UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the year ended December 31, 2005
Commission File Number 0-29613
TIDELANDS OIL & GAS CORPORATION
(Name of small business issuer in its charter)
Nevada 66-0549380
(State or other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification No.)
1862 West Bitters Rd., San Antonio, TX 78248
(Address of principal executive office)
(210) 764-8642
(Issuer's Telephone Number)
Securities Registered Pursuant of Section 12(b) of the Act: None
Securities Registered Pursuant of Section 12(g) of the Act:
Common Stock, $0.001 Par Value
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B in this form, and no disclosure will be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment of
this Form 10-KSB. [ ]
Indicate by check mark whether the registrant is a shell company (as defined by
Rule 12b-2of the Exchange Act. Yes [ ] No [X]
The issuer had operating revenues of $1,861,323 for the year ended December 31,
2005.
This report contains a total of __ pages. The Exhibit Index appears on page __.
As of March 31, 2005, there were 79,805,815 shares of the issuer's common stock
outstanding.
The aggregate market value of the issuer's voting stock held by non-affiliates
was $58,827,842 based on the low bid price on that date as reported by the NASD
OTC Electronic Bulletin Board April 14, 2006. The sum excludes the shares held
by officers, directors, and stockholders whose ownership exceeded 10% of the
outstanding shares at December 31, 2005, in that such persons may be deemed
affiliates of the Company. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
TIDELANDS OIL & GAS CORPORATION
FORM 10-KSB
December 31, 2005
Page
PART I
ITEM 1. Business.......................................................... 3
ITEM 2. Properties........................................................ 6
ITEM 3. Legal Proceedings................................................. 7
ITEM 4. Submission of Matters to vote of Security Holders................. 9
PART II
ITEM 5. Market for Common Equity and Related Stockholder Matters
And Small Business Issuer Purchases of Equity Securities........ 10
ITEM 6. Management's Discussion and Analysis or Plan of Operation......... 11
ITEM 7. Financial Statements.............................................. 27
ITEM 8. Changes In and Disagreements with Accounting and
Financial Disclosure............................................ 27
ITEM 8A. Controls and Procedures........................................... 27
ITEM 8B. Other Information................................................. 28
PART III
ITEM 9. Directors, Executive Officers, Promoters, and Control
Persons: Compliance with Section 16(a) of the Exchange Act..... 28
ITEM 10. Executive Compensation........................................... 29
ITEM 11. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters................................ 31
ITEM 12. Certain Relationships and Related Transactions................... 34
ITEM 13. Exhibits......................................................... 36
ITEM 14. Principal Accounting Fees and Services........................... 38
SIGNATURES................................................................. 39
EXHIBIT INDEX..............................................................
2
PART I
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This 2005 Annual Report on Form 10-KSB, including the sections entitled "Risk
Factors," "Management's Discussion and Analysis or Plan of Operation" and
"Business," contains "forward-looking statements" that include information
relating to future events, future financial performance, strategies,
expectations, competitive environment, regulation and availability of resources.
These forward-looking statements include, without limitation, statements
regarding: statements concerning projections, predictions, expectations,
estimates or forecasts for our business, financial and operating results and
future economic performance; statements of management's goals and objectives;
and other similar expressions concerning matters that are not historical facts.
Words such as "may," "will," "should," "could," "would," "predicts,"
"potential," "continue," "expects," "anticipates," "future," "intends," "plans,"
"believes" and "estimates," and similar expressions, as well as statements in
future tense, identify forward-looking Statements.
Forward-looking statements should not be read as a guarantee of future
performance or results, and will not necessarily be accurate indications of the
times at, or by which, that performance or those results will be achieved.
Forward-looking statements are based on information available at the time they
are made and/or management's good faith belief as of that time with respect to
future events, and are subject to risks and uncertainties that could cause
actual performance or results to differ materially from those expressed in or
suggested by the forward-looking statements. Important factors that could cause
these differences include, but are not limited to:
o our failure to implement our business plan within the time
period we originally planned to accomplish; and
o Other factors discussed under the headings "Risk Factors,"
"Management's Discussion and Analysis or Plan of Operation"
and "Business."
Forward-looking statements speak only as of the date they are made. You should
not put undue reliance on any forward-looking statements. We assume no
obligation to update forward-looking statements to reflect actual results,
changes in assumptions or changes in other factors affecting forward-looking
information, except to the extent required by applicable securities laws. If we
do update one or more forward-looking statements, no inference should be drawn
that we will make additional updates with respect to those or other
forward-looking statements.
All references to "we," "our," "us" and the "Company" in this Annual Report on
Form 10-KSB refer to Tidelands Oil & Gas Corporation and its subsidiaries.
ITEM 1. BUSINESS.
Tidelands Oil & Gas Corporation (the "Company"), formerly known as C2
Technologies, Inc., was incorporated under the laws of the State of Nevada on
February 25, 1997. C2 Technologies, Inc. changed its name to Tidelands Oil & Gas
Corporation on November 19, 1998. The Company has ten subsidiaries which it
directly and indirectly owns as follows: (1) Rio Bravo Energy LLC, (2) Arrecefe
Management LLC, (3) Marea Associates, L.P. , (4) Terranova Energia, S.de R.L. de
C.V., (5) Esperanza Energy LLC and (6) Sonterra Energy Corporation. We also own
a 97% limited partnership interest in Reef Ventures, L.P.(7) Arrecefe Management
LLC owns a 1% general partner interest in Reef Ventures, L.P. Rio Bravo Energy,
LLC owns 100% of the member interest in Sonora Pipeline LLC. (8) Reef Ventures,
L.P. owns 100% of the member interest in Reef International LLC(9) and Reef
Marketing LLC(10).
The Company's 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.
Reef Ventures International Pipeline
The assets of this business consist of two different pipelines: (1) an 8 mile
twelve inch diameter natural gas pipeline with metering and dehydration
facilities and (2) a two mile segment of six inch diameter pipeline to be used
in a future LPG project. The twelve inch pipeline connects and receives natural
gas from a third party pipeline for transmission to the border between Texas and
Coahuila, Mexico. The pipeline is buried underneath the Rio Grande River with
3
its termination at the delivery point in Piedras Negras, Coahuila owned by
CONAGAS (the local distribution company). Reef Ventures, L.P. derives its
revenues from transportation fees charged to CONAGAS for delivery of natural
gas. The LPG project will require the future construction of receiving terminal
facilities in Texas, boring and installation of additional six inch diameter
pipeline under the Rio Grande River and approximately one mile of additional
pipeline in Mexico with an unloading terminal and storage facilities at its
termination point.
Tidelands Oil & Gas Storage Enterprise
In December 2003, we entered into a Memorandum of Understanding (MOU) with PEMEX
to design, build and operate an underground natural gas storage facility in the
vicinity of Reynosa, Tamaulipas, Mexico, in the Burgos Basin area and eventually
at other regions in Mexico. The MOU provides for exclusivity in the development
of the projects and the related transportation and interconnecting pipelines to
and from the storage facilities.
We have completed the initial study of the Burgos facility and expect to receive
permits to construct, own and operate the storage facility and the
interconnecting pipelines from the Comision Reguladora de Energia (the Mexican
regulatory branch of the Secretary of Energy). The capital budget for these two
projects exceeds $700 Million Dollars and is expected to be funded through
issuance of additional equity of the Company, the addition of joint venture
partners and/or debt financing. Marea Associates, L.P. was formed to own the
majority interest in Terranova Energia, S. de R.L. de C.V., a Mexican company
which will conduct all business dealings in Mexico on behalf of Tidelands. Rio
Bravo Energy LLC, an existing wholly owned subsidiary owns the general partner
interest in Marea Associates, L.P. and a minority interest in Terranova Energia,
S. de R.L. de C.V.
Rio Bravo Energy, LLC
Rio Bravo Energy, LLC was formed on August 10, 1998 to operate the Chittim Gas
Processing Plant which was purchased in 1999 and was processing natural gas
primarily from Conoco Oil's Sacatosa Field. The Sacatosa Field was primarily an
oilfield which produced high BTU casinghead gas from which gas processing
operations would yield valuable hydrocarbon components such as propane, butane
and natural gasolines. As the field depleted lower volumes of casinghead gas
were being delivered by Conoco, and other gas producers could not be contracted
with for processing of additional replacement volumes of gas. Therefore, in
October 2002, the plant was temporarily shut down due to the declining economics
associated with low volume operation of the plant. During 2002 through the
fourth quarter of 2005 management planned to reopen the plant when adequate
volumes of gas from third party producers was obtained to make plant operations
economically attractive. However, we have been unsuccessful in locating a
locally available and adequate supply of high BTU natural gas and have elected
to dispose of the gas plant assets. Accordingly, our financial statements
reflect an impairment charge with respect to the carrying value of these assets.
Rio Bravo Energy LLC continues to serve as the parent company for Sonora
Pipeline LLC, as the one percent general partner of Marea Associates, L.P. and
owns a less than one percent minority interest in Terranova Energia, S. de R.L.
de C.V.
Sonora Pipeline, LLC
Sonora Pipeline, LLC was formed in January 1998 to operate the Sonora pipeline
network which has the capability of delivering adequate volumes of natural gas
for economic operation of the Chittim Gas Processing Plant. The pipeline network
consists of approximately 80 miles of gas pipeline. This pipeline network was
acquired in conjunction with the Chittim Gas Processing Plant acquisition and,
when operational, could generate revenue from transportation fees to be charged
to third party gas producers shipping natural gas to the gas plant owned by Rio
Bravo Energy LLC. As noted above, management has evaluated the carrying value of
these assets and has recorded an impairment charge in our financial statements
with respect to pipeline network in addition to the gas plant. These assets will
also be sold at a later date. In connection with the Mexican storage and
pipeline project mentioned above, Sonora Pipeline LLC is the applicant before
the Federal Energy Regulatory Commission for two U.S. pipelines that will
transport gas bidirectionally to/from the United States to Mexico at two
different international crossing points along the Rio Grande River in South
Texas. The Progreso pipeline segment will be approximately 8.7 miles long and
will commence at the existing Alamo station and extend southward and parallel an
existing FERC permitted pipeline route to the international crossing point near
4
the City of Progreso, Hidalgo County, Texas. The Mission pipeline segment will
be approximately 24.3 miles long and will commence at the existing HPL Valero
Gilmore plant in south Texas and extend southward in parallel to existing
pipelines to the international crossing point near the City of Mission, Hidalgo
County, Texas. Both pipeline segments are expected to be 30 inches in diameter.
Draft environmental reports are in the process of submittal and review and upon
completion of these activities we expect to file applications for Certificates
of Public Convenience and Necessity and seek Orders allowing the construction
and operation of these U.S. pipeline segments of our Burgos Hub Storage and
Pipeline project.
Sonterra Energy Corporation Business
The assets of our Sonterra Energy Corporation subsidiary consist of propane
distribution systems, including gas mains, yard lines, meters and storage tanks,
serving the following residential subdivisions in the Austin, Texas area. The
subdivisions include:
o Arbolago*
o Austin's Colony Phase II
o Costa Bella
o Hills of Lakeway
o Jacarandas
o Lake Pointe
o La Ventana
o Lakewinds Estates
o Northshore on Lake Travis Phase I
o Riverbend
o Rob Roy Rim
o Senna Hills
o Sterling Acres
o The Point
o The Preserve at Barton Creek
These subdivisions contain approximately 1,700 lots. At December 31, 2005, 1,067
of these lots are metered for use. There are approximately 633 unmetered future
lots within the above subdivisions where propane service can be connected. As
new homes are constructed on these lots our customer base will grow. An
additional component of future growth will come from the establishment of
propane distribution systems in other developments such as the recent agreement
between Sonterra and Cordillera Ranch Development Corp. in which Sonterra is
currently installing a tank site and gas mains to supply approximately 200 homes
in Units 201-204 of that subdivision. Future phases of lot development at
Cordillera Ranch will result in propane service being extended to approximately
300 more homes. Sonterra is in active negotiations for the installation of
propane distribution systems with other developers of residential lots in the
Texas Hill Country area between San Antonio and Austin, Texas
Sonterra is the exclusive seller of propane in these subdivisions and is not
considered a regulated utility. The Texas Railroad Commission regulates all
aspects of the production, transportation and processing of petroleum products,
including propane, in the State of Texas. Sonterra purchases propane products
from a number of distributors in Austin, Texas.
Competition
-----------
Reef Ventures, L.P. Eagle Pass Pipeline Crossing
Our Eagle Pass international pipeline crossing competes with a pipeline owned by
West Texas Gas, Inc. pipeline crossing which is located two miles north of Eagle
Pass. We believe that the West Texas Gas crossing will be able to compete with
us only marginally beginning in 2006 due to a very limited transmission
capability and marketing efforts currently being undertaken by Management.
5
Sonterra Energy Corporation Propane Distribution
Our propane distribution business is not subject to competition within the
residential subdivisions served because we are the sole propane supplier. The
residential subdivisions are subject to a propane supply covenant granting us
the exclusive supply of propane for each subdivision. In the future, we will
compete in the bidding process for new propane distribution systems as new
residential subdivisions are developed. We may also be able to acquire
additional existing propane distribution systems from competitors.
Employees
Tidelands has ten full time employees including our corporate officers. Our
Sonterra Energy subsidiary, which operates the Austin propane gas distribution
company, has eleven full-time employees.
ITEM 2. DESCRIPTION OF PROPERTIES
Reef Ventures, L.P. owns and operates the international natural gas pipeline and
related facilities located in Maverick County, Texas and Coahuila, Mexico.
Tidelands owns a 97% limited partnership interest and a 1% general partner
interest (thru Arrecefe Management LLC) in this entity. We acquired these
interests from Impact International, LLC. Impact financed our purchase of this
system and we owe Impact $ 4,496,768.
Rio Bravo Energy, LLC owns and operates the Chittim Gas Processing Plant which
is located in Maverick, County, Texas. The plant is currently shut down. The gas
plant has the capability to fractionate natural gas into commercial grade
propane and butane. In the near future, we expect to sell these assets.
Sonora Pipeline, LLC owns the Sonora Pipeline network consisting of
approximately 80 miles of pipeline. No significant encumbrances exist with
respect to the assets of this company. The pipeline is currently inactive and
could be used to transport natural gas from third party producers to supply
feedstock for the Chittim Gas Processing Plant owned by Rio Bravo Energy LLC. In
the near future, we expect to sell these assets. Sonora Pipeline LLC also plans
to construct, own and operate approximately 33 miles of thirty inch diameter
natural gas pipelines in Hidalgo County, Texas which will interconnect at the
U.S.-Mexico border with the pipeline and storage assets to be constructed, owned
and operated by Terranova Energia, S. de R.L. de C.V, another subsidiary of
Tidelands Oil & Gas Corporation.
Sonterra Energy Corporation operates a propane distribution systems providing
propane to 15 residential subdivisions in Austin, Texas. The propane
distribution system is comprised of approximately 25 miles of gas main pipe,
75,000 feet of yard lines, 850 meters and storage tanks with a combined capacity
of 156,000 gallons of LPG. Sonterra is currently constructing a propane
distribution system for approximately 200 residential units in Cordillera Ranch,
a rural subdivision located in Kendall County, Texas.
We lease our San Antonio executive office. We entered into this office lease on
August 1, 2003. The term expired November 30, 2005. We held over our tenancy in
the building under the month to month clause and renewed this lease on February
1, 2006 for a term until December 31, 2007. Our monthly lease payment is $3,400.
Our rent expense for 2005 was $40,800. Sonterra Energy Corporation entered into
a sublease agreement for its offices in an adjacent building for $2,500 per
month until its renewal in October 2005 at which time the rent increased to
$3,000 per month through March 31, 2006. However, on February 1, 2006, Sonterra
Energy Corporation entered into a direct lease with the building owner at a rent
of $3,300 per month for a term ending December 31, 2007. Sonterra's rent expense
for this office for 2005 was $31,500.
6
ITEM 3. 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.
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 ZG 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.
7
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
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 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
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.
8
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 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were brought to a vote of the security holders during the quarter
ended December 31, 2005.
9
PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS
ISSUER PURCHASES OF EQUITY SECURITIES
Market For Common Equity And Related Stockholder Matters
Our common stock is traded on the OTC Electronic Bulletin Board. The following
table sets forth the high and low bid prices of our common stock for each
quarter for the years 2005 and 2004. The quotations set forth below reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
represent actual transactions.
Common Stock
Our common stock trades Over-the-Counter (OTC) on the OTC Bulletin Board under
the symbol TIDE. Table 1. sets forth the high and low bid information for the
past two years. These quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission and may not represent actual transactions.
These quarterly trade and quote data provided by NASDAQ OTC Bulletin Board.
Table 1.
Bid Information
Fiscal Quarter Ended
High Low
December 31, 2005 1.01 0.76
September 30, 2005 1.39 0.80
June 30, 2005 1.77 0.95
March 31, 2005 2.59 1.74
December 31, 2004 1.36 0.60
September 30, 2004 2.18 0.73
June 30, 2004 3.18 1.70
March 31, 2004 4.45 1.72
On December 31, 2005, the closing bid and closing ask prices for shares of our
common stock in the over-the-counter market, as reported by NASD OTC BB were
$0.87 and $0.88 per share, respectively.
We believe that there are presently 39 market makers for our common stock. When
stock is traded in the public market, characteristics of depth, liquidity and
orderliness of the market may depend upon the existence of market makers as well
as the presence of willing buyers and sellers. We do not know if these or other
market makers will continue to make a market in our common stock. Further, the
trading volume in our common stock has historically been both sporadic and
light.
As of December 31, 2005, we had an aggregate of 86 stockholders of record as
reported by our transfer agent, Signature Stock Transfer Co., Inc. Certain
shares are held in the "street" names of securities broker dealers and we
estimate the number of stockholders which may be represented by such securities
broker dealer accounts may exceed 5,000.
Dividends and Dividend Policy
There are no restrictions imposed on the Company which limit its ability to
declare or pay dividends on its common stock, except as limited by state
corporation law. During the year ended December 31, 2005, no cash or stock
dividends were declared or paid and none are expected to be paid in the
foreseeable future.
10
We expect to continue to retain all earnings generated by our future operations
for the development and growth of our business. The Board of Directors will
determine whether or not to pay dividends in the future in light of our
earnings, financial condition, capital requirements and other factors.
Securities Authorized for Issuance under Equity Compensation Plans
The following table summarizes our equity compensation plan information as of
December 31, 2005. Information is included for equity compensation plans not
approved by our security holders.
Table 1.
Equity Compensation Plan Information
---------------------------- ------------------------ --------------------- -----------------------
Plan Category Number of Securities to Weighted-average Number of Securities
be issued upon exercise Exercise price of remaining available for
of outstanding options, outstanding options, future issuance under
warrants and rights warrants, and rights equity compensation
plans (excluding
securities reflected in
column (a)
(a) (b) (c)
---------------------------- ------------------------ --------------------- -----------------------
Equity Compensation
Plans approved by security
holders None None None
---------------------------- ------------------------ --------------------- -----------------------
Equity Compensation
Plans not approved by 5,000,000 (1) $ 0.287 -0-
security holders 5,000,000 (2) $ 0.87 4,350,122
---------------------------- ------------------------ --------------------- -----------------------
Total 10,000,000 4,350,122
---------------------------- ------------------------ --------------------- -----------------------
(1) On May 27, 2003, the Company adopted the 2003 Non-Qualified Stock Grant and
Option Plan. The Plan reserved 5,000,000 shares. The Plan is administered by our
Board of Directors. Directors, officers, employees consultants, attorneys, and
others who provide services to our Company are eligible participants.
Participants are eligible to be granted warrants, options, common stock as
compensation. We granted 210,122 shares from this plan during 2005, 200,000 for
legal services, 10,000 shares to Robert Dowies under the terms of his Employment
Agreement and 122 shares to James Smith as a part of his 150,000 share employee
bonus. The balance of this bonus was issued from the Plan outlined in footnote 2
below.
(2) On November 2, 2004, the company adopted the 2004 Non-Qualified Stock Grant
and Option Plan. The Plan reserved 5,000,000 shares. The Plan is administered by
our Board of Directors. Directors, officers, employees consultants, attorneys,
and others who provide services to our Company are eligible participants.
Participants are eligible to be granted warrants, options, common stock as
compensation. During 2005, we granted 148,878 shares to James Smith the balance
of his 150,000 share employee bonus.
Recent Sales of Unregistered Securities
All sales of unregistered securities have been previously reported in
our filed periodic reports filed with the Securities & Exchange Commission on
Forms 8-K and 10-QSB.
11
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
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.
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. and the sale of propane gas to residential
customers through the assets owned by Sonterra Energy Corporation. This company
also designs and constructs residential propane delivery systems for new
residential developments in Central Texas. We derive revenue from this activity
in two ways, the first being from construction revenue for yard lines and meter
sets installed to a homeowner's lot, and the second being the sale of LPG gas to
customers in the residential subdivisions.
With respect to our pipeline system owned by Reef Ventures, L.P., management is
has evaluated an expansion of the pipeline in Coahuila to serve new markets
along the state highway No. 57 corridor to Monclova, Coahuila. We currently
expect that Reef Ventures, L.P. will not be participating in the construction of
additional pipeline in Mexico to reach these new markets. The required pipeline
will be constructed by end users or an intermediate purchaser of the natural
gas. Reef Ventures, L.P. will simply continue to transport the additional
volumes of natural gas required for these markets through its existing
facilities which will be interconnected in Mexico to the new pipeline that is
required to reach these potential markets. Management believes the timeline for
the initiation of construction for such pipeline project in Mexico is likely to
be a 2007 event. The increased volume for the Reef Ventures pipeline from such
an event would approximate 2-3 times the entire baseload of demand for natural
gas currently taken by the local distribution company, CONAGAS.The expected end
users would be a brewery and bottling operation. While these entities have begun
feasibility studies for the construction and operation of their businesses, no
final decision has been made concerning the building of these facilities. There
is a risk that the facilities will never be built because other sites in Mexico
are deemed to be more advantageous for the location of these facilities. In that
event, the expected growth in volumes for the Reef Ventures pipeline will not
materialize. In addition to these potential developments, management believes
that increasing volumes of natural gas can be transported in its existing
facilities. In 2005, which was the final year of a two year contractual
nomination scheme, the Reef Ventures pipeline was carrying only half the actual
baseload volume (and none of the swing volume) being transported to CONAGAS in
Piedras Negras. We believe that if given adequate supplies, the Reef Ventures
pipeline can transport all the current base load and the swing requirements of
CONAGAS which would result in a doubling of volumes and revenues for the
pipeline. Negotiations are currently underway to achieve that objective. The
planned natural gas liquid line between Eagle Pass, Texas and Piedras Negras,
Coahuila has been re-evaluated in light of new supply sources emerging in Texas
and Mexico and the subsidy scheme for LPG and natural gas currently in use in
Mexico. It appears that the project will need to be developed as a
transportation fee business model instead of a merchant facility where LPG is
purchased in Texas and re-sold in a direct contract with the propane importation
arm of PEMEX. This determination was made in order to reduce the risk of any
future cost incurred on the LPG project. Management will continue to seek a
transportation contract which would support development and operation of this
project.
Sonterra Energy Corporation, a wholly owned subsidiary of Tidelands entered into
the residential propane distribution business on November 1, 2004 with its
acquisition of 850 existing customers located in 15 subdivisions in the vicinity
of Austin, Texas. At December 31, 2005, Sonterra had increased its number of
meter hookups to 1,067 and is expecting a 15% rate of increase in the number of
new meter hookups in 2006. Sonterra's existing and future market area includes
several central Texas locations that do not have access to natural gas as a fuel
for home heating and appliance usage. Current expansion of over 600 lots within
the existing subdivisions is possible. Sonterra has also entered into a new
agreements with the developers of Cordillera Ranch and Northshore at Lake Travis
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to expand the serviced lots by an additional 1,500 units over time. Active
negotiations with developers in our trade area will likely result in additional
lots becoming available for installation of residential propane delivery in the
nearby central Texas vicinity. Revenue growth from propane sold was $250,000
higher than projected primarily due to unit growth as opposed to price increases
applied to product sold. The principal risk in the growth picture for this
business unit comes from a slowing in the absorption rate for developed lots due
to the interest rate cycle. This in turn would slow the rate of meter hookups in
the subdivisions served.
Sonora Pipeline LLC will own and operate the U.S. (Texas) pipeline segments to
be constructed in connection with the Mexican pipeline, LNG regasification
terminal and gas storage projects which will interconnect to the U.S. via two
international pipeline crossings in Hidalgo County, Texas. Management will be
filing with the Federal Energy Regulatory Commission for permission to operate
these new pipelines and for the granting of presidential permits for the
international crossings near Mission and Progreso, Texas for delivery of natural
gas into the state of Tamaulipas and the pipelines owned by our Mexican
subsidiary, Terranova Energia S. de R.L. de C.V.
The Company is focusing on the development of infrastructure projects through
its Mexican entity, Terranova Energia S.de R.L. de C.V., in the nation of the
United Mexican States (Mexico). Terranova Energia is focused on project
development and implementation of a natural gas storage and transportation
infrastructure to support the integration of Northeastern Mexico and South Texas
and the related economic growth of the border regions.
Tidelands and Terranova Energia have hired project development advisors
in the United States and Mexico. The Terranova Energia advisors include ALB
Energia, Rich, Heather Muller, Abogados and Miriam Grunstein, Abogada. The
Tidelands advisors include Netherland Sewell & Associates, CenterPoint Energy,
LLC, Mayer Brown Rowe & Maw, LLP, BNC Engineering, LLC, HSBC Securities, USA,
Inc. and R.W. Beck, Inc.
The Terranova Energia project was developed to serve the need to of
CFE, the Mexican federal electricity commission, to manage swing and seasonal
spread in its procurement and dispatch of natural gas to its combined cycle
power plants in Northern Mexico. The region's forecasted growth will require
additional natural gas for power generation in the region. The same need to
manage swing and seasonal spread is present for the industrial users of natural
gas in Northern Mexico, in particular, the industrial users located in the
Monterrey, Nuevo Leon area.
Our project area is called the Burgos Hub and Storage Project. Our
medium term goals, subject to a variety of factors, including, but not limited
to, regulatory permitting, engineering design, financing, construction and
operating agreements, are focused on the Brasil storage field and Terranova
Occidente pipeline.
The pipelines proposed are (A) the Occidente Section comprised of: (1)
a pipeline from the Brasil Storage field to Nuevo Progresso, proposed
international pipeline crossing into the U.S., (2) a pipeline from Brasil
storage to Station 19 up to Arguelles which is another proposed international
pipeline crossing into U.S. and (3) a pipeline from Pemex's Station 19 south of
Reynosa which will extend southward to the Monterey Nuevo Leon area; and (B) the
Oriente Section from the offshore regasification station to Norte Puerto
Mezquital proceeding to the Brazil storage field. The Occidente Section will
include approximately 323 kilometers of pipeline and the Oriente Section will
contain approximately 149 kilometers of pipeline. Our long term goal includes
the construction of the offshore LNG regasification station.
The proposed international pipeline crossings into South Texas are the
Donna Station and Arguelles and VGP station. At the Donna station our potential
interconnects into Texas are with TETCO, TGPL and Texas Gas Services. At the
Arguelles and VGP station our potential interconnects are with HPL, Calpine and
Kinder Morgan. The Terranova pipeline capacity is estimated at 1.2 BCFD (billion
cubic feet per day).
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The Terranova pipelines have been designed for 30 and 36 inch diameter
with bi-directional flow. The pipeline from the proposed LNG regasification
terminal to the Brasil field is a 36 inch diameter pipeline and from the Brasil
field to Monterey and international crossings are 30 inch diameter pipelines.
We submitted the permit application for the Terranova pipeline
Occidente section to the CRE, the Mexican energy regulatory entity, on March 18,
2005 and they were accepted for full review on June 14, 2005. Management
understands that the average time for processing and receiving pipeline permits
is 15 months, accordingly, a decision concerning this permit application is
expected from the Comision Reguladora de Energia (CRE) in the second quarter of
2006.
The proposed underground natural gas storage facility will be located
in the depleted reservoir at the B1 Horizon-Brasil Field and include above
ground facilities. Our design proposal for the use of this depleted reservoir as
a storage facility was prepared by Netherland Sewell. Netherland Sewell, after
geological and mechanical modeling, reported the reservoir at the B1 horizon as
suitable for natural gas storage. The design capacity of the storage field
contemplates incremental increases in capacity over three seasons. The first
season capacity is 25 BCF (billion cubic feet), second season capacity is 40 BCF
and third season onward is 50 BCF. The design proposes that natural gas be
injected into the reservoir at 350 MMCFD(million cubic feet per day) at
pressures from 2,400 psi up to 3,200 psi. Extraction flows of natural gas will
be kept at 500 MMCFD to maintain structural integrity of the reservoir. The
storage facility plans call for 22 injection and extraction wells. The above
ground facilities will include compression stations.
We submitted the storage 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 CRE. As a
result, management has no reliable estimate concerning when this permit
application will be presented for decision by staff to the CRE Commissioners.
The proposed Offshore LNG Regasification Station will be based on
technology developed by the Norwegian company TORP Technology. It utilizes an
unmanned floating station called a HiLoad. It has a peak capacity of 1.4 BCFD
(billion cubic feet per day). This technology permits any LNG carrier vessel to
connect and carry out regasification operations without any vessel
modifications. It utilizes LNG vaporizers of the shell and tube type, with sea
water as the heating medium. The LNG station will be located no less than 40
nautical miles from the coast at a depth of 450 feet. A support station with a
power generation system and central control will be located on-shore. A buoy
will support the mooring of the LNG carrier vessels. Electrical power cables,
control umbilicals and pipelines will connect the HiLoad to the on-shore support
station.
There are significant challenges for the natural gas supply to the
power generation industry in Northeastern Mexico. We believe the CFE has taken a
proactive role in this region with a view to substantially improving the
reliability, flexibility and pricing of the natural gas supply. Presently, there
are three LNG regasification projects permitted or under construction in Mexico
at Altamira, Rosarito and Manzanillo. Additionally, there new electrical
generation plants and associated pipelines under construction. The CFE has
forecasted natural gas demand growth in the region from 2004 through year 2013.
The CFE forecasts gas demand will increase from 1.7 BCFD in 2004 to 4.2 BCFD in
2013. Natural gas storage facilities in northern Mexico will provide a reliable,
flexible gas supplies while creating conditions for competitive natural gas
pricing.
With the assistance of our financial advisory firm , we have determined that
financing of the project should be possible under a commercial structure
acceptable to debt providers that would involve long-term capacity reservation
agreements with creditworthy counterparties for each constituent element of the
project. Another essential factor that is critcal for the project's ability to
raise debt financing is the ability of Terranova to attract equity capital from
strategic and/or financial investors in the amounts which are likely to be
required by debt providers. Our financial advisory firm has assisted us in
making presentations of the project to the potential strategic and financial
equity investors. We have received positive feedback from several such parties.
On this basis, we could conclude that the project, in its currently envisioned
configuration, could attract considerable equity capital from the potential
investors. Investor appetite will depend on our ability to obtain an acceptable
14
commercial structure, relevant permits and other regulatory approvals and the
fulfillment of other conditions standard for non-recourse project financing.
We have undertaken a risk analysis of the project and have identified the
following project specific risks:
Construction Risks:
- Delays in completion within the budget
- Failure of the EPC contractor to meet the required
contractual performance levels
Operating Risks:
- Project performing below expected levels of
efficiency
- Increased operating costs due to insufficiency of
technology
- Delays due to inclement weather, breakdown or failure
of equipment and third party risks
Market risks:
- Cushion gas price exposure
Regulatory risks:
- Inability of Terranova to obtain the necessary
permits and/or rights of way
- Changes in the regulatory conditions and requirements
may directly affect the profitability of the project
Environmental risks:
- The construction and operation of the project may
result in adverse environmental or social impact,
which could delay completion of the construction,
curtail operation and result in payments of fines or
remediation.
Inflation risks:
- Increased operating costs adversely affecting the
project's earnings
Financial risks:
- Interest rate risk
- Foreign exchange risk
Political risks:
- The risks of expropriation, nationalization,
inability to obtain foreign exchange and transfer it
outside of the project country. (Also see "Sovreign
Risk" section in Risk Factors)
While the above risks are typically dealt with through contractual mechanisms in
project finance and other documents, no assurance can be had that these risks
will be successfully mitigated.
RESULTS OF OPERATIONS
REVENUES: The Company reported revenues of $1,861,323 for the twelve months
ended December 31, 2005 as compared with revenues from continuing operations of
$1,883,838 for the twelve months ended December 31, 2004. The primary
differences in year to year results occurred from the conversion of Reef
Ventures, L.P. income from gas sales to transportation fees. In the year ended
December 31, 2005, Reef Ventures sold no natural gas ($0) compared to $1,323,459
of gas sales for the twelve months ended December 31, 2004. However, Reef
Ventures, L.P. increased transportation fees to $231,077 for the twelve months
ended December 31, 2005 compared to transportation fees of $76,767 for the
twelve months ended December 31, 2004, an increase of $154,310. In addition, the
mix of revenues earned by Sonterra Energy Corporation showed a significant
change in terms of propane gas sales due to the reporting of a full year of
operations in 2005 versus three months for the 2004 year. Propane sales for
Sonterra Energy Corporation for the twelve months ended December 31, 2005 were
$1,494,679 compared to sales of $400,637 for the twelve months ended December
31, 2004, an increase of $1,094,042. Construction service revenues for Sonterra
Energy Corporation increased to $135,567 for the twelve months ended December
31, 2005 compared to $82,975 for the twelve months ended December 31, 2004, an
increase of $52,592.
TOTAL COSTS AND EXPENSES: Total costs and expenses from continuing operations
decreased from $31,626,135 for the twelve months ended December 31, 2004 (as
restated) to $15,171,916 for the twelve months ended December 31, 2005. The most
15
significant decreases occurred in Beneficial Conversion Feature Interest, Sales,
General and Administrative and Impairment Losses. Each of the decreases in these
categories of expenses resulted primarily from results related to the matters
discussed in Footnotes 1 and 2 of the financial statements for the year ended
December 31, 2005 and as described in the related sections below.
COST OF SALES: Total Cost of Sales decreased from $1,508,891 for the twelve
months ended December 31, 2004 to $1,003,386 for the twelve months ended
December 31, 2004. Due to the conversion of Reef Ventures, L.P. to a
transportation arrangement for its business versus the purchase and sale of
natural gas, its cost of sales decreased from $1,299,518 for the twelve months
ended December 31, 2004 to zero ($0) for the twelve months ended December 31,
2005. Cost of sales for Sonterra Energy Corporation rose from $209,373 for the
twelve months ended December 31, 2004 to $1,003,386 for the twelve months ended
December 31, 2005, an increase of $794,013. As stated in the Revenue discussion
above, this increase was primarily the result of twelve months of operations
reported in 2005 versus only three months of operations reported in 2004.
OPERATING EXPENSES: Operating expenses from continuing operations which are
expenses related to the operation of Company assets in an active business
segment increased from $99,665 for the twelve months ended December 31, 2004 to
$202,766 for the twelve months ended December 31, 2005 which is a total increase
of $103,101. This increase was primarily from the operating expenses incurred by
Sonterra Energy Corporation. Depreciation expense increased from $244,889 for
the the twelve months ended December 31, 2004 to $485,481 for the twelve months
ended December 31, 2005 due to a full year of depreciation being incurred in the
2005 year versus seven months of depreciation expense in 2004 on the natural gas
pipeline owned by Reef Ventures, L.P. and the depreciable assets acquired by
Sonterra Energy Corporation for the operation of the residential propane
distribution systems in Austin, Texas.
INTEREST EXPENSE: Interest expense increased from $300,566 during the twelve
months ended December 31, 2004 to $611,363 primarily due to twelve months of
carrying cost in 2005 for the debt incurred to acquire the natural gas pipeline
owned by Reef Ventures, L.P. versus seven months of interest cost reported in
the 2004 acquisition year for these assets. As described in Footnote 2, the
Company has restated its December 31, 2004 financial statements and all
subsequent quarterly financial statements to account for the cost of the
embedded beneficial conversion feature inherent in the convertible notes issued
to the MAG Capital, LLC investors on November 18, 2004. This beneficial
conversion feature represents the difference between the conversion price for
the debentures and the fair market value of the common stock at the commitment
date and subsequent quarterly measurement dates. This discount was charged to
interest expense because the conversion feature is at the option of the holder
and can be exercised at any time. The Company has accordingly recognized
interest expense in its restated December 31, 2004 financial statements in the
amount of $3,092,105 and ($756,329) for the twelve months ended December 31,
2005. The negative figure for 2005 interest expense recognizes the fluctuation
in the market price of the common stock into which the notes are converted at
the quarterly measurement dates. The interest cost associated with the issuance
and conversion of these debentures due to this beneficial conversion feature is
limited to the relevant 2004 and 2005 years due to the completed conversion of
all the debentures into common stock in the fourth quarter of 2005.
SALES, GENERAL AND ADMINISTRATIVE: Sales, General and Administrative expense for
the restated twelve months ended December 31, 2004 was $11,022,019. This amount
includes restated amounts for stock issued for services and finance costs
associated with the valuation of stock issued as part of the Impact
International LLC acquisition in 2004. Sales, General & Administrative expenses
for the twelve months ended December 31, 2005 was $8,033,249 which is a decrease
of $2,988,770 as compared to the twelve months ended December 31, 2004. During
2005, the Company recognized significant decreases in consulting fees and
finance costs which were offset by increased employee expenses, board of
director compensation, and overhead from full year operations of Sonterra Energy
Corporation in 2005.
IMPAIRMENT LOSSES: As described in Footnote 1, the Company has recognized
impairment of goodwill recorded in connection with the Impact International LLC
acquisition in the amount of $5,200,000 and the impairment of the carrying value
of the Chittim gas plant owned by Rio Bravo Energy LLC and the gas pipeline
system connecting to the Chittim gas plant owned by Sonora Pipeline LLC in the
amount of $392,000 for the twelve months ended December 31, 2005.
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GAIN ON REDUCTION OF WARRANT LIABILITY: As part of the Impact International LLC
acquisition in the year ended December 31, 2004, the Company issued warrants at
a conversion price less than the fair market value of the common stock issueable
upon the exercise of those warrants. Accordingly, the Company has restated its
December 31, 2004 financial statements to recognize both the additional goodwill
and the related warrant liability associated with that acquisition. An
evaluation of the difference between the price of the common stock and the
warrant exercise price on a quarterly basis was performed resulting in the Gain
on Reduction of Warrant Liability amounts shown in the restated December 31,
2004 financial statements ($15,390,000) and the amount shown in the December 31,
2005 financial statements ($5,168,000). The warrants originally issued in
connection with this acquisition have been exercised and all common stock
related to their exercise has been issued as of the end of the year December 31,
2005.
NET LOSS FROM OPERATIONS: Net loss of ($14,302,037) for the twelve months ended
December 31, 2004 decreased to ($7,662,904) for the twelve months ended December
31, 2005, a decrease in the amount of loss of $6,639,133. Included in the net
loss from operations is $4,022,525 of expenses for financing costs, investor
relations fees, legal fees, director fees and employee compensation paid by
issuance of common stock.
LIQUIDITY AND CAPITAL RESOURCES: Direct capital expenditures during the twelve
months ended December 31, 2005 totaled $2,040,386 as compared with $8,727,010
for the twelve months ended December 31, 2004. The increased capital
expenditures were composed of increased office furniture, equipment and
leasehold costs ($128,271), higher pre-construction costs regarding potential
international pipeline crossings and storage facilities in Mexico ($1,529,982),
machinery, equipment, trucks, autos and trailers for Sonterra Energy Corporation
($83,078), and storage tanks and main lines for propane distribution ($299,055).
Total debt decreased from $17,474,107 at December 31, 2004 (as restated) to
$5,722,322 at December 31, 2005. The decrease in total debt is primarily due to:
(1) reduction in the acquisition indebtedness created in the acquisition of the
Reef Ventures, L.P. partnership interests from Coahuila Pipeline LLC and Impact
International LLC and (2) the conversion of Convertible Debentures held by the
MAG Capital, LLC, formerly Mercator Advisory Group, LLC, funds, both which
events are described in Note 6 and Note 8 of the Consolidated Financial
Statements for the period ended December 31, 2005. Total debt as of December 31,
2005 and December 31, 2004 expressed as a percentage of the sum of total debt
and shareholders' equity was 42.45% and 77.93% respectively.
Net loss for the twelve months ended December 31, 2005 was ($7,662,904) a
decrease in net loss of 46% from the net loss of ($14,302,037) for the twelve
months ended December 31, 2004 (as restated). Diluted net loss per common share
decreased 59% to ($0.11). The net loss per share calculation for the twelve
months ended December 31, 2004 included an increase in actual and equivalent
shares outstanding.
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.
17
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK:
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.
RISK FACTORS
------------
In addition to the other information presented in this report, the following
should be considered carefully in evaluating our business or purchasing shares
of our common stock. Investing in our common stock involves a high degree of
risk. This report contains various forward looking statements that involve risk
and uncertainties. Our actual results may differ materially from the results
discussed in the forward looking statements. Factors that might cause such a
difference include, but are not limited to, those discussed below and elsewhere
in this report.
OPERATING LOSSES
We have had significant losses ever since starting business and we expect to
continue losing money for some time. To date, we have incurred significant
losses. For the year ended December 31, 2005, we lost $7,662,904 and for the
year ended December 31, 2004, we lost $14,302,037. These losses were caused
primarily by:
o Financing costs in connection with acquisitions made in prior
years and the issuance of convertible debentures;
o Limited volumes of gas transported through the international
pipeline crossing;
o Pre-development and operating expenses associated with the
development of additional pipeline and storage projects in
Mexico;
o Idle assets not producing revenue, such as the gas plant and
associated pipeline.
LIMITED OPERATING HISTORY.
We have a limited operating history and our financial health will be subject to
all the risks inherent in the establishment of a new business enterprise. The
likelihood of success of our company must be considered in the light of the
problems, expenses, difficulties, complications, and delays frequently
encountered in connection with the startup and growth of a new business, and the
competitive environment in which we will operate. Our success is dependent upon
the successful financing and development of our business plan. No assurance of
success is offered. Unanticipated problems, expenses, and delays are frequently
encountered in establishing a new business and marketing and developing
products. These include, but are not limited to, competition, the need to
develop customers and market expertise, market conditions, sales, marketing and
governmental regulation. The failure of the Company to meet any of these
conditions would have a materially adverse effect upon the Company and may force
the Company to reduce or curtail operations. No assurance can be given that the
Company can or will ever operate profitably.
WE DEPEND HEAVILY ON THE CONTINUED SERVICE OF OUR CHIEF EXECUTIVE OFFICER.
We place substantial reliance upon the efforts and abilities of Michael Ward,
our chief executive officer. The loss of Mr. Ward's services could have a
serious adverse effect on our business, operations, revenues or prospects. We
maintain key man insurance on his life in the amount of One Million Dollars.
RELIANCE ON MANAGEMENT.
All decisions with respect to the management of our Company will be made by our
Company's directors and officers. Accordingly, no person should purchase any
shares offered by this Prospectus unless the subscriber is willing to entrust
all aspects of management to the Directors and Officers of our Company. The loss
of their services could have a material adverse effect on our Company's business
and prospects.
18
TRADING IN OUR COMMON STOCK ON THE OTC BULLETIN BOARD MAY BE LIMITED.
Our common stock trades on the OTC Bulletin Board. The OTC Bulletin Board is not
an exchange. Trading of securities on the OTC Bulletin Board is often more
sporadic than the trading of securities listed on an exchange or NASDAQ. You may
have difficulty reselling any of the shares that you purchase from the selling
shareholders.
THERE HAS BEEN AN VOLATILE PUBLIC MARKET FOR OUR COMMON STOCK AND THE PRICE OF
OUR STOCK MAY BE SUBJECT TO FLUCTUATIONS.
We cannot assure you that a liquid transparent trading market for our common
stock will develop or be sustained. You may not be able to resell your shares at
or above the initial offering price. The market price of our common stock is
likely to be volatile and could be subject to fluctuations in response to
factors such as the following, most of which are beyond our control:
o operating results that vary from the expectations of
securities analysts and investors;
o changes in expectations as to our future financial
performance, including financial estimates by securities
analysts and investors;
o the operations, regulatory, market and other risks discussed
in this section;
o announcements by us or our competitors of significant
contracts, acquisitions, strategic partnerships, joint
ventures or capital commitments;
o announcements by third parties of significant claims or
proceedings against us; and
o future sales of our common stock.
In addition, the market for our stock has from time to time experienced extreme
price and volume fluctuations. These broad market fluctuations may adversely
affect the market price of our common stock.
OUR COMMON STOCK IS SUBJECT TO PENNY STOCK REGULATION.
Our common stock is subject to regulations of the Securities and Exchange
Commission relating to the market for penny stocks. The Securities Enforcement
and Penny Stock Reform Act of 1990 (the "Reform Act") also requires additional
disclosure in connection with any trades involving a stock defined as a "penny
stock" (generally, according to recent regulations adopted by the Commission,
any equity security that has a market price of less than $5.00 per share,
subject to certain exceptions), including the delivery, prior to any penny stock
transaction, of a disclosure schedule explaining the penny stock market and the
risks associated therewith. These regulations generally require broker-dealers
who sell penny stocks to persons other than established customers and accredited
investors to deliver a disclosure schedule explaining the penny stock market and
the risks associated with that market. These regulations also impose various
sales practice requirements on broker-dealers. The regulations that apply to
penny stocks may severely affect the market liquidity for our securities and
that could limit your ability to sell your securities in the secondary market.
RISKS RELATING TO LOW-PRICE STOCKS.
Because our stock is quoted on the NASD OTC Electronic Bulletin Board and
subject to the Penny Stock Regulations, an investor may find it difficult to
dispose of, or to obtain accurate quotations as to the market value of, our
Company's securities. The regulations governing low-priced or penny stocks could
limit the ability of broker-dealers to sell the Company's securities and thus
the ability of the purchasers of this Offering to sell their securities in the
secondary market.
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
19
offering before the time that offering is completed or otherwise terminated.
Additionally, we may not have a sufficient quantity of common stock capital if
all of the warrants are exercised and debentures converted. We would have to
amend our articles of incorporation and increase our authorized common stock
capital. 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.
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 may be necessary to raise additional funds through
equity or debt financings. Any equity financings 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. The Company anticipates that its
existing capital resources, together with the net proceeds of this Offering,
will be adequate to satisfy its operating expenses and capital requirements for
at least 6 months after the date of this Prospectus. However, such estimates may
prove to be inaccurate.
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. We believe that the Company will have sufficient cash provided by
operating activities and equity financing to fund planned capital expenditures
in the near future. 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.
WE CAN GIVE NO ASSURANCE REGARDING THE AMOUNTS OF CASH THAT WE WILL GENERATE.
The actual amounts of cash we generate will depend upon numerous factors
relating to our business which may be beyond our control, including:
o the demand for natural gas;
o profitability of operations;
o required principal and interest payments on any debt we may incur;
o the cost of acquisitions;
o our issuance of equity securities;
o fluctuations in working capital;
o capital expenditures;
o continued development of gas transportation network systems;
o prevailing economic conditions;
o government regulations.
WE DO NOT EXPECT TO PAY DIVIDENDS FOR SOME TIME, IF AT ALL.
No cash dividends have been paid on the Common Stock. We expect that any income
received from operations will be devoted to our future operations and growth. We
do not expect to pay cash dividends in the near future. Payment of dividends
would depend upon our profitability at the time, cash available for those
dividends, and other factors.
20
COMPETITION
Our Company will be competing with other established businesses that market
similar products. Many of these companies have greater capital, marketing and
other resources than we do. There can be no assurance that these or other
companies will not develop new or enhanced products that have greater market
acceptance than any that may be marketed by the Company. There can be no
assurance that our Company will successfully differentiate itself from its
competitors or that the market will consider our products to be superior or to
or more appealing than those of our competitors. Market entry by any significant
competitor may have an adverse effect on our sales and profitability. See
"Competition."
WE OPERATE IN HIGHLY COMPETITIVE MARKETS IN COMPETITION WITH A NUMBER OF
DIFFERENT COMPANIES.
We face strong competition in our geographic areas of operations. Our
competitors include major integrated oil companies, interstate and intrastate
pipelines. We compete with integrated companies that have greater access to raw
natural gas supply and are less susceptible to fluctuations in price or volume,
and some of our competitors that have greater financial resources may have an
advantage in competing for acquisitions or other new business opportunities.
GROWING OUR BUSINESS BY CONSTRUCTING NEW PIPELINES AND PROCESSING FACILITIES
SUBJECTS US TO CONSTRUCTION RISKS AND RISKS THAT RAW NATURAL GAS SUPPLIES WILL
NOT BE AVAILABLE UPON COMPLETION OF THE FACILITIES.
One of the ways we intend to grow our business is through the construction of
additions to our existing gathering systems, modification of our existing gas
processing plant and construction of new processing facilities. The construction
of gathering and processing facilities requires the expenditure of significant
amounts of capital, which may exceed our expectations. Generally, we may have
only limited raw natural gas supplies committed to these facilities prior to
their construction. Moreover, we may construct facilities to capture anticipated
future growth in production in a region in which anticipated production growth
does not materialize. As a result, there is the risk that new facilities may not
be able to attract enough raw natural gas to achieve our expected investment
return, which could adversely affect our results of operations and financial
condition.
A SIGNIFICANT COMPONENT OF OUR GROWTH STRATEGY WILL BE ACQUISITIONS AND WE MAY
NOT BE ABLE TO COMPLETE FUTURE ACQUISITIONS SUCCESSFULLY.
Our business strategy will emphasize growth through strategic acquisitions, but
we cannot assure you that we will be able to identify attractive or willing
acquisition candidates or that we will be able to acquire these candidates on
economically acceptable terms. Competition for acquisition opportunities in our
industry exists and may increase. Any increase in the level of competition for
acquisitions may increase the cost of, or cause us to refrain from, completing
acquisitions.
Our strategy of acquisitions is dependent upon, among other things, our ability
to obtain debt and equity financing and possible regulatory approvals. Our
ability to pursue our growth strategy may be hindered if we are not able to
obtain financing or regulatory approvals, including those under federal and
state antitrust laws. Our ability to grow through acquisitions and manage such
growth will require us to invest in operational, financial and management
information systems and to attract, retain, motivate and effectively manage our
employees. The inability to manage the integration of acquisitions effectively
could have a material adverse effect on our financial condition, results of
operations and business. Pursuit of our acquisition strategy may cause our
financial position and results of operations to fluctuate significantly from
period to period.
IF WE ARE UNABLE TO MAKE ACQUISITIONS ON ECONOMICALLY AND OPERATIONALLY
ACCEPTABLE TERMS, OUR FUTURE FINANCIAL PERFORMANCE MAY BE LIMITED.
There can be no assurance that:
21
o we will identify attractive acquisition candidates in the
future;
o we will be able to acquire assets on economically acceptable
terms;
o any acquisitions will not be dilutive to earnings and
operating surplus; or
o any debt incurred to finance an acquisition will not affect
our ability to make distributions to you.
If we are unable to make acquisitions on economically and operationally
acceptable terms, our future financial performance will be limited to the
performance of our present gas gathering network.
Our acquisition strategy involves many risks, including:
o difficulties inherent in the integration of operations and
systems;
o the diversion of management's attention from other business
concerns; and
o the potential loss of key employees of acquired businesses.
In addition, future acquisitions may involve significant expenditures. Depending
upon the nature, size and timing of future acquisitions, we may be required to
secure financing. We cannot assure you that additional financing will be
available to us on acceptable terms.
OUR BUSINESS IS DEPENDENT UPON PRICES AND MARKET DEMAND FOR NATURAL GAS AND
PROPANE, WHICH ARE BEYOND OUR CONTROL AND HAVE BEEN EXTREMELY VOLATILE.
We are subject to significant risks due to fluctuations in commodity prices,
primarily with respect to the prices of gas that we may own as a result of our
processing and distribution activities.
The markets and prices for residue gas depend upon factors beyond our control.
These factors include demand for oil, and natural gas, which fluctuate with
changes in market and economic conditions and other factors, including:
o the impact of weather on the demand for oil and natural gas;
o the level of domestic oil and natural gas production;
o the availability of imported oil and natural gas;
o the availability of local, intrastate and interstate
transportation systems;
o the availability and marketing of competitive fuels;
o the impact of energy conservation efforts; and
o the extent of governmental regulation and taxation.
WE GENERALLY DO NOT OWN THE LAND ON WHICH OUR PIPELINES ARE CONSTRUCTED AND WE
ARE SUBJECT TO THE POSSIBILITY OF INCREASED COSTS FOR THE LOSS OF LAND USE.
We generally do not own the land on which our pipelines are constructed.
Instead, we obtain the right to construct and operate the pipelines on other
people's land for a period of time. If we were to lose these rights, our
business could be affected negatively.
RISKS RELATED TO THE RETAIL PROPANE AND ASSOCIATED BUSINESSES
o Decreases in the demand for propane because of warmer weather
may adversely affect our financial condition and results of
operations.
o Weather conditions have a significant impact on the demand for
propane for heating purposes. All of our propane customers
rely heavily on propane as a heating fuel. The volume of
propane sold is at its highest during the six-month peak
heating season of October through March and is directly
affected by the severity of the winter weather. We estimate
22
that approximately two-thirds of our annual retail propane
volume will be sold during these months. Actual weather
conditions can vary substantially from quarter to quarter and
year to year, significantly affecting our financial
performance. Furthermore, warmer than normal temperatures in
our service area can significantly decrease the total volume
of propane we sell. Consequently, our operating results may
vary significantly due to actual changes in temperature.
Weather conditions in any quarter or year may have a material
adverse effect on our operations.
o Sudden and sharp propane price increases that cannot be passed
on to customers may adversely affect our profits, income, and
cash flow.
o Energy efficiency and technology may reduce the demand for
propane and our revenues.
o The national trend toward increased conservation and
technological advances, including installation of improved
insulation and the development of more efficient furnaces and
other heating devices, has adversely affected the demand for
propane by retail customers. Future conservation and
efficiency measures or technological advances in heating,
conservation, energy generation, or other devices might reduce
demand for propane and our revenues.
o The propane business is highly regulated. New or stricter
environmental, health, or safety regulations may increase our
operating costs and reduce our net income.
o The propane business is subject to a wide range of federal,
state, and local environmental, transportation, health and
safety laws and regulations governing the storage,
distribution, and transportation of propane. We may have
increased costs in the future due to new or stricter safety,
health, transportation, and environmental regulations or
liabilities resulting from non compliance with operating or
other regulatory permits. The increase in any such costs may
reduce our net income.
o We will be subject to all operating hazards and risks normally
associated with handling, storing, transporting, and
delivering combustible liquids such as propane for use by
consumers. As a result, we may be a defendant in various legal
proceedings and litigation arising in the ordinary course of
business. Our insurance may not be adequate to protect us from
all material expenses related to potential future claims for
personal injury and property damage or that insurance will be
available in the future at economical prices. In addition, the
occurrence of a serious accident, whether or not we are
involved, may have an adverse effect on the public's desire to
use our products.
GOVERNMENT REGULATION AND ENVIRONMENTAL MATTERS
Our business is regulated by certain local, state and federal laws and
regulations relating to the exploration for, and the development, production,
marketing, pricing, transportation and storage of, natural gas and oil. We are
also subject to extensive and changing environmental and safety laws and
regulations governing plugging and abandonment, the discharge of materials into
the environment or otherwise relating to environmental protection. In addition,
we are subject to changing and extensive tax laws, and the effect of newly
enacted tax laws cannot be predicted. The implementation of new, or the
modification of existing, laws or regulations, including regulations which may
be promulgated under the Oil Pollution Act of 1990, could have a material
adverse effect on the Company.
FEDERAL, STATE OR LOCAL REGULATORY MEASURES COULD ADVERSELY AFFECT OUR BUSINESS.
While the Federal Energy Regulatory Commission, or FERC, does not directly
regulate the major portions of our operations, federal regulation, directly or
indirectly, influences certain aspects of our business and the market for our
products. As a raw natural gas gatherer and not an operator of interstate
transmission pipelines, we generally are exempt from FERC regulation under the
23
Natural Gas Act of 1938, but FERC regulation still significantly affects our
business. In recent years, FERC has pursued pro-competition policies in its
regulation of interstate natural gas pipelines. However, we cannot assure you
that FERC will continue this approach as it considers proposals by pipelines to
allow negotiated rates not limited by rate ceilings, pipeline rate case
proposals and revisions to rules and policies that may affect rights of access
to natural gas transportation capacity.
While state public utility commissions do not regulate our business, state and
local regulations do affect our business. We are subject to ratable take and
common purchaser statutes in the states where we operate. Ratable take statutes
generally require gatherers to take, without undue discrimination, natural gas
production that may be tendered to the gatherer for handling. Similarly, common
purchaser statutes generally require gatherers to purchase without undue
discrimination as to source of supply or producer. These statutes are designed
to prohibit discrimination in favor of one producer over another producer or one
source of supply over another source of supply. These statutes also have the
effect of restricting our right as an owner of gathering facilities to decide
with whom we contract to purchase or transport natural gas. Federal law leaves
any economic regulation of raw natural gas gathering to the states, and some of
the states in which we operate have adopted complaint-based or other limited
economic regulation of raw natural gas gathering activities. States in which we
operate that have adopted some form of complaint-based regulation, like
Oklahoma, Kansas and Texas, generally allow natural gas producers and shippers
to file complaints with state regulators in an effort to resolve grievances
relating to natural gas gathering access and rate discrimination. The states in
which we conduct operations administer federal pipeline safety standards under
the Pipeline Safety Act of 1968, and the "rural gathering exemption" under that
statute that our gathering facilities currently enjoy may be restricted in the
future. The "rural gathering exemption" under the Natural Gas Pipeline Safety
Act of 1968 presently exempts substantial portions of our gathering facilities
from jurisdiction under that statute, including those portions located outside
of cities, towns, or any area designated as residential or commercial, such as a
subdivision or shopping center.
OUR BUSINESS INVOLVES HAZARDOUS SUBSTANCES AND MAY BE ADVERSELY AFFECTED BY
ENVIRONMENTAL REGULATION.
Many of the operations and activities of our gathering systems, plants and other
facilities are subject to significant federal, state and local environmental
laws and regulations. These include, for example, laws and regulations that
impose obligations related to air emissions and discharge of wastes from our
facilities and the cleanup of hazardous substances that may have been released
at properties currently or previously owned or operated by us or locations to
which we have sent wastes for disposal. Various governmental authorities have
the power to enforce compliance with these regulations and the permits issued
under them, and violators are subject to administrative, civil and criminal
penalties, including civil fines, injunctions or both. Liability may be incurred
without regard to fault for the remediation of contaminated areas. Private
parties, including the owners of properties through which our gathering systems
pass, may also have the right to pursue legal actions to enforce compliance as
well as to seek damages for non-compliance with environmental laws and
regulations or for personal injury or property damage.
There is inherent risk of the incurrence of environmental costs and liabilities
in our business due to our handling of natural gas and other petroleum products,
air emissions related to our operations, historical industry operations, waste
disposal practices and the prior use of natural gas flow meters containing
mercury. In addition, the possibility exists that stricter laws, regulations or
enforcement policies could significantly increase our compliance costs and the
cost of any remediation that may become necessary. We cannot assure you that we
will not incur material environmental costs and liabilities. Furthermore, we
cannot assure you that our insurance will provide sufficient coverage in the
event an environmental claim is made against us.
Our business may be adversely affected by increased costs due to stricter
pollution control requirements or liabilities resulting from non-compliance with
required operating or other regulatory permits. New environmental regulations
might adversely affect our products and activities, including processing,
storage and transportation, as well as waste management and air emissions.
Federal and state agencies also could impose additional safety requirements, any
of which could affect our profitability.
24
RISK OF ADDITIONAL COSTS AND LIABILITIES RELATED TO ENVIRONMENTAL AND SAFETY
REGULATIONS AND CLAIMS
Our pipeline operations are subject to various federal, state and local
environmental, safety, health and other laws, which can increase the cost of
planning, designing, installing and operating such facilities. There can be no
assurance that costs and liabilities relating to compliance will not be incurred
in the future. Moreover, it is possible that other developments, such as
increasingly strict environmental and safety laws, regulations and enforcement
policies thereunder, and claims for damages to property or persons resulting
from our operations, could result in additional costs to and liabilities for us.
GOVERNMENTAL REGULATION OF OUR PIPELINES COULD INCREASE OUR OPERATING COSTS
Currently our operations involving the gathering of natural gas from wells are
exempt from regulation under the Natural Gas Act. Section 1(b) of the Natural
Gas Act provides that the provisions of the Act shall not apply to facilities
used for the production or gathering of natural gas. Our physical dimensions and
operations support the conclusion that our facilities perform primarily a
gathering function. We should not, therefore, be subject to Natural Gas Act
regulation. There, however, can be no assurance that this will remain the case.
The Federal Energy Regulatory Commission's oversight of entities subject to the
Natural Gas Act includes the regulation of rates, entry and exit of service,
acquisition, construction and abandonment of transmission facilities, and
accounting for regulatory purposes. The implementation of new laws or policies
that would subject us to regulation by the Federal Energy Regulatory Commission
under the Natural Gas Act could have a material adverse effect on our financial
condition and operations. Similarly, changes in the method or circumstances of
operation, or in the configuration of facilities, could result in changes in our
regulatory status.
Our gas gathering operations are subject to regulation at the state level, which
increases the costs of operating our pipeline facilities. Matters subject to
regulation include rates, service and safety. We have been granted an exemption
from regulation as a public utility in Texas. Presently, our rates are not
regulated in Texas. Changes in state regulations, or our status under these
regulations due to configuration changes in our operating facilities, that
subject us to further regulation could have a material adverse effect on our
financial condition. Litigation or governmental regulation relating to
environmental protection and operational safety may result in substantial costs
and liabilities.
Our operations are subject to federal and state environmental laws under which
owners of natural gas pipelines can be liable for clean-up costs and fines in
connection with any pollution caused by the pipelines. We can also be liable for
clean-up costs resulting from pollution which occurred before our acquisition of
the gathering systems. In addition, we are subject to federal and state safety
laws that dictate the type of pipeline, quality of pipe protection, depth,
methods of welding and other construction-related standards. While we believe
that the gathering systems comply in all material respects with applicable laws,
we cannot assure you that future events will not occur for which we may be
liable. Possible future developments, including stricter laws or enforcement
policies, or claims for personal or property damages resulting from our
operations could result in substantial costs and liabilities to us.
SOVEREIGN RISK
The Company is focusing on the development of infrastructure projects through
its Mexican entity, Terranova Energia S.de R.L. de C.V., in the nation of the
United Mexican States (Mexico). The risk of indirect or regulatory actions by
local, state or federal authorities in Mexico which may inhibit, delay, hinder
or block projects under development in Mexico is very high given the history of
operations conducted by past businesses other than the Company in Mexico. There
is a substantial risk that a set of actions taken by commission or omission by
the various actors in the public, private, nongovernmental and/or social sectors
could negatively impact a project or investment in Mexico. The legal system
25
employed in Mexico is dramatically different in its structure and method of
operation compared to the common law foundation present in the United States of
America. The level of legal protection afforded investors by the North American
Free Trade Agreement has not materially improved from a foreign investor's
viewpoint.
There can be no assurance that a commercially viable project will be completed
due to the above factors which could result in commercial competitors trying to
circumvent the market system through the exploitation of undocumented,
extraofficial channels of influence that constitute unfair competition. Federal,
state and local authorities are not well coordinated in their legal protections
and improper influence and competition may arise from any level of government to
disrupt or destroy the commercial viability of investments by foreign investors.
While the Company has taken precautions to limit its investments to prudent
levels, there is a continuing risk of adverse activities arising from the above
sources that could impair or result in the entire loss of investment in
otherwise commercially viable projects initiated by the Company in Mexico.
PIPELINE SYSTEM OPERATIONS ARE SUBJECT TO OPERATIONAL HAZARDS AND UNFORESEEN
INTERRUPTIONS
The operations of our pipeline systems are subject to hazards and unforeseen
interruptions, including natural disasters, adverse weather, accidents or other
events, beyond our control. A casualty occurrence might result in injury and
extensive property or environmental damage. Although we intend to maintain
customary insurance coverages for gathering systems of similar capacity, we can
offer no assurance that these coverages will be sufficient for any casualty loss
we may incur.
OPERATING RISKS OF NATURAL GAS OPERATIONS
The natural gas business involves certain operating hazards. The availability of
a ready market for our natural gas products also depends on the proximity of
reserves to, and the capacity of, natural gas gathering systems, pipelines and
trucking or terminal facilities. As a result, substantial liabilities to third
parties or governmental entities may be incurred, the payment of which could
reduce or eliminate the funds available for exploration, development or
acquisitions or result in the loss of the Company's properties. In accordance
with customary industry practices, the Company maintains insurance against some,
but not all, of such risks and losses. The Company does not carry business
interruption insurance. The occurrence of such an event not fully covered by
insurance could have a material adverse effect on the financial condition and
results of operations of the Company.
OUR BUSINESS INVOLVES MANY HAZARDS AND OPERATIONAL RISKS, SOME OF WHICH MAY NOT
BE COVERED BY INSURANCE.
Our operations are subject to the many hazards inherent in the gathering,
compressing, treating and processing of raw natural gas and NGLs and storage of
residue gas, including ruptures, leaks and fires. These risks could result in
substantial losses due to personal injury and/or loss of life, severe damage to
and destruction of property and equipment and pollution or other environmental
damage and may result in curtailment or suspension of our related operations. We
are not fully insured against all risks incident to our business. If a
significant accident or event occurs that is not fully insured, it could
adversely affect our operations and financial condition.
INSURANCE
Companies engaged in the petroleum products distribution and storage business
may be sued for substantial damages in the event of an actual or alleged
accident or environmental contamination. The Company maintains $2,000,000 of
liability insurance. There can be no assurance that we will be able to continue
to maintain liability insurance at a reasonable cost in the future, or that a
potential liability will not exceed the coverage limits. Nor can there be any
assurance that the amount of insurance carried by us will enable it to satisfy
any claims for which it might be held liable resulting from the conduct of its
business operations.
26
ITEM 7. FINANCIAL STATEMENTS
Index to Financial Statements
Independent Accountant's Report..........................................
Financial Statements
Balance Sheets....................................................
Statements of Operations..........................................
Statements of Stockholder's Equity................................
Statements of Cash Flows..........................................
Notes to Financial Statements.....................................
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 8A. CONTROLS AND PROCEDURES.
CONTROLS AND PROCEDURES
(a) Evaluation Of Disclosure Controls And Procedures.
Item 308(a)(3) of Regulation S-B states that "Management is not
permitted to conclude that the small business issuer's internal control over
financial reporting is effective if there are one or more material weaknesses in
the small business issuer's internal control over financial reporting." As a
result of the restatements to our December 31, 2004 financial statements and our
quarterly reports for the periods ending March 31, June 30 and September 30,
2006, as disclosed in our Current Report on Form 8-K and described under
Footnote 2 to our December 31, 2005 financial statements contained herein, our
Chief Executive Officer and Principal Accounting Officer, can no longer conclude
that after evaluating the effectiveness of our "disclosure controls and
procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e)
and 15d-15(e)) as of the end of the period covered by this Report on Form
10-KSB, that our disclosure controls and procedures were effective to provide
reasonable assurance that information we are required to disclose in reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.
However, the Company believes that its restatement to its December 31,
2004 financial statements and restatements to quarterly reports for March 31,
June 30 and September 30, 2005 financial statements, will be a one time
occurrence and that moving forward our Controls and Procedures will once again
be effective as the embedded derivative accounting matters contained in the
December 31, 2004, March 30, June 30 and September 30, 2005 financial statements
involved a highly complex transaction involving an "unconventional" warrants and
convertible debt instruments, and the Company does not anticipate entering into
any additional complex financing transactions involving derivates in the future.
The Company is utilizing the guidelines communicated to it by the SEC after
various communications regarding accounting for derivatives.
(b) Changes In Internal Control Over Financial Reporting.
There were no significant changes in our internal control over
financial reporting during the last fiscal year and/or up to and including the
date of this filing (except as disclosed in (a) above) that we believe
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
27
(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. 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.
ITEM 8B. OTHER INFORMATION: None
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS:
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Date became director
Name Age Position or officer
--------------------------------------------------------------------------------
Michael Ward 50 Director, President, CEO October 21, 1998
James B. Smith, C.P.A. 52 Director, CFO, Sr. V.P. August 16, 2003
Ahmed Karim 33 Director, Vice President October 21, 1998
Robert Dowies 55 V.P. October 18, 2004
Carl Hessel 42 Director January 28, 2004
MICHAEL WARD: Mr. Ward is the President, Chief Executive Officer and Chairman of
our Board of Directors. Michael Ward has served in his present capacities since
October 21, 1998. He is Vice President and Chief Executive Officer of Tidelands
Gas Corporation. He is a Manager and Vice President of Development of Rio Bravo
Energy, LLC. Mr. Ward has more than 25 years of diversified experience as an oil
and gas professional. He was educated in business management and administration
at Southwest Texas State University and the University of Texas. He has wide
experience in the capacity in which he successfully served in operating oil and
gas companies in the United States. During the past 20 years, he has been
associated with Century Energy Corporation where his duties and responsibilities
were production and drilling superintendent and supervised 300 re-completions
and new drills in Duval County, Texas. In association with Omega Minerals, Inc.,
where he was vice president and part owner, he operated 65 wells in 23 counties
in South and West Texas: 17 wells in Seminole and Osage Counties, Oklahoma, 44
wells in Neosho and Wilson Counties, Kansas and 125 wells in Brown, Pike,
Schuyler and Scott Counties. Illinois. He was president and owner of Major
Petroleum Company. He drilled, completed and produced 42 wells in South and West
Texas counties. The company was sold. With Tidelands Oil Corporation, his duties
included supervising and performing remedial well work, work-overs and economic
evaluation of the corporate properties. The primary area of interest was in
Maverick County, Texas. He has performed project financing analysis and
consulting of refinery acquisitions for the Yemen government.
28
JAMES B. SMITH: On August 16, 2003, we employed James B. Smith to act as a
Senior Vice President and Chief Financial Officer. Mr. Smith received a Bachelor
of Science from Texas A&M University and a Master of Professional accounting
degree from the McCombs School of Business at the University of Texas, Austin.
He is licensed as a Certified Public Accountant in Texas and Colorado. From 1996
through 2001, he directed the financial affairs and tax planning for several
closely held corporations engaged in land development in Colorado. From 2000
through 2003, he served as Chief Financial Officer for Starr Produce Company, a
major produce company with significant subsidiaries in real estate development
and agri-business.
AHMED KARIM: Mr. Karim Vice President and director of the Company. He is a
graduate of Simon Fraser University. He holds a degree in Business
Administration, specializing in marketing and international business. Since 1995
his business experience includes work with Quest Investments Group and
Interworld Trade and Finance where his responsibilities included marketing,
finance and investor relations.
ROBERT W. DOWIES: On October 18, 2004, we employed Robert W. Dowies as our Vice
President of Gas Markets and Supply. Mr. Dowies has 30 years experience in the
energy marketing. Ten years as the owner of a natural gas trading company and 20
years with a public utility. Until his employment with Tidelands Oil & Gas
Corporation, since 1998, Mr. Dowies worked for Trebor Energy Resources, Inc. in
Houston, Texas. His principal responsibilities were the development of financial
alliances with various energy merchants and producers providing a $50 million
dollar credit support for gas marketing activities, financial trading accounts,
pipeline transportation agreements, storage strategies and capital projects. He
developed and implemented marketing strategies which resulted in $40 million
dollars of annual revenue. He designed and coordinated the construction and
implementation of a natural gas gathering system. We entered into a three year
employment contract paying him an annual salary of $100,000 which includes an
annual stock grant of 100,000 shares.
CARL HESSEL: On January 28, 2004, Mr. Hessel joined our board of directors. Mr.
Hessel founded Margaux Investment Management Group, S.A. which is located in
Geneva, Switzerland in 2001. Prior to 2001, he served as Vice President of
Merrill Lynch were he was responsible for creating global high net worth
management platform. He began his career at Goldman Sachs and help build the
Scandinavian ultra-high net worth market. Mr. Hessel received his M.B.A. from
Wharton Business School and a degree in Finance and Management from the
University of Pennsylvania. He was awarded the Marcus Wallenberg Foundation's
Scholarship.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors and executive officers, and persons who own more than 10% of the
Company's Common Stock, to file with the Securities and Exchange Commission
initial reports of beneficial ownership and reports of changes in beneficial
ownership of Common Stock of the Company. Officers, directors and greater than
10% shareholders are required by the Securities and Exchange Commission to
furnish the Company with copies of all section 16(a) reports they file. Based
solely on copies of such forms furnished as provided above, or written
representations that no Forms 5 were required, the Company believes that during
the fiscal year ended December 31, 2005 all Section 16(a) filing requirements
applicable to its executive officers, directors and beneficial owners of more
than 10%of its Common Stock were complied with, except as follows:
1. Michael Ward, Ahmed Karim, Carl Hessel and Robert Dowies did not file Forms 5
during 2005.
2. James Smith filed on late Form 4 on November 11, 2005 for a June 27, 2005
transaction.
ITEM 10. EXECUTIVE COMPENSATION
The following sets forth the compensation of the officers of the
Company in the year ended December 31, 2005.
29
Summary Compensation.
The following table sets forth the compensation paid by the Company during
fiscal year 2005 to its officers. This information includes the dollar value of
base salaries, bonus awards and number of stock options granted, and certain
other compensation, if any.
Table 1.
Stock
Underlying Stock
Name and Position Year Salary Bonus Options Grants
Michael Ward, Pres.(1) 2005 $252,000 $10,500 -0- 1,150.000
James Smith, V.P,CFO(2) 2005 $168,000 $19,500 -0- 650,000
Ahmed Karim, V.P.(3) 2005 -0- -0- -0- 150,000
Robert Dowies (4) 2005 $100,000 $ 4,167 -0- 100,000(3)
(1) Mr. Ward received a stock grant of 1,000,000 common shares under the terms
of his employment agreement. He also received 150,000 common shares as director
fees.
(2) Mr. Smith received a stock grant of 500,000 common shares under the terms of
his employment agreement and a bonus stock grant of 150,000 shares. Mr. Smith
joined the board of directors on June 27, 2005.
(3) Mr. Karim received $36,000 compensation as a director including a stock
grant of 150,000 common shares. Mr. Karim resigned his position as Vice
President on June 27, 2005.
(4) Mr. Dowies received a stock grant of 100,000 common shares under the terms
of his employment agreement.
Executive Officer Compensation
During 2005, the Company had four executive officers, Michael Ward, James B.
Smith, Ahmed Karim and Robert Dowies. Michael Ward's was paid $252,000 salary
and a bonus of $10,500. James B. Smith was paid $168,000, plus an $19,500 bonus.
Messrs. Ward and Smith have new and different employment agreements for 2004
discussed below in the Employment Agreement paragraph. During 2005, Michael Ward
received 1,000,000 shares of common stock as his annual stock grant under the
terms of his employment agreement and 150,000 common shares as directors fees.
Mr. Smith received 500,000 common shares as his annual stock grant under the
terms of his employment agreement and 150,000 shares as a stock grant bonus.
During 2005, we paid Mr. Dowies $104,,167 which consisted of his annual salary
of $100,000, a $4,167 dollar bonus and his annual stock grant of 100,000 shares.
Mr. Dowies employment agreement stock grant vested on April 18, 2005.
Mr. Karim did not receive any officer salary during 2005. Mr. Karim resigned as
a Vice President on June 27, 2005. We paid Mr. Karim $36,000 and granted 150,000
common shares as director compensation for 2005.
Director Compensation
On April 11, 2001, the Company agreed to compensate Ahmed Karim, a director, for
services provided at the rate of $5,000 per month until June 30, 2003 and $3,000
per month thereafter. For the year ended December 31, 2005, we incurred $36,000
for cash director compensation and issued a total of 450,000 common shares to
three directors, Michael Ward, Ahmed Karim and Carl Hessel. We plan to
compensate directors with an annual stock grant of 150,000 shares each.
Committees of the Board of Directors
Tidelands does not have a Compensation committee. The Board of Directors acts as
the Compensation Committee. Tidelands has no compensation written policies
outlining factors and criteria underlying awards or payments in relation to
executive officers.
30
Employment and Consulting Agreements with Management
The Company has entered into employment agreements with the following officers:
MICHAEL WARD - Under the terms of Mr. Ward's employment agreement, commencing
January 1, 2004, he was employed as the Company's President and Chief Executive
Officer for a term of five (5) years. His base annual salary is $252,000. The
annual salary may be increased from year to year, as determined by our board of
directors acting as the Compensation Committee, by at least the Consumer Price
Index. As additional compensation, Mr. Ward will be entitled to an annual stock
grant of One Million (1,000,000) shares. Stock grant dates are June 30 and
December 31 each year. As incentive compensation, Mr. Ward will be entitled to
additional compensation equal to two percent of our net profits and one percent
of the increase in sales over a previous year's sales, effective with the fiscal
year ending 2004. Mr. Ward is entitled to all employee benefits as provided by
the Company. He is entitled to four weeks paid vacation and an annual automobile
allowance of $12,000.
JAMES B. SMITH: Under the terms of Mr. Smith's employment agreement, commencing
October 1, 2004, he was employed as the Company's Senior Vice President and
Chief Financial Officer for a term of four (4) years. His base annual salary is
$168,000. The annual salary may be increased from year to year, as determined by
our board of directors acting as the Compensation Committee, by at least the
Consumer Price Index. As additional compensation, Mr. Smith will be entitled to
an annual stock grant of Five Hundred (500,000) shares. Stock grant dates are
October 1 during the four year term. The first year stock grant was paid October
1, 2004. As incentive compensation, Mr. Smith will be entitled to additional
compensation equal to two percent of our net profits and one percent of the
increase in sales over a previous year's sales, effective October 1, 2004. Mr.
Smith is entitled to all employee benefits as provided by the Company. He is
entitled to four weeks paid vacation and an annual automobile allowance of
$12,000. Mr. Smith joined our board of directors on June 27, 2005.
ROBERT W. DOWIES: We employed Mr. Dowies on October 26, 2004 as our Vice
President of Gas Markets and Supply. His employment agreement is for a term of
three (3) years. His annual salary is $100,000. He is entitled to an annual
stock grant of 100,000 common shares. The first 50,000 shares will vest and be
payable April 18, 2005. Thereafter, stock grants will be payable every six
months, October 18 and April 18 for the term of the employment agreement. Mr.
Dowies is entitled to two (2) weeks paid vacation and all employee benefits as
provided by the Company.
Code of Ethical Conduct
Our board of directors adopted a Code of Ethical Conduct which applies to all
our Company directors, officers and employees, including our principal executive
officer and principal financial officer, principal accounting officer or
comptroller, or other persons performing similar functions.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
PRINCIPAL SHAREHOLDERS
The following table sets forth the Common Stock ownership information as of
December 31, 2005, with respect to (i) each person known to the Company to be
the beneficial owner of more than 5% of the Company's Common Stock; (ii) each
director of the Company; and (iii) all directors, executive officers and
designated stockholders of the Company as a group. This information as to
beneficial ownership was furnished to the Company by or on behalf of the persons
named. Unless otherwise indicated, we believe that each has sole voting and
investment power with respect to the shares beneficially owned. The percentages
are based on 78,495,815 shares of our common stock issued and outstanding as of
December 31, 2005.
31
(a) Beneficial Ownership of more than 5% based on 78,495,815 common shares.
Beneficial Ownership of 5%.
Table 1.
(1) (2) (3) (4)
Title of Class Name and Address Amount and Nature Percent of Class
Common Stock
Common Mercator Momentum 751,974 0.957%
Fund, LP (1) Common Stock
555 S. Flower St. Warrants (4)
Suite 4500
Los Angeles, CA 90071
Common Mercator Momentum 521,928 0.66%
Fund III, LP(1) Common Stock/
555 S. Flower St. Warrants (5)
Suite 4500
Los Angeles, CA 90071
Common Monarch Pointe 1,690,462(6) 2.15%
Fund, Ltd. (1) Common Stock
c/o Bank of Ireland Warrants
Securities Services Ltd.
New Century House
International Fin. Ser.Ctr.
Mayor Street Lower
Dublin 1
Republic of Ireland
Common M.A.G. Capital, LLC(1) 3,371,710 (7) 4.29%
555 S. Flower St. Common Stock
Suite 4500 Warrants
Los Angeles, CA 90071
Robinson Reed 200,000 (8) 0.25%
AV.DU Leman 8B Common Stock
CH-1003-Lausanne Warrants
Switzerland
Rhone International (2) 46,710 (9) 0.04%
19 Blvd. Geoorges-Favon Common stock
CH-1204 Geneva Warrants
Switzerland
Common David F. Firestone (1) 6,532,238 (1) 8.32%
555 S. Flower St Common Stock
Suite 4500 Warrants
Los Angeles, CA 90071
Common Impact International, LLC(3) 9,829,500 12.52%
111 W. 5th St. Ste.720
Tulsa, OK 74103
32
Common Michael Ward (10) 6,317,038 8.04%
1862 W. Bitters Rd.
San Antonio, TX78248
Total 22,748,841(11) 28.98 %
Notes:
(1) Mercator Momentum Fund, LP, Mercator Momentum Fund III, LP, Monarch Pointe
Fund, Ltd., MAG Capital, LLC, formerly Mercator Advisory Group, LLC, Robinson
Reed and David F. Firestone are referred to "Reporting Persons". Mercator
Momentum Fund, LP, Mercator Momentum Fund III, LP, Monarch Pointe Fund, Ltd. and
MAG Capital, LLC, formerly Mercator Advisory Group, LLC, each hold warrants to
purchase shares of our common stock. The right to vote and the right to dispose
of the shares beneficially owned by Mercator Momentum Fund, LP, Mercator
Momentum Fund III, LP, Monarch Pointe Fund, Ltd. and Robinson Reed are, in each
case, shared among either of the three funds, as applicable, and both M.A.G.
Capital, LLC and David F. Firestone. The documentation governing the terms of
the warrants contain provisions prohibiting any exercise of the warrants that
would result in the Reporting Persons owning beneficially more than 9.99% of the
outstanding common stock as determined under Section 13(d) of the Securities
Exchange Act of 1934. The Reporting Persons have never had beneficial ownership
of more than 9.99% of our outstanding common stock.
(2) Edward Karr has voting and dispositive control over Rhone International.
(3) Robert May has voting and dispositive authority over Impact International,
LLC.
(4) Mercator Momentum Fund, LP is a private investment limited partnership
organized under California law. MAG Capital, LLC, a California limited liability
company, formerly Mercator Advisory Group, LLC, is its general partner. David F.
Firestone is the Managing Member of the MAG Capital, LLC. Mercator Momentum
Fund, LP holds common stock warrants to purchase up to 751,974 shares of our
common stock. Half the warrants are exercisable at $0.80 per share and half
exercisable at $0.87 per share.
(5) Mercator Momentum Fund III, LP is a private investment limited partnership
organized under California law. MAG Capital, LLC, a California limited liability
company, is its general partner. David F. Firestone is the Managing Member of
the MAG Capital, LLC. Mercator Momentum Fund III, LP holds warrants to purchase
up to 518,092 shares of our common stock and 3,836 shares of common stock. Half
the warrants are exercisable at $0.80 per share and half exercisable at $0.87
per share.
(6) Monarch Pointe Fund, Ltd. is a corporation organized under of the British
Virgin Islands. Mercator Advisory Group controls the investments of Monarch
Pointe Fund. Monarch Pointe Fund holds warrants to purchase up to 1,690,462
shares of our common stock. Half the warrants are exercisable at $0.80 per share
and half exercisable at $0.87 per share.
(7) MAG Capital, LLC, formerly Mercator Advisory Group, LLC, holds warrants to
purchase up to 3,371,710 shares of our common stock. Half the warrants are
exercisable at $0.80 per share and half exercisable at $0.87 per share.
(8) Robinson Reed holds 200,000 common stock warrants, 100,000 exercisable at
$0.80 per share and 100,000 exercisable at $0.87 per share.
(9) Rhone International holds 46,710 common stock warrants, 23,355 exercisable
at $0.80 per share and 23,3550 exercisable at $0.87 per share.
(10) Mr. Ward is the President, Chief Executive officer and Chairman of our
Board of Directors.
(11) This total does not reflect the summation of the beneficial ownership of
Mercator Momentum Fund, LP, Mercator Momentum Fund III, LP, Monarch Pointe Fund,
33
Ltd., MAG Capital, LLC and Robinson Reed and David F. Firestone (Mercator). The
total number of warrants exerciseable the Mercator entities hold is 6,532,238,
therefore the total only includes this figure once and does not duplicate the
beneficial ownership of all entities.
(b) Security Ownership of Management. Based on 78,495,815 shares as set forth in
(a) above as of December 31, 2005.
Table 2.
Title of Class Name and Address Amount and Nature Percent of Class
Common Michael Ward 6,317,038 8.04%
1862 W. Bitters Rd.
San Antonio, TX 78248
Common James B. Smith 1,187,050(1) 1.51%
1862 W. Bitters Rd.
San Antonio, TX 78248
Common Ahmed Karim 502,500 0.64%
1532 Woods Dr.
N. Vancouver, B.C.
Canada V7R 1A9
Common Robert W. Dowies 140,000 0.178%
1862 W. Bitters Rd.
San Antonio, TX 78248
Common Carl Hessel (2) 2,450,000 3.12%
c/o Margaux Investment
Management Group, S.A.
9 Rue de Commerce
CH 1211 Geneva 11
Switzerland
Total 10,596,588 13.49%
Notes:
(1) Includes 500,000 shares in the name of Aigle Partners, Ltd. in which Mr.
Smith has a partnership interest and 494,382 shares in the name of du Midi
Trust, in which Mr. Smith has a beneficial interest.
(2) Mr. Hessel is a partner in Margaux Investment Management Group, S.A. and as
such beneficial ownership reflects 2,000,000 common stock warrants owned by
Margaux and 450,000 shares owned personally by Mr. Hessel.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On December 20, 2005, the Company issued 10,000 common shares valued at $8,350
and 40,000 shares of valued at $33,400,to Robert Dowies, a company vice
president under the terms of his employment agreement.
On September 14, 2005, Michael Ward, James B. Smith and Ahmed Karim, executed
amended promissory notes to the Company bearing interest at a rate of 5%
annually and payable in full on, or before September 14, 2005. The notes were
originally executed on September 14, 2004 in connection with the exercise of
common stock options. The shares of stock issued previously to these individuals
34
remained subject to security agreements. Prior to December 31, 2005, each of the
above individuals paid $5,500 in interest accrued and owing to the Company on
the original promissory note maturity date of September 14, 2005.
On July 1, 2005, the company issued 1,000,000 shares of its restricted common
stock valued at $1,230,000 pursuant to the employment contract with Michael
Ward, company president and CEO.
On July 1, 2005, the Company issued 50,000 shares of its restricted common stock
valued at $61,500 pursuant to an employment contract with Robert Dowies, a
company vice president under the terms of his employment agreement.
On July 1, 2005, the Company issued 10,000 shares of its restricted common stock
valued at $12,150 Jason Jones, a Sonterra employee.
On June 27, 2005, the Company authorized the issuance of 150,000 shares of its
restricted common stock valued at $199,500 to each of the three members of the
Board of Directors, Michael R. Ward, Ahmed Karim and Carl Hessel.
On June 27, 2005, the Company authorized the issuance of 150,000 shares of
common stock to James B. Smith, the Company's Senior Vice President, CFO and
newly appointed member of the Board of Directors. The transaction was valued at
$199,125.
On November 9, 2004, we issued 500,000 common shares to James B. Smith which
represents the annual stock grant under the terms of his employment agreement.
One November 9, 2004, the Company issued 500,000 common shares to Michael Ward
under the terms of his employment contract. The shares were valued at $417,000.
On October 18, 2004 we entered into an employment agreement with Robert Dowies.
Mr .Dowies became a Company Vice President. His annual salary is $ 100,000
including an annual stock grant of 100,000 shares.
On October 13, 2004, we sold Four Million (4,000,000) Tidelands Oil & Gas common
shares to ACH Securities, S.A., a company domiciled in Geneva, Switzerland, for
Two Million ($2,000,000) Dollars. On October 14, 2004, in connection with the
ACH Securities transaction, we issued Margaux Investment Group, S.A. common
stock warrants to purchase One Million (1,000,000) Tidelands Oil & Gas common
shares for Fifty ($0.50) Cents per share and One Million (1,000,000) shares for
$2.50 per share. Mr. Carl Hessel, a company director, is a partner in Margaux
Investment Management Group, S.A. and, as such he has an indirect financial
interest in the common stock warrants.
On September 14, 2004, we issued 500,000 shares of common stock to Michael Ward
under the terms of his employment agreement. The shares were valued at $427,500.
On September 14, 2004, the following individuals exercised common stock options:
On September 14, 2004, Michael Ward, the Company's President and Director,
exercised his common stock option to purchase 500,000 common shares for $110,000
payable on a promissory note bearing interest at the rate of 5% payable in full
on, or before September 14, 2005. The shares are subject to a security
agreement.
On September 14, 2004 Ahmed Karim, the Company's Vice President and Director,
exercised his common stock option to purchase 500,000 common shares for $110,000
payable on a promissory note bearing interest at the rate of 5% payable in full
on, or before September 14, 2005. The shares are subject to a security
agreement.
On September 14, 2005, James Smith, the Company's Chief Financial Officer,
exercised his common stock option to purchase 500,000 common shares for $110,000
payable on a promissory note bearing interest at the rate of 5% payable in full
on, or before September 14, 2005. The shares are subject to a security
agreement.
35
On June 30, 2004, we issued 3,322 common shares to Carl Hessel for $ 4,983. Carl
Hessel was a member of our board of directors at the time of issuance.
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 December 31, 2005, the loan balance was $288,506.
On January 8, 2004, we authorized the issuance of 300,000 common shares to Carl
Hessel for services valued at $450,000. These shares were issued before Mr.
Hessel joined our Board of Directors.
During 2004, the Company had four executive officers, Michael Ward, James B.
Smith, Robert Dowies and Ahmed Karim. Michael Ward's annual salary is $252,000.
James B. Smith's annual salary was $168,000. Mr. Dowies annual salary is
$100,000.
On February 5, 2003, we granted Michael Ward, Royis Ward and Ahmed Karim common
stock options to purchase 500,000 shares each at $0.22 per share. On August 16,
2003, we granted James B. Smith common stock options to purchase 500,000 shares
at $0.22 per share. The options were exercised on September 14, 2004.
ITEM 13. EXHIBITS
Exhibit Description Location of Exhibit
------- ----------- -------------------
2.0 Amendment No. 2 to the Asset Purchase and Sale and between Incorporated by reference
Sonterra Energy Corporation and Oneok Propane Distribution to Exhibit 10.1
Company. 8-K filed November 15, 2004
2.1 Amendment No. 1 to the Asset Purchase and Sale and between
Sonterra Energy Corporation and Oneok Propane Distribution Incorporated by reference to
Company. Exhibit 10.2
8-K filed November 15, 2004
2.3 Asset Purchase and Sale Agreement by and between Sonterra Energy Incorporated by reference to
Corporation and Oneok Propane Distribution Company. Exhibit 10.3
8-K filed November 15, 2004
2.4 Purchase and Sale Agreement for Reef Ventures, L.P. by and Incorporated by reference
between Impact International, LLC ("Impact") and Coahuila Exhibit 10 to 8-K filed
Pipeline, LLC, ("Coahuila"), (jointly "Seller") and Tidelands June 25, 2004
Oil & Gas Corporation ("Tidelands") and Arrecefe
Management, LLC ("Arrecefe"), (jointly "Buyer") dated
May 25, 2004 with Exhibits.
2.5 Purchase and Sale Agreement for Reef Marketing, L.L.C. Incorporated by reference
and Reef International, L.L.C. by and between Tidelands Exhibit 10.1 to 8-K filed
Oil & Gas Corporation and Impact International, L.L.C. May 8, 2003
and Coahuila Pipeline, L.L.C. dated April 16, 2003.
2.6 Agreement of Limited Partnership of Reef Ventures, L.P. "
2.7 Stock Purchase Warrant Impact "
2.8 Registration Rights Agreement Impact "
3.0 Restated Articles of Incorporation of Tidelands Oil Included with this filing
& Gas Corporation., a Nevada corporation.
36
3.1 Restated Bylaws of Tidelands Oil & Gas Corporation. Included with this filing
4.0 7% Convertible Debenture Mercator Momentum Fund, LP Incorporated by reference to
Exhibit 10.2 to 8-K filed on
December 3, 2004
4.1 7% Convertible Debenture Mercator Momentum Fund III, LP Incorporated by reference to
Exhibit 10.3 to 8-K filed on
December 3, 2004
4.2 7% Convertible Debenture Monarch Pointe Fund, LP Incorporated by reference to
Exhibit 10.4 to 8-K filed on
December 3, 2004
10.0 Employment Agreement with Michael Ward Incorporated by reference to
Exhibit 10.0 to SB-2 filed
December 17, 2004.
10.1 Employment Agreement with James B. Smith Incorporated by reference to
Exhibit 10.1 to SB-2 filed
December 17, 2004
10.2 Employment Agreement with Robert Dowies Incorporated by reference to
Exhibit 10.2 to SB-2 filed
December 17, 2004
10.3 2003 Non-Qualified Stock Grant and Option Plan Incorporated by reference to
Form S-8 filed on June 11, 2003
10.4 Securities Purchase Agreement Incorporated by reference to
10.5 Warrant Margaux Incorporated by reference to
Exhibit 10.5 to SB-2 filed
December 17, 2004
10.6 Warrant Margaux Incorporate by reference to
Exhibit 10.6 to SB-2 filed
December 17, 2004
10.7 Amended Stock Purchase Warrant Impact International Incorporated by reference
Exhibit 10 to 8-K filed
June 25, 2004
10.8 Registration Rights Agreement with Mercator Group Incorporated by reference to
Exhibit 10.5 to 8-K filed on
December 3, 2004
10.9 Warrant to Purchase Common Stock Mercator Momentum
Fund, LP. $0.87 Incorporated by reference to
Exhibit 10.6 to 8-K filed on
December 3, 2004
10.10 Warrant to Purchase Common Stock Mercator Momentum
Fund, LP $0.80 Incorporated by reference to
Exhibit 10.7 to 8-K filed on
December 3, 2004
10.11 Warrant to Purchase Common Stock Mercator Momentum
Fund, III, LP $0.87 Incorporated by reference to
Exhibit 10.8 to 8-K filed on
December 3, 2004
10.12 Warrant to Purchase Common Stock Mercator Momentum
Fund III, LP $0.80 Incorporated by reference to
Exhibit 10.9 to 8-K filed on
December 3, 2004
10.13 Warrant to Purchase Common Stock Monarch Pointe
Fund, LP $0.87 Incorporated by reference to
Exhibit 10.10 to 8-K filed on
December 3, 2004
37
10.14 Warrant to Purchase Common Stock Monarch Pointe
Fund, LP $0.80 Incorporated by reference to
Exhibit 10.11 to 8-K filed on
December 3, 2004
10.15 Warrant to Purchase Common Stock Mercator Advisory
Group, LLC. $0.87 Incorporated by reference to
Exhibit 10.12 to 8-K filed on
December 3, 2004
10.16 Warrant to Purchase Common Stock Mercator Advisory
Group, LLC $0.80 Incorporated by reference to
Exhibit 10.13 to 8-K filed on
December 3, 2004
10.17 SBC Center Terrace Suite License Agreement Included with this filing
10.18 Form of Securities Purchase Agreement Incorporated by reference
to Exhibit 10.1 to 8-K
filed January 25, 2006
10.19 Form of Original Issue Discount Convertible Debenture Incorporated by reference
to Exhibit 10.2 to 8-K
filed January 25, 2006
10.20 Form of Registration Rights Agreement Incorporated by reference
to Exhibit 10.3 to 8-K
filed January 25, 2006
10.21 Series A Common Stock Purchase Warrant Incorporated by reference
to Exhibit 10.4 to 8-K
filed January 25, 2006
10.22 Series B Common Stock Purchase Warrant Incorporated by reference
to Exhibit 10.5 to 8-K
filed January 25, 2006
21 List of Subsidiaries Included with this filing
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. "
32.1 Chief Executive Officer-Section 906 Certification pursuant
to Sarbanes-Oxley Act. "
32.2 Chief Financial Officer- Section 906 Certification pursuant
to Sarbanes-Oxley Act. "
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The Company paid or accrued the following fees in each of the prior two
fiscal years to its principal accountant, Baum & Co., P.A. of Coral Springs,
Florida.
Year End Year End
12-31-04 12-31-05
(1) Audit Fees $53,860 $102,553
(2) Audit-related Fees -0- -0-
(3) Tax Fees -0- -0-
(4) All other fees -0- -0-
Total Fees $53,860 $102,553
38
The Company's principal accountant, Baum & Co., P.A. did not engage any other
persons or firms other than the principal accountant's full-time, permanent
employees.
AUDIT FEES. Audit fees consist of fees billed for professional services rendered
for the audit of the Company's consolidated financial statements and review of
the interim consolidated financial statements included in quarterly reports and
services that are normally provided by the Company's principal accountants in
connection with statutory and regulatory filings or engagements.
AUDIT-RELATED FEES. Audit related fees consist of fees billed for assurance and
related services that are reasonably related to the performance of the audit or
review of the Company's consolidated financial statements and are not reported
under "Audit Fees."
TAX FEES. Tax fees are fees billed for professional services for tax compliance,
tax advice and tax planning.
ALL OTHER FEES. All other fees include fees for products and services other than
the services reported above. There were no management consulting services
provided in fiscal 2005 or 2004.
Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit
Services of Independent Auditors
The Company currently does not have a designated Audit Committee. However, as
defined in Sarbanes-Oxley Act of 2002, the entire Board of Directors is the
Company's defacto audit committee.
Accordingly, the Company's Board of Directors' policy is to pre-approve all
audit and permissible non-audit services provided by the independent auditors.
These services may include audit services, audit-related services, tax services
and other services. Pre-approval is generally provided for up to one year and
any pre-approval is detailed as to the particular service or category of
services and is generally subject to a specific budget. The independent auditors
and management are required to periodically report to the Company's Board of
Directors regarding the extent of services provided by the independent auditors
in accordance with this pre-approval, and the fees for the services performed to
date. The Board of Directors may also pre-approve particular services on a
case-by-case basis.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) to the Securities Exchange
Act of 1934, the Company has duly caused this Form 10-KSB Report for the period
ending December 31, 2005 to be signed on its behalf by the undersigned,
thereunto duly authorized on this 17th day of April, 2006.
TIDELANDS OIL & GAS CORPORATION
BY: /s/ Michael Ward
------------------------------------------
Michael Ward, President, CEO
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Company and in
the capacities and on the dates indicated.
Date: April 17, 2006 /s/ Michael Ward
------------------------------------------
Michael Ward, President, Director
39
/s/ James B. Smith
------------------------------------------
James B. Smith, Senior Vice President, CFO
/s/ Ahmed Karim
------------------------------------------
Ahmed Karim
Vice President, Director
40
TIDELANDS OIL & GAS CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 AND 2004
TIDELANDS OIL & GAS CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 AND 2004
TABLE OF CONTENTS
INDEPENDENT AUDITOR'S REPORT............................................ 3
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets........................................ 4
Statements of Consolidated Stockholders' Equity.................... 5
Statements of Consolidated Operations ............................. 6
Statements of Consolidated Cash Flows ............................. 7-8
Notes to Consolidated Financial Statements......................... 9-28
BAUM & COMPANY, P.A.
1515 UNIVERSITY DRIVE, SUITE 209
CORAL SPRINGS, FLORIDA 33071
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
Tidelands Oil & Gas Corporation
San Antonio, Texas
We have audited the accompanying consolidated balance sheets of Tidelands Oil &
Gas Corporation as of December 31, 2005 and 2004, and the related statements of
consolidated stockholders' equity, operations, and cash flows for the years
ended December 31, 2005 and 2004. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Tidelands Oil & Gas Corporation as of December 31, 2005 and 2004, and the
results of their consolidated operations and their consolidated cash flows for
the years ended December 31, 2005 and 2004 in conformity with accounting
principles generally accepted in the United States of America.
As more fully described in Note 2 to the financial statements, the accompanying
consolidated balance sheets and related statements of consolidated shareholders'
equity, operations and cash flows have been restated to reflect the proper
accounting for certain transactions which occurred during the year ended
December 31, 2004. In our original report dated April 13, 2005, we expressed an
unqualified opinion on the consolidated financial statements, and our opinion on
the revised statements, as expressed herein, remains unqualified.
Baum & Company, P.A.
Coral Springs, Florida
April 14, 2006
-3-
TIDELANDS OIL & GAS CORPORATION
CONSOLIDATED BALANCE SHEETS
YEARS ENDED
ASSETS
------
December 31, December 31,
2005 2004
------------ ------------
(Restated)
Current Assets:
Cash $ 1,113,911 $ 5,459,054
Accounts and Loans Receivable 468,458 516,387
Inventory 142,204 82,523
Prepaid Expenses 183,938 487,488
------------ ------------
Total Current Assets 1,908,511 6,545,452
------------ ------------
Property Plant and Equipment, Net 10,042,088 9,086,313
------------ ------------
Other Assets:
Deposits 14,004 4,108
Cash Restricted 76,803 25,000
Deferred Charges 0 116,250
Note Receivable 288,506 286,606
Goodwill 1,158,937 6,358,937
------------ ------------
Total Other Assets 1,538,250 6,790,901
------------ ------------
Total Assets $ 13,488,849 $ 22,422,666
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Current Maturities - Note Payable $ 225,000 $ 0
Accounts Payable and Accrued Expenses 1,225,554 574,224
------------ ------------
Total Current Liabilities 1,450,554 574,224
Long-Term Debt 4,271,768 11,731,883
------------ ------------
Total Liabilities 5,722,322 12,306,107
------------ ------------
Commitments and Contingencies
Derivative Liability 0 5,168,000
------------ ------------
Stockholders' Equity:
Common Stock, $.001 Par Value per Share,
100,000,000 Shares Authorized, 78,495,815
and 61,603,359 Shares Issued and
Outstanding at 2005 and 2004 Respectively 78,497 61,604
Additional Paid-in Capital 40,818,174 30,354,195
Subscriptions Receivable (550,000) (550,000)
Minority Interest -- --
Accumulated (Deficit) (32,580,144) (24,917,240)
------------ ------------
Total Stockholders' Equity 7,766,527 4,948,559
------------ ------------
Total Liabilities and Stockholders' Equity $ 13,488,489 $ 22,422,666
============ ============
See Accompanying Notes to Consolidated Financial Statements
-4-
TIDELANDS OIL AND GAS CORPORATION
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2005 AND 2004 (RESTATED)
Stock
Additional Total
Common Stock Paid-In Subscription Accumulated Stockholders'
Shares Amount Capital Receivable (Deficit) Equity
------------ ------------ ------------ ------------ ------------ ------------
Balance
December 1, 2003 44,825,302 $ 44,826 $ 11,072,987 $ (18,000) $(10,615,203) $ 484,610
Common Stock Issued
for Cash 6,725,545 6,725 6,081,592 -- -- 6,088,317
Common Stock Issued
for Services Regarding
$4,083,335 Sale of Stock 300,000 300 449,700 -- -- 450,000
Fee for Services
Regarding Sale of
Common Stock -- -- (450,000) -- -- (450,000)
Issuance of Common
Stock for Services 6,602,800 6,603 9,321,213 -- -- 9,327,816
Issuance of Common
Stock for Subscription 2,500,000 2,500 547,500 (550,000) -- --
Issuance of Common
Stock for Conversion of
Note Payable and
Accrued Interest 75,000 75 113,236 -- -- 113,311
Beneficial Conversion
Feature - Convertible
Debentures -- -- 3,092,105 -- -- 3,092,105
Write Off Stock
Subscription Receivable -- -- -- 18,000 -- 18,000
Issuance of Common Stock
to Acquire 50% of
Sonterra Energy Corp. 574,712 575 125,862 -- -- 126,437
Net Loss -- -- -- -- (14,302,037) (14,302,037)
------------ ------------ ------------ ------------ ------------ ------------
Balance
December 31, 2004 61,603,359 $ 61,604 $ 30,354,195 $ (550,000) $(24,917,240) $ 4,948,559
Issuance of Common
Stock for Services 2,970,000 2,971 4,019,554 -- -- 4,022,525
Issuance of Common
Stock for Conversion of
Convertible Debentures 6,707,456 6,707 4,993,293 -- -- 5,000,000
Beneficial Conversion
Feature -Convertible
Debentures -- -- (756,328) -- -- (756,328)
Cancellation of Stock
Previously Issued for
Services per Litigation
Settlement (285,000) (285) (297,540) -- -- (297,825)
Exercise of Stock
Purchase Warrants 7,500,000 7,500 2,505,000 -- -- 2,512,500
Net Loss -- -- -- -- (7,662,904) (7,662,904)
------------ ------------ ------------ ------------ ------------ ------------
Balance
December 31, 2005 78,495,815 $ 78,497 $ 40,818,174 $ (550,000) $(32,580,144) $ 7,766,527
============ ============ ============ ============ ============ ============
See Accompanying Notes to Consolidated Financial Statements
-5-
TIDELANDS OIL & GAS CORPORATION
STATEMENTS OF CONSOLIDATED OPERATIONS
YEARS ENDED
December 31, December 31,
2005 2004
------------ ------------
(Restated)
Revenues:
Gas Sales and Pipeline Fees $ 1,725,756 $ 1,800,863
Construction Service 135,567 82,975
Other 0 0
------------ ------------
Total Revenues 1,861,323 1,883,838
------------ ------------
Expenses:
Cost of Sales 1,003,386 1,508,891
Operating Expenses 202,766 99,665
Depreciation 485,481 244,889
Interest 611,363 300,566
Beneficial Conversion Feature Interest (756,329) 3,092,105
Sales, General and Administrative 8,033,249 11,022,019
Impairment Losses 5,592,000 15,358,000
------------ ------------
Total Expenses 15,171,916 31,626,135
------------ ------------
(Loss) from Operations (13,310,593) (29,742,297)
Gain on Reduction of Derivative Liability 5,168,000 15,390,000
Loss on Equipment Sale (3,167) 0
Other Income 61,956 0
Interest and Dividend Income 123,075 50,260
Minority Interest -- --
Litigation Settlement 297,825 0
------------ ------------
Net (Loss) $ (7,662,904) $(14,302,037)
============ ============
Net (Loss) Per Common Share:
Basic and Diluted $ (0.11) $ (0.27)
============ ============
Weighted Average Number of Common
Shares Outstanding
Basic and Diluted 70,049,587 53,214,230
============ ============
See Accompanying Notes to Consolidated Financial Statements
-6-
TIDELANDS OIL & GAS CORPORATION
STATEMENTS OF CONSOLIDATED CASH FLOWS
YEARS ENDED
December 31, December 31,
2005 2004
------------ ------------
(Restated)
Cash Flows Provided (Required) By
Operating Activities:
Net (Loss) $ (7,662,904) $(14,302,037)
Adjustments to Reconcile Net (Loss)
To Net Cash Provided (Required) By
Operating Activities:
Depreciation 485,481 244,889
Goodwill 0 (5,200,000)
Impairment Losses 5,592,000 15,358,000
Change in Derivative Instrument (5,168,000) (10,222,000)
Loss on Disposal of Equipment 3,167 0
Issuance of Common Stock:
For Services Provided 4,022,525 9,327,816
Beneficial Conversion Feature - Interest (756,329) 3,092,105
Return of Issued Stock
Litigation Settlement (297,825) 0
Changes In:
Accounts Receivable 47,929 (516,159)
Inventory (59,681) (82,523)
Prepaid Expenses 303,550 (465,279)
Deferred Charges 116,250 (116,250)
Deposits (61,699) (25,308)
Accounts Payable and Accrued Expenses 651,330 (201,370)
------------ ------------
Net Cash (Required)
By Operating Activities (2,784,206) (3,108,116)
------------ ------------
Cash Flows Provided (Required)
By Investing Activities:
(Increase) In Investments 0 (901,871)
Acquisitions of Property, Plant & Equipment (1,837,222) (8,727,010)
Disposals of Equipment 800 0
------------ ------------
Net Cash Provided (Required)
By Investing Activities (1,836,422) (9,628,881)
------------ ------------
See Accompanying Notes to Consolidated Financial Statements
-7-
TIDELANDS OIL & GAS CORPORATION
STATEMENTS OF CONSOLIDATED CASH FLOWS
(CONTINUED)
YEARS ENDED
December 31, December 31,
2005 2004
------------ ------------
(Restated)
Cash Flows Provided (Required)
By Financing Activities:
Proceeds from Issuance of Common Stock 0 6,088,317
Proceeds from Long-Term Loans 277,385 6,731,883
Proceeds from Issuance Of
Convertible Debentures 0 5,000,000
Repayment of Short-Term Loans 0 (250,000)
Reduction of Stock Subscription Receivable 0 18,000
Loan to Related Party (1,900) (286,606)
------------ ------------
Net Cash Provided (Required) By
Financing Activities 275,485 17,301,594
------------ ------------
Net Increase (Decrease) In Cash (4,345,143) 4,564,597
Cash at Beginning of Period 5,459,054 894,457
------------ ------------
Cash at End of Period $ 1,113,911 $ 5,459,054
============ ============
Supplemental Disclosures of
Cash Flow Information:
Cash Payments for Interest $ 356,504 $ 38,320
============ ============
Cash Payments For Income Taxes $ 0 $ 0
============ ============
Non-Cash Financing Activities:
Return of Issued Stock For
Beneficial Conversion Feature - Interest $ (756,329) $ 3,092,105
Litigation Settlements (297,825) 0
Increase of Stock Subscription Receivable -- 550,000
Issuance of Common Stock: 0 0
Operating Activities 4,022,525 9,327,816
Repayment of Notes 2,512,500 75,000
Conversion of Debentures 5,000,000 0
Payment of Accounts Payable 0 38,311
Acquisition Cost 0 126,437
------------ ------------
Total Non-Cash Financing Activities $ 10,480,871 $ 13,209,669
============ ============
See Accompanying Notes to Consolidated Financial Statements
-8-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------ ------------------------------------------
This summary of significant accounting policies is presented to assist
in understanding these consolidated financial statements. The
consolidated financial statements and notes are representations of
management who is responsible for their integrity and objectivity. The
accounting policies used conform to accounting principles generally
accepted in the United States of America and have been consistently
applied in the preparation of these consolidated financial statements.
Organization
------------
Tidelands Oil and Gas Corporation (the Company and formerly C2
Technologies, Inc.), was incorporated in the state of Nevada on
February 25, 1997. On December 1, 2000, the Company completed its
acquisition of Rio Bravo Energy, LLC, and their related entities
thereby making Rio Bravo Energy, LLC a wholly-owned subsidiary of the
Company. During 2004, the Company acquired all of the stock of Sonterra
Energy Corporation (Sonterra) and through this wholly-owned subsidiary,
the Company purchased all of the assets of a gas distribution
organization (see Note 15-Acquisitions). The Company also, during 2004,
increased its ownership interest from 25% to 98% in Reef Ventures, LP
and their wholly-owned subsidiaries (Reef International LLC and Reef
Marketing, LLC) (see Note 15-Acquisitions).
Nature of Operations
--------------------
The Company currently operates a natural gas pipeline between Eagle
Pass, Texas and Piedras Negras, Mexico and a propane distribution
system serving residential customers in the Austin, Texas area. In
addition, the company is engaged in the development of natural gas
storage facilities in Mexico and other natural gas pipelines between
the United States and Mexico.
Principles of Consolidation
---------------------------
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant
inter-company accounts and transactions have been eliminated.
Fair Value of Financial Instruments
-----------------------------------
Statement of Financial Accounting Standards No. 107 "Disclosure About
Fair Value of Financial Instruments," requires the disclosure of the
fair value of off-and-on balance sheet financial instruments. Unless
otherwise indicated, the fair values of all reported consolidated
assets and consolidated liabilities, which represent financial
instruments (none of which are held for trading purposes), approximate
the carrying values of such amounts.
-9-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
------ ------------------------------------------------------
Use of Estimates
----------------
The preparation of consolidated financial statements in accordance with
accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that
affect certain reported amounts and disclosures. Accordingly, actual
results could differ from those estimates.
Property, Plant and Equipment
-----------------------------
Property, plant and equipment are recorded at historical cost.
Depreciation of property, plant and equipment is provided on the
straight-line method over the estimated useful lives of the related
assets. Maintenance and repairs are charged to operations. Additions
and betterments, which extend the useful lives of the assets, are
capitalized. Upon retirement or disposal of the property, plant and
equipment, the cost and accumulated depreciation are eliminated from
the accounts, and the resulting gain or loss is reflected in
operations.
Long-Lived Assets
-----------------
Statement of Financial Accounting Standards 144 (SFAS 144) "Accounting
for the Impairment or Disposal of Long-Lived Assets" requires that
long-lived assets to be held and used by the Company be reviewed for
impairment whenever events or changes in circumstances indicate that
the related carrying amount may not be recoverable. When required,
impairment losses on assets to be held and used are recognized based on
the fair value of the asset, and long-lived assets to be disposed of
are reported at the lower of carrying amount or fair value less cost to
sell.
The requirements of SFAS 144 and the evaluation by the Company did not
have a significant effect on the consolidated financial position or
results of consolidated operations.
Income Taxes
------------
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards 109 (SFAS 109) "Accounting for Income
Taxes," which requires the establishment of a deferred tax asset or
liability for the recognition of future deductions of taxable amounts
and operating loss carry forwards, deferred tax expense or benefit is
recognized as a result of the change in the deferred asset or liability
during the year. If necessary, the Company will establish a valuation
allowance to reduce any deferred tax asset to an amount which will,
more likely than not, be realized.
-10-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
------ ------------------------------------------------------
Net (Loss) Per Common Share
---------------------------
The Company accounts for net (loss) per share in accordance with
Statement of Financial Accounting Standard 128 (SFAS 128) "Earnings per
Share". Basic (loss) per share is based upon the net (loss) applicable
to the weighted average number of common shares outstanding during the
period. Diluted (loss) per share reflects the effect of the assumed
conversions of convertible securities and exercise of stock options
only in the periods in which such affect would have been dilutive.
Goodwill
--------
Goodwill represents the excess of purchase price and related costs over
the value assigned to the net tangible and identifiable assets of
businesses acquired. Statement of Financial Accounting Standards No.
142 (SFAS142), "Goodwill and Other Intangible Assets" requires goodwill
to be tested for impairment on an annual basis and between annual tests
in certain circumstances, and written down when impaired, rather than
being amortized as previous accounting standards required. Furthermore,
SFAS 142 requires purchased intangible assets other than goodwill to be
amortized over their useful lives unless these lives are determined to
be indefinite. As the result of an acquisition during the second
quarter of 2004, the Company recorded goodwill in the amount of
$20,561,800. The Company evaluates the carrying value of goodwill on a
quarterly basis. As part of the evaluation, the company compares the
carrying value of the intangible asset with its fair value to determine
whether there has been impairment. As a result of management's
impairment review of goodwill during 2004 and 2005, the Company
recognized impairment losses of $15,358,000 and $5,592,000 in 2004 and
2005 respectively.
New Accounting Standards
------------------------
In June 2001, Statement of Financial Accounting Standards No. 143,
"Accounting for Asset Retirement Obligations", (SFAS No. 143) was
issued and is effective for fiscal years beginning after June 15, 2002.
SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The adoption of SFAS
143 does not have a material effect on our consolidated financial
statements.
-11-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
------ ------------------------------------------------------
New Accounting Standards (Continued)
------------------------------------
In July 2002, Statement of Financial Accounting Standards No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities",
(SFAS No. 146) was issued and is effective for periods beginning after
December 31, 2002. SFAS No. 146 requires, among other things, that
costs associated with an exit activity (including restructuring and
employee and contract termination costs) or with a disposal of
long-lived assets be recognized when the liability has been incurred
and can be measured at fair value. Companies must record in earnings
from continuing operations costs associated with an exit or disposal
activity that does not involve a discontinued operation. Costs
associated with an activity that involves a discontinued operation
would be included in the results of discontinued operations. The
implementation of the provisions of SFAS No. 146 does not have a
material effect on the consolidated financial statements.
In December 2002, Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation", (SFAS No. 148) was issued
and is effective for fiscal years beginning after December 15, 2002.
SFAS No. 148 amends the disclosure requirements of SFAS No. 123,
"Accounting for Stock-Based Compensation", (SFAS No. 123) to require
prominent disclosures in both interim and annual financial statements
about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. SFAS No. 148
also amends SFAS No. 123 to provide alternative methods of transition
for a voluntary change to the fair value based method of accounting for
stock-based employee compensation. The Company had decided not to
voluntarily adopt the SFAS No. 123 fair value method of accounting for
stock-based employee compensation. Therefore, the new transition
alternatives allowed in SFAS No. 148 will not affect the consolidated
financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 On Derivative Instruments And Hedging Activities". SFAS No. 149
amends and clarifies accounting for derivative instruments, including
certain derivative instruments embedded in other contracts, and for
hedging activities under SFAS No. 133. SFAS No. 149 is generally
effective for contracts entered into or modified after June 30, 2003
and for hedging relationships designated after June 30, 2003. In May
2003, the FASB issued SFAS No. 150, "Accounting For Certain Financial
Instruments With Characteristics Of Both Liabilities And Equity". SFAS
No. 150 improves the accounting for certain financial instruments that
previously might have been accounted for as equity. SFAS No. 150
required that those instruments be classified as liabilities in
statements of financial position. SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003. The
Company adopted both SFAS 149 and SFAS 150 in 2003. The adoption of
these standards have resulted in beneficial conversion feature charges
(credits) of $3,092,105 and ($756,329) in 2004 and 2005 respectively.
-12-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 2 - SUMMARY OF RESTATED CONSOLIDATED FINANCIAL STATEMENTS
------ ------------------------------------------------------
During the fourth quarter of 2005, management reevaluated its
accounting treatment for several complex transactions which occurred
during the year ended December 31, 2004. After considerable review and
outside consultation, management determined that their interpretation
of the accounting guidelines for these involved issues was not correct
and thereby their recording of the initial transaction needed to be
restated. Accordingly, management has chosen to restate in this note
the consolidated financial statements for the year ended December 31,
2004, as well as the interim reports for the quarters ended March 31,
June 30, and September 30, 2005. Following are the transactions which
precipitated the restatements:
(A) Goodwill associated with the acquisition of Reef Ventures, LP, (May
2004), and the related derivative liability for warrants issued as part
of the purchase price. Management, after their review of EITF 00-19
"Accounting For Derivative Financial Instruments Indexed To, and
Potentially Settled In, A Company's Own Stock", has concluded that it
is necessary to account for goodwill and the related derivative
liability associated with the May 2004 acquisition (see Note 15). At
December 31, 2004, the net effect of this adjustment results in an
increase in goodwill of $5,200,000, an increase in the derivative
liability of $5,168,000, a gain on reduction of the derivative
liability of $15,390,000 and a goodwill impairment loss of $15,358,000.
(B) Issuance of convertible debentures with freestanding warrants and
embedded beneficial conversion features. Management, after reviewing
SFAS 133 and EITF 00-19, has determined that the convertible debentures
issued in November, 2004, contain an embedded beneficial conversion
feature. Accordingly, at December 31, 2004, this charge to the
statement of operations amounted to $3,092,105.
(C) Valuation of stock issued for services and financing costs.
Management reviewed all stock issued for services and financing costs
in 2004, and in accordance with the provisions outlined in EITF 96-18
and SFAS 123, management increased the charges associated with these
stock issuances by $4,724,750 at December 31, 2004.
All of the transactions referred to above relate to non-cash charges
and do not affect the Company's revenues, cash flows from operations or
liquidity.
-13-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 2 - SUMMARY OF RESTATED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------ -----------------------------------------------------------------
SUMMARY OF RESTATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
-----------------
Previously Restatement Restated
Reported Adjustment Total
------------ ------------ ------------
Consolidated Balance Sheets:
Total Assets $ 17,222,666 (1) $ 5,200,000 $ 22,422,666
Total Liabilities 12,306,107 (2) 5,168,000 17,474,107
------------ ------------ ------------
Stockholders' Equity $ 4,916,559 $ 32,000 $ 4,948,559
============ ============ ============
Consolidated Results of Operations:
Revenues 1,883,838 0 1,883,838
Expenses 8,451,280 (3,4) 23,174,855 31,626,135
------------ ------------ ------------
Net (Loss) from Operations (6,567,442) (23,174,855) (29,742,297)
Derivative Gain 0 (5) 15,390,000 15,390,000
Other Income 50,260 0 50,260
------------ ------------ ------------
Net (Loss) $ (6,517,182) $ (7,784,855) $(14,302,037)
============ ============ ============
Net (Loss) per Common Share:
Basic and Diluted $ (0.12) $ (0.27)
============ ============
Weighted Average Number of Common
Shares Outstanding:
Basic and Diluted 53,214,230 53,214,230
============ ============
-14-
TIDELANDS OIL & GAS CORPORATION
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 AND 2004
NOTE 2 - SUMMARY OF RESTATED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------ -----------------------------------------------------------------
SUMMARY OF RESTATED INTERIM REPORTS - 2005
MARCH 31, 2005 JUNE 30, 2005
-------------------------------------------- --------------------------------------------
Previously Restatement Restated Previously Restatement Restated
Reported (1) Adjustment Total Reported (1) Adjustment Total
------------ ------------ ------------ ------------ ------------ ------------
ASSETS
Current Assets:
Cash and Cash
Equivalents $ 4,623,198 -- $ 4,623,198 $ 3,468,839 -- $ 3,468,839
Accounts and Loans
Receivable 404,488 -- 404,488 309,323 -- 309,323
Inventory 60,159 -- 60,159 75,573 -- 75,573
Prepaid
Expenses 418,362 -- 418,362 302,531 -- 302,531
------------ ------------ ------------ ------------ ------------ ------------
Total Current Assets 5,506,207 -- 5,506,207 4,156,266 -- 4,156,266
------------ ------------ ------------ ------------ ------------ ------------
Property, Plant and
Equipment, Net 9,245,326 -- 9,245,326 9,630,591 -- 9,630,591
------------ ------------ ------------ ------------ ------------ ------------
Other Assets:
Deposits 6,608 -- 6,608 6,608 -- 6,608
Deferred Charges 38,750 -- 38,750 0 -- 0
Restricted Cash 75,000 -- 75,000 75,846 -- 75,846
Note Receivable 287,170 -- 287,170 286,114 -- 286,114
Goodwill 1,158,937 5,200,000 6,358,937 1,158,937 -- 1,158,937
------------ ------------ ------------ ------------ ------------ ------------
Total Other Assets 1,566,465 5,200,000 6,766,465 1,527,505 -- 1,527,505
------------ ------------ ------------ ------------ ------------ ------------
Total Assets $ 16,317,998 $ 5,200,000 $ 21,517,998 $ 15,314,362 $ 0 $ 15,314,362
============ ============ ============ ============ ============ ============
LIABILITIES AND
STOCKHOLDERS'
EQUITY
Current Liabilities:
Current Maturities of
Note Payable $ 225,000 $ -- $ 225,000 $ 112,500 $ -- $ 112,500
Convertible Debenture
Payable 5,000,000 -- 5,000,000 2,480,000 -- 2,480,000
Accounts Payable and
Accrued Expenses 438,830 -- 438,830 656,302 -- 656,302
Derivative Liability 0 8,062,500 8,062,500 0 -- 0
------------ ------------ ------------ ------------ ------------ ------------
Total Current
Liabilities 5,663,830 8,062,500 13,726,330 3,248,802 -- 3,248,802
------------ ------------ ------------ ------------ ------------ ------------
Long-Term Debt:
Note Payable,
less Current
Maturities 6,592,301 -- 6,592,301 4,255,990 -- 4,255,990
------------ ------------ ------------ ------------ ------------ ------------
Total
Liabilities 12,256,131 8,062,500 20,318,631 7,504,792 -- 7,504,792
------------ ------------ ------------ ------------ ------------ ------------
Stockholders' Equity:
Common Stock 62,364 -- 62,364 74,281 -- 74,281
Additional Paid-in
Capital 22,918,580 13,151,198 36,069,778 28,655,789 9,531,144 38,186,933
Subscriptions
Receivable (550,000) -- (550,000) (550,000) -- (550,000)
Minority Interest -- -- -- -- -- --
Accumulated Deficit (18,369,077) (16,013,698) (34,382,775) (20,370,500) (9,531,144) (29,901,644)
------------ ------------ ------------ ------------ ------------ ------------
Total Stockholders'
Equity 4,061,867 (2,862,500) 1,199,367 7,809,570 -- 7,809,570
------------ ------------ ------------ ------------ ------------ ------------
Total Liabilities and
Stockholders' Equity $ 16,317,998 $ 5,200,000 $ 21,517,998 $ 15,314,362 $ 0 $ 15,314,362
============ ============ ============ ============ ============ ============
-15-
TIDELANDS OIL & GAS CORPORATION
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 AND 2004
NOTE 2 - SUMMARY OF RESTATED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------ -----------------------------------------------------------------
SUMMARY OF RESTATED INTERIM REPORTS - 2005
SEPTEMBER 30, 2005
--------------------------------------------
Previously Restatement
Reported (1) Adjustment Total
------------ ------------ ------------
ASSETS
Current Assets:
Cash and Cash
Equivalents $ 2,336,430 -- $ 2,336,430
Accounts and Loans
Receivable 208,668 -- 208,668
Inventory 90,332 -- 90,332
Prepaid
Expenses 208,879 -- 208,879
------------ ------------ ------------
Total Current Assets 2,844,309 -- 2,884,309
------------ ------------ ------------
Property, Plant and
Equipment, Net 10,097,779 -- 10,097,779
------------ ------------ ------------
Other Assets:
Deposits 6,708 -- 6,708
Deferred Charges 0 -- 0
Restricted Cash 101,471 -- 101,471
Note Receivable 284,944 -- 284,944
Goodwill 1,158,937 -- 1,158,937
------------ ------------ ------------
Total Other Assets 1,552,060 -- 1,552,060
------------ ------------ ------------
Total Assets $ 14,494,148 $ 0 $ 14,494,148
============ ============ ============
LIABILITIES AND
STOCKHOLDERS'
EQUITY
Current Liabilities:
Current Maturities of
Note Payable $ 168,750 $ -- $ 168,750
Convertible Debenture
Payable 980,000 -- 980,000
Accounts Payable and
Accrued Expenses 642,457 -- 642,457
Derivative Liability 0 -- 0
------------ ------------ ------------
Total Current
Liabilities 1,791,207 -- 1,791,207
------------ ------------ ------------
Long-Term Debt:
Note Payable,
less Current
Maturities 4,252,304 -- 4,252,304
------------ ------------ ------------
Total
Liabilities 6,043,511 -- 6,043,511
------------ ------------ ------------
Stockholders' Equity:
Common Stock 77,157 -- 77,157
Additional Paid-in
Capital 30,369,493 9,682,940 40,052,433
Subscriptions
Receivable (550,000) -- (550,000)
Minority Interest
Accumulated Deficit (21,446,013) (9,682,940) (31,128,953)
------------ ------------ ------------
Total Stockholders'
Equity 8,450,637 -- 8,450,637
------------ ------------ ------------
Total Liabilities and
Stockholders' Equity $ 14,494,148 $ 0 $ 14,494,148
============ ============ ============
-16-
TIDELANDS OIL & GAS CORPORATION
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 AND 2004
NOTE 2 - SUMMARY OF RESTATED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------ -----------------------------------------------------------------
SUMMARY OF RESTATED INTERIM REPORTS - 2005
Three Months Ended March 31, 2005 Six Months Ended June 30, 2005
-------------------------------------------- --------------------------------------------
Previously Restatement Restated Previously Restatement Restated
Reported (1) (2) Total Reported (1) (2) Total
------------ ------------ ------------ ------------ ------------ ------------
Revenues:
Gas Sales and
Pipeline Fees $ 586,949 $ -- $ 586,949 $ 849,490 $ -- $ 849,490
Construction
Services 41,126 -- 41,126 119,121 -- 119,121
------------ ------------ ------------ ------------ ------------ ------------
Total Revenues 628,075 -- 628,075 968,611 -- 968,611
------------ ------------ ------------ ------------ ------------ ------------
Expenses:
Cost of Sales 284,679 -- 284,679 415,248 -- 415,248
Operating
Expenses 66,774 -- 66,774 129,137 -- 129,137
Depreciation 115,441 -- 115,441 236,395 -- 236,395
Interest 209,787 -- 209,787 393,860 -- 393,860
Beneficial
Conversion
Feature
Interest 0 4,736,843 4,736,843 0 135,789 135,789
Sales, General
and
Administrative 1,220,911 597,500 1,818,411 3,098,570 1,578,500 4,677,070
Impairment
Losses 0 -- 0 0 5,200,000 5,200,000
------------ ------------ ------------ ------------ ------------ ------------
Total Expenses 1,897,592 5,334,343 7,231,935 4,273,210 6,914,289 11,187,499
------------ ------------ ------------ ------------ ------------ ------------
(Loss) from
Operations (1,269,517) (5,334,343) (6,603,860) (3,304,599) (6,914,289) (10,218,888)
Derivative Gain
(Loss) -- (2,894,500) (2,894,500) -- 5,168,000 5,168,000
Gain (Loss) on
Equipment Sale (3,167) -- (3,167) (3,167) -- (3,167)
Interest and
Dividend Income 35,992 -- 35,992 69,651 -- 69,651
Minority
Interest -- -- -- -- -- --
Litigation
Settlement 0 -- 0 0 -- 0
------------ ------------ ------------ ------------ ------------ ------------
Net (Loss) $ (1,236,692) $ (8,228,843) $ (9,465,535) $ (3,238,115) $ (1,746,289) $ (4,984,404)
============ ============ ============ ============ ============ ============
Net (Loss) Per
Common Share,
Basic and Diluted: $ (0.02) $ -- $ (0.15) $ (0.05) $ -- $ (0.07)
============ ============ ============ ============ ============ ============
Weighted Average
Number of Common
Shares Outstanding:
Basic and
Diluted 61,893,359 -- 61,893,359 67,941,251 -- 67,941,251
============ ============ ============ ============ ============ ============
-17-
TIDELANDS OIL & GAS CORPORATION
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005 AND 2004
NOTE 2 - SUMMARY OF RESTATED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
------ -----------------------------------------------------------------
SUMMARY OF RESTATED INTERIM REPORTS - 2005
Nine Months Ended September 30, 2005
--------------------------------------------
Previously Restatement
Reported (1) (2) Total
------------ ------------ ------------
Revenues:
Gas Sales and
Pipeline Fees $ 1,097,505 $ -- $ 1,097,505
Construction
Services 119,121 -- 119,121
------------ ------------ ------------
Total Revenues 1,216,626 -- 1,216,626
------------ ------------ ------------
Expenses:
Cost of Sales 635,113 -- 635,113
Operating
Expenses 210,545 -- 210,545
Depreciation 360,817 -- 360,817
Interest 503,950 -- 503,950
Beneficial
Conversion
Feature
Interest 0 (501,659) (501,659)
Sales, General
and
Administrative 4,022,271 2,556,200 6,578,471
Impairment
Losses 0 5,200,000 5,200,000
------------ ------------ ------------
Total Expenses 5,732,696 7,254,541 12,987,237
------------ ------------ ------------
(Loss) from
Operations (4,516,070) (7,254,541) (11,770,611)
Derivative Gain
(Loss) -- 5,168,000 5,168,000
Gain (Loss) on
Equipment Sale (3,167) -- (3,167)
Interest and
Dividend Income 96,240 -- 96,240
Minority
Interest -- -- --
Litigation
Settlement 109,369 188,456 297,825
------------ ------------ ------------
Net (Loss) $ (4,313,628) $ (1,898,085) $ (6,211,713)
============ ============ ============
Net (Loss) Per
Common Share,
Basic and Diluted: $ (0.06) $ -- $ (0.09)
============ ============ ============
Weighted Average
Number of Common
Shares Outstanding:
Basic and
Diluted 69,378,850 -- 69,378,850
============ ============ ============
(1) Adjust goodwill to period ending balances.
(2) Adjust to recognize fair value of derivative financial instruments as
liabilities at December 31, 2004 ($5,168,000) and first quarter
adjustment ($2,894,500) necessitated by marking to market the fair
value of the derivative.
(3) Adjustments associated with the issuance of convertible debentures.
(4) Adjustments to recognize the fair value of services and related
expenses paid for by the issuance of stock.
(5) Adjustments to recognize the gain / (loss) on changes in the derivative
liability. equity to derivative liabilities when the conversion price
became variable.
-18-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 3 - PREPAID EXPENSES
------ ----------------
A summary of prepaid expenses at December 31, 2005 and December 31,
2004 is as follows:
December 31, December 31,
2005 2004
------------ ------------
Prepaid Expenses-Other $ 2,741 $ 4,802
Prepaid Insurance 88,340 82,318
Prepaid License Fee 84,270 79,500
Prepaid Financing 0 310,000
Prepaid Rent 7,500 8,301
Prepaid Interest 1,087 2,567
------------ ------------
$ 183,938 $ 487,488
============ ============
NOTE 4 - PROPERTY, PLANT AND EQUIPMENT
------ -----------------------------
A summary of property, plant and equipment at December 31, 2005 and
December 31, 2004 is as follows:
Estimated
December 31, December 31, Economic
2005 2004 Life
----------- ----------- -----------
Pre-Construction Costs:
International Crossings to Mexico $ 540,880 $ 27,601 N/A
Mexican Gas Storage Facility
and Related Pipelines 1,926,616 928,232 N/A
Domestic LNG System 18,319 0
Propane Distribution Systems 0 207,415 N/A
----------- -----------
Total 2,485,815 1,163,248
Office Furniture, Equipment and
Leasehold Improvements 174,412 46,141 5 Years
Pipelines - Domestic 0 431,560 15 Years
Pipeline - Eagle Pass, TX to Piedras
Negras, Mexico 6,106,255 6,106,255 20 Years
Gas Processing Plant 0 186,410 15 Years
Tanks & Lines - Propane Distribution
System 1,895,494 1,596,439 5 Years
Machinery and Equipment 66,493 57,180 5 Years
Trucks, Autos and Trailers 136,940 63,175 5 Years
----------- -----------
Total 10,865,409 9,650,408
Less: Accumulated Depreciation 823,321 564,095
----------- -----------
Net Property, Plant and Equipment $10,042,088 $ 9,086,313
=========== ===========
Depreciation expense for the years ended December 31, 2005 and December
31, 2004 was $485,581 and $244,889 respectively.
NOTE 5 - RESTRICTED CASH
------ ----------------
Restricted cash consists of certificates of deposit to secure letters
of credit issued to the Railroad Commission of Texas.
-19-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 6 - LONG-TERM DEBT
------ --------------
A summary of long-term debt at December 31, 2005 and December 31, 2004
is as follows:
December 31, December 31,
2005 2004
------------ ------------
Note Payable, Secured, Interest Bearing
at 2% Over Prime Rate, Maturing
May 25, 2008 4,496,468 6,731,883
Convertible Debentures, Unsecured,
7% Interest Bearing,
Maturing May 18, 2006 0 5,000,000
------------ ------------
4,496,468 11,731,883
Less: Current Maturities 225,000 0
------------ ------------
Total Long-Term Debt $ 4,271,468 $ 11,731,883
============ ============
NOTE 7 - INCOME TAXES
------ ------------
The Company files a consolidated federal income tax return. At December
31, 2005, the Company had a net operating loss carry forward of
approximately $24,200,000 available to offset future federal taxable
income through 2025.
The components of the deferred tax assets and liabilities accounts at
December 31, 2005 are as follows:
Total Deferred Tax Assets $ 8,470,000
Less: Valuation Allowance 8,470,000
-----------
Deferred Tax Asset (Liability) $ 0
===========
NOTE 8 - COMMON STOCK TRANSACTIONS
------ -------------------------
On January 3, 2005, the company issued 200,000 shares of its common
stock for 2005 legal fees valued at $100,000 under the 2004 Stock Grant
and Option Plan.
On February 1, 2005, the company issued 500,000 shares of its
restricted common stock valued at $797,500 to Impact International, LLC
pursuant to the terms of the purchase of Reef Ventures, L.P.
On February 25, 2005, the Company approved the issuance of 60,000
shares of its restricted common stock valued at $82,000 for investor
public relations services.
On May 1, 2005, the Company issued 500,000 shares of its restricted
common stock valued at $900,000 to Impact International, LLC pursuant
to the terms of the purchase of Reef Ventures, L.P.
-20-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 8 - COMMON STOCK TRANSACTIONS (CONTINUED)
------ -------------------------------------
On June 23, 2005, the Company issued Impact International, LLC Seven
Million Five Hundred Thousand (7,500,000) common shares in response to
Impact's exercise of their common stock purchase warrants. Impact
tendered payment in the form of a promissory note in the amount of
$2,512,500. The note will reduce and offset the principal balance owed
by the Company under the Purchase and Sale Agreement dated May 25, 2004
whereby it acquired the Eagle Pass pipeline by purchasing an additional
73% of Reef Ventures, LP.
On June 27, 2005, the Company authorized the issuance of 150,000 shares
of its restricted common stock valued at $199,500 to each of the three
members of the Board of Directors, Michael R. Ward, Ahmed Karim and
Carl Hessel.
On June 27, 2005, the Company authorized the issuance of 150,000 shares
of common stock under a 2004 non-qualified stock grant and option plan
which was registered on Form S-8, November 5, 2004. The shares were
valued at $199,125 and were issued to James B. Smith, the Company's
Senior Vice President, CFO and newly appointed member of the Board of
Directors. On July 1, 2005, the company issued 1,000,000 shares of its
restricted common stock valued at $1,230,000 pursuant to an employment
contract with an officer of the Company.
On July 1, 2005, the Company issued 50,000 shares of its restricted
common stock valued at $61,500 pursuant to an employment contract with
an officer of the Company.
On July 1, 2005, the Company issued 10,000 shares of its restricted
common stock valued at $12,150 to an employee of the Company.
On August 18, 2005, Tidelands settled the legal dispute with L. L.
Capital Group, LLC whereby L. L. Capital Group, LLC canceled 285,000
shares of the 1,000,000 shares of the Company's restricted common stock
which it had received for a one year consulting contract executed
August 4, 2004. The 285,000 shares canceled were valued at $297,825.
On December 20, 2005, the Company issued 10,000 shares of its common
stock valued at $8,350 under the 2004 Stock Grant and Option Plan
pursuant to an employment contract with an officer of the Company.
On December 20, 2005, the Company issued 40,000 shares of its
restricted common stock valued at 33,400 pursuant to an employment
contract with an officer of the Company.
-21-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 8 - COMMON STOCK TRANSACTIONS (CONTINUED)
------ -------------------------------------
On June 14, 2005, June 27, 2005, July 5, 2005, September 19, 2005,
September 29, 2005 and November 2, 2005, Mercator Momentum Fund III,
L.P., Monarch Pointe Fund, Ltd (the "Funds") and Robinson Reed, Inc. (a
managed account of the "Funds") notified the Company of their intent to
convert portions of their remaining 7% convertible debentures into
common stock which were converted as follows:
Price
Per Number of
Entity Amount Share Shares
------ ---------- ---------- ----------
June 14, 2005
-------------
Mercator Momentum Fund, III, L.P. $ 273,600 $0.76 360,000
Mercator Momentum Fund, L.P. 380,000 0.76 500,000
Monarch Pointe Fund, Ltd 866,400 0.76 1,140,000
June 27, 2005
-------------
Mercator Momentum Fund, III, L.P. 175,000 0.76 230,263
Mercator Momentum Fund, L.P. 250,000 0.76 328,947
Monarch Pointe Fund, Ltd 575,000 0.76 756,579
July 5, 2005
------------
Robinson Reed, Inc. 200,000 0.76 263,158
September 19, 2005
Mercator Momentum Fund, L.P. 92,000 0.70 131,429
Mercator Momentum Fund III, L.P. 60,000 0.70 85,714
Monarch Pointe Fund, Ltd. 196,000 0.70 280,000
Robinson Reed, Inc. 52,000 0.70 74,286
September 29, 2005
------------------
Mercator Momentum Fund, L.P. 207,000 0.71 291,549
Mercator Momentum Fund, III, L.P. 144,000 0.71 202,817
Mercator Momentum Fund, Ltd. 459,000 0.71 646,479
Robinson Reed, Inc. 90,000 0.71 126,761
November 2, 2005
----------------
Mercator Momentum Fund, L.P. $ 214,000 0.76 261,579
Mercator Momentum Fund, III, L.P. 134,900 0.76 177,500
Monarch Pointe Fund, LTD 473,100 0.76 622,500
Robinson Reed, Inc. 158,000 0.76 217,895
---------- ----------
$5,000,000 6,687,456
========== ==========
The "Funds" shares and the "Impact" shares issued were all included in
the company's registration statement filed on Form SB-2 which was
declared effective by the Securities & Exchange Commission on May 27,
2005.
-22-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 9 - STOCK OPTIONS, STOCK WARRANTS AND SHARES RESERVED FOR CONVERTIBLE
------ DEBENTURES
-----------------------------------------------------------------------
The following table presents the activity for options, warrants and shares
reserved for issuance upon conversion of outstanding convertible debentures for
the year ending December 31, 2005 and 2004:
Shares Reserved Weighted
Stock Stock for Convertible Average
Options Warrants Debentures Exercise Price
----------- ----------- ----------- --------------
Outstanding - December 31, 2003 2,500,000 8,516,807 0 $0.31
Granted / Issued 250,000 10,562,141 11,111,111 0.69
Exercised (2,500,000) (1,500,000) 0 0.14
----------- ----------- ----------- -----
Outstanding - December 31, 2004 250,000 17,578,948 11,111,111 $0.50
----------- ----------- ----------- -----
Granted / Issued 0 0 0 -
Exercised / Converted 0 (8,500,000) (6,687,456) 0.49
Expired 0 0 0 -
Cancelled 0 (50,000) (4,423,655) 0
----------- ----------- ----------- -----
Outstanding - December 31, 2005 250,000 9,028,948 0 $1.01
=========== =========== =========== =====
The 2004 Non-Qualified Stock Grant and Option Plan has 4,350,872 shares
remaining available for future issuance.
On November 18, 2004, the Company entered into a Securities Purchase Agreement
with Mercator Momentum Fund, LP, Mercator Momentum Fund III, LP, Monarch Pointe
Fund, LP, (collectively, "the Funds") and M.A.G. Capital, LLC ("M.A.G.")
(formerly Mercator Advisory Group, LLC). In exchange for $5,000,000 the Company
issued to the Funds, 7% convertible debentures with a maturity date of May 18,
2006. As of November 2, 2005, the $5,000,000 of convertible debentures was
converted for 6,587,456 shares of the Company's common stock.
In connection with this financing the Company issued 6,578,948 common stock
warrants which expire November 18, 2007. The warrants are exercisable at prices
ranging from $0.80 to $0.87. The Company granted the Funds and M.A.G.
registration rights on both groups of securities; such registration was declared
effective May 27, 2005.
Accounting for Stock Based Compensation
As allowed by Statement of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation, the Company has elected to apply the
intrinsic-value-based method of accounting. Under this method, the Company
measures stock based compensation for option grants to employees assuming that
options granted at market price at the date of grant have no intrinsic value.
Restricted stock awards were valued based on the market price of a share of
non-restricted stock on the date earned. No compensation expense has been
recognized for stock-based incentive compensation plans other than for
restricted stock awards pursuant to executive employment agreements.
-23-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 10 - COMMITMENT FOR SUITE LICENSE AGREEMENT
------- --------------------------------------
On June 4, 2004, the Company entered into a Suite License Agreement
with the San Antonio Spurs, L.C.C. commencing July 1, 2004 for a period
of five years. The annual license fee for the first year is $159,000
and is subject to a 6% per annum price escalation thereafter. The
annual fee is payable in installments as indicated in the agreement.
The future annual license fee commitments are as follows:
2005 $168,540
2006 178,652
2007 189,371
2008 200,733
--------
$737,296
========
NOTE 11 - 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 December 31, 2005, the loan
balance was $288,506.
NOTE 12 - LEASES
-------- ------
The Company entered into an operating lease on August 1, 2003 for the
rental of its executive office at a monthly rent of $3,400, which
expired November 30, 2005.
The Company retained tenancy in the building under the month-to-month
clause until February 1, 2006. On February 1, 2006, the Company renewed
the lease until December 31, 2007 at the same $3,400 per month rental.
The Company's wholly owned subsidiary, Sonterra Energy Corporation,
entered into a sublease agreement for its executive officers in an
adjacent building for $2,500 per month until its renewal in October
2005 at which time the monthly rent increased to $3,000 per month
through March 31, 2006. However, on February 1, 2006, Sonterra Energy
Corporation entered into a direct operating lease with the building
owner at a monthly rental of $3,300 for a term ending December 31,
2007.
-24-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 12 - LEASES (CONTINUED)
-------- ------------------
Sonterra Energy Corporation previously had entered into an operating
lease beginning October 1, 2004 for a propane tank site at an annual
rent of $10,000 expiring September 30, 2019.
Future commitments under the operating leases are as follows:
Year Ending Total
----------- -----
2006 $ 83,400
2007 90,400
2008 - 2009 107,500
---------
Total Minimum Lease Payments $ 281,300
=========
Rent expense for the years ended December 31, 2005 and 2004 was $82,300
and $43,300, respectively.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
------- -----------------------------
The Company is subject to the laws and regulations relating to the
protection of the environment. The Company's policy is to accrue
environmental and related cleanup costs of a non-capital nature when it
is both probable that a liability has been incurred and when the amount
can be reasonably estimated. Although it is not possible to quantify
with any degree of certainty the financial impact of the Company's
continuing compliance efforts, management believes any future
remediation or other compliance related costs will not have a material
adverse effect on the consolidated financial condition or reported
results of consolidated operations of the Company.
NOTE 14 - 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 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
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TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 14 - LITIGATION (CONTINUED)
-------- ----------------------
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 a 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.
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 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, as a pre-closing deposit to the purchase of the ZG
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.
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TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 14 - LITIGATION (CONTINUED)
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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 Hessel 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 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.
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 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
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TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 14 - LITIGATION (CONTINUED)
------- ----------------------
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.
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 15 - ACQUISITIONS
------- -------------
REEF VENTURES, L.P. TRANSACTION
-------------------------------
On May 25, 2004, the Company entered into a Purchase and Sale Agreement
for Reef Ventures, L.P. by and between Impact International, LLC
("Impact") and Coahuila Pipeline, LLC. ("Coahuila"), (jointly "Seller")
and Tidelands Oil & Gas Corporation ("Tidelands") and Arrecefe
Management, LLC ("Arrecefe"), (jointly "Buyer"). The transaction closed
on June 18, 2004.
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TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 15 - ACQUISITIONS (CONTINUED)
------- ------------------------
Purchase and Sale Agreement - Background
Reef Ventures, L.P. was formed in Texas on April 16, 2003. Coahuila
owned one percent (1%) of Reef Ventures, L.P. Impact was a limited
partner of Reef Ventures and owned seventy-two percent (72%) of Reef
Ventures, L.P. Tidelands formed Arrecefe Management, L.L.C., a Texas
limited liability company, to act as the general partner for Reef
Ventures, L.P. Tidelands had already owned twenty-five percent (25%) of
Reef Ventures, L.P.
Summary of Purchase and Sale Agreement
The Company and Arrecefe purchased Impact's and Coahuila's units of
interest in Reef Ventures, L.P., respectively. Impact financed the sale
of the Reef interests by taking back a promissory note (the "Tidelands
Note") in the amount of $6,523,773 payable as follows:
(a) The "Tidelands Note" bears interest at prime plus two (2%) percent.
The note calls for quarterly interest payments during the first fifteen
(15) months, and thereafter, principal and interest would be due
quarterly amortized over twenty (20) years, but not to exceed an amount
equal to One Hundred (100%) percent of Reef's net cash flow. All
quarterly interest payments due which are limited by the amounts of
Reef's net cash flow have been and will be added to the note balance if
applicable. The unpaid balance of the note would be due at the end of
the fourth year.
(b) The Tidelands' note is secured by (i) a deed of trust (the "Deed of
Trust") from the Partnership to Impact, covering the pipeline and
related facilities, easements, rights-of-way and the Gas Contracts
which comprise the project, being that 12-inch pipeline Project for
transporting natural gas from Eagle Pass Texas to Piedras Negras,
Mexico, defined in the Partnership Agreement. The Deed of Trust would
include a present assignment of Reef's rights to receive cash flow from
the Gas Project which would be exercisable by Impact only upon default
under the Tidelands' Note, Reef guarantee, or Reef Deed of Trust. (ii)
a guaranty of payment and performance from the Partnership (the
"Partnership Guaranty"), and (iii) a pledge agreement whereby the
Partnership pledges to Impact its 98% membership interest in Reef.
Minority Interest
The remaining two percent (2%) of Reef Ventures, LP, is owned by an
unaffiliated third party. No value or allocation of net income or loss
will be attributed until the total investment by existing ownership has
been recovered.
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TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
NOTE 16 - SUBSEQUENT EVENTS
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During January, 2006, the Company completed a private placement of
$6,569,750 of securities with several institutional investors led by
Palisades Master Fund, L.P. The private placement consists of Original
Issue Discount Convertible Debentures, convertible into common stock of
the Company at a conversion price of $0.87 per share. The investors
will also receive three-year 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. Additional 13 month callable warrants to purchase,
in the aggregate, 7,551,432 were issued to the investors with an
exercise price of $1,275 which warrants include a forced exercise
provision by the Company if certain price and equity conditions are
met. The Company will receive net proceeds of $4,964,410 from the
transactions.
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