UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB/A
Amendment No. 2
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
----------- -----------
Commission File Number 0-33027.
HOUSTON AMERICAN ENERGY CORP
(Exact name of small business issuer as specified in its charter)
Delaware 76-0675953
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
801 Travis Street, Suite 2020, Houston, Texas 77002
(Address of principal executive offices)(Zip Code)
(713) 222-6966
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has 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 [ ]
As of August 10, 2005, we had 19,968,089 shares of $.001 par value Common
Stock outstanding.
Transitional Small Business Disclosure Format (check one) Yes [ ] No [X]
EXPLANATORY NOTE
This quarterly report on Form 10-QSB/A ("Form 10-QSB/A") amendment #2 is being
filed to amend our quarterly report on Form 10-QSB for the quarter ended June
30, 2005 (the "Original Form 10-QSB"), which was originally filed with the
Securities and Exchange Commission ("SEC") on August 12, 2005 and amended on
November 7, 2005.
On February 3, 2006, the independent registered public accounting firm of
Houston American Energy (the "Company"), in conjunction with the preparation of
the Company's Form 10-KSB for the year ended December 31, 2005 and the related
financial statements, advised management of the Company that the previously
filed consolidated financial statements of the Company as of and for the
quarterly and year-to-date periods ended June 30, 2005 and September 30, 2005
needed to be restated. The restatement results from errors in accounting for
financial derivatives embedded in convertible notes and warrants issued by the
Company during 2005.
The Company concluded, after consultation with its audit committee and
independent registered public accounting firm, that it was necessary to restate
its financial results for the interim period ended June 30, 2005 to account for
the embedded derivatives in accordance with SFAS 133, including recording an
appropriate derivative liability, deemed interest expense associated with the
derivative liability and related charges associated with changes in the value of
embedded derivatives, as more fully described in Note 3 to the financial
statements included in this Form 10-QSB/A.
Pursuant to rule 12b-15 under the Securities Exchange Act of 1934, the Form
10-QSB/A contains complete text of Items 1, 2 and 3 of Part I and Items 1 and 6
of Part II, as amended, as well as currently dated certifications from the
Principal Executive Officer and the Principal Financial Officer.
This Form 10-QSB/A does not reflect events occurring after the filing of the
Original Form 10-QSB and does not modify or update the disclosure therein in any
way other than as required to reflect the amendments discussed above.
HOUSTON AMERICAN ENERGY CORP.
-----------------------------
FORM 10-QSB/A
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Balance Sheet as of June 30, 2005 (restated) . . . . . . . . . . . 4
Statements of Operations for the three months and six months
ended June 30, 2005 (restated) and June 30, 2004 . . . . . . . . 5
Statements of Cash Flows for the six months
ended June 30, 2005 (restated) and June 30, 2004 . . . . . . . . 6
Notes to Financial Statements. . . . . . . . . . . . . . . . . . . 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations. . . . . . . . 11
Item 3. Controls and Procedures. . . . . . . . . . . . . . . . . . . 17
PART II OTHER INFORMATION
Item 6. Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . 20
3
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
HOUSTON AMERICAN ENERGY CORP.
BALANCE SHEET
June 30, 2005
(Unaudited)
(Restated)
ASSETS
------
CURRENT ASSETS:
Cash $ 1,929,671
Accounts receivable 402,271
Prepaid expenses 33,411
------------
Total current assets 2,365,353
------------
PROPERTY, PLANT AND EQUIPMENT
Oil and gas properties - full cost method
Costs subject to amortization 2,842,709
Costs not being amortized 511,763
Furniture and equipment 10,878
------------
Total property, plant and equipment 3,365,350
Accumulated depreciation and depletion (1,179,713)
------------
Total property, plant and equipment, net 2,185,637
------------
OTHER ASSETS 101,074
------------
Total Assets $ 4,652,064
============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 282,261
Derivative liability 2,472,577
------------
Total current liabilities 2,754,838
------------
LONG-TERM DEBT:
Notes payable to principal shareholder 1,000,000
Subordinated convertible notes, net of $2,118,111 discount 6,889
Reserve for plugging costs 44,456
------------
Total long-term liabilities 1,051,345
------------
SHAREHOLDERS' EQUITY:
Common stock, $.001 par value; 100,000,000 shares
Authorized; 19,968,089 shares outstanding 19,968
Additional paid-in capital 2,798,324
Treasury stock, at cost; 100,00 shares (85,834)
Accumulated deficit (1,886,576)
------------
Total shareholders' equity 845,882
------------
Total liabilities and shareholders' equity $ 4,652,064
============
The accompanying notes are an integral part of these financial statements
4
HOUSTON AMERICAN ENERGY CORP.
STATEMENT OF OPERATIONS
(Unaudited)
Six Months Ended Three Months Ended
June 30, June 30,
-------------------------- --------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
(Restated) (Restated)
Revenue:
Oil and gas $ 1,091,940 $ 303,548 $ 646,429 $ 166,561
------------ ------------ ------------ ------------
Expenses of operations:
Lease operating expense and
severance tax 440,710 119,497 269,937 51,676
Joint venture expenses 27,424 6,048 13,601 6,048
General and administrative
Expense 340,048 127,280 171,951 81,524
Depreciation and depletion 170,358 57,493 107,731 34,687
------------ ------------ ------------ ------------
Total operating expenses 978,540 310,318 563,220 173,935
------------ ------------ ------------ ------------
Income (loss) from operations 113,400 (6,770) 83,209 (7,374)
------------ ------------ ------------ ------------
Other (income) expenses:
Interest income (7,770) (4,302) (5,566) (1,537)
Interest expense 26,920 - 28,624 -
Interest expense - derivatives 292,436 - 292,436 -
Net change in fair value of
derivative liabilities 62,030 - 62,030 -
Interest expense - shareholders 36,000 31,600 18,000 13,600
Financing costs 4,045 - 4,045 -
------------ ------------ ------------ ------------
Total other expense, net 413,661 27,298 399,569 12,063
------------ ------------ ------------ ------------
Net loss before taxes (300,261) (34,068) (316,360) (19,437)
Income tax expense 30,265 - 18,939 -
------------ ------------ ------------ ------------
Net loss $ (330,526) $ (34,068) $ (335,299) $ (19,437)
============ ============ ============ ============
Basic and diluted loss per share $ (0.02) $ (0.00) $ (0.02) $ (0.00)
============ ============ ============ ============
Basic and diluted weighted
average shares 19,968,089 19,536,060 19,968,089 19,565,279
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements
5
HOUSTON AMERICAN ENERGY CORP.
STATEMENTS OF CASH FLOWS
(Unaudited)
For the Six Months Ended June 30,
---------------------------------------
2005 2004
------------------ -------------------
(Restated)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (330,526) $ (34,068)
Adjustments to reconcile net loss
to net cash from operations
Depreciation and depletion 168,858 55,993
Non-cash expenses - 18,666
Change in fair value of derivatives 62,030 -
Amortization of debt discounts 292,436 -
Changes in operating assets and liabilities:
(Increase) in accounts receivable (162,130) (67,043)
(Increase) decrease in prepaid expense 56,536 (98,502)
(Increase) decrease in other assets (97,907) 36,863
Increase in accounts payable and accrued expenses 41,700 33,265
------------------ -------------------
Net cash provided (used) by operations 30,997 (54,826)
------------------ -------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of oil and gas properties (947,939) (441,778)
------------------ -------------------
Net cash used by investing activities (947,939) (441,778)
------------------ -------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of common stock - 91,193
Issuance of debt 2,125,000 -
------------------ -------------------
Net cash provided by financing activities 2,125,000 91,193
------------------ -------------------
Increase (decrease) in cash and equivalents 1,208,058 (405,411)
Cash, beginning of period 721,613 663,422
------------------ -------------------
Cash, end of period $ 1,929,671 $ 258,011
================== ===================
SUPPLEMENT CASH FLOW INFORMATION:
Interest paid $ 36,000 $ 36,000
================== ===================
SUPPLEMENT NON-CASH INVESTING AND
FINANCING ACTIVITIES
Non-cash expense - 18,666
Stock issued for oil and gas activity - 47,500
Stock issued for financial public relations - 103,000
The accompanying notes are an integral part of these financial statements
6
HOUSTON AMERICAN ENERGY CORP.
Notes to Financial Statements
June 30, 2005
(Unaudited)
NOTE 1. - BASIS OF PRESENTATION
The accompanying unaudited financial statements of Houston American Energy
Corp., a Delaware corporation (the "Company") have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial information and with the instructions to Form 10-QSB and
Item 310(b) of Regulation S-B. They do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for a complete financial presentation. In the opinion of
management, all adjustments, consisting only of normal recurring adjustments,
considered necessary for a fair presentation, have been included in the
accompanying unaudited financial statements. Operating results for the periods
presented are not necessarily indicative of the results that may be expected for
the full year.
These financial statements should be read in conjunction with the financial
statements and footnotes, which are included as part of the Company's Form
10-KSB for the year ended December 31, 2004 and 2005.
NOTE 2. - CHANGES IN PRESENTATION
Certain financial presentations for the periods presented for 2004 have been
reclassified to conform to the 2005 presentation.
NOTE 3. - RESTATED FINANCIAL STATEMENTS
The accompanying financial statements as of June 30, 2005 and for the
three-month and six-month periods ended June 30, 2005 are restated from those
originally issued to reflect certain adjustments related to derivative financial
instruments.
The restatement relates to the accounting for embedded features in certain
convertible notes and warrants issued by the Company during 2005 (See Note 4
below). The notes were originally recorded at their notional amounts; and the
fair value of the warrants was included in Shareholders' Equity. The Company
subsequently determined that the convertible notes and warrants contain
detachable and embedded derivatives that should have been accounted for as
derivative financial instruments in accordance with SFAS 133 and EITF 00-19 (See
Note 5 below).
In connection with the referenced restatement, interest income and certain
financing costs have been reclassified from operating revenue and expense,
respectively, to other (income) expense.
7
The following is a summary of the restatement adjustments.
As Previously
Reported Adjustments As Restated
--------------- ------------- -------------
Balance Sheet
-------------
Current assets
Prepaid expense 65,978 (32,567) 33,411
Total current assets 2,397,920 (32,567) 2,365,353
Other assets 225,913 (124,839) 101,074
Total assets 4,809,470 (157,406) 4,652,064
Currently liabilities
Derivative liability - 2,472,577 2,472,577
Total current liabilities 282,261 2,472,577 2,754,838
Long term debt
Subordinated convertible notes 2,125,000 (2,118,111) 6,889
Total long term debt 3,169,456 (2,118,111) 1,051,345
Shareholder equity
Additional paid in capital 2,962,589 (164,265) 2,798,324
Accumulated deficit (1,538,970) (347,606) (1,886,576)
Total stockholders' equity 1,357,753 (511,871) 845,882
Total liabilities and shareholders equity 4,809,470 (157,406) 4,652,064
Statement of Operations
Six Months Ended 6/30/05
------------------------
Other (income) expense
Interest expense-derivative - 292,436 292,436
Net change in fair value of derivative liabilities - 62,030 62,030
Financing costs 9,201 (5,156) 4,045
Interest expense 64,624 (1,704) 62,920
Total other (income) expense 66,055 347,606 413,661
Income (loss) before income taxes 47,345 (347,606) (300,261)
Net income (loss) 17,080 (347,606) (330,526)
Basic and diluted income (loss) per share $ 0.00 $ (0.02) $ (0.02)
Three Months Ended 6/30/05
--------------------------
Other (income) expense
Interest expense-derivative - 292,436 292,436
Net change in fair value of derivative liabilities - 62,030 62,030
Financing costs 9,201 (5,156) 4,045
Total other (income) expense 50,259 349,310 399,569
Income (loss) before income taxes 32,950 (349,310) (316,360)
Net income (loss) 14,011 (349,310) (335,299)
Basic and diluted income (loss) per share $ 0.00 $ (0.02) $ (0.02)
8
NOTE 4. - SUBORDINATED CONVERTIBLE NOTES AND WARRANTS
On May 4, 2005, the Company entered into Purchase Agreements (the "Purchase
Agreements") with multiple investors pursuant to which the Company sold
$2,125,000 of 8% Subordinated Convertible Notes Due 2010 (the "Notes").
The Notes bear interest at 8%, provide for semi-annual interest payments and
mature May 1, 2010. The Notes are convertible, at the option of the holders,
into common stock of the Company at a price of $1.00 per share (the "Conversion
Price"), subject to standard anti-dilution provisions relating to splits,
reverse splits and other transactions, including issuances of common stock at
prices below the Conversion Price. The Notes are subject to automatic
conversion in the event the Company conducts an underwritten public offering of
its common stock from which the Company receives at least $5 million and the
public offering price is at least 150% of the then applicable Conversion Price.
The Company has the right to cause the Notes to be converted into common stock
after May 1, 2006 if the price of the Company's common stock exceeds 200% of the
then applicable Conversion Price on the date of conversion and for at least 20
trading days over the preceding 30 trading days. The Company has the right to
repurchase the Notes after May 1, 2007 at 103% of the face amount during 2007,
102% of the face amount during 2008, 101% of the face amount during 2009 and
100% of the face amount thereafter. The Notes are unsecured general obligations
of the Company and are subordinated to all other indebtedness of the Company
unless the other indebtedness is expressly made subordinate to the Notes.
The Notes were offered and sold in private placement transaction pursuant to the
exemption from registration provided by Section 4(2) of the Securities Act of
1933 and Rule 506 promulgated thereunder. Each of the investors is either an
"accredited investor", as defined in Rule 501 promulgated under the Securities
Act, or a "qualified institutional buyer", as defined in Rule 144A promulgated
under the Securities Act.
Pursuant to the terms of the Purchase Agreements, the Company and the investors
entered into Registration Rights Agreements under which the Company agreed to
file with the Securities and Exchange Commission, within 90 days, a registration
statement covering the Notes and the common stock underlying the Notes and to
use its best efforts to cause the registration statement to become effective
within 180 days.
In connection with the placement of the Notes, the Company issued to the
placement agent in the offering a three year warrant (the "Placement Agent
Warrant") to purchase 191,250 shares of the Company's common stock at $1.00 per
share and paid commissions totaling $127,500. The Registration Rights
Agreements provide that the shares of common stock underlying the Placement
Agent Warrant are to be included in the registration statement required to be
filed.
NOTE 5. - DERIVATIVE LIABILITIES
In conjunction with the issuance of the Notes, the conversion feature, the
conversion price, reset provision and the Company's optional early redemption
right in the Notes have been bundled together as a single compound embedded
derivative liability and, using a layered discounted probability-weighted cash
flow approach, was initially fair valued at $2,368,485 at May 4, 2005. The fair
value model comprises multiple probability-weighted scenarios under various
assumptions reflecting the economics of the Notes, such as the risk-free
interest rate, expected Company stock price and volatility, likelihood of
conversion and or redemption, and likelihood default status and timely
registration. At inception, the fair value of this single compound embedded
derivative was bifurcated from the host debt contract and recorded as a
derivative liability which resulted in a reduction of the initial notional
carrying amount of the Notes (as unamortized discount which will be amortized
over a five-year period under the effective interest method). At inception the
excess of the unamortized discount over the notional amount of the Note in the
amount of $285,547 was charged to expense in the Company's statement of
operations.
9
At June 30, 2005, the Notes comprised the following:
Notional balance of Convertible Notes at June 30, 2005 $ 2,125,000
Adjustment - Discount for single compound derivative liability (2,118,111)
------------
Convertible Notes balance at June 30, 2005, as adjusted $ 6,889
============
For the period from inception (May 4, 2005) through June 30, 2005, the
amortization of unamortized discount on the Notes was $6,889, which has been
classified as interest expense in the accompanying statement of operation.
The Derivative Liability reflected on the balance sheet at June 30, 2005
consists of the Derivative Liability-Compound Embedded Derivatives within the
Notes plus the Derivative Liability-Compound Embedded Derivatives within the
Warrants issued in conjunction with the Notes.
The Derivative Liability-Compound Embedded Derivatives within Notes reflect the
following activity for the period from Inception (May 4, 2005) through June 30,
2005:
Balance at inception (May 4, 2005) $2,368,485
Mark-to-market adjustment for the period from inception to
June 30, 2005 23,712
----------
Balance at June 30, 2005 $2,392,197
==========
The Derivative Liability-Compound Embedded Derivatives within Warrants reflect
the following activity for the period from inception (May 4, 2005) to June 30,
2005.
Balance at inception (May 4, 2005) $42,063
Mark-to-market adjustment for the period from inception to
June 30, 2005 38,317
-------
Balance at June 30, 2005 $80,380
=======
NOTE 6. - WARRANTS
Activity of warrants during the three months ended June 30, 2005 is as follows:
Weighted
Average
Warrants Share Price
-------- ------------
Outstanding at beginning of period
Granted 191,250 $ 1.00
-------- ------------
Outstanding at end of period 191,250 $ 1.00
======== ============
Warrants outstanding and exercisable as of June 30, 2005:
Exercise Number of Remaining Number of
Price Shares Life Shares
--------- --------- --------- ---------
1.00 191,250 2.83 191,250
========= ========= ========= =========
10
NOTE 7. - FINANCING COSTS
In conjunction with the issuance of long-term debt described in Note 4 above,
the Company paid $127,500 in commissions and issued a warrant to the placement
agent to purchase 191,250 shares of the Company's common stock at an exercise
price of $1.00 per share expiring May 3, 2008. The market price on the date the
warrants were granted was $0.85. The warrants are accounted for as derivative
instruments pursuant to SFAS 133 and EITF 00-19 (see Note 5 above).
The aggregate financing costs of $127,500, comprised of commissions, are being
expensed ratably over the life of the Notes as financing costs. $4,045 of
financing costs were expensed during the quarter and the six months ended June
30, 2005. Unamortized financing costs of $97,907 are classified as other
assets; the remaining balance of $25,548 is classified as prepaid expense.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
FORWARD-LOOKING INFORMATION
This Form 10-QSB quarterly report of Houston American Energy Corp. (the
"Company") for the six months ended June 30, 2005, contains certain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, which are intended to be covered by the safe harbors created
thereby. To the extent that there are statements that are not recitations of
historical fact, such statements constitute forward-looking statements that, by
definition, involve risks and uncertainties. In any forward-looking statement,
where the Company expresses an expectation or belief as to future results or
events, such expectation or belief is expressed in good faith and believed to
have a reasonable basis, but there can be no assurance that the statement of
expectation or belief will be achieved or accomplished.
The following are factors that could cause actual results or events to differ
materially from those anticipated, and include, but are not limited to: general
economic, financial and business conditions; the Company's ability to minimize
expenses and exposures related to its oil and gas properties in which other
companies have control over the operations conducted on such properties; changes
in and compliance with governmental laws and regulations, including various
state and federal environmental regulations; the Company's current dependency on
John F. Terwilliger, its sole director and executive officer; and the Company's
ability to obtain additional necessary financing from outside investors and/or
bank and mezzanine lenders.
Readers are cautioned not to place undue reliance on the forward-looking
statements contained herein, which speak only as of the date hereof. The
Company believes the information contained in this Form 10-QSB to be accurate as
of the date hereof. Changes may occur after that date, and the Company will not
update that information except as required by law in the normal course of its
public disclosure practices.
The oil and gas industry is subject to volatile price movements based on various
factors including supply and demand and other factors beyond the control of the
Company. While the industry has generally benefited from higher prices during
the past two years, sudden and/or sustained decreases in energy prices can
occur, which could limit our ability to fund planned levels of capital
expenditures.
Additionally, the following discussion regarding the Company's financial
condition and results of operations should be read in conjunction with the
financial statements and related notes contained in Item 1 of Part 1 of this
Form 10-QSB, as well as the financial statements in Item 7 of Part II of the
Company's Form 10-KSB for the fiscal year ended December 31, 2004.
11
CRITICAL ACCOUNTING POLICIES
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The Company believes certain critical accounting
policies affect its more significant judgments and estimates used in the
preparation of its financial statements. A description of the Company's
critical accounting policies is set forth in the Company's Form 10-KSB for the
year ended December 31, 2004. As of, and for the quarter ended, June 30, 2005,
there have been no material changes or updates to the Company's critical
accounting policies other than (1) the application of derivative accounting
treatment prescribed by SFAS 133 and EITF 00-19 to outstanding convertible notes
and warrants, and (2) the following updated information relating to Unevaluated
Oil and Gas Properties:
UNEVALUATED OIL AND GAS PROPERTIES. Unevaluated oil and gas properties not
subject to amortization include the following at June 30, 2005:
Acquistion costs $ 59,269
Evalution costs 452,494
--------
Total $511,763
========
The carrying value of unevaluated oil and gas prospects include $439,333
expended for properties in the South American country of Colombia at June 30,
2005. We are maintaining our interest in these properties and development has
or is anticipated to commence within the next twelve months.
-- DERIVATIVES. The Company determined that the convertible notes and warrants
issued during 2005 contain detachable and embedded derivatives that should have
been accounted for as derivative instruments in accordance with SFAS 133 and
EITF 00-19. In assessing the value of the derivative instruments in accordance
with SFAS 133 and EITF 00-19, the Company utilizes a fair value model comprised
of multiple probability-weighted scenarios under various assumptions reflecting
the economics of the Convertible Notes, such as the risk-free interest rate,
expected Company stock price and volatility, likelihood of conversion and or
redemption, and likelihood default status and timely registration. Changes in
the subjective assumptions can materially affect the estimated fair value of
derivative instruments and consequently, the related amounts recognized in the
financial statements. See Note 5 of the Notes to the Financial Statements in
this Form 10-QSB for further discussion of derivative instruments.
CURRENT YEAR DEVELOPMENTS
Drilling, Leasehold and Seismic Activity
Through August 10, 2005, the Company has drilled two on-shore domestic wells as
follows:
- Drilling of a 10,600-foot well, the first well, on the South Sibley
Prospect in Webster Parish, Louisiana was completed in May 2005 with
multiple pay sands apparently identified. Sales from the well commenced
June 28, 2005. The Company has a 7.5% working interest at an 8.3% net
revenue interest carried to point of sales for the well.
- Drilling of a 12,100-foot well, the Baronet #2 well, on the Crowley
Prospect in Acadia Parish, Louisiana was completed in April 2005. The well
tested the Hayes Sand and flanks a natural gas well that produced 1.6 BCF
of natural gas from the Hayes Sand. After logging 21-feet of apparent net
pay, hole conditions deteriorated before logging could be completed. The
well was completed
12
and production began in June 2005. The Company has a 3% working interest
and 2.25% net revenue interest until payout for the well.
Assuming the Baronet #2 performs consistently, the Company plans to drill a
developmental well on the Crowley Prospect during the fourth quarter of 2005.
Through August 10, 2005, the Company has drilled six international wells in
Colombia as follows:
- Drilling of 5 offset wells on the Cara Cara concession in Colombia was
completed with production commencing on the Bengala #4, #5, #6 and #7 and
the Jaguar #5 in the first and second quarters of 2005. The Company holds a
1.59% working interest in each of the wells subject to a 30% reversionary
interest to Ecopetrol at payout.
- The Tambaqui #5 well commenced drilling, and production, in March 2005. The
Company holds a 12.6% working interest in the well.
Seismic surveying began on our Cara Cara concession in Colombia as part of our
planned delineation of additional drilling prospects on the concession. Seismic
surveying was completed on our Dorotea and Cabiona concessions to establish
drilling prospect locations.
The Company and its partners plan to drill up to 5 additional wells on the Cara
Cara concession through the end of 2005.
The Company and its partners are permitting 30 drilling locations on the Dorotea
and Cabiona concessions. The Company and its partners plan to add a second rig
to begin drilling as soon as permits are obtained and locations are built.
Financing Activity
In May 2005, the Company sold $2,125,000 of 8% Subordinated Convertible Notes
Due 2010 (the "Notes").
The Notes bear interest at 8%, provide for semi-annual interest payments and
mature May 1, 2010. The Notes are convertible, at the option of the holders,
into common stock of the Company at a price of $1.00 per share (the "Conversion
Price"), subject to standard anti-dilution provisions relating to splits,
reverse splits and other transactions, including issuances of common stock at
prices below the Conversion Price. The Notes are subject to automatic
conversion in the event the Company conducts an underwritten public offering of
its common stock from which the Company receives at least $5 million and the
public offering price is at least 150% of the then applicable Conversion Price.
The Company has the right to cause the Notes to be converted into common stock
after May 1, 2006 if the price of the Company's common stock exceeds 200% of the
then applicable Conversion Price on the date of conversion and for at least 20
trading days over the preceding 30 trading days. The Company has the right to
repurchase the Notes after May 1, 2007 at 103% of the face amount during 2007,
102% of the face amount during 2008, 101% of the face amount during 2009 and
100% of the face amount thereafter. The Notes are unsecured general obligations
of the Company and are subordinated to all other indebtedness of the Company
unless the other indebtedness is expressly made subordinate to the Notes.
Pursuant to the terms of the Purchase Agreements, the Company and the investors
entered into Registration Rights Agreements under which the Company agreed to
file with the Securities and Exchange Commission, within 90 days, a registration
statement covering the Notes and the common stock underlying the Notes and to
use its best efforts to cause the registration statement to become effective
within 180 days.
13
In connection with the placement of the Notes, the Company issued to the
placement agent in the offering a three year warrant (the "Placement Agent
Warrant") to purchase 191,250 shares of the Company's common stock at $1.00 per
share and paid commissions totaling $127,500. The Registration Rights
Agreements provide that the shares of common stock underlying the Placement
Agent Warrant are to be included in the registration statement required to be
filed.
RESTATEMENT OF FINANCIAL STATEMENTS
The financial statements as of June 30, 2005 and for the three-month and
six-month periods ended June 30, 2005 are restated from those originally issued
to reflect certain adjustments related to derivative financial instruments.
The restatement relates to the accounting for embedded features in the Notes and
Placement Agent Warrants issued by the Company during 2005. The Notes were
originally recorded at their notional amounts; and the fair value of the
Placement Agent Warrants were included in Shareholders' Equity. The Company
subsequently determined that the Notes and Placement Agent Warrants contain
detachable and embedded derivatives that should have been accounted for as
derivative financial instruments in accordance with SFAS 133 and EITF 00-19.
In connection with the referenced restatement, interest income and certain
financing costs have been reclassified from operating revenue and expense,
respectively, to other (income) expense.
RESULTS OF OPERATIONS
Oil and Gas Revenues. Total oil and gas revenues increased 260% to $1,091,940
in the six months ended June 30, 2005 when compared to the six months ended June
30, 2004. The increase in revenue is due to (1) increased production resulting
from the development of the Columbian fields and the new domestic wells that
have come on line during the second half of 2004 and the first half of 2005, and
(2) increases in oil prices. The Company had interests in 13 producing wells in
Colombia and 7 producing wells in the U.S. during the 2005 period as compared to
4 producing wells in Columbia and 5 producing wells in the U.S. during the 2004
period. Average prices from sales were $38.22 per barrel of oil and $5.93 per
mcf of gas during the 2005 period as compared to $28.43 per barrel of oil and
$5.10 per mcf of gas during the 2004 period. Following is a summary comparison,
by region, of oil and gas sales for the periods.
Columbia U.S. Total
--------- -------- --------
2005 Period
Oil sales $ 844,210 $ 42,640 $886,850
Gas sales - 205,090 205,090
2004 Period
Oil sales 149,358 8,067 157,425
Gas sales - 146,123 146,123
Lease Operating Expenses. Lease operating and severance tax expenses, excluding
joint venture expenses relating to our Columbian operations discussed below,
increased 269% to $440,710 in the 2005 period from $119,497 in the 2004 period.
The increase in lease operating expenses was attributable to the increase in the
number of wells operated during the 2005 period (20 wells as compared to 10
wells). Following is a summary comparison of lease operating expenses for the
periods.
Columbia U.S. Total
--------- -------- --------
2005 Period $ 420,472 $20,238 $440,710
2004 Period 98,084 21,413 119,497
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Joint Venture Expenses. The Company's allocable share of joint venture expenses
attributable to the Colombian Joint Venture totaled $27,424 during the 2005
period and $6,048 during the 2004 period. The increase in joint venture
expenses was attributable to an increase in operational activities of the joint
venture in acquiring new concessions.
Depreciation and Depletion Expense. Depreciation and depletion expense was
$170,358 and $57,493 for the periods ended June 30, 2005 and 2004, respectively.
The increase is due to increases in domestic and Colombian production.
General and Administrative Expenses. General and administrative expense
increased by 167% to $340,048 during the 2005 period from $127,280 in the 2004
period. The increase in general and administrative expense was primarily
attributable to the payment of salary (up $97,184 from $0) to the Company's
principal officer beginning in the fourth quarter of 2004 and increases in
professional fees (up $136,594, or 243%) relating primarily to legal fees
associated with the ongoing Moose Oil litigation.
Other Expense, Net. Other expense, net, consists of financing costs in the
nature of interest and deemed interest associated with outstanding shareholder
loans and convertible notes and warrants issued in May 2005, net of interest
earned by the Company. Certain features of the convertible notes and warrants
resulted in the recording of a deemed derivative liability on the balance sheet
and periodic interest associated with the deemed derivative liabilities and
changes in the fair market value of those deemed liabilities.
Other expenses, in total, increased from $27,298 in the six-month period ended
June 30, 2004 to $413,661 in the six-month period ended June 30, 2005. The
increase in other expenses was attributable to interest incurred on the
convertible notes issued in May 2005 and deemed interest and related charges
associated with the derivative liability. During the 2004 period, other expense
was entirely attributable to interest accruing on a shareholder loan $31,600
offset by earned interest $4,302. During the 2005 period, other expense related
primarily to deemed interest on the derivative liability $292,436, the net
change in fair value of the derivative liability $62,030, interest accrued on
the convertible notes $26,920, interest accrued on the shareholder loan $36,000
and financing costs $4,045, offset by interest earnings $7,770.
FINANCIAL CONDITION
Liquidity and Capital Resources. At June 30, 2005 we had a cash balance of
$1,929,671 and working capital of $2,083,092 compared to a cash balance of
$721,613 and working capital of $771,392 at December 31, 2004. The increase in
cash and working capital during the period was primarily attributable to the
sale, during 2005, of $2,125,000 of Subordinated Convertible Notes partially
offset by investing activities relating to oil and gas properties.
Derivative liabilities of $2,472,577 are recorded as current liabilities at June
30, 2005 as compared to $0 at December 31, 2004, but are not considered in
computing working capital. The derivative liabilities represent the deemed fair
value of the embedded derivatives included in the subordinated convertible notes
and accompanying warrants that were issued during 2005 as measured at June 30,
2005. Included within the derivative liabilities at June 30, 2005 was
$2,118,111 attributable to the derivative features in the subordinated
convertible notes which amount is reflected as a discount in the amount of the
subordinated convertible note on the balance sheet as compared to $0 at December
31, 2004.
Operating cash flows for the 2005 period totaled $30,997 as compared to cash
used in operations during the 2004 period of $54,826. The improvement in
operating cash flow was primarily attributable to improved profitability and
increases in depreciation and depletion, partially offset by changes in
operating assets and liabilities.
15
Investing activities used $947,939 during the 2005 period as compared to
$441,778 used during the 2004 period. The increase in funds used in investing
activities during the current period was primarily attributable to the payment
of the Company's portion of seismic survey costs on Colombian prospects totaling
$447,605.
Financing activities provided $2,125,000 during the 2005 period attributable to
the sale of Subordinated Convertible Notes and $91,193 during the 2004 period
attributable to the issue of common stock.
Long-Term Debt. At June 30, 2005, our long-term debt was $1,051,345 as compared
to $1,000,000 at December 31, 2004. Long-term debt at June 30, 2005 consisted
of a reserve for plugging costs of $44,456, a note payable to our principal
shareholder in the amount of $1,000,000 and 8% subordinated convertible notes in
the principal amount of $2,125,000, recorded net of discounts in the amount of
$2,118,111 relating to the fair value of the embedded derivatives included in
the subordinated convertible notes. The increase in long-term debt was
attributable to the issuance during the period of the subordinated convertible
notes and recording the plugging cost reserve.
Notes payable to our principal shareholder, in the amount of $1,000,000, bear
interest at 7.2% and mature January 1, 2007.
Notes payable also included $2,125,000 in principal amount of Convertible Notes.
The Convertible Notes bear interest at 8%, provide for semi-annual interest
payments and mature May 1, 2010. The Convertible Notes are convertible, at the
option of the holders, into common stock of the Company at a price of $1.00 per
share (the "Conversion Price"), subject to standard anti-dilution provisions
relating to splits, reverse splits and other transactions, including issuances
of common stock at prices below the Conversion Price. The Convertible Notes are
subject to automatic conversion in the event the Company conducts an
underwritten public offering of its common stock from which the Company receives
at least $5 million and the public offering price is at least 150% of the then
applicable Conversion Price. The Company has the right to cause the Convertible
Notes to be converted into common stock after May 1, 2006 if the price of the
Company's common stock exceeds 200% of the then applicable Conversion Price on
the date of conversion and for at least 20 trading days over the preceding 30
trading days. The Company has the right to repurchase the Convertible Notes
after May 1, 2007 at 103% of the face amount during 2007, 102% of the face
amount during 2008, 101% of the face amount during 2009 and 100% of the face
amount thereafter. The Convertible Notes are unsecured general obligations of
the Company and are subordinated to all other indebtedness of the Company unless
the other indebtedness is expressly made subordinate to the Convertible Notes.
Capital and Exploration Expenditures and Commitments. Our principal capital and
exploration expenditures relate to our ongoing efforts to acquire, drill and
complete prospects. Historically, we funded our capital and exploration
expenditures from funds borrowed from John F. Terwilliger, our principal
shareholder and officer. With the receipt of additional equity financing in
2003, 2004 and the May 2005 sale of convertible notes, and the increase in our
revenues, profitability and operating cash flows, we expect that future capital
and exploration expenditures will be funded principally through funds on hand
and funds generated from operations.
During the first half of 2005, we invested approximately $947,939 for the
acquisition and development of oil and gas properties, consisting of (1) seismic
surveying in Colombia ($447,605), (2) drilling the well on the Crowley Prospect,
and (3) drilling 6 wells in Colombia.
At June 30, 2005, our only material contractual obligations requiring
determinable future payments on our part were notes payable to our principal
shareholder and holders of subordinated convertible notes and our lease relating
to our executive offices.
16
In addition to the contractual obligations requiring that we make fixed
payments, in conjunction with our efforts to secure oil and gas prospects,
financing and services, we have, from time to time, granted overriding royalty
interests (ORRI) in various properties, and may grant ORRIs in the future,
pursuant to which we will be obligated to pay a portion of our interest in
revenues from various prospects to third parties.
At June 30, 2005, our acquisition and drilling budget for the balance of 2005
totaled approximately $427,500, consisting of (1) $120,000 for drilling of 5
wells in South America on the Cara Cara concession, (2) $187,500 to drill one
additional concession acquired in South America in 2004 and (3) $120,000 to
drill an additional well on the Crowley Prospect. Our acquisition and drilling
budget has historically been subject to substantial fluctuation over the course
of a year based upon successes and failures in drilling and completion of
prospects and the identification of additional prospects during the course of a
year.
Management anticipates that our current financial resources combined with our
increases in revenues over the past year will meet our anticipated objectives
and business operations, including our planned property acquisitions and
drilling activities, for at least the next 12 months without the need for
additional capital. Management continues to evaluate producing property
acquisitions as well as a number of drilling prospects. It is possible,
although not anticipated, that the Company may require and seek additional
financing if additional drilling prospects are pursued beyond those presently
under consideration.
OFF-BALANCE SHEET ARRANGEMENTS
We had no off-balance sheet arrangements or guarantees of third party
obligations at June 30, 2005.
INFLATION
We believe that inflation has not had a significant impact on our operations
since inception.
ITEM 3. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures (as defined in Exchange
Act Rule 13a-15(e) and 15d-15(e)) that are designed to ensure that information
required to be disclosed in the Company's Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms, and that such information
is accumulated and communicated to the Company's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding the required disclosure.
In designing and evaluating the disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management necessarily is required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
At the time the original Quarterly Report on Form 10-QSB was prepared and filed
on August 12, 2005, an evaluation as of the end of the period covered by this
report had been carried out under the supervision and with the participation of
our management, including our chief executive officer and chief financial
officer, of the effectiveness of our disclosure controls and procedures, as such
term is defined under Rule 13a-15(e) and Rule 15d -15(e) promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). This
evaluation was performed in light of weaknesses identified, and described in the
original Quarterly Report, relating to accounting for non-routine transactions.
Based on their evaluation, our chief executive officer, who also served at that
time as chief financial officer, had originally concluded that our disclosure
controls and procedures were effective to ensure that we record, process,
summarize, and report information required to be disclosed by us in our reports
filed under the Securities Exchange
17
Act within the time periods specified by the Securities and Exchange
Commission's rules and forms even though weaknesses in controls were identified.
In connection with the audit of our financial statements for the fiscal year
ended December 31, 2005, our independent registered public accounting firm
informed us that we had significant deficiencies constituting material
weaknesses as defined by the standards of the Public Company Accounting
Oversight Board, some of which had previously been identified in connection with
the audit of our financial statements for the fiscal year ended December 31,
2004 and continued to exist at December 31, 2005.
The weaknesses in question were detected during the audit of our financial
statements for the fiscal year ended December 31, 2004, which audit occurred in
February/March 2005, and during the audit of our financial statements for the
fiscal year ended December 31, 2005, which audit occurred in March 2006.
The weaknesses were detected in the routine course of the audit review of
accounting for certain non-routine transactions.
The specific problems identified by the auditor were (1) lack of segregation of
duties necessary to maintain proper checks and balances between functions, (2)
failure of internal personnel to adequately communicate the scope and nature of
non-routine transactions, and (3) application of improper accounting principles
to financial derivatives. The absence of qualified full time accounting
personnel was a contributing factor to the problems identified by the auditor.
The specific circumstances giving rise to the weaknesses include our President
serving as both Chief Executive Officer and as Chief Financial Officer and our
utilizing the services of contract accountants on a part time basis in the
absence of internal accounting personnel. As a result of the absence of full
time in-house accounting personnel and the failure of in-house personnel to
adequately communicate information to the outside contract accountants, certain
journal entries required during 2004 and 2005 were not made until the time of
the audit when the need for such entries was identified by the auditor.
As a result of our review of the items identified by our auditors, we have
concluded that our previous derivative accounting policies were incorrect.
In light of the above items, we have restated our financial statements for the
quarterly and year-to-date periods ended June 30, 2005 and September 30, 2005 to
correct our accounting for derivatives.
Further, based on the material weaknesses described herein, we have re-evaluated
our disclosure controls at June 30, 2005 and concluded that our disclosure
controls and procedures were not effective at the reasonable assurance level at
June 30, 2005. More specifically, our failure to maintain effective controls
over the selection, application and monitoring of our accounting policies to
assure that certain transactions were accounted for in conformity with generally
accepted accounting principles resulted in a failure to record an appropriate
derivative liability, deemed interest expense associated with the derivative
liability and related charges associated with changes in the value of embedded
derivatives, all arising from the issuance of convertible notes and warrants
that included embedded derivatives.
Because we lack the financial resources to support in-house accounting personnel
at this time, no formal steps had been taken as of the time of filing of the
original quarterly report for the period ended June 30, 2005 to resolve the
weaknesses identified by the auditor. We, however, began emphasizing
improvement in communications with outside accounting personnel to assure that
non-routine transactions are accounted for in a timely manner. Further, with
respect to the specific accounting principles that were subject of the
weaknesses identified - derivatives accounting and compensation accounting - we
placed an emphasis on reviewing the application of such principles in connection
with all future accounting periods.
18
During the quarter ended June 30, 2005, there were no changes in our internal
controls over financial reporting that materially affected, or are reasonably
likely to materially affect, internal controls over financial reporting. We
subsequently hired a full-time in-house chief financial officer and expect that
such hiring will alleviate some or all of the weaknesses in disclosure control
previously identified.
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PART II
ITEM 6. EXHIBITS
Exhibit
Number Description
-------- -----------
31.1 Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
31.2 Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
32.1 Certification of CEO Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of CFO Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on behalf by the undersigned
thereunto duly authorized.
HOUSTON AMERICAN ENERGY CORP.
By: /s/ John Terwilliger
---------------------------
John Terwilliger
CEO and President
By: /s/ James Jacobs
---------------------------
James Jacobs
Chief Financial Officer
Date: December 1 , 2006
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