Form 10QSB for TERAX ENERGY, INC.
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15-May-2007
Quarterly Report
ITEM 2. PLAN OF OPERATIONS
Forward-Looking Statements
This report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact are "forward-looking statements" for purposes of federal and state securities laws, including, but not limited to, any projections of earnings, revenue or other financial items; any statements of the plans, strategies and objections of management for future operations; any statements concerning proposed new services or developments; any statements regarding future economic conditions or performance; any statements or belief; and any statements of assumptions underlying any of the foregoing.
Forward-looking statements may include the words "may", "could", "estimate", "intend", "continue", "believe", "expect" or "anticipate" or other similar words. These forward-looking statements present our
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estimates and assumptions only as of the date of this report. Except for our ongoing securities laws, we do not intend, and undertake no obligation, to update any forward-looking statement.
Although we believe that the expectations reflected in any of our forward-looking statements are reasonable, actual results could differ materially from those projected or assumed in any of our forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to change and inherent risks and uncertainties. The factors impacting these risks and uncertainties include, but are not limited to:
o increased competitive pressures from existing competitors and new entrants;
o increases in interest rates or our cost of borrowing or a default under any material debt agreements;
o deterioration in general or regional economic conditions;
o adverse state or federal legislation or regulation that increases the costs of compliance, or adverse findings by a regulator with respect to existing operations;
o loss of customers or sales weakness;
o inability to achieve future sales levels or other operating results;
o fluctuations of oil and gas prices;
o the unavailability of funds for capital expenditures; and
o operational inefficiencies in distribution or other systems.
For a detailed description of these and other factors that could cause actual results to differ materially from those expressed in any forward-looking statement, please see "Factors That May Affect Our Results of Operation" in this document and in our Report on Form 10-KSB for the period ended June 30, 2006.
Overview
We are an oil and gas exploration, development and production company. Our properties are located in the Fort Worth Basin. Our corporate strategy is to continue building value in Terax through the development and acquisition of gas and oil assets that exhibit consistent, predictable, and long-lived production. Our current focus is exploring the gas reserves located in the Barnett Shale formations of the Fort Worth Basin.
We have consolidated mineral lease positions in both Erath and Comanche counties. Our current focus is on the development and production of our Erath County properties. We have begun the evaluation process of our Comanche County properties but any further evaluation will require Terax to resolve its financial situation.
We may seek acquisition opportunities which compliment our current focus. We intend to fund our development activity primarily through proceeds from various private placements sufficient enough to evaluate our mineral leases.
Our revenue, profitability, and future growth rate depend substantially on factors beyond our control, such as economic, political, and regulatory developments and competition from other sources of energy. Oil and natural gas prices historically have been volatile and may fluctuate widely in the future. Sustained periods of low prices for oil or natural gas could materially and adversely affect our financial position, our results of operations, the quantities of oil and natural gas reserves that we can economically produce and our access to capital.
Results of Operations
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Third Quarter of 2007 Compared to Third Quarter of 2006
The following overview provides a summary of key information concerning our
financial results for the third quarter of our fiscal year ending June 30, 2007.
Three Months Three Months Increase
March 31, 2007 March 31, 2006 (Decrease)
Revenue $ - $ - $ -
Expenses:
Depletion and depreciation 151,131 7,475 143,656
Impairment of properties - - -
General and administrative 244,437 832,228 (587,791 )
Total expenses 395,568 839,703 (444,135 )
(Loss) from operations (395,568 ) (839,703 ) 444,134
Other income (expense):
Dividend income - 43,902 (43,902 )
Interest expenses (99,645 ) (460,702 ) 361,057
Other - (243 ) 243
Gain (loss) on derivative 37,522 (18,535,627 ) 18,573,149
liability
Net Income( loss) $ (457,691 ) (19,792,373 ) 19,334,682
Revenue
Terax had no revenue for the third quarter of fiscal 2007 and 2006. Production on Terax's properties did not begin until the fourth quarter of 2006. In August and September 2006 Terax shut in all of its production due to its financial situation.
Expenses
Operations on Terax's oil and gas properties did not begin until the fourth quarter of 2006 and all production was shut in during August and September 2006. Terax did not incur any lease operating, depletion and depreciation, or impairment expenses on oil and gas properties for the third quarter of 2006 and no lease operating expenses or impairment expenses on oil and gas properties were incurred in third quarter of 2007.
General and administrative expenses for the third quarter of 2007 as compared to the third quarter of 2006 were $244,437 and $832,228, respectively, for a decrease of $587,791. The decrease in general and administrative expenses was primarily due to a reduction in professional fees in the third quarter of 2007 of $387,324 compared to 2006.
Other Income (Expense)
Dividend income for the third quarter of 2007 and 2006 was $nil and $43,902, respectively, for a decrease of $43,902 which was the result of a decrease in funds available in an interest bearing account.
Interest expense for the third quarter of 2007 and 2006 was $99,645 and $460,702, respectively, for a decrease of $361,057. During the third quarter of 2007and 2006 the outstanding debt was $2,500,000 and $5,000,000, respectively, but the debt in the third quarter of 2006 was outstanding for only part of the
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quarter. The rate of interest for the debts in the third quarter of 2007 and 2006 was approximately the same but the debt holder in 2006 was issued stock with a value of $375,000 in addition to the interest earned.
The gain on derivative liability in the third quarter of 2007 was $37,522 compared to a loss of $18,535,627 in the third quarter of 2006 for decrease of $18,573,149.
Net Income (Loss)
Our net loss for the third quarter of 2007 was $457,691 compared to a net loss of $19,792,373 for the third quarter of 2006, for an decrease in net loss of $19,334,682. Of this decrease in net loss, $18,573,149 was attributable to non-cash gain associated with derivative liability offset by $143,656 increase in non-cash cost associated with depletion and depreciation expenses.
First Nine Months of 2007 Compared to First Nine Months of 2006
The following overview provides a summary of key information concerning our
financial results for the first nine months of our fiscal year ending June 30,
2007.
Nine Months Nine Months Increase
March 31, 2007 March 31, 2006 (Decrease)
Revenue $ 189,139 $ - $ 189,139
Expenses:
Depletion and depreciation 513,963 10,864 503,099
Impairment of properties 998,911 - 998,911
General and administrative 1,573,933 2,472,748 (898,815 )
Total expenses 3,086,807 2,483,612 603,195
(Loss) from operations (2,897,668 ) (2,483,612 ) (414,056 )
Other income (expense):
Dividend income 3,262 74,841 (71,579 )
Interest expenses (257,179 ) (493,251 ) 236,072
Other - (25,878 ) 25,878
Gain (Loss) on derivative 16,411,419 (18,535,627 ) 34,947,046
liability
Net Income ( loss) $ 13,259,834 (21,463,527 ) $ 34,723,361
Revenue
Total revenue for the first nine months of 2007 and 2006 was $189,139 and $0, respectively. Production on the Company's properties did not begin until the fourth quarter of 2006. In August and September 2006 Terax shut in all of its production due to its financial situation.
Expenses
Operations on the Company's oil and gas properties did not begin until the fourth quarter of 2006. Therefore the Company did not incur any lease operating, depletion and deprecation, and impairment expenses for the first nine months of 2006.
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General and administrative expenses for the first nine months of 2007 as compared to the first nine months of 2006 were $1,573,933 and $2,472,748, respectively, for a decrease of $898,815. The decrease in general and administrative expenses is due primarily to severance payment to a former officer in the first nine months of 2006.
Other Income (Expense)
Dividend income for the first nine months of 2007 and 2006 was $3,262 and $74,841, respectively, for a decrease of $71,579 which was the result of a decrease in funds available in an interest bearing account.
Interest expense for the first nine months of 2007 and 2006 was $257,179 and $493,251, respectively, for a decrease of $236,072. During the first nine months of 2007 and 2006 the outstanding debt was $2,500,000 and $5,000,000, respectively, but the debt was outstanding for only part of the quarter in 2006. The rate of interest for the debt in the first nine months of 2007 was the same as the interest rate on the debt in the first nine months of 2006. The rate of interest for the debts in the third quarter of 2007 and 2006 was approximately the same but the debt holder in 2006 was issued stock with a value of $375,000 in addition to the interest earned.
The gain on derivative liability in the first nine months of 2007 was $16,411,419 compared to a loss of $18,535,627 for an increase of $34,947,046.
Net Income (Loss)
Our net income for the first nine months of 2007 was $13,259,834 compared to a net loss of $21,463,527 for the first nine months of 2006, for an increase in the income of $34,723,361. Of this increase, $34,947,046 was attributable to non-cash income associated with derivative liability offset by $503,099 non-cash cost associated with depletion and depreciation expenses.
Liquidity and Capital Resources
As of March 31, 2007 we had a net working capital deficit of $9,709,208 compared to a net working capital deficit of $23,200,422 at year end June 30, 2006. If the non-cash derivative liability is not considered, the working capital deficit would be $9,661,909 at March 31, 2007 and $6,741,703 at June 30, 2006. The $13,491,214 increase in our working capital position was primarily attributable to the decrease in derivative liability of $16,411,419, offset by a decrease in prepaid expense and advances to operators of $556,093, an increase in accounts payable of $920,653 and an increase in accrued liabilities of $574,235.
Net cash flow used in operations was $405,205 for the nine months ended March 31, 2007. The primary use of cash in operating activities was to fund our net loss. Net cash used in investing activities for the nine months was $464,020 and primarily consisted of an increase in purchases of oil and gas leases of $252,451, an increase in investment in drilling and equipment, and an investment in pipeline and gathering system of $160,265, compared to $19,110,551 in purchases of oil and gas leases, drilling and equipment; and pipeline and gathering for the nine months ended March 31, 2006.
There was $100,000 in net cash provided by financing activities during the nine months ended March 31, 2007, compared to $22,249,880 provided from the sale of stock for the nine months ended March 31, 2006. The cash provided in the nine months ended March 31, 2006 was from both equity and debt financings. From August 8, 2005 through September 14, 2005, Terax issued 739,000 Units at a price of $10.00 per Unit for gross proceeds to Terax of $7,390,000. Each Unit consisted of eight shares of our common stock (each a "Unit Share") and four non-transferable share purchase warrants (each a "Unit Warrant"). Each Unit Warrant is exercisable into one share of our common stock (each a "Warrant Share") at an exercise price of $1.75 per share. During the nine months ended March 31, 2006, Terax borrowed $325,000 bearing interest at 6% per annum and $7,500,000 bearing interest at 12.5% per annum. The notes had interest of $493,251 during the first nine months of 2006. In May 2006, Terax borrowed $2,500,000 which was still outstanding at March 31, 2007. The interest rate on the $2,500,000
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is 12.5% per annum and the note had accrued interest of $297,021 at March 31, 2007. On January 19, 2007, Terax received notice of default from the lender and a demand for payment.
Our liquidity has continued to be adversely affected during the nine months ended March 31, 2007, due to Terax not being able to secure additional financing to fund its operations. Since March 31, 2007, Terax has continued to seek financing for its operations but has been unsuccessful.
Terax has numerous litigation related matters which also raise significant doubt about Terax's ability to continue as a going concern.
Satisfaction of our cash obligations for the next 12 months
Our current capital resources, together with our expected cash flow from operations, are not sufficient to continue and maintain our operations (including resolution of amounts relating to pending litigation discussed elsewhere in this document) over the course of the next twelve months. If Terax does not secure additional financing in the near term it will be forced to seek other alternatives including the sale of assets to repay its current creditors. This includes resources for the payment of our anticipated overhead expenses and current liabilities. If Terax is successful in securing sufficient capital to repay its creditors, it will need additional capital to continue its operations and evaluate its properties. We would, therefore, continue to seek to raise capital over the next 12 months as we attempt to finance the development of our existing projects and in order to fund our future growth and exploration activities. This may take the form of either debt-based financing, or sale of equity securities. If we are unable to obtain additional funds when we need them or if we cannot obtain funds on terms favorable to us, we may need to delay, scale back, or eliminate plans for further development efforts.
Our oil and gas properties have been shut-in until Terax can resolve its current working capital deficit. We have no significant history of earnings or cash flow from our operations. A critical component of our operating plan impacting our continued existence is to efficiently manage the costs associated with exploratory drilling efforts, our ability to obtain additional capital through additional equity and/or debt financing, and joint venture or working interest partnerships will also be important to our expansion plans. In the event we experience any significant problems assimilating acquired assets into our operations or cannot obtain the necessary capital to pursue our strategic plan, we may have to significantly curtail our operations. This would materially impact our ability to continue operations.
We will need additional capital to proceed with the current phase of our operations and the continued field development of our Erath County properties.
Over the next twelve months, our existing capital combined with cash flow from operations will not be sufficient to sustain operations and our planned expansion.
We believe we will continue to incur operating losses over the next twelve months. Our lack of operating history makes predictions of future operating results difficult to ascertain. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of development and production, particularly companies in the oil and gas industry. Such risks include, but are not limited to, an evolving and unpredictable business model and the management of growth. To address these risks we must, among other things, implement and successfully execute our business and marketing strategy, continue to develop and upgrade technology and products, respond to competitive developments, and attract, retain and motivate qualified personnel. There can be no assurance that we will be successful in addressing such risks, and the failure to do so can have a material adverse effect on our business prospects, financial condition, and results of operations.
All of the leases purchased by Terax are paid up oil and gas leases which do not require future payments. If we begin production of oil or natural gas on a lease before the end of the primary lease term, we may retain that lease without additional cost. If production is established, we are required to pay the leaseholder a portion of the oil or gas production as "royalty payments" which range from 16.66% to
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21.5% . If production is not established during the primary term of the lease, in most cases, we have the right but not the obligation to extend the lease for an additional 2 years in Erath and an additional 3 years in Comanche by making an additional lump sum payment to the leaseholder, as provided for in each lease. If oil and gas production is not established within the additional two years period, the lease is returned to the leaseholder and we have no additional rights to the lease.
As of March 31, 2007, we had assets of $16,054,228, and $9,747,970 in liabilities, resulting in a stockholders' equity of $6,306,258.
Significant changes in the number of employees
During the nine month period ended March 31, 2007, there were reductions in the number of employees and full-time consultants. The number of employees has been reduced from 4 to 2 and the numbers of full-time consultants were reduced from 6 to none.
Our desired personnel structure could be divided into three broad categories:
management and professional, administrative, and project field personnel. As in most small companies, the divisions between these three categories are somewhat indistinct, as employees are engaged in various functions as projects and work loads demand.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results or operations, liquidity, capital expenditures or capital resources that is material to investors.
Critical Accounting Policies and Estimates
Our discussion of financial condition and results of operations is based upon the information reported in our financial statements. The preparation of these statements requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses as well as the disclosure of contingent assets and liabilities at the date of our financial statements. We base our assumptions and estimates on historical experience and other sources that we believe to be reasonable at the time. Actual results may vary from our estimates due to changes in circumstances, weather, politics, global economics, mechanical problems, general business conditions, and other factors. Our significant accounting policies are detailed in Note 1 to our financial statements included in our Annual Report. We have outlined below certain of these policies as being of particular importance to the portrayal of our financial position and results of operations and which require the application of significant judgment by our management.
Revenue Recognition
It is our policy to recognize revenue when production is sold to a purchaser at a fixed or determinable price.
Successful Efforts Method of Accounting
We account for our oil and natural gas operations using the successful efforts method of accounting. Under this method, all costs associated with property acquisition, exploration, and development of oil and gas reserves are capitalized. Costs capitalized include acquisition costs, geological and geophysical expenditures, lease rentals on undeveloped properties and cost of drilling and equipping productive wells. In the event we do not find proved reserves, geological and geophysical costs, and costs of carrying and retaining unproved properties are expensed. All of our properties are located within the continental United States.
Oil and Natural Gas Reserve Quantities |
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