UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
(Mark one)
[X] Quarterly Report Under Section 13 or 15(d) of The Securities Exchange
Act of 1934
For the quarterly period ending September 30, 2006
[_] Transition Report Under Section 13 or 15(d) of The Securities Exchange
Act of 1934
For the transition period from ______________ to _____________
Commission File Number: 0-29613
-------
TIDELANDS OIL & GAS CORPORATION
(Exact name of small business issuer as specified in its charter)
Nevada 66-0549380
------------------------ ------------------------
(State of incorporation) (IRS Employer ID Number)
1862 West Bitters Rd., San Antonio, TX 78248
--------------------------------------------
(Address of principal executive offices)
(210) 764-8642
--------------
(Issuer's telephone number)
Securities registered under Section 12 (b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock - $0.001 par value
Check whether the issuer has (1) filed all reports required to be files by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period the Company was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definitions of "accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer , Accelerated filer , Non-accelerated filer X
--- --- ---
Indicate by check mark whether the registrant is a shell company (as defined by
Rule 12b-2of the Exchange Act. Yes No X
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS
As of September 30, 2006, there were 84,537,270 shares of Common Stock issued
and outstanding.
Transitional Small Business Disclosure Format: Yes No X
--- ---
TIDELANDS OIL & GAS CORPORATION
FORM 10-Q
INDEX
Page
PART I - Financial Information
Item 1 - Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 2006 and December 31, 2005......................... 3
Condensed Consolidated Statements of Operations
For the Three Months Ended September 30, 2006 and 2005........... 4
Condensed Consolidated Statements of Operations
For the Nine Months Ended September 30, 2006 and 2005............ 5
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2006 and 2005............ 6-7
Notes to Condensed Consolidated Financial Statements............. 8-14
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................
Item 3 - Quantitative and Qualitative Disclosures About Market Risk.......
Item 4 - Controls and Procedures..........................................
PART II - Other Information
Item 1 - Legal Proceedings ...............................................
Item 1A. Risk Factors.....................................................
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds......
Item 3 - Defaults Upon Senior Securities..................................
Item 4 - Submission of Matters to a Vote of Security Holdings.............
Item 5 - Other Information................................................
Item 6 - Exhibits ........................................................
Signature.................................................................
-2-
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
TIDELANDS OIL & GAS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
September 30, December 31,
2006 2005
------------- -------------
(Unaudited)
Current Assets:
Cash and Cash Equivalents $ 887,194 $ 1,113,911
Accounts and Loans Receivable 290,968 468,458
Inventory 74,589 142,204
Prepaid Expenses 312,918 183,938
------------- -------------
Total Current Assets 1,565,669 1,908,511
------------- -------------
Property Plant and Equipment, Net 12,226,640 10,042,088
------------- -------------
Due from Related Party 283,854 288,506
------------- -------------
Other Assets:
Deposits 64,004 14,004
Restricted Cash 52,159 76,803
Deferred Charges 880,256 0
Goodwill 1,158,937 1,158,937
------------- -------------
Total Other Assets 2,155,356 1,249,744
------------- -------------
Total Assets $ 16,231,519 $ 13,488,849
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current Maturities - Notes Payable $ 225,000 $ 225,000
Accounts Payable and Accrued Expenses 1,000,176 1,225,554
------------- -------------
Total Current Liabilities 1,225,176 1,450,554
Long-Term Debt 10,014,752 4,271,768
------------- -------------
Total Liabilities 11,239,928 5,722,322
------------- -------------
Commitments and Contingencies -- --
Stockholders' Equity:
Common Stock, $.001 Par Value per Share,
250,000,000 Shares Authorized, 84,537,270
and 78,495,815 Shares Issued and
Outstanding at September 30, 2006
and December 31, 2005 Respectively 84,538 78,497
Paid-in Capital in Excess of Par Value 45,250,456 40,818,174
Subscriptions Receivable (330,000) (550,000)
Minority Interest -- --
Accumulated (Deficit) (40,013,403) (32,580,144)
------------- -------------
Total Stockholders' Equity 4,991,591 7,766,527
------------- -------------
Total Liabilities and Stockholders' Equity $ 16,231,519 $ 13,488,849
============= =============
See Accompanying Notes to Condensed Consolidated Financial Statements
-3-
TIDELANDS OIL & GAS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Three Months Ended
September 30, 2006 September 30, 2005
------------------ -----------------
(Restated)
Revenues:
Gas Sales and Pipeline Fees $ 355,937 $ 248,015
Construction Services 13,289 0
------------------ -----------------
Total Revenues 369,226 248,015
------------------ -----------------
Expenses:
Cost of Sales 176,675 219,865
Operating Expenses 102,010 81,408
Depreciation 114,085 124,422
Interest 2,572,249 110,090
Beneficial Conversion Feature Interest 0 (637,448)
Sales, General and Administrative 1,229,528 1,901,401
------------------ -----------------
Total Expenses 4,194,547 1,799,738
------------------ -----------------
(Loss) From Operations (3,825,321) (1,551,723)
Derivative Gain (Loss) 0 0
(Loss) on Sale of Investments (743) 0
(Loss) on Sale of Equipment (4,500) 0
Interest and Dividend Income 53,500 26,589
Litigation Settlement 0 297,825
------------------ -----------------
Net Income (Loss) $ (3,777,064) $ (1,227,309)
================== =================
Net Income (Loss) Per Common Share:
Basic and Diluted $ (0.05) $ (0.02)
================== =================
Weighted Average Number of Common
Shares Outstanding 82,551,543 75,712,742
================== =================
See Accompanying Notes to Condensed Consolidated Financial Statements
-4-
TIDELANDS OIL & GAS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Nine Months Ended Nine Months Ended
September 30, 2006 September 30, 2005
------------------ ------------------
(Restated)
Revenues:
Gas Sales and Pipeline Fees $ 1,420,551 $ 1,097,505
Construction Services 157,693 119,121
------------------ ------------------
Total Revenues 1,578,244 1,216,626
------------------ ------------------
Expenses:
Cost of Sales 759,954 635,113
Operating Expenses 286,128 210,545
Depreciation 345,887 360,817
Interest 3,057,258 503,950
Beneficial Conversion Feature Interest 0 (501,659)
Sales, General and Administrative 4,672,273 6,578,471
Impairment Losses 0 5,200,000
------------------ ------------------
Total Expenses 9,121,500 12,987,237
------------------ ------------------
(Loss) From Operations (7,543,256) (11,770,611)
Derivative Gain (Loss) 0 5,168,000
(Loss) on Sale of Investments (743) 0
(Loss) on Sale of Equipment (4,500) (3,167)
Interest and Dividend Income 115,239 96,240
Litigation Settlement 0 297,825
------------------ ------------------
Net (Loss) $ (7,433,260) $ (6,211,713)
================== ==================
Net (Loss) Per Common Share:
Basic and Diluted $ (0.09) $ (0.09)
================== ==================
Weighted Average Number of Common
Shares Outstanding 81,516,543 69,378,850
================== ==================
See Accompanying Notes to Condensed Consolidated Financial Statements
-5-
TIDELANDS OIL & GAS CORPORATION
STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS
(UNAUDITED)
Nine Months Ended Nine Months Ended
September 30, 2006 September 30, 2005
------------------ ------------------
(Restated)
Cash Flows Provided (Required) By
Operating Activities:
Net (Loss) $ (7,433,260) $ (6,211,713)
Adjustments to Reconcile Net (Loss)
to Net Cash Provided (Required) By
Operating Activities:
Depreciation 314,666 360,817
Loss on Disposal of Equipment 4,500 3,167
Change in Derivative Liability 0 (5,168,000)
Issuance of Common Stock:
For Services Provided 1,910,800 3,682,950
For Payment of Interest 1,696,982 0
Beneficial Conversion Feature Interest 0 (501,659)
Changes in:
Accounts Receivable 177,490 307,719
Inventory 67,615 (7,809)
Prepaid Expenses (128,980) 278,609
Deferred Charges (880,256) 116,250
Deposits (50,000) (2,600)
Restricted Cash 24,644 (101,471)
Accounts Payable and
Accrued Expenses 219,622 68,233
Impairment Losses 0 5,200,000
------------------ ------------------
Net Cash (Required) By Operating Activities (4,076,177) (1,975,507)
------------------ ------------------
Cash Flows Provided (Required)
By Investing Activities:
Acquisitions of Property, Plant
and Equipment (2,525,218) (1,376,250)
Disposals of Equipment 21,500 800
------------------ ------------------
Net Cash (Required) By Investing Activities (2,503,718) (1,375,450)
------------------ ------------------
See Accompanying Notes to Condensed Consolidated Financial Statements
-6-
TIDELANDS OIL & GAS CORPORATION
STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS
(CONTINUED)
(UNAUDITED)
Nine Months Ended Nine Months Ended
September 30, 2006 September 30, 2005
------------------ ------------------
(Restated)
Cash Flows Provided (Required)
by Financing Activities:
Proceeds from Stock Subscriptions
Receivable 220,000 0
Proceeds from Long-Term Loans 6,737,276 201,671
Repayment of Long-Term Loans (608,750) 0
Repayment of Loan by Related Party 4,652 1,662
------------------ ------------------
Net Cash Provided by Financing Activities 6,353,178 203,333
------------------ ------------------
Net (Decrease) in Cash (226,717) (3,147,624)
Cash at Beginning of Period 1,113,911 5,484,054
------------------ ------------------
Cash at End of Period $ 887,194 $ 2,336,430
================== ==================
Supplemental Disclosures of
Cash Flow Information:
Cash Payments for Interest $ 1,153,116 $ 266,938
================== ==================
Cash Payments for Income Taxes $ 0 $ 0
================== ==================
Non-Cash Investing and Financing Activities:
Issuance of Common Stock:
Repayment of Note $ 0 $ 2,512,500
Repayment of Convertible Debentures 385,542 4,020,000
Payment of Accrued Expense 445,000 0
------------------ ------------------
Total Non-Cash Investing and
Financing Activities $ 830,542 $ 6,532,500
================== ==================
See Accompanying Notes to Condensed Consolidated Financial Statements
-7-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 1 - BASIS OF PRESENTATION
------ ---------------------
The accompanying unaudited condensed consolidated financial statements
for the nine month periods ended September 30, 2006, and 2005, have
been prepared in conformity with accounting principles generally
accepted in the United States of America for interim financial
information and with the instructions to Form 10-Q and Regulation S-X.
The financial information as of December 31, 2005, is derived from the
registrant's Form 10-K for the year ended December 31, 2005. Certain
information or footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed or omitted
pursuant to the rules and regulations of the Securities and Exchange
Commission.
The preparation of condensed consolidated financial statements in
conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates. In the opinion of management, the accompanying
financial statements include all adjustments necessary (which are of a
normal and recurring nature) for the fair presentation of the results
of the interim periods presented. While the registrant believes that
the disclosures presented are adequate to keep the information from
being misleading, it is suggested that these accompanying financial
statements be read in conjunction with the registrant's audited
consolidated financial statements and notes for the year ended December
31, 2005, included in the registrant's Form 10-K for the year ended
December 31, 2005.
Operating results for the nine-month period ended September 30, 2006,
are not necessarily indicative of the results that may be expected for
the remainder of the fiscal year ending December 31, 2006. The
accompanying unaudited condensed consolidated financial statements
include the accounts of the registrant, its wholly-owned subsidiaries,
Rio Bravo Energy, LLC, Sonora Pipeline, LLC, Arrecefe Management, LLC,
Marea Associates, LP, Reef Ventures, LP, Reef International, LLC, Reef
Marketing, LLC, Terranova Energia S. de R. L. de C. V., Esperanza
Energy, LLC, and Tidelands Exploration & Production Corporation. All
significant inter-company accounts and transactions have been
eliminated in consolidation.
-8-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 2 - GOING CONCERN
------ -------------
The Company has sustained recurring losses and negative cash flows from
operations. Over the past year, the Company's growth has been funded
through issuance of convertible debentures. As of September 30, 2006,
the Company had approximately $900,000 of unrestricted cash. However,
the Company has experienced and continues to experience negative
operating margins and negative cash flows from operations, as well as
an ongoing requirement for substantial additional capital investment.
The Company expects that it will need to raise substantial additional
capital to accomplish its business plan over the next several years.
The Company is seeking to obtain such additional funding through
private equity sources, possible sale of certain operating assets along
with reduction of operating expenses. There can be no assurance as to
the availability or terms upon which such financing and capital might
be available or that asset sales will be possible at suitable pricing.
NOTE 3 - LITIGATION
------ ----------
On January 6, 2003, we were served as a third party defendant in a
lawsuit titled Northern Natural Gas Company vs. Betty Lou Sheerin vs.
Tidelands Oil & Gas Corporation, ZG Gathering, Ltd. and Ken Lay, in the
150th Judicial District Court, Bexar County, Texas, Cause Number
2002-C1-16421. The lawsuit was initiated by Northern Natural Gas
(Northern) when it sued Betty Lou Sheerin (Sheerin) for her failure to
make payments on a note she executed payable to Northern in the
original principal amount of $1,950,000. Sheerin's answer generally
denied Northern's claims and raised the affirmative defenses of
fraudulent inducement by Northern, estoppel, waiver and the further
claim that the note does not comport with the legal requirements of a
negotiable instrument. Sheerin seeks a judicial ruling that Northern be
denied any recovery on the note. Sheerin's answer included a
counterclaim against Northern, ZG Gathering, Ltd., and Ken Lay
generally alleging, among other things, that Northern, ZG Gathering,
Ltd ., and Ken Lay, fraudulently induced her execution of the note.
Northern has filed a general denial of Sheerin's counterclaims.
Sheerin's answer included a third party cross claim against Tidelands
Oil and Gas Corporation (Tidelands). She alleges that Tidelands entered
into an agreement to purchase the Zavala Gathering System from ZG
Gathering, Ltd., and that, as a part of the agreement, Tidelands agreed
to satisfy all of the obligations due and owing to Northern, thereby
relieving Sheerin of all obligations she had to Northern on the
$1,950,000 promissory note in question. Tidelands participated in
mediation on March 11, 2003. The case was not settled at that time.
Tidelands' answer denies all of Sheerin's allegations.
Betty Lou Sheerin filed amended pleadings, wherein she sued current and
former Tidelands' Board members, Michael Ward, Royis Ward, James B.
Smith, Carl Hessel and Ahmed Karim in their individual capacities. Her
claims against these individuals are for fraud, breach of contract,
breach of the Uniform Commercial Code, breach of duty of good faith and
fair dealing and conversion. Sheerin has now non-suited her claims
against Michael Ward, Royis Ward and James B. Smith.
In September 2002, the Company executed a $300,000 promissory note to
Betty L. Sheerin, a partner of ZG Gathering, Ltd. In addition, the
Company issued 1,000,000 shares of its common stock to various partners
of ZG Gathering, Ltd. On December 3, 2003, Sheerin filed a separate
lawsuit against Tidelands in Bexar County, Texas on this note seeking a
judgment against Tidelands for the principle amount of the note, plus
interest. Tidelands answered this lawsuit denying liability on the
note. The Company believes that the promissory note and shares of
common stock should be cancelled based upon the outcome of the
litigation described above. Accordingly, our financial statements
reflect this belief.
-9-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 3 - LITIGATION (CONTINUED)
------ ----------------------
In September, and again in October 2004, Sheerin amended her pleadings
regarding the third party cross action against Tidelands adding a claim
for the $300,000 promissory note. Sheerin also deleted her claims
against Carl Hessel and Ahmed Karim (Company Directors).
Tidelands won a partial summary judgment against Sheerin as to all of
her tort claims pled against Tidelands, save and except only her claim
for conversion of 500,000 shares of Tidelands' stock.
Sheerin seeks damages against Tidelands for indemnity for any sums
found to be due from her to Northern, unspecified amounts of actual
damages, statutory damages, unspecified amounts of exemplary damages,
attorneys fees, costs of suit, and prejudgment and post judgment
interest.
On August 5, 2005, Northern, for the first time, named Tidelands as a
defendant to Northern. Northern seeks to impose liability on Tidelands
for $1,950,000 promissory note signed by McDay Energy Partners, Ltd.
(the predecessor to ZG Gathering, Ltd.) and Sheerin and the $1,700,000
promissory note signed by McDay only. Northern contends that Tidelands
is alternatively liable to Northern for payment of both such promissory
notes totaling $3,709,914 plus interest because Northern is a
third-party beneficiary under a December 3, 2001, purchase and sale
agreement between ZG Gathering, Ltd., and Tidelands claiming that in
such agreement Tidelands agreed to assume and satisfy all indebtedness
due and owing Northern by Sheerin and ZG Gathering, Ltd. Northern also
claims that it is entitled to foreclosure of a lien on the gas
gathering system and pipeline that was the subject of the promissory
notes in question.
On March 6, 2006, Tidelands won a summary judgment motion it filed
against Northern and the court has now dismissed Northern's claims
against Tidelands.
On November 28, 2005, ZG Gathering, Ltd. and ZG Pipeline Management
("ZG") filed its answer to its counter-claim against Northern, and its
answer and cross claim against Tidelands. ZG contends that the
promissory notes given by ZG and Sheerin to Northern were procured by
Northern's fraudulent misrepresentations and it claims unspecified
amounts of damages against Northern. ZG's cross action against
Tidelands claims that Tidelands entered into an agreement to purchase
the Zavala Gathering System from ZG and that, as part of that
agreement, Tidelands agreed to satisfy the $3,700,914 Northern
indebtedness of ZG, and to defend, indemnify, and hold ZG and Sheerin
harmless from such indebtedness to pay off a Sheerin loan of $300,000,
and to issue 1 million shares of Tidelands' stock, of which 500,000 was
to be free-trading shares. ZG claims that Tidelands breached this
agreement. ZG seeks specific performance of the agreement, recovery of
an unspecified amount of damages, and its attorney's fees.
-10-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 3 - LITIGATION (CONTINUED)
------ ----------------------
Much of the discovery has been completed at this time. Based on
investigation, and discovery to date, Tidelands appears to have a
number of potential defenses to the claims of Sheerin and Northern.
Tidelands intends to aggressively defend these lawsuits. The complexity
of the issues in this case and the inherent uncertainties in litigation
of this kind prevent a more definitive evaluation of the extent of
Tidelands' liability exposure.
During April and May, 2005, three separate legal actions were initiated
against Sonterra Energy Corporation (Sonterra), a wholly-owned
subsidiary of the Company. Two of the actions concern claims made by
developers against Sonterra for their failure to pay rent and easement
use fees as a result of their asset purchase from Oneok Propane
Distribution Company on November 1, 2004. The third action involves a
claim made by a builder that Sonterra does not have a proper easement
for the current use of certain property. The Company believes that the
three actions filed are without merit and intend to vigorously defend
itself. Litigation regarding these three actions are still in their
early stages, therefore, potential financial impacts, if any, cannot be
determined at this time.
In accordance with Statement of Financial Accounting Standards No. 5,
"Accounting for Contingencies," management has reached the conclusion
that there is a remote possibility that any or all of the
aforementioned claims would be upheld at trial and has also determined
that the amount of the claims cannot be reasonably estimated.
Accordingly, the Company's financial statements reflect no accrual of a
loss contingency with response to the above legal matters.
NOTE 4 - COMMON STOCK TRANSACTIONS
------ -------------------------
On August 6, 2006, the Company issued 100,000 shares of its common
stock valued at $63,500 to an employee of the Company.
On September 18, 2006, the Company issued 349,856 shares of its common
stock to a holder of its Convertible Debentures for conversion of
$304,375.
On September 25, 2006, the Company issued 93,295 shares of its common
stock to a holder of its Convertible Debentures for conversion of
$81,167.
On September 25, 2006, the Company issued 150,000 shares of its
restricted common stock valued at $87,000 to three Directors for a
total of 450,000 common shares valued at $261,000.
-11-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 4 - COMMON STOCK TRANSACTIONS (CONTINUED)
------ -------------------------------------
On September 25, 2006, the Company issued 150,000 shares of its common
stock valued at $87,000 to a fourth Director.
On September 28, 2006, the Company issued 2,828,304 shares of its
restricted common stock valued at $1,696,982 to five investors in order
to cure all existing events of default in accordance with the terms of
a Waiver and Amendment Agreement relating to the Convertible Debentures
they previously acquired (See NOTE 5 - Debt Financing).
NOTE 5 - RELATED PARTY TRANSACTION
------ -------------------------
The Company executed an agreement in January 2004 with a related party
to provide charter air transportation for its employees, customers and
contractors to job sites and other business related destinations. A
$300,000 5% interest bearing loan due in January 2007 was made by the
Company regarding the transaction. The loan balance is credited by
airtime charges at standard industry rates offset by interest charges
computed on the average monthly balance. At September 30, 2006, the
loan balance was $283,854.
During 2006, the President acquired the airplane being utilized to
provide charter air transportation for the Company which is being held
by his wholly-owned corporation. The transaction includes assumption of
the $300,000 5% interest bearing loan due in January 2007 to the
Company.
On July 9, 2006, the Company acquired a 50% interest in a 24-mile
natural gas pipeline located in Medina, Atascosa and Bexar Counties in
the state of Texas. In addition, the Company also acquired an undivided
50% working interest in two leases with 5 recompleted natural gas wells
on approximately 1,000 acres with at least 10 additional natural gas
wells for re-entry. These leases are located in Atascosa and Medina
counties. The Company expects to participate in acquiring additional
leases which could be developed around the area serviced by the
pipelines. Total consideration for these transactions is $500,000 which
is being paid to a related party.
-12-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 6 - DEBT FINANCING
------ --------------
On January 20, 2006, the Company completed a private placement of
$6,569,750 of convertible debt with seven institutional investors. The
net proceeds realized by the Company were $4,949,291 after deduction of
legal costs, commission and interest discount. The Company issued
original issue discount debentures with a maturity date of January 20,
2008, and a conversion feature which permitted the holders to convert
into common stock of the Company at a price of $0.87 per share. The
investors also received three year "Series A Common Stock Warrants" to
purchase, in the aggregate, 2,491,975 shares of common stock of the
Company at a conversion price of $0.935 per share. Additionally, the
Company issued to the investors "Series B Common Stock Warrants" which
provided for a thirteen month exercise period, at a conversion price of
$1.275 per share, and an aggregate purchase total of 7,551,432 shares
of common stock of the Company.
In accordance with this private placement, the Company entered into a
"Registration Rights Agreement" with the investors, whereby, among
other terms and conditions, the Company must comply with various
effective dates and periods or, if in default of said dates and/or
periods, be subject to liquidated damages as outlined in the master
agreement. Between June 2006 and September 22, 2006, the investors
billed and were paid $478,155 of liquidated damages including $182,625
paid to RHP Master Fund, Ltd., as described below for not meeting the
required effective date.
On September 20, 2006, RHP Master Fund, Ltd. ("RHP") gave the Company
its notice of default for failure to timely pay liquidated damages
associated with the Company's failure to timely register the underlying
debenture shares and warrants with the Securities and Exchange
Commission. RHP accelerated payment of the RHP Debenture at the
Mandatory Default Amount. The Mandatory Default Amount was 130% of the
aggregate principal amount of the Debenture. On September 22, 2006, the
Company paid RHP the sum of $791,375 including an $182,625 Default
Amount, thereby discharging the RHP debenture obligation.
On September 26, 2006, Palisades Master Fund, LP ("Palisades") gave the
Company its notice of election accelerating payment of the Palisades
Debenture at the Mandatory Default Amount asserting a cross default
event triggered by the RHP Notice of Default Event received by the
Company on September 20, 2006, as disclosed in the Current Report filed
on Form 8-K on September 25, 2006. Palisades demanded immediate payment
of its Debentures at the Mandatory Default Amount of $5,597,687.
On September 28, 2006, Company entered into a Waiver and Amendment
Agreement ("Agreement") with Palisades and all of the remaining
Holders, which include Crescent International, Ltd., Double U Master
Fund, LP, JGB Capital, LP and Nite Capital, LP.
-13-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 6 - DEBT FINANCING (CONTINUED)
------ --------------------------
In consideration of that Agreement, all existing events of default
known to the Holders were waived in consideration of the issuance of
2,828,304 common shares. The Company issued the shares as follows:
Palisades - 2,000,000 shares, Crescent International, Ltd. - 304,375
shares, Double U Master Fund, LP - 152,179 shares, JGC Capital, LP -
250,000 shares, and Nite Capital, LP - 121,750 shares (See NOTE 3 -
Common Stock Transactions).
-14-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operation
Business Overview
Our products and services are primarily focused on development and operation of
transportation, processing, distribution and storage projects for natural gas
and natural gas liquids in the northeastern states of Mexico (Chihuahua,
Coahuila, Nuevo Leon and Tamaulipas) and the state of Texas in the United States
of America. The Company has also begun a feasibility study for the potential
development of an offshore LNG regasification terminal and connecting natural
gas pipeline in the vicinity of Long Beach, California.
We derive our revenue from transportation fees from delivery of natural gas to
Conagas, the local distribution company in Piedras Negras, Coahuila, through the
pipeline owned by Reef Ventures, L.P. Additionally, revenues are derived from
the provision of construction services for yard lines and meter sets installed
to a homeowner's lot, and the sale of propane gas to residential customers in
Central Texas through the assets owned by Sonterra Energy Corporation.
Recent Developments
In the nine months ended September 30, 2006, several significant developments
occurred with respect to the businesses operated by the Company.
Financing Transaction
On January 20, 2006, the Company entered into Securities Purchase Agreements
(the "Agreements) with seven accredited investors (collectively, "Purchasers or
Holders"). The original Holders included Palisades Master Fund, L.P., PEF
Advisors, Crescent International, Ltd., Double U Master Fund, L.P., JGB Capital,
L.P. and Nite Capital, L.P., and RHP Master Fund, Ltd. Palisades subsequently
acquired PEF Advisors interests in the Agreements.
We sold $6,569,750 Dollars, in the aggregate principal amount, of discounted
convertible debentures ("Debentures") and Series A and Series B Warrants to
purchase common stock ("Warrants") for an aggregate payment of $5,396,098 after
deduction for the interest discount. The Company paid an 8% commission to the
placement agent, HPC Capital Management, LLC, a registered broker-dealer. The
Company granted HPC Capital Management Series A Common Stock Purchase Warrants
as additional transaction compensation. The Company received net proceeds of
$4,949,292 after deduction of legal costs, commissions and interest discount. We
intend to use the proceeds for working capital.
-15-
The sale of these securities required the Company to increase its authorized
common stock capital because it had insufficient authorized capital to comply
with all of the Debenture conversion and Warrant exercise provisions contained
in the Transaction Documents. We have reserved 9,000,000 common shares of our
unissued authorized common stock capital for the transaction. On April 17, 2006,
an amendment to the articles of incorporation of the Company was approved via
written consent in lieu of a special meeting of the shareholders of the Company
and on April 19, 2006, the Company amended its articles of incorporation by
increasing its authorized common stock capital from One Hundred Million
(100,000,000) shares, par value $0.001 per share to Two Hundred Fifty Million
(250,000,000) shares, par value $0.001 per share, thus satisfying the
requirements of the financing documents.
We agreed to file a registration statement. We filed a registration statement on
Form SB-2 and later converted to Form S-1 with the U.S. Securities and Exchange
Commission ("SEC") to register the common stock underlying the Debentures and
Warrants.
The Debentures are Original Issue Discount Convertible Debentures with an
aggregate face amount of $6,569,750. The purchasers paid an aggregate principal
sum of $5,396,098. The face amount of the Debentures is due January 20, 2008.
The difference between the face amount and the aggregate principal paid
represents the interest expense. The Debenture Holder may convert all or part of
the Debenture face amount into shares of Tidelands' common stock at any time at
an initial conversion rate of $0.87 per share.
The Purchasers have agreed to restrict their ability to convert their Debentures
or Exercise their Warrants and receive our shares such that the number of shares
of common stock held by each of them individually in the aggregate after such
conversion or exercise does not exceed 4.99% of the then issued and outstanding
Company common shares. This beneficial ownership limitation may be waived by the
Holder.
Subject to specific terms and conditions in the Debenture, the Company has the
option to force conversion of the Debentures into common shares if the Company's
share price as quoted on the Over-the-Counter Electronic Bulletin Board exceeds
250% of the then Conversion Price for a period of time based on a Volume
Weighted Average Price ("VWAP") formula. The VWAP share price must exceed this
250% price for at least 20 consecutive Trading Days.
The conversion price will be subject to adjustment for corporate events, such as
stock splits, stock dividends, and stock combinations, as more specifically
outlined in the transaction documents.
We granted the Purchasers Series A Common Stock Purchase Warrants ("Series A
Warrants") to purchase 2,491,974 shares of our common stock at $0.935 per share.
We also granted HPC Capital Management 65,697 Series A Warrants to purchase our
common stock at $0.935 per share.
-16-
The Series A Warrants may be exercised immediately by the Purchasers and
terminate on January 20, 2009. Subject to specific terms and conditions in the
Series A Warrant including an effective registration statement registering
underlying shares, the Company has the call option to force conversion of this
Warrant into common shares if the Company's share price as quoted on the
Over-the-Counter Electronic Bulletin Board exceeds 250% of the then effective
Exercise Price for a period of time based on a VWAP formula. The VWAP share
price must exceed this 250% threshold price for at least 20 consecutive Trading
Days. If at any time after one year from the date of issuance there is no
effective registration statement registering, or no current prospectus available
for the resale of the underlying shares, then this Warrant may also be exercised
by means of "cashless exercise" as determined by a formula described in the
Warrant. The exercise price will be subject to adjustment for corporate events,
such as stock splits, stock dividends, and stock combinations, as more
specifically outlined in the transaction documents.
We granted the Purchasers Series B Common Stock Purchase Warrants ("Series B
Warrants") to purchase 7,551,432 shares of our common stock at $1.275 per share.
The Purchasers have the right to exercise the Series B Warrants commencing at
any time on, or after January 20, 2007 and on, or before February 19, 2007.
Subject to specific terms and conditions in the Series B Warrant, including an
effective registration statement registering underlying shares, the Company has
the option to force the exercise of this Warrant into common shares if the
Company's share price as quoted on the Over-the-Counter Electronic Bulletin
Board exceeds 150% of the then effective Exercise Price for a period of time
based on a VWAP formula. The VWAP share price must exceed this 150% threshold
price for at least 20 consecutive Trading Days. If at any time after one year
from the date of issuance there is no effective registration statement
registering, or no current prospectus available for the resale of the underlying
shares, then this Warrant may also be exercised by means of "cashless exercise"
as determined by a formula described in the Warrant. The exercise price will be
subject to adjustment for corporate events, such as stock splits, stock
dividends, and stock combinations, as more specifically outlined in the
transaction documents. We granted the Purchasers and HPC Capital Management
registration rights on the shares underlying the Debentures and the Warrants.
The Common Stock underlying the Debentures and Warrants will be registered under
the Securities Act of 1933, as amended, for re-offer and re-sale by the
Purchasers and HPC Capital Management.
If the Company failed to timely file a registration statement or was unable to
have the registration statement declared effective by the SEC within the stated
periods of time, this would trigger a default and be subject to among other
things, acceleration of the Debentures, at the Purchasers' options, additional
default interest payment and monetary liquidated damages. The liquidated damages
will be capped at 20% of the Debentures' face amounts.
-17-
The registration provisions of the Agreements required the Company to have the
registration statement declared effective by the Securities and Exchange
Commission on, or before June 20, 2006, ("Effectiveness Deadline"), or pay
liquidated damages until the registration statement was declared effective. On
June 20, 2006, the Company was obligated to pay liquidated damages to the
Holders, however, did not pay all of the holders timely. Failure to timely pay
these liquidated damage sums constituted an event of default. The Company has
paid all of the Effectiveness Deadline liquidated damage sums to each Holder,
albeit untimely. However, prior to these payments, on September 20, 2006, one
Holder, RHP Master Fund, Ltd. ("RHP") gave the Company its notice of election
accelerating payment of the RHP Debenture at the Mandatory Default Amount. Under
the Debenture terms defining default events, a Holder may elect to declare the
aggregate principal Debenture amount, together with other amounts owing to the
date of acceleration, immediately due and payable in cash at the Mandatory
Default Amount. In the RHP case, the elected Mandatory Default Amount was 130%
of the aggregate principal amount of the Debenture. On September 22, 2006, the
Company paid RHP the sum of $791,375 thereby discharging the RHP debenture
obligation. On September 26, 2006, Palisades Master Fund, L.P. ("Palisades")
gave the Company its notice of election accelerating payment of the Palisades
Debenture at the Mandatory Default Amount asserting a cross default event
triggered by the RHP Master Fund, Ltd. Notice of Default Event received by the
Company on September 20, 2006. On September 27, 2006, Company entered into a
Waiver and Amendment Agreement with Palisades and all of the remaining Debenture
Holders, which included Crescent International, Ltd., Double U Master Fund,
L.P., JGB Capital, L.P. and Nite Capital, L.P. We issued the Holders 2,828,304
shares in consideration for the Waiver and Amendment Agreement. The Company
agreed to register these shares with the Securities and Exchange Commission and
this registration statement has been prepared and filed for this purpose.
Esperanza Energy, LLC
Esperanza Energy, LLC, ("Esperanza") was formed as a wholly-owned subsidiary of
the Company in March 2006 to evaluate the feasibility of developing an offshore,
deep-water liquefied natural gas (LNG) regas terminal in the offshore waters
near Long Beach, California. Esperanza would utilize TORP Technology's HiLoad
LNG Regas unit which attaches to an LNG tanker, directly vaporizes the LNG as it
is offloaded and injects the regasified natural gas into an undersea pipeline
for transportation of the natural gas to onshore metering stations and
transmission pipelines to supply nearby gas markets. The TORP HiLoad LNG Regas
unit eliminates the need for extensive above-ground storage tanks or large
marine structures required for berthing and processing of the LNG.
Esperanza is conducting the feasibility study for this project with the
assistance of best-in-class LNG, environmental, pipeline and legal experts that
include: David Maul, former Manager of the California Energy Commission Natural
Gas Office,
o ENTRIX, Inc., a professional environmental consulting company
specializing in environmental permitting and compliance for major
offshore oil and gas projects in California and the United States,
-18-
o Project Consulting Services, Inc., a leader in engineering,
construction, management, and inspection of onshore and offshore
pipelines, and
o Pillsbury Winthrop Shaw Pittman, LLP, an interdisciplinary law firm
with leading practices in environmental, land use and energy legal
advice and in project development and finance.
Active consultations continue with California stakeholders, commercial
counterparties, financial investors, and the above mentioned team regarding the
optimal design and operational configuration of the project. A primary objective
of the project feasibility study is to design the project to exceed California
environmental, public health and safety requirements. An announcement concerning
the results of the feasibility study and whether the Company will pursue the
project is expected prior to the end of the first quarter of 2007.
Sonora Pipeline, LLC, and Terranova Energia, S. de R.L. de C.V.
The cross-border gas pipeline and storage development activities of the above
entities to establish the Burgos Hub Export/Import project progressed forward in
two principal areas:
Permitting Activities -
Sonora Pipeline, LLC, ("Sonora") continued its efforts to finish all activities
necessary to move from NEPA pre-filing status to a submission for Certification
for its two International Pipeline U.S. segments, the Progreso International
Pipeline and the Mission International Pipeline. Sonora believes it has filed
all needed revisions to the Draft Environmental Report for both pipeline
segments with FERC for purposes of the NEPA Environmental Assessment
requirements. The Progreso International Pipeline is the eastern leg of the U.S.
pipelines which will interconnect with the Tennessee Gas Pipeline transmission
lines at the Alamo Station and deliver natural gas to the Brasil Storage
facility approximately 17 miles south of the U.S./Mexico border at Progreso,
Texas. The Mission International Pipeline segment was re-designed in the first
quarter of 2006 due to a routing conflict with a fiber optic line. It will be
approximately 24 miles long and will commence at the existing HPL Valero-Gilmore
gas plant in Hidalgo County, Texas, and extend southward to the Arguelles
crossing of the Rio Grande River into Mexico near the city of Mission, Texas. We
anticipate the issuance of an Environmental Assessment by the staff of FERC in
the first quarter of 2007 to be followed by a complete application for a
Certificate of Public Convenience and Necessity to construct, own, operate and
maintain the proposed pipelines. The current catalog of FERC correspondence for
Sonora's activities is located at www.ferc.gov under Docket No. PF05-15.
On May 23, 2006, Terranova Energia, S. de R.L. de C.V. ("Terranova"), a
wholly-owned subsidiary of the Company, was awarded a permit by the Comision
Reguladora de Energia de Mexico ("CRE") to construct its 30 inch diameter
natural gas pipeline segment in Mexico to link to the Sonora's United States
pipelines and Terranova's proposed underground natural gas storage facility in
the Brasil field (located approximately 17 miles south of Nuevo Progreso on the
U.S./Mexico border in Texas). Terranova submitted the application for the
-19-
storage facility permit to the CRE on August 5, 2005 and it was accepted for
full review on October 14, 2005. Several unique questions are presented by the
filing of this permit due to the proposed location and the lack of previous
storage permit applications having been considered by the CRE. The CRE has
recently selected GEOSTOCK (an entity owned 50% by Total, 25% by BP, and 25% by
Entrepose Contracting) as its technical consultant to review the storage
facility permit application. GEOSTOCK is an international engineering group with
over 40 years experience in the design, construction and operation of all types
of underground storage facilities for liquid, liquefied or gaseous hydrocarbons.
The technical review of the permit application is expected to be completed by
the end of 2006. Management expects the storage permit application will be
presented for decision by staff to the CRE Commissioners in the first quarter of
2007.
Commercial Activities -
The Company continues to present the pipeline and storage segments of the Burgos
Hub Export/Import project to commercial audiences in efforts to solicit their
interest and participation in the project at various levels. There have been
numerous introductory meetings with staff of the CFE and the Monterrey
industrial consumers of natural gas with a view toward clarifying their need and
usage of the proposed project facilities. Letters of Intent concerning capacity
reservation of the project facilities are currently underway with various
industrial customers and natural gas distributors in the Monterrey area.
Discussions with an industrial group concerning the acquisition of rights of way
is ongoing due to potential cost savings for this important project component.
Preliminary evaluation of demand for storage capacity reservation based upon
direct discussion with the various customers is conservatively estimated at 40
Bcf for the market area influenced by the project. Similarly, discussions
continue with interested parties in the U.S. and Mexico regarding the execution
of a joint development agreement between Terranova and their firms for the
funding, development and ownership of the project. An announcement concerning
the participation of these parties is expected in the fourth quarter of 2006.
Sonterra Energy Corporation
The residential home markets in Central Texas remain strong and are reflected in
the continued growth of new meter hookups in existing subdivisions served by
Sonterra Energy Corporation. Sonterra served 1,115 customers with propane
service at the end of the third quarter of 2006 with an additional 40 customers
added in existing subdivisions during the quarter. Construction activities
continue in the existing subdivisions, such as Senna Hills, where an expansion
phase of development will result in the addition of approximately 50 customers
in the near future. Sonterra's participation in the launch of new subdivisions
is also occurring, as exemplified by the signing of a construction contract with
the developers of Las Brisas at Ensenada Shores (located on Canyon Lake), where
75 new lots with propane service have been completed for sale to new customers.
This subdivision's second phase of development is expected to add another 175
lots. Construction continues on Section 205 of the Cordillera Ranch subdivision
which will add 50 more residential customers when completed in the fourth
quarter of 2006.
-20-
Sonterra has expanded into additional markets as evidenced by the signing of a
construction contract to build a central propane system for a multi-use retail
center in Lago Vista, Texas. The system will serve five to ten large commercial
customers including two restaurants.
FORWARD-LOOKING STATEMENTS:
We have included forward-looking statements in this report. For this purpose,
any statements contained in this report that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, words such as "may", "will", "expect", "believe", "anticipate",
"estimate", "plan" or "continue" or the negative or other variations thereof or
comparable terminology are intended to identify forward-looking statements.
These statements by their nature involve substantial risks and uncertainties,
and actual results may differ materially depending on a variety of factors.
Factors that might cause forward-looking statements to differ materially from
actual results include, among other things, overall economic and business
conditions, demand for the Company's products, competitive factors in the
industries in which we compete or intend to compete, natural gas availability
and cost and timing, impact and other uncertainties of our future acquisition
plans.
Results of Operations
REVENUES: The Company reported revenues of $1,578,244 for the nine months ended
September 30, 2006 as compared with revenues from continuing operations of
$1,216,626 for the nine months ended September 30, 2005. The revenue increase
resulted primarily from increasing revenues of Sonterra Energy Corporation due
to an increase in total customers served and product prices in the first nine
months of 2006 versus the first nine months of 2005.
TOTAL COSTS AND EXPENSES: Total costs and expenses from continuing operations
decreased from $12,987,237 for the nine months ended September 30, 2005 to
$9,121,500 for the nine months ended September 30, 2006. The principal reason
for this amount of decrease was the lack of expense for Impairment Loss in the
nine months ended September 30, 2006 versus the nine months ended September 30,
2005.
COST OF SALES: Total Cost of Sales increased from $635,113 for the nine months
ended September 30, 2005 to $759,954 for the nine months ended September 30,
2006. This increase resulted from the increased cost and volume of propane sold
by Sonterra Energy Corporation in the nine months ended September 30, 2006
versus September 30, 2005.
OPERATING EXPENSES: Operating expenses from continuing operations increased from
$210,545 for the nine months ended September 30, 2005 to $286,128 for the nine
months ended September 30, 2006. This increase was primarily due to additional
operating expenses incurred by Sonterra Energy Corporation in its operations for
-21-
the period which were not present in the comparative nine months for 2005.
Depreciation expense declined in the first nine months of 2006 versus the first
nine months of 2005, decreasing from $360,817 for the nine months ended
September 30, 2005 to $345,887 for the nine months ended September 30, 2006
reflecting a minor decrease in depreciable assets for the respective periods due
to impairment charges.
INTEREST EXPENSE: Interest expense increased from $503,950 for the nine months
ended September 30, 2005 to $3,057,258 for the nine months ended September 30,
2006 primarily as a result of three factors: (a) interest penalties in the
amount of $1,696,182 in connection with the payment of stock to the various
investors upon the defaults described in Notes 3 and 5 of the Financial
Statements, (b) liquidated damage payments in the amount of $478,155 paid in
cash to the various investors upon as described in Note 5 of the Financial
Statements, and (c) interest paid in connection with the conversion of
debentures to common stock in the amount of $277,282 during the period ended
September 30, 2006. No income or expense for Beneficial Conversion Feature
Interest was recorded for the nine months ended September 30, 2006 as compared
to ($501,659) for the nine months ended September 30, 2005. The market price for
the Company's common stock at the relevant measurement dates during the nine
months ended September 30, 2006 was less than the conversion price for the
debentures issued on January 20, 2006. Accordingly, there was no benefit to the
holders of the debentures in the event of conversion during those periods and no
beneficial conversion interest charge was recorded.
SALES, GENERAL AND ADMINISTRATIVE: Sales, General & Administrative Expenses
decreased by $1,906,198 during the nine months ended September 30, 2006 to a
total amount of $4,672,273 as compared $6,578,471 for the nine months ended
September 30, 2005. This decrease was due primarily to the absence of financing
costs paid to Impact International LLC during the period ended September 30,
2006 as compared to financing costs of $1,272,500 paid to Impact International
LLC during the period ended September 30, 2005. The remaining decrease in Sales,
General & Administrative expense was due to a reduction in the issuance of
common stock for consulting services during the nine months ended September 30,
2006 versus the nine months ended September 30, 2005.
IMPAIRMENT LOSS: No expense for impairment loss was recorded for the nine months
ended September 30, 2006 compared to $5,200,000 of impairment of goodwill
recorded as a loss for the period ended September 30, 2005.
DERIVATIVE GAIN: Gain from embedded derivative instrument liabilities decreased
from ($5,168,000) for the nine months ended September 30, 2005 to zero for the
nine months ended September 30, 2006. The warrants issued in connection with the
January 20, 2006 financing had an exercise price that was greater the fair
market value of the Company's common stock at the relevant measurement dates.
Accordingly, no derivative gain or reduction in liability for the issuance of
the warrants in this financing transaction was recorded for the nine months
ended September 30, 2006.
-22-
NET LOSS: Net loss of ($6,211,713) for the nine months ended September 30, 2005
increased to ($7,433,260) for the nine months ended September 30, 2006, an
increase in the amount of loss of $1,221,547. The principal reason for this
amount of increase in net loss was the lack of Derivative Gains to offset Loss
from Operations for the nine months ended September 30, 2006 versus the nine
months ended September 30, 2005. Included in the net loss of ($7,433,260) for
the nine months ended September 30, 2006 is $1,562,800 of expenses for
employment contract costs and legal fees paid by issuance of common stock.
LIQUIDITY AND CAPITAL RESOURCES: With regard to liquidity and adequacy of
capital resources, management believes that adequate liquidity and cash
resources exist to sustain current corporate activities for the remainder of the
fiscal year. However, in the event that a decision to proceed with the offshore
LNG regas terminal project in Southern California is made during the upcoming
months, additional funding for the permit process will be needed. Management
will evaluate the required budget and funding alternatives for such an effort as
an integral part of the project feasibility study underway. Furthermore, the
Company will need to raise additional capital to fund ongoing development
activities for its Mexican subsidiary, Terranova Energia and also to fund
operating overhead at the parent company level. New issuance of common stock
sufficient to retire the outstanding debentures and to provide additional
required capital is under active negotiation. In addition, management is seeking
commitments to fund the development activities of the Mexican and California
projects by private equity sources. No assurance can be made that such capital
can be acquired in a timely fashion or at all. Furthermore, if capital is
available through these sources, if may be at terms that are disadvantageous to
the Company and its shareholders. In light of these possible outcomes and the
current cash resources available for the sustenance of corporate operations,
management is taking immediate action to reduce overhead costs and otherwise
obtain cash resources for the Company. Actions underway include reduction of
staff, termination of leases for the resulting unused office space, subletting
of the Suite License Agreement with the San Antonio Spurs, LLC, conveyance of an
interest in Reef Ventures, LP for cash, collection of stock subscriptions
receivable from current and past officers, collection of an account receivable
from an officer, accelerated collection of past due accounts from customers of
Sonterra Energy and Reef Ventures, LP, and collection of the $283,854 balance of
the Note Receivable for the related party aircraft charter services including
termination of those services to the Company. Furthermore, management expects
that in the fourth quarter of 2006, the Company will begin receiving proceeds
from the sale and transportation of natural gas by its subsidiary, Tidelands
Exploration & Production, as a result of its participation in the working
interests in the gas wells and the gathering pipeline located in Bexar, Medina,
and Atascosa counties.
Direct capital expenditures during the nine months ended September 30, 2006
totaled $2,525,218. The capital expenditures were composed of increased
pre-construction costs regarding potential international pipeline crossings and
storage facilities in Mexico, pre-construction costs regarding an offshore LNG
terminal in Southern California, and additional machinery, equipment, trucks,
autos and trailers for the operation of the Sonterra Energy Corporation propane
systems. Total debt increased from $5,722,322 at December 31, 2005 to $
11,239,928 at September 30, 2006. The increase in total debt is due primarily to
the issuance of $6,569,750 of convertible debentures in the financing
transaction of January 20, 2006. Net loss for the nine months ended September
30, 2006 was ($7,433,260) an increase in net loss of 19% from the net loss of
($6,211,713) for the nine months ended September 30, 2005. Basic and diluted net
loss per common share remained the same in the nine months ended September 30,
2006 at ($0.05). The net loss per share calculation for the nine months ended
September 30, 2006 included an increase in actual and equivalent shares
outstanding.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Cash and Cash Equivalents
We have historically invested our cash and cash equivalents in short-term, fixed
rate, highly rated and highly liquid instruments which are reinvested when they
mature throughout the year. Although our existing investments are not considered
at risk with respect to changes in interest rates or markets for these
instruments, our rate of return on short-term investments could be affected at
the time of reinvestment as a result of intervening events. As of September 30,
2006, we had cash and cash equivalents aggregated $887,194.
The Company does not issue or invest in financial instruments or their
derivatives for trading or speculative purposes. The operations of the Company
are conducted primarily in the United States, and are not subject to material
foreign currency exchange risk. Although the Company has outstanding debt and
related interest expense, market risk of interest rate exposure in the United
States is currently not material.
-23-
Debt
The interest rate on our Impact International debt obligation is generally
determined based on the prime interest rate plus two percent and may be subject
to market fluctuation as the prime rate changes.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
As of the end of the reporting period, September 30, 2006, we carried out an
evaluation, under the supervision and with the participation of our management,
including the Company's Chairman and Chief Executive Officer/Principal
Accounting Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Rule 13a-15(e) of the Securities
Exchange Act of 1934 (the "Exchange Act"), which disclosure controls and
procedures are designed to insure that information required to be disclosed by a
company in the reports that it files under the Exchange Act is recorded,
processed, summarized and reported within required time periods specified by the
SEC's rules and forms. Based upon that evaluation, the Chairman and the Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in timely alerting them to required material information relating to
the Company to be included in the Company's period SEC filings.
(b) Changes in Internal Control.
Subsequent to the date of such evaluation as described in subparagraph (a)
above, there were no changes in our internal controls or other factors that
could significantly affect these controls, including any corrective action with
regard to significant deficiencies and material weaknesses.
(c) Limitations.
Our management, including our Principal Executive Officer and Principal
Financial Officer, does not expect that our disclosure controls or internal
controls over financial reporting will prevent all errors or all instances of
fraud. However, we believe that our disclosure controls and procedures are
-24-
designed to provide reasonable assurance of achieving this objective. A control
system, no matter how well designed and operated, can provide only reasonable,
not absolute, assurance that the control system's objectives will be met.
Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within our company have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty, and that breakdowns can occur because of simple error or mistake.
Controls can also be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls. The
design of any system of controls is based in part upon certain assumptions about
the likelihood of future events, and any design may not succeed in achieving its
stated goals under all potential future conditions. Over time, controls may
become inadequate because of changes in conditions or deterioration in the
degree of compliance with policies or procedures. Because of the inherent
limitation of a cost-effective control system, misstatements due to error or
fraud may occur and not be detected.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Matter No. 1:
On January 6, 2003, we were served as a third party defendant in a lawsuit
titled Northern Natural Gas Company vs. Betty Lou Sheerin vs. Tidelands Oil &
Gas Corporation, ZG Gathering, Ltd. and Ken Lay, in the 150th Judicial District
Court, Bexar County, Texas, Cause Number 2002-C1-16421. The lawsuit was
initiated by Northern Natural Gas when it sued Betty Lou Sheerin for her failure
to make payments on a note she executed payable to Northern in the original
principal amount of $1,950,000. Northern's suit was filed on November 13, 2002.
Sheerin answered Northern's lawsuit on January 6, 2003. Sheerin's answer
generally denied Northern's claims and raised the affirmative defenses of
fraudulent inducement by Northern, estoppel, waiver and the further claim that
the note does not comport with the legal requirements of a negotiable
instrument. Sheerin seeks a judicial ruling that Northern be denied any recovery
on the note. Sheerin's answer included a counterclaim against Northern, ZG
Gathering, and Ken Lay generally alleging, among other things, that Northern, ZG
Gathering, Ltd. and Ken Lay, fraudulently induced her execution of the note.
Northern has filed a general denial of Sheerin's counterclaims. Sheerin's answer
included a third party cross claim against Tidelands. She alleges that Tidelands
entered into an agreement to purchase the Zavala Gathering System from ZG
Gathering Ltd. and that, as a part of the agreement, Tidelands agreed to satisfy
all of the obligations due and owing to Northern, thereby relieving Sheerin of
all obligations she had to Northern on the $1,950,000 promissory note in
question. Tidelands and Sheerin agreed to delay the Tideland's answer date in
order to allow time for mediation of the case. Tidelands participated in
mediation on March 11, 2003. The case was not settled at that time. Tideland's
answered the Sheerin suit on March 26, 2003. Tideland's answer denies all of
Sheerin's allegations.
-25-
On May 24 and June 16, 2004 respectively, Betty Lou Sheerin filed her first and
second amended original answer, affirmative defenses, special exceptions and
second amended original counterclaim, second amended original third party
cross-actions and requests for disclosure. In these amended pleadings, she sued
Michael Ward, Royis Ward, James B. Smith, Carl Hessell and Ahmed Karim in their
individual capacities. Her claims against these individuals are for fraud,
breach of contract, breach of the Uniform Commercial Code, breach of duty of
good faith and fair dealing and conversion. Sheerin has now non-suited her
claims against Michael Ward, Royis Ward, and James B. Smith.
In September 2002, as a pre-closing deposit to the purchase of the Zavala
Gathering System pipelines, the Company executed a $300,000 promissory note to
Betty L. Sheerin, a partner of ZG Gathering, Ltd. In addition, the Company
issued 1,000,000 shares of its common stock to various partners of ZG Gathering,
Ltd. On December 3, 2003, Sheerin filed a separate lawsuit against Tidelands in
the 150th District Court of Bexar County, Texas on this promissory note seeking
a judgment against Tidelands for the principle amount of the note, plus
interest. On December 29th, 2003, Tidelands answered this lawsuit denying
liability on the note. On April 1, 2004, Tidelands filed a plea in abatement
asking the court to dismiss or abate Sheerin's lawsuit on the $300,000
promissory note as it was related to and its outcome was dependent on the
outcome of the Sheerin third party cross action against Tidelands in Cause
Number 2002-C1-16421. The company believes that the promissory note and shares
of common stock should be cancelled based upon the outcome of the litigation
described above. Accordingly, our financial statements reflect this belief.
On September 15, 2004 and again on October 15, 2004 respectively, Sheerin
amended her pleadings to include a third and fourth amended third party cross
action against Tidelands adding a claim for the $300,000 promissory note. In
these amended pleadings, Sheerin also deleted her claims against Carl Hessell
and Ahmed Karim. After adding the claim on the $300,000 promissory note to the
third party claims of Sheerin against Tidelands in Cause No. 2002-C1-16421,
Sheerin dismissed Cause Number 2002-C1-16421.
Tidelands won a partial summary judgment against Sheerin as to all of her tort
claims pled against Tidelands, save and except only her claim for conversion of
500,000 shares of Tidelands' stock.
Sheerin seeks damages against Tidelands for indemnity for any sums found to be
due from her to Northern Natural Gas Company, unspecified amounts of actual
damages, statutory damages, unspecified amounts of exemplary damages, attorneys
fees, costs of suit, and prejudgment and post judgment interest.
On August 5, 2005, Northern Natural Gas Company filed its Fourth Amended
Original Petition which, for the first time, named Tidelands as a defendant to
Northern. Northern seeks to impose liability on Tidelands for $1,950.000
-26-
promissory note signed by McDay Energy Partners, Ltd. (the predecessor to ZG
Gathering, Ltd.) and Sheerin and the $1,700,000 promissory note signed by McDay
only. Northern contends that Tidelands is alternatively liable to Northern for
payment of both such promissory notes totaling $3,709,914 plus interest because
Northern is a third party beneficiary under a December 3, 2001 purchase and sale
agreement between ZG and Tidelands claiming that in such agreement Tidelands
agreed to assume and satisfy all indebtedness due and owing Northern by Sheerin
and ZG. Northern also claims that it is entitled to foreclosure of a lien on the
gas gathering system and pipeline that was the subject of the promissory notes
in question.
Tidelands has won a summary judgment motion it filed against Northern and the
court has now dismissed Northern's claims against Tidelands.
On November 28, 2005, ZG Gathering, Ltd. and ZG Pipeline Management ("ZG") filed
its answer to Northern's Fifth Amended Petition, its counter-claim against
Northern, and its answer and cross claim against Tidelands. ZG contends that the
promissory notes given by ZG and Sheerin to Northern were procured by Northern's
fraudulent misrepresentations and it claims unspecified amounts of damages
against Northern. ZG's cross action against Tidelands claims Tidelands entered
into an agreement to purchase the Zavala Gathering System from ZG and that, as
part of that agreement, Tidelands agreed to satisfy the $3,700,914 Northern
indebtedness of ZG, and to defend, indemnify, and hold ZG and Sheerin harmless
from such indebtedness, to pay off a Sheerin loan of $300,000, and to issue 1
million shares of Tidelands stock, of which 500,000 was to be free trading
shares. ZG claims that Tidelands breached this agreement by failing to satisfy
the Northern indebtedness, failing to defend and indemnify it from such debt,
failing to pay off the $300,000 note, failing to issue the free trading shares
in Tidelands, and by placing a stop transfer order on the restricted stock that
was issued by Tidelands. ZG seeks specific performance of the agreement,
recovery of an unspecified amount of damages, and its attorney's fees.
Much of the discovery has been completed at this time. Based on investigation,
and discovery to date, Tidelands appears to have a number of potential defenses
to the claims of Sheerin and Northern. Tideland's intends to aggressively defend
these lawsuits. The complexity of the issues in this case and the inherent
uncertainties in litigation of this kind prevent a more definitive evaluation of
the extent of Tidelands' liability exposure.
Matter No. 2:
On May 4, 2005, HBH Development Company, LLC initiated legal action against
Sonterra Energy Corporation ("Sonterra") in the District Court of Travis County,
Texas, 98th Judicial District, Cause No. GN 501626 HBH Development Co., LLC vs.
Sonterra Energy Corp. This action involves the developer of the Austin's Colony
Subdivision in Travis County, Texas and the propane distribution system
originally constructed by Southern Union Company. Southern Union entered into a
letter agreement with HBH concerning the construction and operation of a propane
distribution system in the subdivision to be owned and operated by Southern
-27-
Union. Southern Union assigned the letter agreement and its interests in the
propane system to Oneok, Inc., the parent company of Oneok Propane Company.
Sonterra acquired its interest in the propane system from Oneok Propane
Distribution Company. HBH is claiming that Sonterra has failed or refused to pay
HBH rent and easement use fees under the terms of the letter agreement. HBH
alleges that Sonterra's actions cause a failure of the assignment whereby it
acquired rights in the propane system or alternatively, if the assignment is
effective, for breach of contract. HBH seeks to have the court terminate
Sonterra's rights in the propane distribution system, award unspecified monetary
damages, cancellation of the contract and rights associated with the propane
distribution system, issue to HBH a writ of possession for the property, and for
attorneys fees. HBH has amended its complaint adding claims for mutual mistake
and reformation as to the letter agreement and a developer's bonus under terms
of the letter agreement.
Sonterra is defending the legal action. It believes that under the terms of the
letter agreement between HBH Development Company and Southern Union Company that
the easement use fees terminated when Southern Union conveyed its interest in
the propane distribution system to Oneok Propane Company.
Matter No. 3:
On May 4, 2005, Senna Hills, Ltd. initiated legal action against Sonterra Energy
Corporation in the District Court of Travis County, Texas, 53rd Judicial
District Cause No. GN 501625 Senna Hills, Ltd. vs. Sonterra Energy Corp. This
action involves the developer of the Senna Hills Subdivision in Travis County,
Texas and the propane distribution system originally constructed by Southern
Union Company. Southern Union entered into a letter agreement with Senna Hills
concerning the construction and operation of a propane distribution system in
the subdivision to be owned and operated by Southern Union. Southern Union
assigned the letter agreement and its interests in the propane system to Oneok,
Inc., the parent company of Oneok Propane Company. Sonterra acquired its
interest in the propane system from Oneok Propane Distribution Company. Senna
Hills is claiming that Sonterra has failed or refused to pay Senna Hills rent
and easement use fees under the terms of the letter agreement. Senna Hills
alleges that Sonterra's actions cause a failure of the assignment whereby it
acquired rights in the propane system or alternatively, if the assignment is
effective, for breach of contract. Senna Hills seeks to have the court terminate
Sonterra's rights in the propane distribution system, award unspecified monetary
damages, and cancellation of the contract and rights associated with the propane
distribution system, issue to Senna Hills a writ of possession for the property,
and attorneys fees.
Senna Hills sold certain undeveloped sections of Senna Hills Subdivision to a
new owner. Sonterra believes that it has the right to expand its distribution
system into such undeveloped sections of the subdivision. Sonterra plans to
expand the distribution system into these sections under an agreement with the
new owner. Senna Hills has stated that although it is not presently objecting to
Sonterra's expansion of the system at this time, it is reserving its claim that
Sonterra does not have the right to do so and that it intends to ask the court
-28-
to cancel Sonterra's right to use and possession of the propane distribution
system, including the system in the new sections of the subdivision. Senna Hills
has amended its complaint adding claims for mutual mistake and reformation as to
the letter agreement and a developer's bonus under terms of the letter
agreement.
Sonterra is defending the legal action. It believes that under the terms of the
letter agreement between Senna Hills and Southern Union Company that the
easement use fees terminated when Southern Union conveyed its interest in the
propane distribution system to Oneok Propane Company.
Matter No. 4:
On April 7, 2005, Goodson Builders, Ltd. named Sonterra Energy Corporation in a
legal action titled, Goodson Builders, Ltd, Plaintiff vs. Jim Blackwell and BNC
Engineering, LLC, Defendants. The legal action is in the District Court of
Travis County, Texas 345th Judicial District. This legal action arises from a
claim that an underground propane storage tank and underground distribution
lines is situated on the Plaintiff's lot in the Hills of Lakeway subdivision,
Travis County, Texas. Plaintiff alleges that there is no recorded easement
setting forth the rights and obligations of the parties for use of the propane
tank and lines. However, there is reference to a "suburban propane easement" on
the plat document. Plaintiff alleges that the property is being used without
permission and the use constitutes an on-going trespass. Plaintiff asks the
court to determine that his lot is not subject to a "suburban propane easement",
declare the propane equipment the property of plaintiff, enjoin Sonterra from
use of Plaintiff's land, and award damages. The Plaintiff seeks damages of
$165,000 based on a market rental rate he claims to be $5,000 per month, $50,000
damages for depreciation of the value of the lot, an unspecified amount of
exemplary damages, and attorneys' fees. Sonterra is defending the claims.
Item 1A. Risk Factors
WE MAY NOT HAVE ENOUGH FUNDING TO COMPLETE OUR BUSINESS PLAN.
We will need additional financing to fully implement our business plan. We
cannot give any assurance that this additional financing could be obtained of
attractive terms or at all. In addition, our ability to raise additional funds
through a private placement may be restricted by SEC rules which limit a
company's ability to sell securities similar to those being sold in a registered
offering before the time that offering is completed or otherwise terminated.
Lack of funding could force us to curtail substantially or cease our operations.
FUTURE CAPITAL NEEDS COULD RESULT IN DILUTION TO INVESTORS; ADDITIONAL FINANCING
COULD BE UNAVAILABLE OR HAVE UNFAVORABLE TERMS.
-29-
Our Company's future capital requirements will depend on many factors, including
cash flow from operations, progress in its gas operations, competing market
developments, and the Company's ability to market its proposed products
successfully. Although the Company currently has specific plans and arrangements
for financing its working capital is presently insufficient to fund the
Company's activities. It will be necessary to raise additional funds through
equity or debt financings. Any equity financings or debt refinancing could
result in dilution to our Company's then-existing stockholders. Sources of debt
financing may result in higher interest expense. Any financing, if available,
may be on terms unfavorable to the Company. If adequate funds are not obtained,
the Company may be required to reduce or curtail operations.
SUBSTANTIAL CAPITAL REQUIREMENTS
We may make substantial capital expenditures for the development, acquisition
and production of natural gas pipeline, processing systems and, or storage
facilities. If revenues or the Company's equity financing decrease as a result
of lower natural gas prices, operating difficulties, the Company may have
limited ability to expend the capital necessary to undertake or complete
proposed plans and opportunities. There can be no assurance that additional debt
or equity financing or cash generated by operations will be available to meet
these requirements.
THERE CAN BE NO ASSURANCE THAT WE WILL BE ABILITY TO CONTINUE AS A GOING
CONCERN.
Our substantial historical operating losses, limited revenues, negative working
capital and our capital needs raise substantial doubt about our ability to
continue as a going concern. We can provide no assurances that cash generated
from operations together with cash received in the future from external
financing sources will be sufficient to enable us to continue as a going
concern. If sufficient cash cannot be obtained we would have to substantially
alter our operations, or we may be forced to substantially curtail or
discontinue some or all operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During this fiscal quarter, we issued the following common stock:
On September 25, 2006, the Company issued Michael Ward, Ahmed Karim and Carl
Hessel 150,000 restricted common shares each as director compensation. The
shares were valued at $0.58 per share.
On September 28, 2006, Company entered into a Waiver and Amendment Agreement
(the, "Agreement") with Palisades Master Fund, L.P., Crescent International,
Ltd., Double U Master Fund, L.P., JGB Capital, L.P. and Nite Capital, L.P.
(collectively, "Holders"). In consideration of that Agreement, the Holders were
issued 2,828,304 common shares. The Company issued the shares as follows:
Palisades Master Fund, L.P.: 2,000,000; Crescent International, Ltd.: 304,375;
Double U Master Fund, L.P.:152,179; JGB Capital, L.P.: 250,000; and Nite
Capital, L.P.: 121,750. These shares were valued at $0.60 per share.
These are restricted securities and may not be resold absent registration under
the Securities Act of 1933, as amended (the "Securities Act") or an exemption
from the registration provisions of the Securities Act. We relied on Section
4(2) of the Securities Act as securities transaction exemption.
-30-
Item 3. Defaults Upon Senior Securities
Defaults relating to RHP Master Fund, Ltd. and Palisades Master Fund, L.P. were
disclosed under Item 2.04 titled "Triggering Event that Accelerates or Increases
a Direct Financial Obligation or an Obligation under an Off Balance Sheet
Arrangement" on Current Reports filed on Form 8-K September 25 and September 29,
2006.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter
covered by this report.
Item 5. Other Information
Regency Energy Transaction
Tidelands Exploration and Production, Inc. (TEPI) has completed its acquisition
of a 50% interest (with Regency Energy, Inc.) in a 24-mile natural gas pipeline
located in Medina, Atascosa and Bexar Counties, Texas. This Participation
Agreement and Joint Operating Agreement with Regency allows TEPI to take
stranded gas to market on leases in which TEPI has retained an interest.
Item 6. Exhibits
a) Exhibits
Exhibit No. Exhibit Name
10.1* Regency Energy Participation Agreement
10.2* Regency Energy Joint Operating Agreement
31.1 Chief Executive Officer-Section 302 Certification
pursuant to Sarbanes-Oxley Act.
31.2 Chief Financial Officer- Section 302 Certification
pursuant to Sarbanes-Oxley Act.
32.0 Chief Executive and Financial Officer-Section 906
Certification pursuant to Sarbanes-Oxley Act.
* Filed as Exhibits 10.1 and 10.2 to the 10-Q filed for the period
ending June 30, 2006 which was filed on August 21, 2006.
-31-
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
TIDELANDS OIL & GAS CORP.
Dated: November 13, 2006 /s/ Michael Ward
--------------------------------
By: Michael Ward
Title: President, CEO
Dated: November 13, 2006 /s/ James B. Smith
--------------------------------
By: James B. Smith
Title: CFO, Principal Accounting
Officer
-32-