additional
equity, sell assets or seek other financing to fund possible acquisitions and an
expanded exploration program, and to take advantage of other opportunities that
may become available. The availability of such funds will depend upon prevailing
market conditions and other factors over which we have no control, as well as
our financial condition and results of operations.
Credit Facility
Our credit facility is a secured, reducing revolving line of credit with
Guaranty Bank, FSB that matures in June 2004. In July 2002, the hydrocarbon
borrowing base was increased to $24.0 million. This amount reduces by $580,000
per month the first day of each month beginning August 1, 2002. Borrowings under
the credit facility bear interest, at our option, at either (i) LIBOR plus two
percent (2%) or (ii) the bank's base rate plus one-fourth percent (1/4%) per
annum. Additionally, we pay a quarterly commitment fee of three-eighths percent
(3/8%) per annum on the average availability under the credit facility. The
hydrocarbon borrowing base is subject to semi-annual redetermination based
primarily on the value of our proved reserves. The credit facility requires the
maintenance of certain ratios, including those related to working capital,
funded debt to EBITDAX, and debt service coverage, as defined in the credit
facility. Additionally, the credit facility contains certain negative covenants
that, among other things, restrict or limit our ability to incur indebtedness,
sell assets, pay dividends and reacquire or otherwise acquire or redeem capital
stock. Failure to maintain required financial ratios or comply with the credit
facility's covenants can result in a default and acceleration of all
indebtedness under the credit facility.
31
As of June 30, 2002, $18.95 million was outstanding under the credit
facility, and we were in compliance with all financial covenants and ratios. As
of September 20, 2002, $16.3 million was outstanding under the credit facility,
and we had $6.5 million of loan availability.
Quantitative and Qualitative Disclosure About Market Risk
Commodity Risk. Our major commodity price risk exposure is to the prices
received for our natural gas and oil production. Realized commodity prices
received for our production are the spot prices applicable to natural gas and
crude oil. Prices received for natural gas and oil are volatile and
unpredictable and are beyond our control. For the year ended June 30, 2002, a
10% fluctuation in the prices received for natural gas and oil production would
have had an approximate $2.7 million impact on our revenues.
We periodically enter into hedges on a portion of our projected natural gas
and oil production to manage our exposure to declines in natural gas and oil
prices. We may use futures contracts, swaps, options and fixed-price physical
contracts to hedge commodity prices. We use these derivative financial
instruments for non-trading purposes only. For the year ended June 30, 2002, we
recognized a gain of $5.0 million.
Hedging Activities. Our revenues, profitability and future growth depend
substantially on prevailing prices for natural gas and oil. These prices also
affect the amount of cash flow available for capital expenditures and our
ability to borrow and raise additional capital. The amount we can borrow under
our credit facility is subject to periodic redetermination based in part on
changing expectations of future prices of natural gas and oil. Lower prices may
also reduce the amount of natural gas and oil that we can economically produce.
From time to time, we enter into hedging arrangements on a portion of our
anticipated natural gas and oil production as a part of our overall risk
management strategy. The following table provides our pricing and notional
volumes on open commodity derivative contracts as of September 20, 2002.
Strike
Description Term Price (1) Quantity (2)
---------------------------- --------------- --------- ------------
Natural gas call ........... 10/2002-12/2002 $ 4.02 8,000/day
Crude oil swap ............. 09/2002-10/2002 $ 24.95 5,000/mth
------------
(1) Prices per MMbtu for natural gas and per barrel for oil.
(2) Natural gas quantities in MMbtu, oil quantities in barrels.
At June 30, 2002, the mark-to-market valuation was a loss of $125,674.
Because these open contracts are marked-to-market on a daily basis, we are
exposed to wide swings in commodity prices and could be subject to significant
hedging losses in the event of a significant increase in natural gas and oil
prices. Accordingly, the terms of the agreements with certain counter parties
provide that if the mark-to-market loss to that counter party exceeds $1.0
million, we will have to provide collateral to cover the potential loss
position.
We have never had any derivative contracts with Enron Corp. or its
affiliates.
32
Interest Rate Risk. The carrying value of our debt approximates fair value.
At June 30, 2002, we had approximately $19.4 million of total long-term debt,
represented by $18.95 million outstanding under our credit facility, $1.3
million of which was current, and $483,900 of other long-term payables. The
credit facility matures in June 2004 and bears interest, at our option, at
either (i) LIBOR plus two percent (2%) or (ii) the bank's base rate plus
one-fourth percent (1/4%) per annum. The average interest rate on long-term debt
at June 30, 2002 was 4.1%. The results of a 10% fluctuation in short-term rates
would have had an approximate $29,000 impact on interest expense for the year
ended June 30, 2002. We had no long-term debt prior to January 1, 2002.
Item 7. Financial Statements and Supplementary Data
The financial statements and supplemental information required to be filed
under this item are presented on pages Page F-1 through F-26 of this Form
10-KSB.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On June 10, 2002, the Board of Directors determined, upon the
recommendation of the Audit Committee, to appoint Grant Thornton LLP our
independent public accountants to audit our financial statements for the fiscal
year ending June 30, 2002, replacing Arthur Andersen LLP, which we dismissed on
the same date.
The audit reports of Arthur Andersen LLP on our consolidated financial
statements as of and for the fiscal years ended June 30, 2001 and 2000 did not
contain any adverse opinion or disclaimer of opinion, nor were they qualified or
modified as to uncertainty, audit scope or accounting principles.
During our fiscal years ended June 30, 2001 and 2000 and subsequent interim
periods to June 10, 2002, there were no disagreements between us and Arthur
Andersen LLP on any matter of accounting principles or practices, financial
statement disclosure, or audit scope or procedures, which disagreements, if not
resolved to Arthur Andersen LLP's satisfaction, would have caused Arthur
Andersen LLP to make reference to the subject matter of the disagreement in
connection with its reports. None of the reportable events described under Item
304(a)(1)(v) of Regulation S-K occurred within our two most recent fiscal years
ended June 30, 2001 and subsequent interim periods to June 10, 2002.
During our fiscal year ended June 30, 2001 and the subsequent interim
period to June 10, 2002, the Company did not consult with Grant Thornton LLP
regarding any of the matters or events set forth in Item 304(a)(2)(i) and (ii)
of Regulation S-K.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
The information regarding directors, executive officers, promoters and
control persons required under Item 9 of Form 10-KSB will be contained in our
Definitive Proxy Statement for our 2002 Annual Meeting of Stockholders (the
"Proxy Statement") under the headings "Election of Directors", "Executive
Compensation" and "Section 16(a) Beneficial Ownership Reporting Compliance" and
is incorporated herein by reference. The Proxy Statement will be filed with the
33
Securities and Exchange Commission pursuant to Regulation 14A of the Exchange
Act of 1934, as amended, not later than 120 days after June 30, 2002.
Item 10. Executive Compensation
The information required under Item 10 of Form 10-KSB will be contained
in the Proxy Statement under the heading "Executive Compensation" and is
incorporated herein by reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The information required under Item 11 of Form 10-KSB will be contained
in the Proxy Statement under the heading "Security Ownership of Certain Other
Beneficial Owners and Management" and is incorporated herein by reference.
Item 12. Certain Relationships and Related Transactions
The information required under Item 12 of Form 10-KSB will be contained
in the Proxy Statement under the heading "Certain Relationships and Related
Transactions" and "Executive Compensation" and is incorporated herein by
reference.
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits:
The following is a list of exhibits filed as part of this Form 10-KSB.
Where so indicated by a footnote, exhibits, which were previously filed, are
incorporated herein by reference.
Exhibit
Number Description
------- -------------------------------------------------------------------
3.1 Certificate of Incorporation of Contango Oil & Gas Company, a
Delaware corporation. (8)
3.2 Bylaws of Contango Oil & Gas Company, a Delaware corporation. (8)
3.3 Agreement of Plan of Merger of Contango Oil & Gas Company, a
Delaware corporation, and Contango Oil & Gas Company, a Nevada
corporation. (8)
4.1 Facsimile of common stock certificate of the Company. (1)
4.2 Certificate of Designations, Preferences and Relative Rights and
Limitations for Series A Senior Convertible Cumulative Preferred
Stock of Contango Oil & Gas Company, a Delaware corporation. (8)
4.3 Certificate of Designations, Preferences and Relative Rights and
Limitations for Series B Senior Convertible Cumulative Preferred
Stock of Contango Oil & Gas Company, a Delaware corporation. (8)
10.1 Agreement, dated effective as of September 1, 1999, between
Contango Oil & Gas Company and Juneau Exploration, L.L.C. (2)
10.2 Securities Purchase Agreement between Contango Oil & Gas Company
and Trust Company of the West, dated December 29, 1999. (15)
10.3 Warrant to Purchase Common Stock between Contango Oil & Gas Company
and Trust Company of the West, dated December 29, 1999. (3)
10.4 Co-Sale Agreement among Kenneth R. Peak, Contango Oil & Gas Company
and Trust Company of the West, dated December 29, 1999. (3)
34
10.5 Securities Purchase Agreement by and between Contango Oil & Gas
Company and the Southern Ute Indian Tribe doing business as the
Southern Ute Indian Tribe Growth Fund, dated June 8, 2000. (4)
10.6 Securities Purchase Agreement dated August 24, 2000 by and between
Contango Oil & Gas Company and Trust Company of the West. (5)
10.7 Securities Purchase Agreement dated August 24, 2000 by and between
Contango Oil & Gas Company and the Southern Ute Indian Tribe doing
business as the Southern Ute Indian Tribe Growth Fund. (5)
10.8 Securities Purchase Agreement dated August 24, 2000 by and between
Contango Oil & Gas Company and Fairfield Industries Incorporated.
(5)
10.9 Securities Purchase Agreement dated August 24, 2000 by and between
Contango Oil & Gas Company and Juneau Exploration Company, L.L.C.
(5)
10.10 Amendment dated August 14, 2000 to agreement between Contango Oil &
Gas Company and Juneau Exploration Company, LLC. dated effective as
of September 1, 1999. (6)
10.11 Securities Purchase Agreement dated September 27, 2000 by and
between Contango Oil & Gas Company and Aquila Energy Capital
Corporation. (7)
10.12 Credit Agreement between Contango Oil & Gas Company and Guaranty
Bank, FSB, dated June 29, 2001. (9)
10.13 First Amendment dated as of January 8, 2002 to Credit Agreement
between Contango Oil & Gas Company and Guaranty Bank, FSB, dated
June 29, 2001. (10)
10.14 Asset Purchase Agreement by and among Juneau Exploration, L.P. and
Contango Oil & Gas Company dated January 4, 2002. (10)
10.15 Asset Purchase Agreement by and among Mark A. Stephens, John
Miller, The Hunter Revocable Trust, Linda G. Ferszt, Scott Archer
and the Archer Revocable Trust and Contango Oil & Gas Company dated
January 9, 2002. (11)
10.16 Asset Purchase Agreement by and among the Southern Ute Indian Tribe
doing business as Red Willow Production Company and Contango Oil &
Gas Company dated January 28, 2002. (12)
10.17 Securities Repurchase Agreement by and among the Southern Ute
Indian Tribe doing business as Red Willow Production Company and
Southern Ute Indian Tribe Growth Fund and Contango Oil & Gas
Company dated March 28, 2002. (14)
10.18 Second Amendment dated as of February 13, 2002 to Credit Agreement
between Contango Oil & Gas Company and Guaranty Bank, FSB, dated
June 29, 2001. (13)
10.19 Waiver dated as of March 25, 2002 to Credit Agreement between
Contango Oil & Gas Company and Guaranty Bank, FSB, dated June 29,
2001. (13)
10.20 Option Purchase Agreement between Contango Oil & Gas Company and
Cheniere Energy, Inc. dated June 4, 2002. (16)
10.21 Waiver and Third Amendment dated as of April 26, 2002 to Credit
Agreement between Contango Oil & Gas Company and Guaranty Bank,
FSB, dated June 29, 2001. *
10.22 Fourth Amendment dated as of September 9, 2002 to Credit Agreement
between Contango Oil & Gas Company and Guaranty Bank, FSB, dated
June 29, 2001. *
21.1 Subsidiaries of the Company. *
23.1 Consent of W.D. Von Gonten & Co. *
99.1 Section 9.06 Certificate of Chief Executive Officer and Chief
Financial Officer dated September 16, 2002. *
_____________
* Filed herewith.
35
(1) Filed as an exhibit to the Company's Form 10-SB Registration Statement,
as filed with the Securities and Exchange Commission on October 16, 1998.
(2) Filed as an exhibit to the Company's Form 10-QSB for the quarter ended
June 30, 1999, as filed with the Securities and Exchange Commission on
November 11, 1999.
(3) Filed as an exhibit to the Company's Form 10-QSB for the quarter ended
December 31, 1999, as filed with the Securities and Exchange Commission
on February 14, 2000.
(4) Filed as an exhibit to the Company's report on Form 8-K, dated June 8,
2000, as filed with the Securities and Exchange Commission on June 14,
2000.
(5) Filed as an exhibit to the Company's report on Form 8-K, dated August 24,
2000, as filed with the Securities and Exchange Commission of September
8, 2000.
(6) Filed as an exhibit to the Company's annual report on Form 10-KSB for the
fiscal year ended June 30, 2000, as filed with the Securities and
Exchange Commission on September 27, 2000.
(7) Filed as an exhibit to the Company's report on Form 8-K, dated September
27, 2000, as filed with the Securities and Exchange Commission on October
3, 2000.
(8) Filed as an exhibit to the Company's report on Form 8-K, dated December
1, 2000, as filed with the Securities and Exchange Commission on December
15, 2000.
(9) Filed as an exhibit to the Company's annual report on Form 10-KSB for the
fiscal year ended June 30, 2001, as filed with the Securities and
Exchange Commission on September 21, 2001.
(10) Filed as an exhibit to the Company's report on Form 8-K, dated January 4,
2002, as filed with the Securities and Exchange Commission on January 8,
2002.
(11) Filed as an exhibit to the Company's Form 10-QSB for the quarter ended
December 31, 2001, as filed with the Securities and Exchange Commission
on February 14, 2002.
(12) Filed as an exhibit to the Company's report on Form 8-K, dated March 8,
2002, as filed with the Securities and Exchange Commission on March 15,
2002.
(13) Filed as an exhibit to the Company's report filed on Form 10-QSB for the
quarter ended March 31, 2002, dated May 2, 2002, as filed with the
Securities and Exchange Commission.
(14) Filed as an exhibit to the Company's report on Form 8-K, dated March 28,
2002, as filed with the Securities and Exchange Commission on April 3,
2002.
(15) Filed as an exhibit to the Company's Form 10-QSB/A for the quarter ended
December 31, 1999, as filed with the Securities and Exchange Commission
on June 4, 2002.
(16) Filed as an exhibit to the Company's Registration Statement on Form S-1
(Registration No. 333-89900) as filed with the Securities and Exchange
Commission on June 14, 2002.
(b) Reports on Form 8-K:
On June 14, 2002, we filed a report on Form 8-K reporting that on June
10, 2002 the Board of Directors determined, upon the recommendation of its Audit
Committee, to appoint Grant Thornton LLP as our independent public accountants
to audit the Company's financial statements for the fiscal year ending June 30,
2002, replacing Arthur Andersen LLP, which we dismissed on the same date.
36
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CONTANGO OIL & GAS COMPANY
/s/ KENNETH R. PEAK /s/ LESIA BAUTINA
-------------------------------------- ---------------------------------
Kenneth R. Peak Lesia Bautina
Chairman, Chief Executive Officer and Chief Vice President and Controller
Financial Officer (principal executive, (principal accounting officer)
financial officer)
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
Name Title Date
------------------------------------- ------------------------ --------------------
/s/ KENNETH R. PEAK Chairman of the Board September 26, 2002
-------------------------------------
Kenneth R. Peak
/s/ JAY BREHMER Director September 26, 2002
-------------------------------------
Jay Brehmer
/s/ JOHN B. JUNEAU Director September 26, 2002
-------------------------------------
John B. Juneau
/s/ JOSEPH J. ROMANO Director September 26, 2002
-------------------------------------
Joseph J. Romano
/s/ DARRELL W. WILLIAMS Director September 26, 2002
-------------------------------------
Darrell W. Williams
37
CONTANGO OIL & GAS COMPANY
Section 302 Certification of Chief Executive Officer and Chief Financial
Officer
I, Kenneth R. Peak, Chairman, Chief Executive Officer and Chief
Financial Officer of Contango Oil & Gas Company, certify that:
1. I have reviewed this annual report on Form 10-KSB of Contango
Oil & Gas Company;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this annual report.
Date: September 16, 2002
/s/ KENNETH R. PEAK
-----------------------------------
Kenneth R. Peak
Chairman, Chief Executive Officer and Chief Financial Officer
38
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Reports of Independent Certified Public Accountants .................................................. F-2
Consolidated Balance Sheets, June 30, 2002 and 2001 .................................................. F-4
Consolidated Statements of Operations for the Years Ended June 30, 2002 and 2001 ..................... F-5
Consolidated Statements of Cash Flows for the Years Ended June 30, 2002 and 2001 ..................... F-6
Consolidated Statements of Shareholders' Equity for the Years
Ended June 30, 2002 and 2001 ....................................................................... F-7
Notes to Consolidated Financial Statements ........................................................... F-8
Supplemental Oil and Gas Disclosures ................................................................. F-24
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Shareholders of Contango Oil & Gas Company:
We have audited the accompanying consolidated balance sheet of Contango
Oil & Gas Company (a Delaware corporation) and subsidiaries as of June 30, 2002,
and the related consolidated statements of operations, shareholders' equity and
cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit. The consolidated
financial statements of Contango Oil & Gas Company and subsidiaries as of June
30, 2001, and for the year then ended were audited by other auditors who have
ceased operations. These auditors expressed an unqualified opinion on those
consolidated financial statements in their report dated September 17, 2001.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the 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 audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Contango Oil
& Gas Company and subsidiaries as of June 30, 2002, and the results of their
operations and their cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States.
As discussed in Footnote 2 to the consolidated financial statements,
the Company changed its method of accounting for stock options for the year
ended June 30, 2002.
GRANT THORNTON LLP
Houston, Texas
September 16, 2002
F-2
The following report is a copy of the previously issued report by Arthur
Andersen LLP and has not been reissued by Arthur Andersen LLP. Financial
Statements as of June 30, 2000 and for the year then ended are not presented
therein.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Contango Oil & Gas Company:
We have audited the accompanying consolidated balance sheets of
Contango Oil & Gas Company (a Delaware corporation) and subsidiaries as of June
30, 2001 and 2000, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the two years in the period
ended June 30, 2001. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the 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 financial position of Contango Oil
& Gas Company and subsidiaries as of June 30, 2001 and 2000, and the results of
its operations and its cash flows for each of the two years in the period ended
June 30, 2001, in conformity with accounting principles generally accepted in
the United States.
ARTHUR ANDERSEN LLP
Houston, Texas
September 17, 2001
F-3
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30,
-----------------------------------
2002 2001
------------- ------------
CURRENT ASSETS:
Cash and cash equivalents .................................................. $ 2,726,845 $ 1,586,342
Accounts receivable, net ................................................... 5,220,453 5,517,197
Advances to operators ...................................................... 597,294 -
Price hedge contracts ...................................................... 57,726 888,400
Other ...................................................................... 184,437 313,140
------------- ------------
Total current assets ..................................................... 8,786,755 8,305,079
------------- ------------
PROPERTY, PLANT AND EQUIPMENT:
Natural gas and oil properties, successful efforts method of accounting:
Proved properties ........................................................ 46,565,998 20,317,257
Unproved properties, not being amortized ................................. 3,650,558 2,587,354
Furniture and equipment .................................................... 188,884 120,388
Accumulated depreciation, depletion and amortization ....................... (13,056,575) (4,866,732)
------------- ------------
Total property, plant and equipment ...................................... 37,348,865 18,158,267
------------- ------------
OTHER ASSETS:
Investment in Republic Exploration L.L.C ................................... 3,945,270 5,047,476
Investment in Magnolia Offshore Exploration L.L.C .......................... 787,456 -
Investment in LNG project .................................................. 750,000 -
Other assets ............................................................... 221,170 211,375
------------- ------------
Total other assets ....................................................... 5,703,896 5,258,851
------------- ------------
TOTAL ASSETS .................................................................. $ 51,839,516 $ 31,722,197
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ........................................................... $ 613,537 $ 131,929
Accrued exploration and development ........................................ 517,000 2,837,181
Income taxes payable ....................................................... 1,040,788 -
Price hedge contracts ...................................................... 183,400 -
Short term hedge payable ................................................... 525,870 -
Other accrued liabilities .................................................. 648,654 554,146
Current portion of long term debt .......................................... 1,330,000 -
------------- -----------
Total current liabilities ................................................ 4,859,249 3,523,256
------------- -----------
LONG-TERM DEBT ................................................................ 18,103,920 -
DEFERRED INCOME TAXES ......................................................... 3,777,864 3,179,248
SHAREHOLDERS' EQUITY:
Convertible preferred stock, 8%, Series A, $0.04 par value, 5,000 shares
authorized, 2,500 shares issued and outstanding at June 30, 2002 and 2001,
liquidation preference of $1,000 per share ............................... 100 100
Convertible preferred stock, 8%, Series B, $0.04 par value, 10,000 shares
authorized, 5,000 shares issued and outstanding at June 30, 2002 and 2001,
liquidation preference of $1,000 per share ............................... 200 200
Common stock, $0.04 par value, 50,000,000 shares authorized, 11,618,282
issued and 9,043,282 outstanding at June 30, 2002, and 11,501,882 shares
issued and outstanding at June 30, 2001 .................................. 464,732 460,076
Additional paid-in capital ................................................. 21,236,701 20,959,549
Treasury stock at cost (2,575,000 shares) .................................. (6,180,000) -
Retained earnings .......................................................... 9,576,750 3,599,768
------------- ------------
Total shareholders' equity ................................................. 25,098,483 25,019,693
------------- ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .................................... $ 51,839,516 $ 31,722,197
============= ============
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended June 30,
---------------------------------
2002 2001
-------------- --------------
REVENUES:
Natural gas and oil sales ................................................. $ 23,901,995 $ 24,548,723
Gain (loss) from hedging activities ....................................... 5,016,173 (557,654)
-------------- --------------
Total revenues ......................................................... 28,918,168 23,991,069
-------------- --------------
EXPENSES:
Operating expenses ........................................................ 3,904,541 2,631,905
Exploration expenses ...................................................... 2,694,425 4,167,427
Depreciation, depletion and amortization .................................. 8,593,635 4,023,672
Impairment of natural gas and oil properties .............................. 527,150 300,466
General and administrative expense ........................................ 2,901,566 2,356,421
-------------- --------------
Total expenses ......................................................... 18,621,317 13,479,891
-------------- --------------
INCOME FROM OPERATIONS ....................................................... 10,296,851 10,511,178
Interest expense ............................................................. (285,159) (8,674)
Interest income .............................................................. 194,905 414,403
Gain on sale of assets ....................................................... 373,539 -
INCOME BEFORE INCOME TAXES ................................................... 10,580,136 10,916,907
Provision for income taxes ................................................... 4,003,154 3,179,248
-------------- ---------------
NET INCOME ................................................................... 6,576,982 7,737,659
Preferred stock dividends .................................................... 600,000 475,205
-------------- --------------
NET INCOME ATTRIBUTABLE TO COMMON STOCK ...................................... $ 5,976,982 $ 7,262,454
============== ==============
NET INCOME PER SHARE:
Basic ..................................................................... $ 0.55 $ 0.64
============== ==============
Diluted ................................................................... $ 0.48 $ 0.54
============== ==============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic ..................................................................... 10,841,665 11,287,098
============== ==============
Diluted ................................................................... 13,711,597 14,381,124
============== ==============
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended June 30,
-------------------------------
2002 2001
------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .............................................................................. $ 6,576,982 $ 7,737,659
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, depletion and amortization ........................................... 8,593,635 4,023,672
Impairment expense ................................................................. 527,150 300,466
Exploration expenditures ........................................................... 2,236,515 2,824,304
Provision for deferred income taxes ................................................ 598,616 3,179,248
Gain on sale of assets ............................................................. (373,539) -
Unrealized hedging (gain) loss ..................................................... 1,014,074 (888,400)
Stock-based compensation ........................................................... 56,808 131,738
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable ....................................... 74,186 (5,013,840)
(Increase) decrease in prepaid insurance ......................................... 1,901 (120,031)
Increase in accounts payable ..................................................... 1,496,307 294
Increase in other accrued liabilities ............................................ 311,768 747,771
Increase in taxes payable ........................................................ 1,040,788 -
Other ............................................................................ 317,368 34,831
------------ -----------
Net cash provided by operating activities ..................................... 22,472,559 12,957,712
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Natural gas and oil exploration and development expenditures ......................... (7,743,984) (21,425,847)
Investment in Republic Exploration, L.L.C ............................................ - (6,666,051)
Investment in Magnolia Offshore Exploration, L.L.C ................................... (1,612,860) -
Investment in LNG project ............................................................ (750,000) -
Additions to furniture and equipment ................................................. (15,854) (37,730)
Decrease (increase) in advances to operators ......................................... (311,068) 1,056,696
Purchase of proved producing reserves ................................................ (23,449,488) -
Increase in payables for capital expenditures ........................................ - 2,537,445
Proceeds from sale of assets and other ............................................... 261,448 -
------------ -----------
Net cash used in investing activities .............................................. (33,621,806) (24,535,487)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under credit facility ..................................................... 31,050,000 -
Repayments under credit facility ..................................................... (12,100,000) -
Purchase of treasury shares .......................................................... (6,180,000) -
Proceeds from issuance of common stock, preferred stock and warrants ................. - 9,993,416
Preferred stock dividends ............................................................ (600,000) (475,205)
Proceeds from exercised options and warrants ......................................... 225,000 -
Debt issue costs ..................................................................... (105,250) (125,000)
------------ -----------
Net cash provided by financing activities .......................................... 12,289,750 9,393,211
------------ -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .................................... 1,140,503 (2,184,564)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .......................................... 1,586,342 3,770,906
------------ -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................................................ $ 2,726,845 $ 1,586,342
============ ===========
SUPPLMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for taxes .................................................................. $ 2,355,000 $ -
============ ===========
Cash paid for interest ............................................................... $ 265,664 $ 9,142
============ ===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-6
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Preferred Stock Common Stock Retained Total
--------------- ---------------------- Paid-in Treasury Earnings Shareholders'
Shares Amount Shares Amount Capital Stock (Deficit) Equity
------ ------- ---------- --------- ----------- ----------- ----------- -------------
Balance at June 30, 2000 .... - $ - 10,198,330 $ 407,933 $ 9,660,137 $ - $(3,662,686) $ 6,405,384
Stock-based compensation .... - - 24,302 973 1,360,964 - - 1,361,937
Exercise of stock options ... - - 29,250 1,170 56,830 - - 58,000
Sale of shares .............. 7,500 300 1,250,000 50,000 9,949,700 - - 10,000,000
Offering expenses ........... - - - - (68,082) - - (68,082)
Net income .................. - - - - - - 7,737,659 7,737,659
Preferred stock dividends ... - - - - - - (475,205) (475,205)
------ ------ ---------- --------- ----------- ----------- ----------- ------------
Balance at June 30, 2001 .... 7,500 300 11,501,882 460,076 20,959,549 - 3,599,768 25,019,693
Stock-based compensation .... - - 3,900 156 11,106 - - 11,262
Exercise of stock options
and warrants ............... - - 112,500 4,500 220,500 - - 225,000
Tax benefit from exercise
of stock options ........... - - - - 15,750 - - 15,750
Expense of stock options .... - - - - 29,796 - - 29,796
Treasury stock acquired ..... - - (2,575,000) - - (6,180,000) - (6,180,000)
Net income .................. - - - - - - 6,576,982 6,576,982
Preferred stock dividends ... - - - - - - (600,000) (600,000)
------ ------ ---------- --------- ----------- ----------- ----------- ------------
Balance at June 30, 2002 .... 7,500 $ 300 9,043,282 $ 464,732 $21,236,701 $(6,180,000) $ 9,576,750 $ 25,098,483
====== ====== ========== ========= =========== =========== =========== ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Business
Contango Oil & Gas Company (the "Company" or "Contango") is an
independent natural gas and oil company engaged in the exploration, development
and acquisition of natural gas and oil properties in the United States.
Contango's entry into the natural gas and oil business began on July 1, 1999
when the board appointed Kenneth R. Peak as president, chief executive officer,
chief financial officer, secretary and director of the Company. At the annual
stockholders' meeting held on September 28, 1999, the stockholders elected a new
board of directors, including Kenneth R. Peak, president, chief executive
officer and chairman of the board. The Company's common stock commenced trading
on the American Stock Exchange in January 2001 under the symbol "MCF". Prior to
listing on the American Stock Exchange, the Company's common stock traded on the
Nasdaq over-the-counter bulletin board.
2. Summary of Significant Accounting Policies
Successful Efforts Method of Accounting. The Company follows the
successful efforts method of accounting for its oil and gas activities. Under
the successful efforts method, lease acquisition costs and all development costs
are capitalized. Unproved properties are reviewed quarterly to determine if
there has been impairment of the carrying value, and any such impairment is
charged to expense in the period. Exploratory drilling costs are capitalized
until the results are determined. If proved reserves are not discovered, the
exploratory drilling costs are expensed. Other exploratory costs, such as
seismic costs and other geological and geophysical expenses, are expensed as
incurred. The provision for depreciation, depletion and amortization is based on
the capitalized costs as determined above, plus future costs to abandon offshore
wells and platforms. Depreciation, depletion and amortization is on a cost
center by cost center basis using the unit of production method, with lease
acquisition costs amortized over total proved reserves and other costs amortized
over proved developed reserves. The Company creates cost centers on a
well-by-well basis for natural gas and oil activities on our South Texas
Exploration Program ("STEP") properties and in the Gulf of Mexico.
When circumstances indicate that proved properties may be impaired, the
Company compares expected undiscounted future cash flows on a well-by-well basis
to the unamortized capitalized cost of the asset. If the future undiscounted
cash flows, based on the Company's estimate of future natural gas and oil prices
and operating costs and anticipated production from proved reserves, are lower
than the unamortized capitalized cost, then the capitalized cost is reduced to
fair market value. During the fiscal years ended June 30, 2002 and 2001, the
Company recorded impairments of $527,150 and $300,466, respectively, related to
natural gas and oil properties.
Principles of Consolidation. Our consolidated financial statements
include the accounts of Contango Oil & Gas Company and its subsidiaries and
affiliates, after elimination of all intercompany balances and transactions.
Majority-owned subsidiaries are fully consolidated. Minority-owned natural gas
and oil affiliates, such as 33.3% owned Republic Exploration, L.L.C. ("Republic
Exploration") and 50% owned Magnolia Offshore Exploration, L.L.C. ("Magnolia
Offshore Exploration"), are proportionately consolidated. In the case of
minority-owned affiliates that have disproportionate allocations among the
investors, our share of the affiliate's net income or loss is based on how
increases or decreases in the net assets of the venture will ultimately affect
cash payments to Contango. Since we are the only member that contributed cash to
Republic Exploration and Magnolia Offshore Exploration, we consolidate 100% of
all activities in a loss position into our financial statements until we recoup
our investment.
F-8
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Recently Issued Accounting Standards. The FASB has recently issued
three new pronouncements, Statement of Accounting Standard No. 143 ("SFAS 143"),
"Accounting for Asset Retirement Obligations", Statement of Financial Accounting
Standard No. 144 ("SFAS 144"), "Accounting for Impairment or Disposal of
Long-Lived Assets" and Statement of Accounting Standard No. 146 ("SFAS 146"),
"Accounting for Costs Associated with Exit and Disposal Activities".
SFAS 143 requires companies to record a liability relating to the
retirement of tangible long-lived assets. When the liability is initially
recorded, a company increases the carrying amount of the related long-lived
asset. Over time, the liability is accreted to its present value each period,
and the capitalized cost is depreciated over the useful life of the related
asset. Upon settlement of the liability, an entity either settles the obligation
for its recorded amount or incurs a gain or loss upon settlement. This standard
is effective for fiscal years beginning after June 15, 2002, with earlier
application encouraged. The new standard requires entities to record a
cumulative effect of the change in accounting principle to earnings in the
period of adoption. Contango has determined that the impact of SFAS 143 will not
be significant to the Company's financial statements.
SFAS 144 addresses the financial accounting and reporting for the
impairment or disposal of long-lived assets. SFAS 144 supersedes SFAS 121 but
retains its fundamental provisions for the (a) recognition and measurement of
impairment of long-lived assets to be held and used and (b) measurement of
long-lived assets to be disposed of by sale. SFAS 144 also supersedes the
accounting and reporting portions of APB Opinion No. 30 for segments of a
business to be disposed of but retains the requirements to report discontinued
operations separately from continuing operations and extends that reporting to a
component of an entity that either has been disposed of or is classified as
"held for sale". This standard is effective for fiscal years beginning after
December 15, 2001. The adoption of SFAS 144 will not be significant to the
Company's financial statements.
SFAS 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)". This standard is effective for exit or disposal activities
that are initiated after December 31, 2002, with early application encouraged.
The Company does not anticipate the adoption of SFAS 146 to be significant to
the Company's financial statements.
Use of Estimates. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
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 periods. Actual results could differ from those
estimates. Significant estimates with regard to these financial statements
include the estimate of proved natural gas and oil reserve quantities and the
related present value of estimated future net cash flows therefrom (See
"Supplemental Oil and Gas Disclosures").
Revenue Recognition. Revenues from the sale of natural gas and oil
produced are recognized upon the passage of title, net of royalties. Revenues
from natural gas production are recorded using the sales method. When sales
volumes exceed the Company's entitled share, an overproduced imbalance occurs.
To the extent the overproduced imbalance exceeds the Company's share of the
remaining
F-9
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
estimated proved natural gas reserves for a given property, the Company records
a liability. At June 30, 2001 and 2002, the Company had no overproduced
imbalances.
Cash Equivalents. Cash equivalents are considered to be all highly
liquid debt investments having an original maturity of three months or less. As
of June 30, 2002, the Company had cash and cash equivalents of approximately
$2.7 million. The carrying amounts approximated fair market value due to the
short maturity of these instruments.
Net Income per Common Share. Basic and diluted net income per common
share have been computed in accordance with SFAS No. 128, "Earnings per Share".
Basic net income per common share is computed by dividing income attributable to
common stock by the weighted average number of common shares outstanding for the
period. Diluted net income per common share reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. (See Footnote 5 for the calculations
of basic and diluted net income per common share.)
Income Taxes. The Company follows the liability method of accounting
for income taxes under which deferred tax assets and liabilities are recognized
for the future tax consequences of (i) temporary differences between the tax
bases of assets and liabilities and their reported amounts in the financial
statements and (ii) operating loss and tax credit carryforwards for tax
purposes. Deferred tax assets are reduced by a valuation allowance when, based
upon management's estimates, it is more likely than not that a portion of the
deferred tax assets will not be realized in a future period.
Concentration of Credit Risk. Substantially all of the Company's
accounts receivable result from natural gas and oil sales or joint interest
billings to a limited number of third parties in the natural gas and oil
industry. This concentration of customers and joint interest owners may impact
the Company's overall credit risk in that these entities may be similarly
affected by changes in economic and other conditions.
Stock-Based Compensation. Prior to the fiscal year ended June 30, 2002,
the Company accounted for employee stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". Under the intrinsic method,
compensation cost for stock options is measured as the excess, if any, of the
fair value of the Company's common stock at the date of the grant over the
amount an employee must pay to acquire the common stock.
Effective July 1, 2001, the Company prospectively changed its method of
accounting for employee stock-based compensation to the fair value based method
prescribed in Statement of Financial Accounting Standards No. 123, "Accounting
for Stock Based Compensation". Under the fair value based method, compensation
cost is measured at the grant date based on the fair value of the award and is
recognized over the award vesting period. The fair value of each award is
estimated as of the date of grant using the Black-Scholes options-pricing model.
The Company has determined that the fair value method is preferable to
the intrinsic value method previously applied. During the fiscal year ended June
30, 2002, the Company recorded a charge of $29,796 to general and administrative
expense related to fiscal year 2002 grants. Because compensation expense is
recognized over a vesting period, the effect of applying the fair value method
in
F-10
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
the initial year of adoption may not be representative of the effects on net
income that will be reported in future years.
Derivative Instruments and Hedging Activities. Contango periodically
enters into commodity derivatives contracts and fixed-price physical contracts
to manage its exposure to natural gas and oil price volatility. Commodity
derivatives contracts, which are usually placed with investment grade companies
that the Company believes is a minimal credit risk, may take the form of futures
contracts, swaps or options. The natural gas and oil reference prices upon which
these commodity derivatives contracts are based reflect various market indices
that have a high degree of historical correlation with actual prices received by
the Company.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 established accounting and
reporting standards requiring that derivative instruments (including certain
derivative instruments embedded in other contracts), as defined, be recorded in
the balance sheet as either an asset or liability measured at fair value and
requires that changes in fair value be recognized currently in earnings unless
specific hedge accounting criteria are met.
Although the Company's hedging transactions generally are designed as
economic hedges for a portion of future natural gas and oil production, the
Company has elected not to designate the derivative instruments as "hedges"
under SFAS No. 133. As a result, gains and losses, representing changes in these
derivative instruments' mark-to-market fair values, are recognized currently in
Contango's earnings. (See Footnote 10 for more information on hedging
activities.)
3. Natural Gas and Oil Exploration Risk
The Company's future financial condition and results of operations will
depend upon prices received for its natural gas and oil production and the cost
of finding, acquiring, developing and producing reserves. Substantially all of
its production is sold under various terms and arrangements at prevailing market
prices. Prices for natural gas and oil are subject to fluctuations in response
to changes in supply, market uncertainty and a variety of other factors beyond
its control. Other factors that have a direct bearing on the Company's prospects
are uncertainties inherent in estimating natural gas and oil reserves and future
hydrocarbon production and cash flows, particularly with respect to wells that
have not been fully tested and with wells having limited production histories;
access to additional capital; changes in the price of natural gas and oil;
availability and cost of services and equipment; and the presence of competitors
with greater financial resources and capacity.
4. Liquidity
Management believes that cash on hand, anticipated cash flow from
operations and availability under the Company's bank credit facility (See
Footnote 9), will be adequate to satisfy planned capital expenditures to fund
drilling activities and to satisfy general corporate needs over the next twelve
months. The Company may continue to seek additional equity or other financing to
fund the Company's exploration program and to take advantage of other
opportunities that may become available. The availability of such funds will
depend upon prevailing market conditions and other factors over which the
Company has no control, as well as the Company's financial condition and results
of operations. There can be no assurances that the Company will have sufficient
funds available to finance its intended
F-11
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
exploration and development programs or acquisitions. The Company's exploration
drilling program could be adversely affected if sufficient funds are
unavailable.
5. Net Income Per Common Share
A reconciliation of the components of basic and diluted net income per
common share for the fiscal years ended June 30, 2002 and 2001 is presented
below:
Year Ended June 30,
-------------------------------------------------------------------------------
2002 2001
--------------------------------------- --------------------------------------
Per Per
Income Shares Share Income Shares Share
------------ ----------- ----------- ----------- ----------- ----------
Basic:
Net income attributable
to common stock .................. $ 5,976,982 10,841,665 $ 0.55 $ 7,262,454 11,287,098 $ 0.64
=========== ==========
Effect of Dilutive Securities:
Stock options and warrants ......... - 733,569 - 1,384,664
Series A preferred stock ........... 200,000 1,000,000 170,822 847,826
Series B preferred stock ........... 400,000 1,136,363 304,383 861,536
------------ ---------- ----------- -----------
Diluted:
Net income attributable
to common stock .................. $ 6,576,982 13,711,597 $ 0.48 $ 7,737,659 14,381,124 $ 0.54
============ ========== =========== =========== =========== ==========
6. Income Taxes
Actual income tax expense differs from income tax expense computed by
applying the U.S. federal statutory corporate rate of 35 percent to pretax
income as follows:
Year Ended June 30,
---------------------------------------------------
2002 2001
------------------------ ------------------------
Provision at statutory tax rate ..................... $ 3,703,048 35.0% $ 3,820,917 35.0%
Decrease in valuation allowance ..................... - - (646,000) -5.9%
State income taxes .................................. 450,000 4.3% - -
Federal benefit of state income taxes ............... (157,500) -1.5% - -
Other ............................................... 7,606 - 4,331 -
----------- --------- ----------- ---------
Income tax provision ............................. $ 4,003,154 37.8% $ 3,179,248 29.1%
=========== ========= =========== =========
F-12
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
The provision for income taxes for the periods indicated are comprised
of the following:
Year Ended June 30,
------------------------
2002 2001
----------- -----------
Current:
Federal ................................................................. $ 2,961,538 $ -
State ................................................................... 450,000 -
----------- -----------
Total .............................................................. $ 3,411,538 $ -
=========== ===========
Deferred:
Federal ................................................................. $ 591,616 $ 3,179,248
State ................................................................... - -
----------- -----------
Total .............................................................. $ 591,616 $ 3,179,248
=========== ===========
Tax Provision:
Federal ................................................................. $ 3,553,154 $ 3,179,248
State ................................................................... 450,000 -
----------- -----------
Total .............................................................. $ 4,003,154 $ 3,179,248
=========== ===========
The net deferred income tax liability is comprised of the following:
June 30,
------------------------
2002 2001
----------- -----------
Deferred income tax asset:
Net operating loss carryforwards ........................................ $ - $ (715,194)
Deferred income tax liabilities:
Temporary basis differences in natural gas and oil properties
and other ............................................................. 3,777,864 3,894,442
----------- -----------
Net deferred income tax liability ................................... $ 3,777,864 $ 3,179,248
=========== ===========
Realization of the net deferred tax asset is dependent on the
Company's ability to generate taxable earnings in the future. During the fiscal
year ended June 30, 2002, the Company realized the remainder of its previously
unbenefitted net operating loss carryforwards. As of June 30, 2002, the Company
had no federal net operating loss carryforwards.
7. Purchase of Assets
Effective as of January 1, 2002, Contango entered into separate Asset
Purchase Agreements with Juneau Exploration L.P. ("JEX") and other individuals
to purchase certain working and revenue interests of JEX and other individuals
in its STEP properties. Contango paid approximately $12.9 million with cash on
hand and increased availability under its credit facility. Mr. Juneau is the
sole manager of JEX and is a director of the Company.
Effective January 1, 2002, Contango completed the acquisition from the
Southern Ute Indian Tribe ("SUIT") of additional ownership interests in its STEP
properties at a cost of approximately $7.0 million, subject to purchase price
adjustments. This acquisition was funded with cash on hand and increased
availability under the Company's credit facility.
F-13
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Effective April 1, 2002, Contango completed an acquisition from JEX
and other individuals of additional ownership interests in its STEP properties
at a cost of approximately $3.4 million. This acquisition was funded with
increased availability under the Company's credit facility.
8. Acquisition Pro Forma
The following summary presents unaudited pro forma consolidated
results of operations as if the acquisitions referred to in Footnote 7 had
occurred on July 1, 2001. The pro forma results are for illustrative purposes
only and include the pre-acquisition historical results of the acquired
properties. This unaudited pro forma information is not necessarily indicative
of the operating results that would have occurred had the acquisitions been
consummated at this date, nor are they necessarily indicative of future
operating results.
Year Ended
June 30, 2002
-----------------
Natural gas and oil sales ............................... $ 30,252,070
Net income attributable to common stock ................. $ 7,118,849
Earnings per share:
Basic ................................................... $ 0.66
Diluted ................................................. $ 0.56
9. Long-Term Debt
Effective December 1, 2000, Contango entered into a reducing revolving
line of credit of up to $10.0 million with Bank One, Texas, National
Association. The 18-month credit facility provided for a borrowing base of $5.0
million, $3.0 million of which was unsecured, with the borrowing base
redetermined semi-annually. Interest was payable monthly at the bank's prime
rate plus one and one-fourth percent. Additionally, the Company paid a quarterly
commitment fee of one-fourth percent (1/4%) per annum on the average
availability under the credit facility.
On June 29, 2001, Contango replaced its existing line of credit with a
new, three year, secured, $20 million reducing revolving line of credit with
Guaranty Bank, FSB. The initial borrowing base was set at $10.0 million, with
the borrowing base to be redetermined semi-annually. Our current credit facility
with Guaranty Bank, FSB is a secured, reducing revolving line of credit that
matures in June 2004. The hydrocarbon borrowing base as of June 30, 2002 was
$21.1 million. The hydrocarbon borrowing base reduces by $475,000 the first day
of each month and is subject to semi-annual redeterminations. Borrowings under
the credit facility bear interest, at our option, at either (i) LIBOR plus two
percent (2%) or (ii) the bank's base rate plus one-fourth percent (1/4%) per
annum. Additionally, we pay a quarterly commitment fee of three-eighths percent
(3/8%) per annum on the average availability under the credit facility. The
hydrocarbon borrowing base is subject to semi-annual redetermination based
primarily on the value of our proved reserves. The credit facility requires the
maintenance of certain ratios, including those related to working capital,
funded debt to EBITDAX, and debt service coverage, as defined in the credit
facility. Additionally, the credit facility contains certain negative covenants
that, among other things, restrict or limit our ability to incur indebtedness,
sell assets, pay dividends and reacquire or otherwise acquire or redeem capital
stock. Failure to maintain required
F-14
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
financial ratios or comply with the credit facility's covenants can result in a
default and acceleration of all indebtedness under the credit facility.
As of June 30, 2002, our long term debt was as follows:
Outstanding under line of credit ............................ $ 18,950,000
Current portion of long term debt ........................... (1,330,000)
--------------
17,620,000
Long term hedge payable ..................................... 483,920
--------------
Total long term debt ..................................... $ 18,103,920
==============
As of June 30, 2002, the Company was in compliance with its financial
covenants, ratios and other provisions of the credit facility. The Company had
no long term debt at June 30, 2001.
On July 24, 2002, the hydrocarbon borrowing base was increased to
$24.0 million. This amount reduces by $580,000 per month the first day of each
month beginning August 1, 2002.
10. Commodity Price Hedges
Contango periodically enters into commodity derivative contracts.
These contracts, which are usually placed with large energy pipeline and trading
companies, major petroleum companies or financial institutions that the Company
believes are minimal credit risks, may take the form of futures contracts, swaps
or options. In June 1998, the FASB issued SFAS 133. In June 2000, the FASB
issued SFAS 138, "Accounting for Derivative Instruments and Hedging Activities,
an amendment of FASB Statement No. 133". SFAS 133, as amended, establishes
accounting and reporting standards requiring that every derivative instrument be
recorded in the balance sheet as either an asset or liability measured at its
fair value. The statement requires that changes in a derivative's fair value be
recognized currently in earnings unless specific hedge criteria are met. The
Company recognizes the changes in the derivative's fair value in its income
statement under gain (loss) from hedging activities. The derivative contracts
call for the Company to receive, or make, payments based upon the differential
between a fixed and a variable commodity price as specified in the contract. The
table below sets forth the Company's hedging activities for the periods
indicated.
Year Ended June 30,
-----------------------------
2002 2001
------------ ------------
Mark-to-market reversal of prior period
unrealized recognized gain ........................................ $ (888,400) $ -
Net cash received (paid) from swap settlements ....................... 6,030,247 (1,446,054)
Mark-to-market gain (loss) unrealized ................................ (125,674) 888,400
------------ ------------
Gain (loss) from hedging activities .................................. $ 5,016,173 $ (557,654)
============ ============
F-15
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
The table below sets forth the Company's pricing and notional volumes
on open commodity derivative contracts as of June 30, 2002.
Weighted
Average
Strike
Contract Description Term Price (1) Quantity (2)
---------------------------------------------------------- -------------------- ------------- ----------------
Natural gas put .......................................... 08/2002 - 10/2002 $ 3.00 8,000/day
Natural gas call ......................................... 07/2002 - 12/2002 $ 4.02 8,000/day
Natural gas swap ......................................... 08/2002 - 09/2002 $ 3.23 4,000/day
Natural gas swap ......................................... 08/2002 - 09/2002 $ 3.525 4,000/day
Natural gas swap ......................................... 10/2002 - 01/2003 $ 3.66 2,000/day
Crude oil swap ........................................... 06/2002 - 10/2002 $ 24.95 5,000/mth
--------
(1) Per Mmbtu for natural gas and per barrel for oil.
(2) Natural gas quantities in Mmbtu, oil quantities in barrels.
Although these transactions were designed as economic hedges for a
portion of future natural gas and oil production, the Company has elected not to
designate these as "hedges" under SFAS No. 133. As a result, gains and losses,
representing changes in these derivative instruments' mark-to-market values, are
recognized currently in Contango's earnings. The Company's derivative position
as of June 30, 2002 had a mark-to-market loss of $125,674.
Because these open contracts are marked-to-market on a daily basis,
the Company is exposed to wide swings in its exposure and could be subject to
significant hedging losses in the event of a significant increase in natural gas
prices. While the use of hedging arrangements limits the downside risk of
adverse price movements, they also may limit future revenue from favorable price
movements. The use of hedging transactions also involves the risk that the
counter parties will be unable to meet the financial terms of such transactions.
All of the Company's recent historical hedging transactions have been carried
out in the over-the-counter market with investment grade institutions.
Accordingly, the terms of the agreements with certain counter parties provide
that if the mark-to-market loss to that counter party exceeds $1.0 million,
Contango will have to provide collateral to cover the potential loss position.
The Company has never had any derivative contracts with Enron Corp. or
its affiliates. In addition, the Company does not hold any non-exchange traded
derivative instruments.
11. Commitments and Contingencies
Contango leases its office space and certain other equipment. As of
June 30, 2002, minimum future lease payments are as follows:
Fiscal Year Ending June 30,
2003 ........................................................ $ 77,188
2004 ........................................................ 30,638
2005 ........................................................ 7,363
2006 ........................................................ 1,227
Thereafter .................................................. -
-----------
Total ................................................... $ 116,416
===========
F-16
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
The amount incurred under operating leases during the year ended June
30, 2002 and 2001 was $80,009 and $64,076, respectively.
In October 2001, the Company purchased a 50% interest in Magnolia
Offshore Exploration for a $1.0 million initial contribution and an agreement to
pay an additional $4.0 million as needed to cover capital needs. As of June 30,
2002, the Company had paid approximately $600,000 of the $4.0 million. If the
Company does not promptly pay the remaining $3.4 million when requested, the
Company will forfeit its 50% interest in Magnolia Offshore Exploration, as well
any right to recover previous contributions.
12. Shareholders' Equity
Common Stock. Holders of the Company's common stock are entitled to one
vote per share on all matters to be voted on by shareholders and are entitled to
receive dividends, if any, as may be declared from time to time by the Board of
Directors of the Company. Upon any liquidation or dissolution of the Company,
the holders of common stock are entitled to receive a pro rata share of all of
the assets remaining available for distribution to shareholders after settlement
of all liabilities and liquidating preferences of preferred stockholders.
On August 24, 2000, the Southern Ute Indian Tribe doing business as the
Southern Ute Indian Tribe Growth Fund ("SUIT Growth Fund") exercised the option
previously acquired to purchase 1,250,000 shares of common stock for net
proceeds of $2,500,000.
On March 28, 2002, Contango repurchased 2,575,000 shares of Contango
common stock owned by the Growth Fund for $6,180,000. This share repurchase
represents a 22% reduction in Contango's outstanding common shares. The SUIT
Growth Fund originally purchased these securities in private placements during
June and August 2000. In addition, the Company cancelled a warrant held by the
SUIT Growth Fund to purchase 125,000 shares of its common stock at $2.00 per
share and options to purchase 17,500 shares of its common stock at prices
between $2.70 and $5.87 per share. In connection with these transactions, Robert
J. Zahradnik, Director of Operations of the SUIT Growth Fund and a Contango
director, tendered his resignation as a director to the Company's Board of
Directors.
Preferred Stock. The Company's Board of Directors has authorized
125,000 shares of preferred stock, of which 2,500 shares of Series A convertible
preferred stock and 5,000 shares of Series B convertible preferred stock were
issued and outstanding as of June 30, 2002.
On August 24, 2000, Contango sold in a private placement transaction
2,500 shares of its Series A senior convertible cumulative preferred stock (the
"Series A Preferred Stock") to Trust Company of the West, as an investment
manager and custodian on behalf of a client, for net proceeds of $2,500,000.
Series A Preferred Stock ranks prior to the Company's common stock (and any
other junior stock) with respect to the payment of dividends or distributions
and upon liquidation, dissolution, winding-up or otherwise and is pari passu to
the Company's Series B senior convertible cumulative preferred stock. Holders of
Series A Preferred Stock are entitled to receive quarterly dividends at a
dividend rate equal to 8% per annum if paid in cash on a current quarterly basis
or otherwise at a rate of 10% per annum if not paid on a current quarterly basis
or if paid in shares of Series A Preferred Stock, in each case, computed on the
basis of $1,000 per share. Holders of Series A Preferred Stock may, at their
discretion, elect to convert such shares to shares of the Company's common stock
at a conversion price of $2.50 per share.
F-17
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
In addition, upon the occurrence of certain events, the Company may elect to
convert all of the outstanding shares of Series A Preferred Stock at a
conversion price of $2.50 per share.
On September 27, 2000, Contango sold in a private placement transaction
5,000 shares of its Series B senior convertible cumulative preferred stock (the
"Series B Preferred Stock") to Aquila Energy Capital Corporation for net
proceeds of $5,000,000. Series B Preferred Stock ranks prior to the Company's
common stock (and any other junior stock) with respect to the payment of
dividends or distributions and upon liquidation, dissolution, winding-up or
otherwise and is pari passu to the Company's Series A Preferred Stock. Holders
of Series B Preferred Stock are entitled to receive quarterly dividends at a
dividend rate equal to 8% per annum if paid in cash on a current quarterly basis
or otherwise at a rate of 10% per annum if not paid on a current quarterly basis
or if paid in shares of Series B Preferred Stock, in each case, computed on the
basis of $1,000 per share. Holders of Series B Preferred Stock may, at their
discretion, elect to convert such shares to shares of the Company's common stock
at a conversion price of $4.40 per share. In addition, upon the occurrence of
certain events, the Company may elect to convert all of the outstanding shares
of Series B Preferred Stock at a conversion price of $4.40 per share.
13. Stock Options
In September 1999, the Company established the Contango Oil & Gas
Company 1999 Stock Incentive Plan (the "Option Plan"). Under the Option Plan,
the Company may issue up to 2,500,000 shares of common stock with an exercise
price of each option equal to or greater than the market price of the Company's
common stock on the date of grant, but in no event less than $2.00 per share.
The Company may grant key employees both incentive stock options intended to
qualify under Section 422 of the Internal Revenue Code of 1986, as amended, and
stock options that are not qualified as incentive stock options. Stock option
grants to non-employees, such as directors and consultants, can only be stock
options that are not qualified as incentive stock options. Options generally
expire after five or ten years. The vesting schedule varies, but vesting
generally occurs either (a) immediately; (b) one-third immediately and one-third
on the next two anniversary dates of the grant; or one-fifth immediately and
one-fifth on the next four anniversary dates of the grant. As of June 30, 2002,
options under the Option Plan to acquire 688,500 shares of common stock have
been granted at prices between $2.00 and $5.87 per share and were outstanding.
In addition to grants made under the Option Plan, the Company has
granted options to purchase common stock outside the Option Plan. These options
generally expire after five years. The vesting schedule varies, but vesting
generally occurs either (a) immediately, (b) one-third immediately and one-third
on the next two anniversary dates of the grant or (c) under a vesting schedule
that is tied to the payout and rate of return on specific projects for which the
option was granted. As of June 30, 2002, options to acquire 521,834 shares of
common stock have been granted at prices between $2.00 and $5.87 per share and
were outstanding.
F-18
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
A summary of the status of the plans as of June 30, 2002 and 2001, and
changes during the fiscal years then ended, is presented in the table below:
Year Ended June 30,
----------------------------------------------------
2002 2001
------------------------- -------------------------
Weighted Weighted
Shares Average Shares Average
Under Exercise Under Exercise
Options Price Options Price
------------ ----------- ------------ -----------
Outstanding, beginning of year ........................ 1,015,334 $ 2.89 507,084 $ 2.18
Granted ............................................... 255,000 $ 2.60 537,500 $ 3.51
Exercised ............................................. (37,500) $ 2.00 (29,250) $ 2.00
Cancelled ............................................. (22,500) $ 3.40 - $ -
----------- -----------
Outstanding, end of year .............................. 1,210,334 $ 2.85 1,015,334 $ 2.89
=========== ===========
Exercisable, end of year .............................. 795,334 $ 2.76 598,666 $ 2.60
=========== ===========
Available for grant, end of year ...................... 1,794,750 2,024,750
=========== ===========
Weighted average fair value of
options granted during the year (1) ................ $ 0.69 $ 1.70
=========== ===========
_____________
(1) The fair value of each option is estimated as of the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants during the years ended June 30, 2002 and 2001,
respectively: (i) risk-free interest rate of 3.98 percent and 5.77 percent;
(ii) expected lives of five years for the Option Plan and other options;
(iii) expected volatility of 20 percent and 50 percent; and (iv) expected
dividend yield of zero percent.
The following table summarizes information about options that were
outstanding at June 30, 2002:
Options Outstanding Options Exercisable
-------------------------------------------- -------------------------
Number of Weighted Number of
Shares Average Weighted Shares Weighted
Under Remaining Average Under Average
Outstanding Contractual Exercise Exercisable Exercise
Range of Exercise Price Options Life Price Options Price
-------------------------------- ------------- ------------ ----------- ------------ ----------
$2.00 ......................... 500,334 2.8 $ 2.00 429,500 $ 2.00
$2.00 - $2.99 ................. 225,000 8.6 $ 2.51 192,500 $ 2.97
$3.00 - $3.81 ................. 225,000 3.2 $ 3.18 16,667 $ 3.60
$4.00 - $4.38 ................. 235,000 3.4 $ 4.36 140,000 $ 4.36
$5.00 - $5.87 ................. 25,000 3.6 $ 5.56 16,667 $ 5.56
------------- ------------
1,210,334 4.1 $ 2.85 795,334 $ 2.76
============= ============
F-19
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
For the fiscal year ended June 30, 2001, the Company accounted for
stock-based compensation for employees under APB Opinion No. 25 and related
interpretations, under which no compensation cost has been recognized for the
Option Plan. If compensation costs for these plans had been determined in
accordance with SFAS No. 123, the Company's net income and net income per common
share for the fiscal year ended June 30, 2001 would approximate the following
pro forma amounts:
Year Ended
June 30, 2001
--------------
Income Attributable to Common Stock:
As reported .................................................. $ 7,262,454
Pro forma .................................................... $ 7,166,014
Net Income per Common Share:
Basic:
As reported ............................................... $ 0.64
Pro forma ................................................. $ 0.63
Diluted:
As reported ............................................... $ 0.54
Pro forma ................................................. $ 0.53
Effective July 1, 2001, the Company changed it method of accounting
for employee stock-based compensation to the fair value method prescribed in
SFAS No. 123, "Accounting for Stock-Based Compensation" (See Footnote 2).
All employee stock options grants are expensed over the stock options
vesting period based on the fair value at the date the options are granted. The
fair value of each option is estimated as of the date of grant using the
Black-Scholes options-pricing model. During the fiscal year ended June 30, 2002,
the Company recorded an expense of $29,796 related to the fiscal year 2002
employee stock options.
F-20
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
14. Warrants
As of June 30, 2002, the Company had issued and outstanding warrants
to purchase 1,840,185 shares of the Company's common stock. All warrants were
exercisable at June 30, 2002. The Company has reserved an equal number of shares
of common stock for issuance upon the exercise of its outstanding warrants.
Warrants issued by the Company do not confer upon the holders any voting or
other rights of a shareholder of the Company. A summary of the Company warrants
as of June 30, 2002 and 2001, and changes during the fiscal years then ended, is
presented in the table below:
Year Ended June 30,
------------------------------------------------------------
2002 2001
---------------------------- ----------------------------
Number of Number of
Shares Weighted Shares Weighted
Under Average Under Average
Outstanding Exercise Outstanding Exercise
Warrants Price Warrants Price
------------- ---------- ------------- ----------
Outstanding, beginning of year ................. 2,040,185 $ 2.13 1,415,185 $ 2.00
Granted ..................................... - - 625,000 2.42
Exercised ................................... (75,000) 2.00 - -
Cancelled ................................... (125,000) 2.00 - -
------------- ---------- ------------- ----------
Outstanding, end of year ....................... 1,840,185 $ 2.14 2,040,185 $ 2.13
============= ========== ============= ==========
The following table summarizes information about warrants that were
outstanding at June 30, 2002:
Warrants Outstanding
and Exercisable
-----------------------------
Number of Weighted
Shares Average
Under Remaining
Outstanding Contractual
Exercise Price Warrants Life
------------------------------------------------------------------------ ------------- -------------
$2.00 ................................................................ 1,715,185 2.5
$4.12 ................................................................ 125,000 3.4
--------------
1,840,185 2.60
==============
15. Related Party Transactions
On August 24, 2000, as part of the formation of Republic Exploration,
Contango granted to JEX a five-year warrant to purchase 62,500 shares of common
stock at an exercise price of $2.00 per share. Mr. Juneau is the sole manager of
Juneau Exploration and is a director of the Company.
On November 10, 2000, in consideration for the consent to extend an
option to increase Contango's ownership in Republic Exploration from 10.0% to
33.3%, Contango granted to JEX a five-year warrant to purchase 62,500 shares of
common stock at an exercise price of $2.00 per share.
F-21
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
During the fiscal year ended June 30, 2001, Contango issued 6,600
shares of common stock at an average value of $4.09 to William H. Gibbons as
partial consideration for his services as Vice President and Treasurer of the
Company.
Effective as of January 1, 2002, Contango entered into separate Asset
Purchase Agreements with JEX and other individuals to purchase certain working
and revenue interests of JEX and other individuals in its STEP properties.
Contango paid approximately $12.9 million with cash on hand and availability
under its credit facility for the acquisition.
Effective January 1, 2002, Contango completed an acquisition from the
Southern Ute Indian Tribe ("SUIT") of additional ownership interests in its STEP
properties at a cost of approximately $7.0 million, subject to purchase price
adjustments. This acquisition was funded with cash on hand and increased
availability under the Company's credit facility.
On March 28, 2002, Contango repurchased 2,575,000 shares of Contango
common stock owned by the SUIT Growth Fund for $6,180,000. This share repurchase
represents a 22% reduction in Contango's outstanding common shares. The SUIT
Growth Fund originally purchased these securities in private placements during
June and August 2000. In addition, the Company cancelled a warrant held by the
SUIT Growth Fund to purchase 125,000 shares of its common stock at $2.00 per
share and options to purchase 17,500 shares of its common stock at prices
between $2.70 and $5.87 per share. In connection with these transactions, Robert
J. Zahradnik, Director of Operations of the SUIT Growth Fund and a Contango
director, tendered his resignation as a director to the Company's Board of
Directors.
Effective April 1, 2002, Contango completed an acquisition from JEX and
other individuals of additional ownership interests in its STEP properties at a
cost of approximately $3.4 million. This acquisition was funded with
availability under the Company's credit facility.
During the fiscal year ended June 30, 2002, Contango issued 3,900
shares of common stock at an average value of $2.88 to two employees and a
consultant as partial consideration for services provided to the Company.
16. Non-Cash Investing and Financing Activities
A summary of non-cash investing and financing activities is presented
below.
For the year ended June 30, 2001, the Company issued options, warrants
and shares to certain individuals and companies as a result of (i) services
provided to the Company, (ii) sales of common and preferred stock and (iii)
exploration activities and, in connection with such issuances, recognized
non-cash costs of approximately $1.3 million.
For the year ended June 30, 2002, the Company issued options and shares
to certain individuals and companies as a result of services provided to the
Company and, in connection with such issuances, recognized non-cash costs of
approximately $12,000.
F-22
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
17. Investment in LNG
On June 5, 2002, the Company purchased options to buy up to a 20%
equity interest in a proposed LNG receiving terminal to be located in Freeport,
Texas. The purchase price for an initial 10% interest in the project was $1.5
million, consisting of a $750,000 payment made at signing and the balance
payable upon exercise of the option. In the event Contango elects not to
exercise the initial 10% option, the $750,000 up-front payment will be repaid to
Contango with interest on or prior to July 15, 2003. The repayment obligation is
evidenced by a promissory note secured by all of the option writer's accounts,
revenues and accounts receivable.
18. Subsequent Events
Effective July 1, 2002, Contango completed the acquisition from JEX and
other individuals of additional ownership interests in its STEP properties at a
cost of approximately $2.6 million. This acquisition was funded with
availability under the Company's credit facility.
F-23
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
SUPPLEMENTAL OIL AND GAS DISCLOSURES (Unaudited)
The following disclosures provide unaudited information required by
SFAS No. 69, "Disclosures About Oil and Gas Producing Activities".
Costs Incurred. The following table sets forth the costs incurred in
natural gas and oil property acquisition, exploration and development activities
for the fiscal years ended June 30, 2002 and 2001:
Year Ended June 30,
---------------------------
2002 2001
------------ ------------
Property acquisition costs:
Unproved ......................................... $ 1,063,204 $ 1,901,405
Proved ........................................... 23,449,488 -
Exploration costs ................................ 7,138,690 20,867,565
------------ ------------
Total costs incurred ............................. $ 31,651,382 $ 22,768,970
============ ============
Natural Gas and Oil Reserves. Proved reserves are estimated quantities
of natural gas and oil that geological and engineering data demonstrate with
reasonable certainty to be recoverable in future years from known reservoirs
under existing economic and operating conditions. Proved developed reserves are
proved reserves that reasonably can be expected to be recovered through existing
wells with existing equipment and operating methods.
Proved natural gas and oil reserve quantities at June 30, 2002, and
the related discounted future net cash flows before income taxes are based on
estimates prepared by W.D. Von Gonten & Co., petroleum engineering. Proved
natural gas and oil reserve quantities at June 30, 2001, and the related
discounted future net cash flows before income taxes are based on estimates
prepared by William M. Cobb & Associates, Inc., independent petroleum engineers.
Such estimates have been prepared in accordance with guidelines established by
the Securities and Exchange Commission.
The Company's net ownership interests in estimated quantities of
proved natural gas and oil reserves and changes in net proved reserves as of
June 30, 2002 and 2001, all of which are located in the continental United
States, are summarized below:
As of June 30, 2002 As of June 30, 2001
--------------------------- --------------------------
Oil and Natural Oil and Natural
Condensate Gas Condensate Gas
-------------- --------- -------------- ---------
(MBbls) (MMcf) (MBbls) (MMcf)
Proved developed and undeveloped reserves:
Beginning of year ......................................... 335 16,134 137 2,686
Purchases of natural gas and oil properties ............... 275 11,410 - -
Sale of reserves .......................................... (9) (11) - -
Discoveries ............................................... 138 5,661 280 17,146
Recoveries and revisions .................................. 37 (1,812) 40 (128)
Production ................................................ (186) (6,983) (122) (3,570)
-------------- --------- -------------- ---------
End of year ............................................... 590 24,399 335 16,134
============== ========= ============== ==========
Proved developed reserves at end of year ..................... 590 24,399 300 14,013
============== ========= ============== ==========
F-24
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
SUPPLEMENTAL OIL AND GAS DISCLOSURES (Unaudited)
Standardized Measure. The standardized measure of discounted future net
cash flows relating to the Company's ownership interests in proved natural gas
and oil reserves as of June 30, 2002 and 2001 are shown below:
As of June 30,
----------------------------------
2002 2001
--------------- ---------------
Future cash flows ........................................................... $ 99,854,148 $ 73,861,851
Future operating expenses ................................................... (27,032,959) (19,352,469)
Futrure development costs ................................................... (119,572) (541,577)
Future income tax expenses .................................................. (17,506,926) (12,516,200)
-------------- --------------
Future net cash flows .................................................... 55,194,691 41,451,605
10% annual discount for estimated timing of cash flows ................ (14,390,805) (8,305,000)
-------------- --------------
Standardized measure of discounted future net cash flows ................. $ 40,803,886 $ 33,146,605
============== ==============
Future cash flows are computed by applying fiscal year-end prices of
natural gas and oil to year-end quantities of proved natural gas and oil
reserves. Future operating expenses and development costs are computed primarily
by the Company's petroleum engineers by estimating the expenditures to be
incurred in developing and producing the Company's proved natural gas and oil
reserves at the end of the year, based on year end costs and assuming
continuation of existing economic conditions.
Future income taxes are based on year-end statutory rates, adjusted for tax
basis and applicable tax credits. A discount factor of 10 percent was used to
reflect the timing of future net cash flows. The standardized measure of
discounted future net cash flows is not intended to represent the replacement
cost or fair value of the Company's natural gas and oil properties. An estimate
of fair value would also take into account, among other things, the recovery of
reserves not presently classified as proved, anticipated future changes in
prices and costs, and a discount factor more representative of the time value of
money and the risks inherent in reserve estimates of natural gas and oil
producing operations.
F-25
CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES
SUPPLEMENTAL OIL AND GAS DISCLOSURES (Unaudited)
Change in Standardized Measure. Changes in the standardized measure of
future net cash flows relating to proved natural gas and oil reserves are
summarized below:
Year Ended June 30,
-------------------------------
2002 2001
--------------- ---------------
Changes due to current year operation:
Sales of natural gas and oil, net of
natural gas and oil operating expenses ................................ $ (19,997,454) $ (21,916,818)
Extensions and discoveries ............................................... 14,197,323 53,366,000
Net change in prices and production costs ................................ (6,906,532) (2,794,442)
Change in future development costs ....................................... 309,046 327,231
Revisions of quantity estimates .......................................... (3,228,270) 1,181,000
Sale of reserves ......................................................... (146,669) -
Accretion of discount .................................................... 4,262,580 1,226,000
Change in the timing of production rates and other ....................... (3,510,030) (1,024,000)
Purchases of natural gas and oil properties .............................. 25,743,424 -
Changes in income taxes .................................................. (3,066,137) (7,445,000)
-------------- --------------
Net change .................................................................. 7,657,281 22,919,971
Beginning of year ........................................................... 33,146,605 10,226,634
-------------- --------------
End of year ................................................................. $ 40,803,886 $ 33,146,605
============== ==============
F-26