UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

 

 

 

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DOCUMENTS INCORPORATED BY REFERENCE:

 

Portions of the Registrant’s Proxy Statement for its 2007 Annual Meeting of Stockholders are incorporated by reference as to Part III, Items 10, 11, 12, 13 and 14.

 

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THE BEARD COMPANY

FORM 10-K

For the Fiscal Year Ended December 31, 2006

 

TABLE OF CONTENTS

 

 

 

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THE BEARD COMPANY

 

FORM 10-K

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

THIS REPORT INCLUDES “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. ALL STATEMENTS OTHER THAN STATEMENTS OF HISTORICAL FACTS INCLUDED OR INCORPORATED BY REFERENCE IN THIS REPORT, INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING THE COMPANY’S FUTURE FINANCIAL POSITION, BUSINESS STRATEGY, BUDGETS, PROJECTED COSTS AND PLANS AND OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS, ARE FORWARD-LOOKING STATEMENTS. IN ADDITION, FORWARD-LOOKING STATEMENTS GENERALLY CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS “MAY,” “WILL,” “EXPECT,” “INTEND,” “PROJECT,” “ESTIMATE,” “ANTICIPATE,” “BELIEVE,” OR “CONTINUE” OR THE NEGATIVE THEREOF OR VARIATIONS THEREON OR SIMILAR TERMINOLOGY. ALTHOUGH THE COMPANY BELIEVES THAT THE EXPECTATIONS REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE REASONABLE, IT CAN GIVE NO ASSURANCE THAT SUCH EXPECTATIONS WILL PROVE TO HAVE BEEN CORRECT. IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE COMPANY’S EXPECTATIONS (“CAUTIONARY STATEMENTS”) ARE DISCLOSED UNDER “ITEM 1. BUSINESS (c) NARRATIVE DESCRIPTION OF OPERATING SEGMENTS,” “ITEM 1A, RISK FACTORS,” “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” AND ELSEWHERE IN THIS REPORT. ALL SUBSEQUENT WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE COMPANY, OR PERSONS ACTING ON ITS BEHALF, ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY STATEMENTS. THE COMPANY ASSUMES NO DUTY TO UPDATE OR REVISE ITS FORWARD-LOOKING STATEMENTS BASED ON CHANGES IN INTERNAL ESTIMATES OR EXPECTATIONS OR OTHERWISE.

 

PART I

 

Item 1. Business.

 

 

General. Prior to October, 1993, The Beard Company (“Beard” or the “Company”), then known as Beard Oil Company (“BOC”), was primarily an oil and gas exploration company. During the late 1960’s we made the decision to diversify. In 1968 we started a hazardous waste management company, USPCI, Inc. (“USPCI”), which was partially spun off to shareholders in January 1984. Following two public offerings and several acquisitions USPCI became so successful that it subsequently listed on the New York Stock Exchange in 1986. It was acquired by Union Pacific Corporation in 1987-1988 for $396 million ($111 million to BOC stockholders for their residual 28% interest, of which $60 million was distributed to shareholders).

 

In 1989 BOC founded Beard Investment Company (now The Beard Company) for the purpose of building new businesses which Beard management believed to have either high growth potential or better-than-average profit potential. Our goal has been to nurture each investment to the point where it could sustain its growth through internal cash flow.

 

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We have been involved in numerous businesses during the last 29 years, many of them unsuccessful. Our operating activities are now comprised of five segments:

 

 

Net Operating Loss Carryforwards. We have approximately $44.1 million of unused net operating losses ("NOL's") available for carryforward, including $41.1 million which expire between 2007 and 2008 and $3 million which expire in 2021 through 2026, plus approximately $3 million in tax depletion carryforwards. The loss of the NOL's would have a negative impact on our future value. If we were to experience an “ownership change” as defined in Section 382 of the Internal Revenue Code, we would be severely limited in our ability to use our NOL’s in the future. Our Certificate of Incorporation contains provisions to prevent the triggering of such a change by restricting transfers of shares without our Board of Directors’ consent to any person if that person was, or would thereby become, a holder of 5% or more of the fair market value of our outstanding capital stock.

 

Effect of Recent Operations on Liquidity. Sustaining the operating activities of our unprofitable Coal, China and e-Commerce Segments, plus our overhead, has resulted in a serious outflow of cash during the past several years. We have managed this cash shortfall through a series of financings and the sale of various assets, principally those left over from our previously discontinued operations. These financings were supplemented by the $4,094,000 ($3,976,000 after tax) we received from the McElmo Dome litigation (the “Settlement” ---See “Item 3. Legal Proceedings—McElmo Dome Litigation” for complete details).

 

Private Debt Placements. The financings included private placements of (i) $1,200,000 of 10% Floating Rate Notes due November 30, 2006 (the “2006 Notes”) coupled with warrants and Production Payments completed in June of 2004; (ii) $2,100,000 of 12% Convertible Subordinated Notes due February 15, 2010 (the “2010 Notes”) completed in October of 2004 and January of 2005; (iii) $2,004,102 of 12% Convertible Subordinated Notes due August 31, 2009 (the “2009 Notes”) completed in October of 2005 and February of 2006; and (iv) $1,268,000 of 12% Convertible Subordinated Notes due in 2008 (the “2008 Notes”) completed in November of 2006. In each case the Notes were offered to accredited investors and sold on a best efforts basis by us and by an investment banking firm which acted as a selling agent.

 

All of the 2006 and 2010 Notes were sold. A total of $1,328,000 of the 2009 Notes were sold, including $193,000 which were sold in the first quarter of 2006 and generated working capital of approximately $191,000. The exchange in 2005 of $624,000 of 2009 Notes for 2006 Notes generated $624,000 of working capital by converting current maturities of long-term debt to long-term debt. A total of $651,000 of the 2008 Notes were sold in 2006, including $568,000 of 2008 Notes which were exchanged for Production Payments. This exchange generated working capital of $568,000 in 2006 for the same reason.

 

The 2010, 2009 and 2008 Notes (collectively, the “Notes”) were convertible into 2,100,000, 650,000 and 651,000 shares of the Company’s common stock, respectively, at year-end 2006. The warrants issued with the 2006 Notes were convertible into 480,000 shares; 200,000 of the warrants have already been exercised. Conversion of the Notes and our outstanding 647,240 warrants will create a substantial amount of dilution on our future earnings per share. Sale of the Notes, net of the exchange and legal and other costs associated with the offerings, provided approximately $2,195,000 of net cash proceeds to us in 2005, $275,000 in 2006 and $105,000 in 2007. The note exchanges in 2005 and 2006 provided additional working capital of $1,192,000 as discussed

 

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above. The working capital provided by the sales and exchanges of Notes substantially improved our liquidity and provided most of the working capital needed to “bridge the gap” until the coal projects we have under development can generate positive cash flow.

 

Bank Credit Facility on Colorado Gas Wells. On March 28, 2006, we closed on a $350,000 reducing revolving credit facility with a local bank secured by a first lien on our share of the production from eight gas wells in Yuma County, Colorado. The new credit facility provided an initial borrowing base of $350,000, with such commitment reducing at the rate of $10,000 per month. $115,000 of the initial borrowings of $175,000 under the facility were used to repay loans from related parties; the balance was added to working capital. Our borrowings under the facility peaked at $290,000 in July of 2006. Borrowings had been reduced to $260,000 at year-end 2006 and to $230,000 at March 31, 2007. The loan matures on September 30, 2007, with interest payable monthly at the Wall Street Journal Prime Rate plus 150 basis points.

 

Other Financings. The financings were further supplemented in 2007 by (i) a $150,000 short-term loan from a shareholder of a former affiliate, (ii) $39,000 of short-term loans from our Note holders, and (iii) $105,000 of additional 2010 Notes (convertible into 105,000 common shares) sold to a 2010 Note holder.

 

Coal Projects. We have several projects in various stages of development in the Coal Segment which, subject to arranging necessary financing, we ultimately expect to mature into operating projects. We have finalized definitive agreements with PinnOak Resources, LLC (“PinnOak”), to construct and operate a pond fines recovery project in West Virginia (the “Pinnacle Project” or the “Project”). Construction of the Project has been completed, and the facility is now in the ramp up stage. See “Recent Developments---Loans from and Agreements with PinnOak Resources” below and “Narrative description of operating segments---COAL RECLAMATION ACTIVITIES---Pinnacle Project”).

 

Unless the context otherwise requires, references to us herein include our consolidated subsidiaries.

 

Recent Developments

 

Loans from and Agreements with PinnOak Resources. When the original agreement was signed in September of 2004 for the construction of the Pinnacle Project, PinnOak was anxious to start the Project despite the fact that the USDA guaranty needed to secure a $9,000,000 bank loan had not yet been obtained. Accordingly, during the fourth quarter of 2005, PinnOak loaned $1,100,000 to Beard Pinnacle, LLC (“BPLLC”), which owns the Project, to get construction started.

 

In February of 2006 Beard Technologies, Inc. ("BTI") and BPLLC executed a supplemental agreement (the “Agreement”) with PinnOak in connection with the Project. We had previously received and accepted a proposal from a lending institution to provide a $9,000,000 loan for the Project and affiliates of PinnOak had agreed to provide $2,800,000 of equity and own 50% of BPLLC. Both commitments were subject to the condition that the USDA guarantee at least 70% of the borrowed amount (the “Guaranty”).

 

The Agreement also provided that if BPLLC had not obtained the Guaranty or a third party loan in an amount sufficient to complete the Project on or before April 1, 2006, PinnOak was committed to assume control of the Project and be responsible for funding or arranging the funding of the Project. If additional funding was needed prior to receipt of the Guaranty, PinnOak agreed to provide additional loans to BPLLC and BPLLC and BTI agreed to provide certain collateral. As of April 12, 2006 PinnOak had advanced a total of $5,910,000 to finance the construction. On March 23, 2006, the amount of BPLLC’s note was increased from $5,100,000 to $9,000,000 and the “trigger date” for certain events was extended from April 1, 2006 to May 1, 2006. PinnOak elected not to take control at that time, while both PinnOak and BTI unsuccessfully pursued third party financing. Meanwhile, BTI unsuccessfully pursued the Guaranty, and PinnOak continued to provide additional loans to BPLLC to finance construction of the Project. On September 30, 2006, PinnOak elected to convert $2,800,000 of its loans to equity in BPLLC, which interest was acquired by the investor group. Effective October 1, 2006,

 

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the PinnOak investor group exercised their option to assume control of BPLLC and increased their interest in BPLLC to 75%. BTI’s interest in BPLLC was reduced to 25% at that time and BP LLC ceased to be a consolidated subsidiary. As of March 31, 2007, PinnOak had advanced more than $14,150,000 to finance the Project, including the $2,800,000 of equity provided by its affiliates.

 

Because there have been cost over-runs of more than $3,000,000, neither we nor PinnOak have been able to secure an alternative source of financing, and their loans have become the permanent source of financing for the Project. Because of the low rate of production achieved during the ramp-up period due to initial start-up problems with the plant, we have agreed in principle to terminate most of the existing agreements governing the Project and give up our remaining 25% interest therein while remaining as the contract operator for the Project. Some of the details of this agreement are still being negotiated but we anticipate the new agreement will be effective in April, 2007. We are confident the Project will be economic. Despite the cost over-runs and the low price being paid for the coal produced from the Project, the Project will be highly economic to the pond owner. BTI will be relieved of its guaranty of all loans made by PinnOak (totaling more than $11,350,000) which was secured by BTI’s remaining 25% interest in BPLLC.

 

China Fertilizer Plant. To date our China fertilizer manufacturing plant has not demonstrated the ability to market sufficient product to reach its projected breakeven point, much less become profitable. Several new marketing initiatives have been undertaken, but all were unsuccessful. Because of the delay in reaching our targeted production rate, the plant owners have had to loan an additional US$885,000, including US$166,000 during the 2007 first quarter, to provide the working capital needed to keep the plant operating. We have engaged an investment banking firm to explore the alternatives available to us including, but not limited to: sale of the plant, merger of the operation with a competitor, or bringing in a new partner. We expect to have a recommendation concerning our best option before the end of the second quarter. Additional funds may need to be provided to keep the plant operating until the operative decision has been made.

 

Expansion of McElmo Dome Production Capacity. In May of 2006 Kinder Morgan CO2 Company, L.P. (“KM”), the operator of the McElmo Dome Unit, circulated an authorization for expenditure in connection with a planned $99,800,000 expansion of production capacity of the Unit. We elected to participate in the expansion for our 0.538142% working interest share (approximately $537,000). In March of 2007 KM advised us that the owner of a 40% working interest had elected not to participate in the expansion since they have sold their West Texas oil production and no longer need the CO2. Our share of the costs has accordingly increased to approximately $967,000. We and a number of other small working interest owners who also had elected to participate in the expansion have attempted to revoke our approval to participate and elect the opt out provision, but KM has to date refused our request. At this point the final determination is uncertain.

 

CONTINUING OPERATIONS

 

Coal Reclamation Activities. Our coal reclamation activities, which are conducted by Beard Technologies, Inc. (“BTI”), comprise the Coal Segment. BTI is in the business of operating coal fines reclamation facilities in the U.S. and provides slurry pond core drilling services, fine coal laboratory analytical services and consulting services.

 

Carbon Dioxide Operations. Our carbon dioxide activities comprise the CO2 Segment, consisting of the production of CO2 gas which is conducted through Beard. We own non-operated working and overriding royalty interests in two producing CO2 gas units in Colorado and New Mexico.

 

Operations in China. Our activities in China, which are conducted by Beard Environmental Engineering, LLC (“BEE”) through its consolidated subsidiaries, comprise the China Segment. BEE and its subsidiaries are focusing on the manufacture of organic chemical compound fertilizer ("OCCF") and liquid fertilizer in the Peoples Republic of China (the "PRC").

 

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e-Commerce. Our e-Commerce activities, which are conducted by starpay.com™, l.l.c. (“starpay”) and its parent, Advanced Internet Technologies, L.L.C. (“AIT”), comprise the e-Commerce Segment. starpay’s current focus is on developing licensing agreements and other fee based arrangements with companies implementing technology in conflict with its intellectual property.

 

Oil and Gas Operations. Our oil and gas activities comprise the Oil & Gas Segment, consisting of the production of oil and gas which is conducted through BOC. We own non-operated working interests or overriding royalty interests in producing wells in Colorado and Wyoming. We also own undeveloped oil and gas leases in such states and in Mississippi.

 

 

Financial information about industry segments is contained in the Statements of Operations and Note 15 of Notes to the Company's Financial Statements. See Part II, Item 8---Financial Statements and Supplementary Data.

 

 

We currently have five operating segments: Coal, CO2, China, e-Commerce and Oil & Gas. All of such activities, with the exception of our CO2 gas production activities, are conducted through subsidiaries. We, through our corporate staff, perform management, financial, consultative, administrative and other services for our subsidiaries.

 

COAL RECLAMATION ACTIVITIES

 

Background of Beard Technologies, Inc. In early 1990 we acquired more than 80% of Energy International Corporation (“EI”), a research and development firm specializing in coal-related technologies. We sold EI in 1994, retaining certain assets which we contributed to a wholly-owned subsidiary, BTI.

 

Impact of Section 29. In the late 1990’s significant activity in the coal industry was focused upon the development of fine coal waste impoundment recovery projects which qualified for Federal tax credits of $20 to $25 per ton under Section 29 of the Internal Revenue Code. In order to qualify for the tax credit, the projects had to produce a synthetic fuel (i) from a facility placed in service before July 1, 1998; (ii) pursuant to a binding contract entered into before January 1, 1997; and (iii) before January 1, 2008.

 

The MCN Projects. Beginning in April of 1998, BTI operated six pond recovery/Section 29 briquetting projects for a subsidiary of MCN Energy Group, Inc. (“MCN”). At the time this made BTI, to the best of our knowledge, the largest operator of coal recovery plants in the world. MCN became concerned that the plants might not qualify for the tax credit and took a special charge of $133,782,000 at year-end 1998 to completely write off the projects. In January of 1999 MCN terminated the contracts with BTI. This was a major setback to BTI and had a severe negative impact on its subsequent income and cash flow. The contracts later qualified for the tax credits.

 

Sharp Increase in Natural Gas Prices; Effect on Coal Demand. The sharp increase in natural gas prices in 2004 and 2005 had a major impact upon the electric power generating industry which began to focus on building new generating capacity utilizing coal-fired rather than gas-fired plants. Although warmer weather in 2006 resulted in some relief on natural gas prices, it appears that natural gas will continue to be in relatively short supply in future years. As a result, the price of coal when compared to the price of gas on a Btu basis remains

 

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quite attractive. It now appears that coal, which accounts for over 50% of the nation’s power generating capacity, will remain the principal fuel source for electric power production for a number of years.

 

The rising price of natural gas drove the spot price of coal to record levels in 2005---prices that have not been seen in the coal industry since the oil crisis of 1974 and 1975. Although the warmer weather triggered pricing relief in 2006, many energy economists continue to believe that natural gas prices will remain high for many years to come. The strong coal market, plus added pressure from regulatory agencies to more quickly reclaim or re-mine abandoned slurry impoundments, has sparked renewed interest among pond owners and coal operators to move forward with pond recovery projects. Many of these recovery projects had been sitting on the back burner for a number of years because of marginal coal prices and stagnant demand.

 

We believe this is an ideal set of circumstances for BTI, which in recent years has been totally focused on pond recovery. During the last eight years, BTI has called on numerous coal producers and utilities, particularly those having ponds which it believes have large reserves of recoverable coal fines. We have a great deal of expertise in the complicated business of coal pond recovery. We believe that we are the industry leader and that most coal operators contact us first when they are interested in having a pond recovered.

 

Projects Under Development. This convergence of high coal prices with added regulatory agency pressure has resulted in BTI having more potential projects on the drawing board than at any other time in its existence. We have had more coal producers and utilities call us to discuss projects in the last three years than we had during the previous 13 years of BTI’s existence. In September of 2004 we signed an agreement to perform the Pinnacle Project. (See below). Currently, we are actively pursuing a number of other projects, most of which are located in the Central Appalachian Coal Basin. We have a number of other projects in the pipeline for follow up once these projects have come to a resolution. However, we cannot assure you that any of the pond recovery projects currently under development will proceed.

 

Pinnacle Project. In 2004 we formed Beard Pinnacle, LLC (“BPLLC”), an Oklahoma limited liability company, and originally a wholly-owned subsidiary of BTI. BPLLC was formed to construct and operate a pond fines recovery facility, known as the Pinnacle Project, located at the Smith Branch Coal Refuse Disposal Facility owned by PinnOak’s wholly-owned subsididary, Pinnacle Mining Company, LLC, a coal mining and energy resources company (“PMC”). The facility is located near Pineville, West Virginia. BTI and PinnOak executed an agreement regarding the initial equity funding of BPLLC and its development and operation of the Pinnacle Project based upon the premise that BPLLC or its lender would receive a USDA loan guaranty of up to 70% of a $9,000,000 loan.

 

Based upon this premise, BPLLC commenced construction of the Pinnacle Project in September of 2005. As of March 31, 2007, PinnOak had advanced more than $14,150,000 to finance the Pinnacle Project, including $2,800,000 of equity provided by its affiliates. Effective September 30, 2006 the affiliates converted $2,800,000 of PinnOak’s advances to equity in BPLLC. Effective October 1, 2006, the PinnOak investor group exercised their option to assume control of BPLLC and increased their interest in BPLLC to 75%. BPLLC ceased to be a consolidated subsidiary, and our 25% interest therein has been reflected as equity in earnings (loss) of unconsolidated subsidiaries at year-end 2006. (See “Item 1. Business. General development of business---Recent Developments---Loans from and Agreements with PinnOak Resources” for additional details).

 

Improved Drilling and Lab Capabilities. In 2000 BTI made substantial investments to improve its slurry pond core drilling equipment and its fine coal laboratory analytical services capabilities. In addition to supporting its own pond recovery project evaluations, BTI is now able to offer state of the art drilling and analytical services to commercial clients who are independently investigating their own projects.

 

Principal Products and Services. The principal products and services supplied by our Coal Segment are (i) the capability to undertake large reclamation projects and the cleanup of slurry pond recovery sites; (ii) core

 

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drilling of slurry ponds and evaluation of recoverable coal reserves; (iii) consulting reclamation technology; (iv) technical services; and (v) proprietary coal reclamation technology.

 

Sources and Availability of Raw Materials. There are numerous coal impoundments scattered throughout the eastern third of the U.S. which contain sizeable reserves of coal fines which we believe can be recovered on an economic basis while at the same time solving an environmental problem. As a result of the increase in coal prices during the last three years, slurry pond owners are recognizing that recovery can be done on a profitable basis, making it a win-win proposition for both the pond owner and the company undertaking the project.

 

Dependence of the Segment on a Single Customer. The Coal Segment accounted for the following percentages of our consolidated revenues from continuing operations for each of the last three years.

 

 

Since BPLLC is no longer a consolidated subsidiary, the sale of coal from the Pinnacle Project after October 1, 2006 is not reflected as revenues. Accordingly, the loss of PMC as a customer would not have a material adverse effect on the segment nor on us. We are unable to predict whether we will become dependent on a single customer in the future as additional projects under development by the segment are negotiated and finalized.

 

Facilities. BTI leases an office and laboratory facilities from the Applied Research Center at the University of Pittsburgh (“UPARC”). BTI’s facilities at UPARC give the Coal Segment access to a wide range of coal and mineral testing capabilities.

 

Market Demand and Competition. The coal reclamation industry is highly competitive, and the Coal Segment must compete against larger companies, as well as several small independent concerns. Competition is largely on the basis of technological expertise and customer service.

 

Seasonality. The coal reclamation business is somewhat seasonal due to the tendency for field activity to be reduced in cold and/or bad weather.

 

Environmental Matters. Compliance with Federal, state and local laws regarding discharge of materials into the environment or otherwise relating to protection of the environment are of primary concern to the segment, and the cost of addressing such concerns are factored into the cost of each project. The cost of compliance varies by project and cannot be estimated until all of the contract provisions have been finalized. See “ Regulation---Environmental and Worker Safety Matters.”

 

Financial Information. Financial information about the Coal Segment is set forth in the Financial Statements. See Part II, Item 8---Financial Statements and Supplementary Data.

 

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CARBON DIOXIDE OPERATIONS

 

General. Our carbon dioxide (CO2) gas operations are conducted by the parent company which owns working and overriding royalty interests in two CO2 gas producing units.

 

Carbon Dioxide (CO2) Properties

 

McElmo Dome. The McElmo Dome field in Dolores and Montezuma Counties in western Colorado is a 240,000-acre unit which produces CO2 gas.

 

We own a 0.53814206% working interest (0.4526611% net revenue interest) and an overriding royalty interest equivalent to a 0.0920289% net revenue interest in the Unit, giving us a total 0.5446900% net revenue interest.

 

Deliveries of CO2 gas are transported through a 502-mile, 30-inch diameter pipeline to the Permian Basin in West Texas where such gas is utilized primarily for injection into mature oil fields. Kinder Morgan CO2 Company, L.P. (“KM”) serves as operator of the unit. There are 54 producing wells, ranging from 7,634 feet to 8,026 feet in depth, that produce from the Leadville formation. The wells produced a combined total of 972 million cubic feet per day in 2006. McElmo Dome is believed to be the largest producing CO2 field in the world. The Four Corners Geological Society in 1983 estimated that the field contained 17 trillion cubic feet (“TCF”) of CO2. The gas is approximately 98% CO2.

 

In 2006 we sold 1,933,000 Mcf attributable to our working and overriding royalty interests at an average price of $.0.79 per Mcf. In 2005 we sold 1,902,000 Mcf (thousand cubic feet) attributable to our working and overriding royalty interests at an average price of $.60 per Mcf. In 2004, we sold 1,787,000 Mcf attributable to our working and overriding royalty interests at an average price of $.42 per Mcf. We were underproduced by 8,000 Mcf on the sale of our share of McElmo Dome gas at year-end 2006.

 

As the result of the recent increase in oil prices, CO2 demand for tertiary recovery and McElmo Dome production has increased accordingly. CO2 production, which averaged 887 million cubic feet per day in 2004, increased to 957 million cubic feet per day in 2005, and increased further to 972 million cubic feet per day in 2006. We have been advised by the operator that the field is now capable of producing 1.2 billion cubic feet per day.

 

We consider our ownership interest in the McElmo Dome Field to be one of our most valuable assets. At year-end 2006 the field had produced 5.048 TCF of CO2, leaving more than nine TCF of remaining reserves (49 BCF to our net interest) per KM’s estimate of reserves. As a result of the settlement of the McElmo Dome litigation, the recent improvement in oil prices and the increased demand and improved pricing for CO2, we now believe that our interest in the field has a fair market value of approximately $10.7 million versus a book value of $384,000 at year-end 2006.

 

Our interest in the McElmo Dome Field is subject to a deed of trust lien in the amount of approximately (i) $635,000 in favor of a holder of our 2009 Notes and (ii) $3,243,000 in favor of a related party.

 

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Anticipated Improvement in Pricing as a Result of the McElmo Dome Settlement. In addition to establishing a cash settlement fund to settle the litigation, the McElmo Dome Settlement Agreement also provided for the monitoring of pipeline tariffs, minimum prices and funding for a CO2 Claims Committee to enforce these provisions. (See “Item 3. Litigation”). We anticipate additional improvement in pricing from the above. Moreover, we are continuing to investigate marketing our share of the CO2 through other parties at a higher price.

 

Bravo Dome. We also own a 0.05863% working interest in the 1,000,000-acre Bravo Dome CO2 gas unit in northeastern New Mexico. Bravo Dome is believed to be the second largest producing CO2 field in the world. At December 31, 2006, we had produced 732,000 Mcf of CO2 gas which is presently in storage. We sold no CO2 gas from Bravo Dome in 2006, 2005 and 2004. Our solid CO2 segment, which was sold in 1997, had previously provided the market for such gas. We are continuing our efforts to market our share of the gas at a reasonable price, but such efforts have to date been unsuccessful.

 

Occidental Petroleum Corporation operates the Bravo Dome field. The 350 producing wells are approximately 2,500 feet deep. The gas is approximately 99% CO2.

 

Net CO2 Production. The following table sets forth our net CO2 production from McElmo Dome for each of the last three fiscal years:

 

 

Average Sales Price and Production Cost. The following table sets forth our average sales price per unit of CO2 produced and the average lifting cost (lease operating expenses and production taxes) per unit of production for the last three fiscal years:

 

 

Market Demand and Competition. Our principal market for CO2 is for injection into mature oil fields in the Permian Basin, where industry demand is expected to grow modestly for the next several years. Our primary competitors for the sale of CO2 include suppliers that have an ownership interest in McElmo Dome, Bravo Dome and Sheep Mountain CO2 reserves, and Petro-Source Carbon Company, which gathers waste CO2 from natural gas production in the Val Verde Basin of West Texas. There is no assurance that new CO2 sources will not be discovered or developed, which could compete with us or that new methodologies for enhanced oil recovery will not replace CO2 flooding.

 

Dependence of the Segment on a Single Customer. The CO2 Segment accounted for the following percentages of our consolidated revenues from continuing operations for each of the last three years. Our CO2 revenues are received from two operators who market the CO2 gas to numerous end users on behalf of the

 

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interest owners who elect to participate in such sales. In 2006, approximately 98% of our revenues from the sale of CO2 gas was derived from KM and approximately 2% was derived from Exxon Mobil.

 

 

Under the existing operating agreements, so long as any CO2 gas is being produced and sold from the field, we have the right to sell our undivided share of the production to either KM or Exxon Mobil and also have the right to sell such production to other users. During 2006 KM was offering a slightly higher price than Exxon Mobil, so more of the segment’s production was sold to KM. We believe that the loss of either KM or Exxon Mobil as a customer would have a material adverse effect on the segment and on us.

 

Productive Wells. Our principal CO2 properties are held through our ownership of working interests in oil and gas leases which produce CO2 gas. As of December 31, 2006, we held a working interest in a total of 396 gross (0.45 net) CO2 wells located in the continental United States. The table below is a summary of such developed properties by state:

 

 

Financial Information. Financial information about our CO2 gas operations is contained in our Financial Statements. See Part II, Item 8---Financial Statements and Supplementary Data.

 

OPERATIONS IN CHINA

Background Information. In 1998 we opened an office in the People’s Republic of China (the “PRC” or “China”). In 1999 we established a Representative Office in Beijing. In 2001 Beijing Beard Bio-Tech Engineering Co., Ltd. (“BTEC”), a Chinese corporation, was organized as a wholly-owned subsidiary to serve as the operating entity for all of the China Segment’s activities in the PRC. In 2002 we formed BEE, a wholly-owned Oklahoma limited liability company, to serve as the parent company of BTEC and all of the segment’s subsidiaries in the PRC. In February of 2005 BEE and a private investor formed BEE/7HBF, LLC which is owned 50% each by BEE and the private investor. This new entity then formed a wholly foreign-owned enterprise (“WFOE”) in China, called Xianghe BH Fertilizer Co., Ltd. (“XBH”), that serves as the marketing arm for the fertilizer we produce in China and controls and manages the segment’s initial fertilizer manufacturing plant in the PRC.

 

Environmental Opportunities. China is a large country with serious environmental problems which include atmospheric pollution, ground water pollution and land pollution. To solve these problems the government has made the decision to permit the use of foreign equipment and technology. The amount of arable land in China is limited considering its dense population. China is the largest user of chemical fertilizers in the world.

 

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Unfortunately, the carryover of fertilizers from one planting to the next and the considerable runoff into lakes and rivers has polluted much of China’s arable land and fresh water resources.

 

Organic-Chemical Compound Fertilizer Initiatives. China, which is the world’s fourth largest country in area, is also the world’s most heavily populated country, with a population of almost 1.3 billion. China categorizes about 800 million of their population as “farmers.” The average sized farm is less than two acres. In order to earn a subsistence living, China’s farmers must, if possible, multi-crop the same plot of soil, frequently using hybrid crop varieties with greater yields that stress the soil much more so than non-hybrid crops. To ensure production, fertilizers are used with each planting, which increases soil stress. This abusive farming practice has, over time, resulted in damaged, less productive soil. Working with the top agronomists and academicians in the Chinese agricultural community, we have developed a concept to mitigate this problem by manufacturing organic chemical compound fertilizers (“OCCF”). The end result is a line of environmentally friendly fertilizers utilizing organics derived from waste materials that, due to their abundance, are a serious environmental nuisance in China.

 

Formulation of Product. The formulation of our products will be based on the target crops and determined by leading soil scientists at China Agricultural University in Beijing and agronomists in each province. Our production amounts to less than 1% of total fertilizer demand in the province where we have constructed our initial facility. We believe that the sales price for our products will be commensurate with and that the quality will be superior to other similar products presently available. We expect to receive strong support for our products from these senior scientists and from the Provincial authorities.

 

Financing of Initial Fertilizer Manufacturing Plant in China. In February of 2005 we announced that a private investor had agreed to finance the cost of our initial fertilizer manufacturing facility in the PRC. Beard Environmental Engineering, L.L.C. (“BEE”) and the investor formed a limited liability company, BEE/7HBF, LLC (“BEE/7HBF”) to own all of our fertilizer operations in China. BEE/7HBF then formed XBH to serve as the marketing arm for the fertilizer we produce in China and control and manage the day-to-day operations of the facility. The investor and BEE each made a $50,000 cash contribution to and have a 50% ownership and equity in BEE/7HBF. The investor loaned $850,000 of additional funds to BEE/7HBF in the first half of 2005 to fund the capital costs and pre-operating costs of the facility. The lender can look only to available funds of BEE/7HBF for repayment, and neither we nor BEE will be liable for repayment of the loan.

 

The initial plant is located near Beijing and produces a new, environmentally friendly, OCCF. The new fertilizer will use up to 62% less chemicals and yet provide superior performance as compared to chemical fertilizers presently used in the PRC. The plant was initially targeted to produce about 32,000 metric tons per year of OCCF annually. However, in order to reduce the initial cost of the facility, it was later scaled back to a capacity of approximately 18,000 metric tons of OCCF per year. In addition, the plant has added equipment to produce a new line of liquid fertilizer which has added to its sales capacity. The facility has been sized to permit production capacity to be more than doubled to meet future market demand. The plant produced and shipped its initial product in October of 2005.

 

Method of Distribution. Our OCCF is distributed primarily through warehouse distributors who purchase our product in bulk and then market directly to end users who are primarily farmers. Presently, XBH distributes its production through small to mid-size warehouse distributors. These are fertilizer distributors that maintain one or more warehouses stocked with various fertilizer products and distribute on demand to 50 or more retail outlets. Some of the retail outlets may also be owned by the warehouse distributor, but the majority are independently owned or are part of a chain of retail outlets. Orders received from the warehouse distributor are generally priced Ex-Factory.

 

Sources and Availability of Raw Materials. We maintain at least two qualified sources of all raw materials necessary for producing our OCCF product. In addition, our purchasing department is continuously seeking better pricing while maintaining quality.

 

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Backlog. At December 31, 2006, XBH had an immaterial backlog of orders. All of such orders are expected to be filled within the current fiscal year.

 

Dependence of the Segment on a Single Customer. As of December 31, 2006, XBH was not dependent upon a single customer. Loss of all of the segment’s customers at that time would not have a material adverse effect on the segment nor on us. The segment recorded revenues of US$368,000 in 2006, US$29,000 in 2005 and no revenues in 2004. The China Segment accounted for the following percentages of our consolidated revenue from continuing operations for each of the last three years:

 

 

Principal Products and Services. The principal products and services supplied by our China Segment are the manufacture and production of OCCF and liquid fertilizer.

 

Facilities. XBH leases office, manufacturing and appurtenant space in Xianghe County, Hebei Province, located about 37 miles southeast of Beijing. The facility is sited on about 22 acres of land in an industrial development and is comprised of a workshop (approximately 30,000 square feet, three-story office building with third-floor apartments (approximately 9,500 square feet/floor), finished-goods warehouse (approximately 11,000 square feet), dormitory and shower/mechanical building (approximately 2,500 square feet), two guardhouses and a coal storage building. The total area under roof is approximately 74,500 square feet.

 

Market Demand and Competition. The China Segment must compete against significantly larger companies, as well as a number of small independent concerns. Competition is largely on the basis of technological expertise, product quality and customer service.

 

Seasonality. Fertilizer sales in China are subject to seasonal swings in demand. In general, producers of row crops (e.g., wheat, corn and cotton) in our market area of China purchase fertilizers during two major buying seasons. Fertilizer is used at an increased rate in early spring to provide the boost winter crops require to become active again and to carry their growth through to harvest. Orders for spring sales begin in September and run through November. Again in the fall, fertilizer usage is increased as farmers prepare their fields for planting winter crops. Orders for winter sales, although not as significant as fall sales orders, begin in March and run through May. Alternately, greenhouse growers in this part of China generally have three growing seasons as a result of the type of vegetable crops raised there. Fertilizer sales into this market tend to be much less seasonal. As opposed to row crops farmers, who have two major application events each year, greenhouse growers apply fertilizers to their crops over a longer period of time during the growth cycle of the crop.

 

Financial Information. Financial information about the China Segment is set forth in the Financial Statements. See Part II, Item 8---Financial Statements and Supplementary Data.

 

 

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e-COMMERCE

 

Formation of starpay.com™, inc. (now starpay.com, l.l.c.). In 1999 four patent applications were filed embodying the features of a new secure payment system for Internet transactions and we formed starpay.com, inc. (“starpay”) to pursue the development of the payment system. In 2000, starpay filed two additional patent applications which considerably broadened the scope and the potential of its patent claims. In 2001 starpay became starpay.com, l.l.c.

 

In May of 2003 we formed Advanced Internet Technologies, L.L.C. (“AIT”). The members of starpay.com, l.l.c. contributed their entire membership interests in starpay to AIT for equivalent membership interests in AIT. starpay became a wholly-owned subsidiary of AIT with Marc Messner, Beard’s VP-Corporate Development and the inventor of starpay’s technology, serving as its Sole Manager. Current ownership in AIT is as follows: Beard (71%); Messner (15%); patent attorney (7%); Web site company (7%).

 

The starpay Technology. Our secure payment methods and technologies address payer and transaction authentication in many forms. These include, but are not limited to, performing a payer query for authentication and transaction consent verification, as well as, chaining split transactions into an integrated verifiable unique transaction authenticating the user and the transaction attributes in the process.

 

Other features of starpay’s technology include a patent-pending system that incorporates the innovative use of the ubiquitous compact disc or smart card as a security and transaction-enabling device. The enabling device, user’s identifier and/or PIN must all be present to enable a payment transaction on the Internet. This technology is an additional layer of security that may or may not be applied to starpay’s proprietary process flow models.

 

License Agreement. In November of 2001 VIMachine, Inc. (“VIMachine”), the owner of U.S. Patent 5,903,878, “Method and Apparatus for Electronic Commerce” (the “VIMachine Patent”) granted to starpay the exclusive marketing rights, with respect to certain clients (the “Clients”) which starpay has identified to VIMachine, for security software and related products and applications. starpay believes the VIMachine Patent will provide numerous opportunities to generate related licensing agreements in the electronic authentication and payment transaction fields.

 

In March 2002 starpay’s marketing rights with respect to its Clients were broadened to include the right to litigate on behalf of VIMachine all patent claims in relation to the VIMachine Patent and related foreign applications or patents. Any settlement and/or judgment resulting from starpay’s prosecution of the VIMachine Patent claims will be shared 50/50 or 25/75 between starpay and VIMachine (depending upon who the infringing party may be) following reimbursement to starpay (from the settlement and/or judgment monies) for litigation related expenses incurred, including defense of any counterclaims.

 

Visa Litigation. In May of 2003 starpay along with VIMachine filed a suit in the U. S. District Court for the Northern District of Texas, Dallas Division against Visa International Service Association and Visa USA, Inc., both d/b/a Visa (Case No. CIV:3-03-CV0976-L). In July of 2003 the Plaintiffs filed, with the express written consent of the Defendants, an Amended Complaint. The ongoing suit seeks damages and injunctive relief (i) related to Visa’s infringement of the VIMachine Patent; and (ii) under California’s common law and statutory doctrines of unfair trade practices, misappropriation and/or theft of starpay’s intellectual property and/or trade secrets. In addition, Plaintiffs are seeking attorney fees and court costs related to the foregoing claims. If willfulness can be shown, Plaintiffs will seek treble damages.

 

On January 4, 2005, following a Markman hearing held in late October of 2004, the Magistrate Judge filed a Report and Recommendation of the United States Magistrate Judge addressing his findings and recommendations with respect to the claim constructions to be applied to the VIMachine Patent. The Magistrate Judge found that 24 of the 28 claims asserted by the Plaintiffs were valid. Both parties have pursued modifications of the

 

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Magistrate’s recommendations in the form of an appeal to the District Court and are awaiting the Court’s final ruling on claim construction issues.

 

See “Item 3. Legal Proceedings---Visa Litigation” for additional details.

 

Issuance of Initial Patent; Exclusive License Agreement. On April 9, 2002, the U.S. Patent and Trademark Office issued U.S. Patent No. 6,370,514 (the “Voucher Patent”) to starpay on its patent application titled “Method for Marketing and Redeeming Vouchers for use in Online Purchases.” All claims submitted in this application were allowed.

 

On March 28, 2003, starpay finalized a Patent License Agreement with Universal Certificate Group LLC (“UCG”), a private company based in New York City. UCG has developed a universal online gift certificate that is accepted as payment at hundreds of online stores through its subsidiary, GiveAnything.com, LLC. The Agreement, which remains in effect for the term of the patent, grants to UCG the exclusive, worldwide license to use, improve, enhance or sublicense the Voucher Patent. Under the Agreement, starpay received a license fee payable annually for three years plus a royalty payable semi-annually during the patent term. The $25,000 license fee which starpay received in 2005 was its final license fee under the Agreement. starpay also shares in any license fees or royalties paid to UCG for any sublicenses. UCG has the exclusive right to institute any suit for infringement under the Agreement. starpay has the right to jointly participate in any suit, in which case any damages obtained will be shared according to the fees and expenses borne by each party. UCG has the option to terminate the Agreement at any time without liability.

 

starpay’s Strategy and Current Opportunities. starpay’s plan is to develop licensing agreements and other fee based arrangements with companies implementing technology in conflict with our intellectual property. We have identified and investigated many opportunities for our intellectual property portfolio which include various e-commerce payment systems, security access applications and secure document transmission. Although there are many applications for our technology, our focus is on Internet security, authentication and electronic payments. starpay is continuously assessing these situations looking toward the possibility of generating additional licensing opportunities.

 

starpay believes that its intellectual property portfolio provides the technology and methods for enabling the most secure payment system and authentication protocols available for use on the Internet. If starpay is successful in its strategic licensing and litigation efforts, the e-Commerce Segment is expected to become a major contributor to our future success. However, no assurance can be given that starpay will successfully capitalize on its Internet security methods and technologies.

 

Facilities. starpay occupies a small portion of the office space occupied by us at our corporate headquarters located in Oklahoma City, Oklahoma.

 

Market Demand and Competition. The e-commerce industry is rapidly changing and highly competitive, and the e-Commerce Segment must compete against significantly larger companies, as well as a number of small independent concerns. Competition is largely on the basis of technological expertise, customer service, capital available for product branding and the ability to react quickly to a constantly changing environment.

 

Dependence of the Segment on a Single Customer. The e-Commerce Segment accounted for the following percentages of the Company's consolidated revenues from continuing operations for each of the last three years.

 

 

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The segment presently has only one customer, a licensee. However, the licensee has already generated one sublicense and is pursuing others. We believe that the loss of the segment’s present customer would not have a material adverse effect on the segment since the segment would then be in a position to pursue licenses directly with other parties. The loss of the present customer would not have a material adverse effect on us.

 

Financial Information. Financial information about the e-Commerce Segment is set forth in the Financial Statements. See Part II, Item 8---Financial Statements and Supplementary Data.

 

OIL AND GAS OPERATIONS

The activities of the Oil and Gas Segment are conducted through our wholly-owned subsidiary, BOC. BOC is engaged in exploration for, development, production and sale of oil and gas. BOC was incorporated in Delaware in 1986 and is the successor to the original Beard Oil Company which was incorporated in Delaware in 1969 as the successor to the oil and gas business originally founded by a Beard family member in 1921.

 

Exploration Practices and Policy. BOC’s principal exploratory approach since re-entering the business has been to acquire oil and gas leases and then to encourage other operators to drill on or in close proximity to our acreage by supporting their exploratory wells with acreage contributions. BOC has also entered into arrangements with major and independent operators who make certain exploratory commitments relative to our acreage for an interest in one or more of our leaseholds while we retain some form of reversionary working interest or overriding royalty interest and may also retain the right to participate in the drilling of development wells. Since BOC does not have a production staff, it has not operated any wells since it has re-entered the oil and gas business.

 

A significant phase of BOC’s exploration effort involves the acquisition of oil and gas leases from the U. S. government and various state governments on a “non-competitive” basis. All of the undeveloped acreage we hold is under such governmental leases.

 

From time to time BOC also sells an interest in its undeveloped acreage and retains an overriding royalty. Such sale is commonly known as a “sublease”. In fiscal years 2006 and 2005, sublease activities accounted for revenues of $7,000 and $0, respectively.

 

Sandy Lake Field. In January of 2005 we announced that we were back in the oil and gas business. One of the leases which we acquired was a 640-acre tract covering all of Section 36, Township 3 North, Range 48 West, in Yuma County, Colorado.

 

In January of 2004 BOC entered into a farmout agreement with Vista Resources (“Vista”) of Pittsburgh, Pennsylvania. Vista drilled eight wells in the Niobrara Formation on the farmout lands. Under the farmout arrangement, BOC was carried for a 22.5% working interest in the initial well in which it owns a 3.6% overriding royalty interest until payout and a 22.5% working interest (19.6875% net revenue interest) thereafter. We paid our 22.5% share of the cost of the seven additional wells. All eight of the wells were completed as gas producers

 

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in the Niobrara Formation at a depth of approximately 2,800 feet. The wells were placed on production in the fourth quarter of 2005, and are currently producing at an average rate of approximately 40-45 MCF per day from each well. Our share of the production from these wells totaled $121,000 in 2006 and $86,000 in 2005.

 

Big Porcupine Field. BOC also has a 4.5% overriding royalty interest in 12 wells which produce coal bed methane gas from the Mesaverde Formation from a 317-acre tract in Section 1, Township 41 North, Range 71 West, Campbell County, Wyoming. The wells were drilled by Peabody Natural Gas, LLC on a lease BOC sold to them in 2000 on which BOC retained an overriding royalty interest. Our share of production from these wells totaled $20,000 in 2006 and $8,000 in 2005.

 

Due to the limited pipeline capacity in the Rocky Mountain area, the price we have received for the gas we have sold to date has been lower than normally received in other areas of the U.S.

 

In addition to the producing tracts in Colorado and Wyoming, BOC owns undeveloped leases covering 41 acres in Colorado, 11,828 acres in Mississippi and 6,881 acres in Wyoming, a total of 18,750 acres.

 

Principal Products and Services. The principal products produced by our Oil & Gas Segment are oil and gas which accounted for the following percentage of total consolidated revenues from continuing operations for each of the last three fiscal years:

 

 

Sources and Availability of Raw Materials. BOC is involved in an extractive enterprise which does not require the consumption of raw materials other than fuel, water and drilling mud and chemicals which are utilized by the drilling rigs employed to drill the wells in which it has an interest. Such materials are normally available to the drilling contractors employed by the operator, although the cost thereof may vary considerably between wells.

 

Seasonality. Because BOC’s acreage is located primarily in the Rocky Mountains, the Oil & Gas Segment’s operations are considered to be seasonal since any drilling activities conducted in the winter may be hindered or impaired by adverse weather conditions.

 

Working Capital Items. The Oil & Gas Segment does not carry significant amounts of inventory nor does it provide extended payment terms to its customers. The segment’s working capital is considered adequate to conduct its present and contemplated operations since its modus operandi is to let third parties pay for all of the costs of the wells in which it participates unless proven locations are involved and borrowings can be arranged to finance such drilling operations.

 

Dependence of the Segment on a Single Customer. The Oil & Gas Segment does not have any customers which accounted for 10% or more of Registrant’s consolidated revenues during the last three years. Accordingly, the loss of a single customer would not have a material adverse effect on us and our subsidiaries taken as a whole.

 

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Markets, Competition and Regulation. Oil and gas production generally is sold at the wellhead to various pipeline companies. Market demand (and the resulting prices received for crude oil and natural gas) can be affected by weather conditions, economic conditions, import quotas, the availability and cost of alternative fuels, the proximity to, and capacity of, natural gas pipelines and other systems of transportation, by the effect of state regulation of production, and federal regulation of oil and/or gas sold in interstate and intrastate commerce, all of which factors are beyond our control.

 

At the present time the Oil & Gas Segment has no oil production. Our natural gas production is being sold on a “spot” basis to the only pipeline markets available in the two fields in which our properties are located. And, since both of our properties are non-operated, we have no control over the price we are receiving. In 2006 the price we received in Colorado ranged from $2.60 per mcf to $7.48 per mcf; in 2005 it ranged from $4.96 per mcf to $9.58 per mcf; in Wyoming the price we received ranged from $2.63 per mcf to $5.81 per mcf in 2006 and from $5.26 per mcf to $8.76 per mcf in 2005, the first year of production for the wells in these fields.

 

We encounter competition from other independent operators and from major oil and gas companies in acquiring properties suitable for exploration. Virtually all of these competitors have financial resources and staffs substantially larger then ours. Our ability to discover reserves in the future depends in part on our ability to select suitable prospects for future exploration.

 

Golden Bear Drilling & Services, LLC (“GBDS”). Partly as a result of (i) the connections we have developed over the last several years stemming from our activities in China, (ii) our renewed involvement in the oil and gas business, and (iii) our efforts in connection with the organization, promotion and development of the entity, we have a 14% interest (11% fully diluted) in GBDS, a Denver-based drilling and services company. We also provide certain management and accounting services to GBDS for a monthly fee.

 

GBDS was organized in May of 2005 with the concept of acquiring and transporting to the U. S. high quality drilling assets manufactured in the PRC. Since its organization, GBDS has acquired two new drilling rigs manufactured by a subsidiary of a large Chinese oil and gas exploration company. In each case a large privately-held exploration and production company based in Denver, Colorado, provided the funds to acquire the rigs, transport them to the U. S. and pay for all mobilization costs. The exploration company will own the rigs until they have recouped all of their initial purchase, transportation and mobilization costs plus interest at ten percent per year; after payout they will own 10% and GBDS will own 90% of each rig. GBDS receives a daily fee for operating each rig or a smaller fee if it is on stand-by. The exploration company provides the locations to be drilled. If they do not have a location ready, GBDS is free to drill for a third party; otherwise they will receive the stand-by fee until a location is available.

 

In addition, GBDS has been able to finance the acquisition of two top drives. One of these has been leased to the exploration company for $1,500 per day; the second will shortly be available for lease to third parties, hopefully at a higher rate.

 

It should be noted that the Chinese-manufactured rigs, which are of very high quality, cost less than a comparable rig manufactured in the U. S. GBDS hopes to arrange the financing for an additional five to 10 rigs and five to 10 top drives during the next three years.

 

REGULATION

 

General. We are subject to extensive regulation by federal, state, local, and foreign governmental authorities. Our operations in the United States and China are subject to political developments that we cannot accurately predict. Adverse political developments and changes in current laws and regulations affecting us could dramatically impact the profitability of our current and intended operations. More stringent regulations

 

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affecting our coal reclamation activities could adversely impact the profitability of our future coal reclamation operations and the availability of those projects.

 

Environmental and Worker Safety Matters. Federal, state, and local laws concerning the protection of the environment, human health, worker safety, natural resources, and wildlife affect virtually all of our operations, especially our coal reclamation and environmental remediation activities. These laws affect our profitability and increase the Company’s exposure to third party claims.

 

It is not possible to reliably estimate the amount or timing of our future expenditures relating to environmental matters because of continually changing laws and regulations, and the nature of our businesses. We cannot accurately predict the scope of environmental or worker safety legislation or regulations that will be enacted. Our cost to comply with newly enacted legislation or regulations affecting our business operations may require us to make material expenditures to comply with these laws. We do not presently include environmental exposures in our insurance coverage. Should we become involved with projects having environmental exposure, we believe we will have no difficulty in obtaining environmental coverage adequate to satisfy our probable environmental liabilities. As of this date, we are not aware of any environmental liability or claim that could reasonably be expected to have a material adverse effect upon our present financial condition.

 

OTHER CORPORATE ACTIVITIES

 

Other Assets. During the last seven years we have disposed of most of the assets related to the operations which we discontinued in 1999 and 2001. However, we still have a few remaining assets and investments which we are in the process of liquidating as opportunities materialize. At year-end 2006 such assets consisted primarily of the residue of an iodine extraction plant and related equipment, drilling rig components and related equipment, wastewater storage tanks and a real estate limited partnership in which we are a limited partner. All of such assets are reflected on our books for less than their anticipated realizable value, which we estimate in total would not exceed $100,000. As excess funds become available from such liquidations they will be utilized for working capital, reinvested in our ongoing business activities or redeployed into newly targeted opportunities.

 

Office and Other Leases. We lease office space in Oklahoma City, Oklahoma, aggregating 5,817 square feet under a lease expiring September 30, 2007, at a current annual rental of $85,000. In addition, our subsidiaries lease space at other locations as required to serve their respective needs.

 

Employees. As of December 31, 2006, we employed 69 full time employees and one part time employee in all of our operations, including five full time employees and one part time employee on the corporate staff.

 

 

See Item 1(c) for a description of foreign and domestic operations and export sales.

 

Item 1A.  Risk Factors.

 

Lack of Profitable Operations in Recent Periods. Although we were profitable in 2004 as a result of the McElmo Dome Settlement (see “Item 3. Legal Proceedings---McElmo Dome Litigation” for complete details), we have suffered net operating losses during each of the last eight years. Until we can demonstrate the ability to generate positive cash flow from operations, this shortcoming will impede our ability to borrow funds and may impact our ability to achieve profitability in the future.

 

There is no certainty that we will be able to achieve or sustain profitability or positive cash flows from operating activities in the future.

 

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Our Financial Position. Our net worth became negative as of December 31, 2001, and the deficiency increased to ($5,333,000) at year-end 2003. Receipt of the second installment of the Settlement reduced the deficiency to ($4,144,000) at year-end 2004. However, such deficiency increased to ($7,348,000) at year-end 2006 and will continue to increase until we are able to achieve profitability in our Coal and China Segments. Our business will continue to require substantial expenditures. Our inability to generate positive cash flow from operations has limited our ability to borrow funds and impacted our ability to achieve profitability. We must achieve a turnaround in both our Coal and China Segments this year. If a turnaround is not successful or is only partially successful, we will need to pursue additional outside financing which would likely involve further dilution to our shareholders. We cannot assure that we will be able to obtain additional financing on terms that we deem acceptable, or at all. (See "Item 1. Business. General development of business---Recent Developments --- China Fertilizer Plant" for additional details).

 

We have substantial indebtedness and may not have enough revenues to pay our debts. As of December 31, 2006, we had $8,797,000 of total debt outstanding, including $391,000 of accrued interest to an affiliate of the Chairman, $471,000 of which is due in 2007. We, or our subsidiaries may become further indebted. This much debt could pose substantial risks to our business. The indebtedness may require us to use available funds for payment of principal and interest instead of funding our operations. The debt could also inhibit our ability to raise additional capital. It is possible that we will not have enough cash flow from our operations to pay the principal and interest on our debt. This would have a material adverse effect on us.

 

Limited Liquidity. Our common stock trades on the Over-The-Counter Bulletin Board. Although we currently have nine firms making a market in our stock, the volume of trading has been relatively low and fairly sporadic. At year-end 2006, 56.5% of our 5,592,000 outstanding shares was held by management and another 8.4% was held by a long-term institutional holder. In addition, there is substantial potential dilution, with preferred shares convertible into 296,000 shares, presently exercisable warrants and options totaling 672,000 shares, notes convertible into 3,401,000 shares at year-end 2006 and a total of 629,000 shares at year-end 2006 in two DSC Plans scheduled for distribution in 2007 and future years.

 

History of Delays in Finalizing New Coal Projects. We have experienced delays in the past in finalizing our new coal projects. We may experience additional delays in the future. Although the financing for the Pinnacle Project has been provided by the pond owner, no definitive contracts have been signed in connection with the other projects currently under development in the Coal Segment, nor has any financing been arranged to date for these projects. Continued delays in finalizing our new coal projects may have a material adverse effect on us.

 

History of Delays in Finalizing Projects in China. We have experienced delays in the past in finalizing projects in China and may experience additional delays in the future. We successfully arranged the financing for our fertilizer plant in 2005. Although the project was completed under budget and in a timely manner, we have failed to achieve our projected rate of market penetration and the project has to date been uneconomic. Continued delays in meeting budgeted projections would have a material adverse effect on us.

 

starpay Intellectual Property Rights; Copying by Competitors. We have identified at least three competitors that offer services that potentially conflict with starpay’s intellectual property rights. If we are unable to protect our intellectual property rights from infringement, we may not be able to realize the anticipated profit potential from the e-Commerce Segment.

 

Failure to Achieve a Settlement or Win a Judgment in the Lawsuit Against Visa. In connection with the lawsuit against Visa, we have agreed to bear one-half of the out-of-pocket expenses (excluding legal fees) borne by the law firm handling the case. At this point it is difficult to estimate the maximum exposure for such expenses, or the length of time before the matter might be resolved. However, if our operating results do not improve going forward and we are unable to pay our share of the expenses, then we would be faced with reducing our potential recovery from any settlement or judgment.

 

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Political and economic uncertainty in China could worsen at any time and our operations could be delayed or discontinued.

 

Our business is subject to political and economic risks, including:

 

 

Item 1B.  Unresolved Staff Comments.

 

Not applicable.

 

Item 2.  Properties.

 

See Item 1(c) for a description of properties.

 

Item 3.  Legal Proceedings.

 

Neither we nor any of our subsidiaries are engaged in any litigation or governmental proceedings which we believe will have a material adverse effect upon the results of operations or financial condition of any of such companies. However, we are involved in two lawsuits where our share of the amount at stake, exclusive of interest and costs, exceeded 10% of consolidated current assets at year-end 2006. The first suit has been settled, but there are follow-on issues still in dispute. See “McElmo Dome Litigation” below.

 

McElmo Dome Litigation. In 1996 we joined with other Plaintiffs in filing in U.S. District Court for the District of Colorado a suit against Shell Oil Company, Shell Western E & P, Inc., Mobil Producing Texas and New Mexico, Inc. and Cortez Pipeline Company, a partnership (collectively, the “Defendants”). Plaintiffs’ complaint alleged damages caused by Defendants’ wrongful determination of the value of CO₂ produced from the McElmo Dome Field (the “Field”---see “Carbon Dioxide Operations” at pages 10-12 of our Form 10-K) and the corresponding wrongful underpayment to Plaintiffs.

 

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A Settlement Agreement was signed in 2001 (the “Settlement”). The Settlement became final in 2003 and we received our share in three installments totaling $4,094,000 in 2003 and 2004. The Settlement proceeds resulted in net income of $3,976,000, after alternative minimum taxes of $118,000.

 

Subsequent to the Settlement several issues have arisen concerning implementation of the Settlement Agreement that are currently in dispute which may result in additional money being owed to the Plaintiffs in the litigation. A mediation held in Denver in March of 2005 was unsuccessful. In July of 2005, the party who served as the court-appointed fairness expert in the McElmo Dome Litigation rendered his advisory opinion on the merits of several issues currently in dispute concerning implementation of the Settlement Agreement. While this advisory opinion was favorable to the Plaintiffs, it was nonbinding and failed to resolve the matter. In October 2005 the Plaintiffs initiated formal binding arbitration. A hearing on the merits was concluded in Albuquerque on June 30, 2006. By an Arbitration Opinion dated August 7, 2006, the Plaintiffs lost the arbitration. However, the Plaintiffs filed a Motion to Vacate the Opinion on November 6, 2006. Both the Court appointed Fairness Expert and Plaintiffs’ counsel believe reasonable grounds exist for vacating the Opinion. If the Opinion is vacated, another arbitration will occur unless the dispute is earlier settled.

 

The second suit also stems from issues involved in the Settlement. See “Coalition Managers Litigation” below.

 

Coalition Managers Litigation. In April of 2002 a suit was filed in the U.S. District Court of Colorado (Harry Ptasynski v. John M. Cogswell, et al---Case No. 02-WM-0830 (OES) against the attorneys and managers (including our Chairman) of the CO₂ Claims Coalition, LLC (the “Coalition”---one of the Plaintiffs in the preceding lawsuit which has now been settled). We are not a defendant in the suit, which was initially brought by Ptasynski and another party which later dismissed itself from the action. In this action Ptasynski is seeking to recover a share of the proceeds of the Coalition’s settlement against the Defendants in the McElmo Dome lawsuit despite the fact that he opted out of the lawsuit in order to pursue his own claims in a separate lawsuit against the Defendants in Texas. Although his case was initially successful in Texas it was later overturned on appeal.

 

The Coalition held back $1 million of the Settlement proceeds to defend the costs of the Ptasynski suit (and any other suits that might develop) until such time as its outcome has been determined. Presently approximately $529,000 remains in the defense fund. Once the case has been resolved, any remaining funds net of costs will be distributed to the Coalition members, including us. In March of 2004 the Court dismissed the claims against the attorneys and several of the claims against the managers but gave the Plaintiff the opportunity to make additional arguments as to why other claims should not be dismissed. In April of 2004 Plaintiff asked the Court not to dismiss the remaining claims and moved to file a Second Amended Complaint against the managers and, for the first time, against the Coalition. In May of 2004 the Defendants asked the Court to dismiss Plaintiff’s new Complaint.

 

On April 25, 2006, Magistrate Hagerty entered an Amended Scheduling Order in the civil action, pursuant to which discovery in this case was recommenced. Motions for summary judgment were entered by the Defendants on August 31, 2006. Unless a motion to dismiss is entered by the Judge or a settlement is reached in the meantime, a five-day trial is scheduled to proceed on April 16-20, 2007 in Denver.

 

We consider the Plaintiff’s claims to be without merit. We will receive approximately 22% of the remaining funds, if any, once the suit has been resolved.

 

We are also involved in a third suit where the claims involved could exceed, by a considerable margin, 10% of our consolidated current assets at year-end 2006. See “Visa Litigation” below.

 

Visa Litigation. In May of 2003 our 71%-owned subsidiary, starpay.com, l.l.c., along with VIMachine, Inc. filed a suit in the U. S. District Court for the Northern District of Texas, Dallas Division against Visa International Service Association and Visa USA, Inc., both d/b/a Visa (Case No. CIV:3-03-CV0976-L).

 

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VIMachine is the holder of U.S. Patent No. 5,903,878 (the “VIMachine Patent”) that covers, among other things, an improved method of authenticating the cardholder involved in an Internet payment transaction. In July of 2003, the Plaintiffs filed an Amended Complaint. The suit seeks damages and injunctive relief (i) related to Visa’s infringement of the VIMachine Patent; (ii) related to Visa’s breach of certain confidentiality agreements express or implied; (iii) for alleged fraud on the Patent Office based on Visa’s pending patent application; and (iv) under California’s common law and statutory doctrines of unfair trade practices, misappropriation and/or theft of starpay’s intellectual property and/or trade secrets. In addition, Plaintiffs are seeking attorney fees and costs related to the foregoing claims. If willfulness can be shown, Plaintiffs will seek treble damages.

 

In August of 2003 the Defendants filed a motion to dismiss the second, third and fourth claims. Despite objections to such motion by the Plaintiffs, the Judge in February of 2004 granted Defendants’ motion to dismiss the second and third causes of action, and denied the motion insofar as it sought to dismiss the fourth cause of action. Accordingly, Plaintiffs’ fourth claim (misappropriation and/or theft of intellectual property and/or trade secrets) will continue to move forward.

 

In February of 2004 Defendants filed an Answer to Plaintiffs’ Amended Complaint. In such filing Visa denied each allegation relevant to claim four. Visa asked that the VIMachine Patent be declared invalid, and, even if it is found valid, Visa asked that they be found not to infringe the VIMachine Patent. Visa asked for other related relief based on these two allegations.

 

In April and May 2004, Plaintiffs filed their Patent Infringement Contentions and a supplement thereto detailing Visa’s alleged infringement of the majority of the patent claims depicted in the VIMachine Patent. Subsequently, in May 2004, Defendants filed Preliminary Invalidity Contentions requesting the VIMachine Patent be found invalid.

 

From May through October 2004, the Plaintiffs and Defendants submitted numerous filings related to interpretation of the terms and phrases set out in the VIMachine Patent claims. A hearing regarding patent claim construction (a “Markman hearing”) was held in October of 2004, allowing both parties to present oral arguments before the Court regarding the claim construction issues. On January 4, 2005, Magistrate Judge Sanderson filed a Report and Recommendation of the United States Magistrate Judge addressing his findings and recommendations with respect to the claim constructions to be applied to the VIMachine Patent. Judge Sanderson found that 24 of the 28 claims asserted by the Plaintiffs were valid. Both parties have pursued modifications of the Magistrate’s recommendations in the form of an appeal to District Judge Lindsey and are awaiting the Court’s final ruling on claim construction issues.

 

In July of 2005 the Federal Circuit Court of Appeals issued an en banc decision in the patent case of Phillips v. AWH Corp. (the “Phillips Case”). That is, instead of relegating the case to a three-judge panel, it was heard by the entire Federal Circuit bench. The Federal Circuit attempted to explain how the operative language in patents is to be interpreted. One key question before the Court was to which sources of information the trial court should refer when construing patent claims.

 

Subsequent to the Federal Circuit’s decision in July, Defendants requested and the Court ordered supplemental briefs to the Court addressing Magistrate Judge Sanderson’s Report and Recommendation respective to the Markman hearing in light of the Federal Circuit’s en banc decision in the Phillips Case. Both parties filed their supplemental briefs in August 2005. Oral arguments regarding these issues were held in November of 2005. On January 19, 2006, Magistrate Judge Sanderson filed his final Report and Recommendation on the Markman issues to District Judge Lindsay who will in turn provide the Court’s final ruling on claim construction issues. In his report Judge Sanderson found no reason to change any portions of his recommendations filed on January 4, 2005, in light of the Federal Circuit’s decision in the Phillips Case. A final Markman ruling is expected to occur at any time. Thereafter, a revised Scheduling Order will be prepared setting out a new trial date.

 

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During the first quarter of 2000 starpay’s trade secrets were relayed to Visa verbally in face-to-face conferences and telephone calls, as well as in correspondence by post and electronic mail. After receiving starpay’s technology and ideas, Visa filed a series of provisional patent applications beginning in April of 2000 using starpay’s trade secrets. At the same time, Visa wrongfully incorporated starpay’s trade secrets in to its Visa Payer Authentication Service, also known as Verified by Visa (“VPAS”). VPAS infringes the VIMachine Patent. From early 2000 until recently, starpay tried on several occasions to enter into meaningful negotiations with Visa to resolve their intellectual property concerns. Visa has continually denied their infringement of the VIMachine Patent and starpay’s assertion that Visa has appropriated starpay’s trade secrets.

 

In November of 2000 Visa publicly announced that it was testing VPAS. In September of 2001 Visa stated that, once rolled out globally, it expected VPAS to reduce Internet payment disputes by at least 50%. In an October 2004, news release, Visa depicted Verified by Visa as “the leading security standard for authentication of Internet transactions.” In this release Visa announced that Verified by Visa had “recorded an increase of close to 200% in the number of transactions for the quarter ending in September 2004,” and that “total Verified by Visa card volume for the first nine months of 2004 was $5.4 billion.” In April of 2005 Visa announced that “transaction volume during the first quarter of 2005 had increased more than 230% over last year.” Towards the end of 2005 Visa announced that Verified by Visa had “$7 billion in volume during the first half of the year......a 194% year-over-year increase.” Since late 2005, Plaintiffs have not seen or received public information bearing on the transaction volume within the Verified by Visa system. However, Visa’s current Verified by Visa Fact Sheet touts that “more than 110,000 merchants have adopted Verified by Visa and 10,000 banks have made the service available to over 395 million consumers globally” through implementation in more than 65 countries representing 99% of global e-commerce volume. Other Visa documents state that “since Verified by Visa was implemented in 2003, there has been a 75% reduction in chargebacks on Verified by Visa compared with non-Verified by Visa transactions.”

 

Until Judge Lindsey rules regarding pending claim construction issues, there is no scheduling order in place. Plaintiffs will push for a trial date as quickly as practical following a ruling on claim construction issues by Judge Lindsey.

 

Item 4.  Submission of Matters to a Vote of Security Holders.

 

No matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders, through the solicitation of proxies or otherwise.

 

Item 4a.  Executive Officers and Significant Employees of the Registrant.

 

The table below sets forth the age, positions with us and the year in which each person first became our executive officer or significant employee. All positions are held with us unless otherwise indicated, and such persons are part of the corporate staff serving us and all of our subsidiaries unless otherwise indicated.

 

 

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ADirector of the Company.

BTrustee of certain assets of the Company's 401(k) Trust.

^DDevotes most of his time to these subsidiaries.

^EIndicated entities are subsidiaries of the Registrant.

 

Information concerning our executive officers and certain significant employees is set forth below:

 

W. M. Beard has served as our Chairman of the Board and Chief Executive Officer since December 1992. He previously served as our President and Chief Executive Officer from our incorporation in October 1974 until January 1985. He has served BOC as its Chairman of the Board and Chief Executive Officer since its incorporation. He has also served as our director and as a director of BOC since their incorporation. Mr. Beard has been actively involved since 1952 in all management phases of us and BOC from their inception, and as a partner of their predecessor company.

 

Herb Mee, Jr. has served as our President since October 1989 and as our Chief Financial Officer since June 1993. He has served as BOC's President since its incorporation and as its Chief Financial Officer since June 1993. He has also served as our director and as a director of BOC since their incorporation. Mr. Mee served as President of Woods Corporation, a New York Stock Exchange diversified holding company, from 1968 to 1972 and as its Chief Executive Officer from 1970 to 1972.

 

C. David Henry has served as President of BTI since July 2004. He previously served from 2000 until July 2004 as BTI’s Vice President of Operations where he focused on the development of coal recovery operations through the utilization of advanced coal processing technologies and the production of high-grade fine coal products. His area of expertise includes recovery and reclamation of coal slurry impoundments, testing and analysis of coal slurry samples, slurry pond reclamation design and coal preparation.

 

Riza E. Murteza has served as President and Chief Executive Officer of BEE since December 2002 and of its predecessor since November 1998. He has served as Chairman of BTEC since December 2001. He was appointed Senior Advisor to the United Nations Development Project for China, residing in China for one year

 

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(1996-1997) while assisting large Chinese enterprises move to a market economy. Prior to that he served as General Manager and Project Manager for two large projects in Indonesia and a large project in the Soviet Union for periods totaling nine years.

 

Marc A. Messner has served as President of AIT and as sole manager of starpay. com, l.l.c. since May 2003. He served as President and Chief Executive Officer of starpay (and its predecessor) from April 1999 to May 2003, and as Sole Manager of starpay since May 2003. He has also served as our Vice President – Corporate Development since August 1998. Mr. Messner is the inventor of starpay’s proprietary payment system technology. From 1993 to 1998 he served as President of Horizontal Drilling Technologies, Inc., a company he founded in 1993 which we acquired in 1996.

 

Jack A. Martine has served as our Controller, Chief Accounting Officer and Tax Manager since 1996. Mr. Martine had previously served as tax manager for BOC from June 1989 until October 1993. Mr. Martine is a certified public accountant.

 

Harl R. Dubben has served as our Treasurer since August 1, 2006. Prior to such time Mr. Dubben had served as Assistant to the Controller and Chief Accounting Officer since 2002.

 

All executive officers serve at the pleasure of the Board of Directors.

 

There is no family relationship between any of our executive officers. All executive officers hold office until the first meeting of the Board of Directors following the next annual meeting of stockholders or until their prior resignation or removal.

 

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PART II

 

Item 5.  Market for the Registrant's Common Equity and Related Stockholder Matters.

 

Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters.

 

 

Our common stock trades on the OTC Bulletin Board (“OTCBB”) under the ticker symbol BRCO. The following table sets forth the range of reported high and low bid quotations ^A for such shares on the OTCBB for each full quarterly period within the two most recent fiscal years:

 

 

 

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^AThe reported quotations were obtained from the OTCBB Web Site. Such quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. The quotations reflect the high best bid and low best bid for each quarter. One market maker has frequently quoted a bid of $0.01 per share, and at other times a bid of $.0001 per share, and such bids are not considered to reflect a realistic bid for the shares.

 

 

As of March 31, 2007, the Company had 425 record holders of common stock.

 

 

To date, we have not paid any cash dividends. The payment of cash dividends in the future will depend upon our financial condition, capital requirements and earnings. We intend to employ our earnings, if any, primarily in our coal reclamation activities and in paying down our debt, and do not expect to pay cash dividends for the foreseeable future. The Certificate of Designations of our Preferred Stock does not preclude the payment of cash dividends. The Certificate provides that, in the event we pay a dividend or other distribution of any kind, holders of the Preferred Stock will be entitled to receive the same dividend or distribution based upon the shares into which their Preferred Stock would be convertible on the record date for such dividend or distribution.

 

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(d)   Securities authorized for issuance under equity compensation plans^A.

 

 

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^AThe numbers shown in the above table are as of December 31, 2006.

^BThe 2003-2 Deferred Stock Compensation Plan, as amended, which authorized 800,000 shares to be issued, was approved by the stockholders at the 2004 Annual Stockholders’ Meeting. At the time the Plan was terminated on November 17, 2005, a total of 797,812 Stock Units had been credited to the Participants’ Stock Unit Accounts based upon the Participants’ deferral of $425,100 of Fees or Compensation. At year-end 2006, a total of 316,265 shares had been distributed to the Participants, 4 fractional shares had been cashed out, and 481,543 additional shares remained to be distributed to Participants who had elected the equal annual installments distribution method.

^CThe 2005 Deferred Stock Compensation Plan, which authorized 100,000 shares to be issued, was adopted by the Board of Directors on November 17, 2005. On April 27, 2006, the Plan was amended to increase the authorized shares up to 200,000. The Plan, as amended, was approved by the stockholders at the 2006 Annual Stockholders’ Meeting. At year-end 2006, a total of 144,838 shares had been credited to the Participants’ Accounts, based upon the Participants’ deferral of $175,500 of Fees or Compensation. As of March 31, 2007, a total of 185,824 shares had been credited to the Participants’ Accounts, based upon the Participants’ deferral of $211,200 of Fees or Compensation.

^DSince the exercise price of the Stock Units in the DSC Plans is determined by the Fair Market Value of the shares on their date of distribution from the respective Plans, we have used the year-end 2006 price of $1.01 per share as the weighted-average exercise price of the outstanding Stock Units since the value on the distribution dates is not determinable.

^EThe 2006 Stock Option Plan (the “2006 SO Plan”), which superseded and replaced the 2005 Stock Option Plan (the “2005 SO Plan”), authorized the issuance of 100,000 shares of common stock to be issued. The 2006 SO Plan was adopted by the Board of Directors on May 1, 2006 and approved by the stockholders on July 11, 2006 at the 2006 Annual Stockholders’ Meeting. 15,000 ISO Options were granted to each of three officers on the date the 2006 SO Plan was adopted by the Board, replacing the ISO Options previously granted under the 2005 Plan. One of these new 2006 grants was cancelled on July 31, 2006 when the officer resigned.

Due to delays caused by the necessity to file an amended 2004 Form 10-K and amended Forms 10-Q for the three quarters of 2005, we had to file our 2005 Form 10-K 15 days late. This delayed the filing of our Proxy Statement and caused us to delay our 2006 Annual Meeting until July 11, 2006, more than 13 months after the Board approved the 2005 SO Plan. This meant that any stock issued under the 2005 SO Plan could not be registered with the SEC since we had exceeded the required 12 month period for stockholder approval. Accordingly, upon advise of counsel, the Board effective May 1, 2006: (i) cancelled the 2005 SO Plan and the options granted thereunder; (ii) adopted the 2006 SO Plan; and (iii) replaced the three previously granted ISO Options with new ISO Options at current market price.

 

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^FReflects 5-year warrants, expiring in January of 2010, to purchase 72,240 shares of common stock issued to the Selling Agents as part of their commission in connection with the private placement by them of $1,806,000 of our 2010 Notes.

^GReflects a 2-year option, expiring in March of 2007, to purchase 25,000 shares of common stock issued to a consultant for providing certain financial services. The holder thereof elected not to exercise the option.

 

 

The following performance graph compares our cumulative total stockholder return on our common stock against the cumulative total return of the NASDAQ Market Index and the SIC Code Index of the Bituminous Coal, Surface Mining Industry compiled by Hemscott, Inc. for the period from December 31, 2001 through December 31, 2006. The performance graph assumes that the value of the investment in our stock and each index was $100 on December 31, 2001, and that any dividends were reinvested. We have never paid dividends on our common stock.

 

COMPARE 5-YEAR CUMULATIVE TOTAL RETURN AMONG THE BEARD COMPANY,

NASDAQ MARKET INDEX AND SIC CODE INDEX

 

 

The Industry Index chosen consists of the following companies: Alliance Holdings GP LP, Alliance Resource Partners, Arch Coal, Inc., Consol Energy, Inc., Foundation Coal Holdings, International Coal Group Inc., James River Coal Company, National Coal Corp., Peabody Energy Corp., Penn Virginia GP Holdings, Westmoreland Coal Co. and Yanzhou Coal Mining Co.

 

 

 

Item 6.  Selected Financial Data.

 

The following financial data are an integral part of, and should be read in conjunction with, the financial statements and notes thereto. Information concerning significant trends in the financial condition and results of operations is contained in Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 32 through 45 of this report.

 

 

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(a)  All per share numbers have been adjusted to reflect the 2-for-1 stock split effected by us as of August 6, 2004.

(b)  In December 1999, management of North American Brine Resources (“NABR”), a 40%-owned subsidiary accounted for under the equity method, adopted a formal plan to discontinue the business and dispose of its assets. NABR represented Beard’s entire brine extraction/iodine manufacturing segment (the “BE/IM Segment”).

(c)  In May 2001, we sold the fixed assets of the 50%-owned subsidiary involved in natural gas well testing operations. In August 2001, we made the decision to cease pursuing opportunities in Mexico and the WS Segment was discontinued.

 

Page 32 of 86 Pages

 

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(d)  Beard’s share of the BE/IM and WS Segments’ operating results have been reported as discontinued for all periods presented. (See note 3 of notes to financial statements).

 

Page 32 of 86 Pages

 

 

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion addresses the significant factors affecting our results of operations, financial condition, liquidity and capital resources. Such discussion should be read in conjunction with our financial statements including the related notes and our selected financial information.

 

Overview

 

General. In 2006 we operated within the following operating segments: (1) the coal reclamation (“Coal”) Segment, (2) the carbon dioxide (“CO₂”) Segment, (3) the China Segment, (4) the e-Commerce Segment, and (5) the oil and gas (“Oil & Gas”) Segment.

 

The Coal Segment is in the business of operating coal fines reclamation facilities in the U.S. and provides slurry pond core drilling services, fine coal laboratory analytical services and consulting services. The CO2 Segment consists of the production of CO2 gas. The China Segment manufactures environmentally friendly organic chemical compound fertilizer (“OCCF”) and liquid fertilizer in China. The e-Commerce Segment is engaged in a strategy to develop business opportunities to leverage starpay’s intellectual property portfolio of Internet payment methods and security technologies. The Oil & Gas Segment consists of the production of oil and gas.

 

In 2006 our continuing operations reflected a loss of $1,522,000 compared to a loss of $2,302,000 in 2005 and earnings of $937,000 in 2004.

 

Beginning in 1999 we started discontinuing the operations of those segments that were not meeting their targeted profit objectives and which did not appear to have significant growth potential. This ultimately led to the discontinuance of four of our unprofitable segments. Such discontinued operations reflected a loss of $32,000 in 2006 compared to earnings of $142,000 in 2005. Losses in one segment of our discontinued operations were offset by earnings in another in 2004, resulting in no income or loss for that year. See “Discontinued Operations” below.

 

We are focusing our primary attention on the Coal, Carbon Dioxide and e-Commerce Segments, which we believe have significant potential for growth and profitability.

 

We have other assets and investments that we have been liquidating as opportunities have materialized.

 

Operating results for 2006, 2005 and 2004 continue to be impacted by the lack of a coal contract generating operating profits since January of 1999. Although the Pinnacle Project is in the final ramp-up stage, it is not yet generating operating profits and our interest has been reduced to 25%. Termination of our last previous significant contract (see “Coal Reclamation Activities---The MCN Projects”) resulted in a severe decline in the segment’s revenues---from $8,585,000 in 1998 down to $25,000 in 2006---with a correspondingly dramatic impact on profitability. The segment, which had an operating profit of $1,678,000 in 1998, recorded operating losses of $682,000 in 2004, $783,000 in 2005 and $780,000 in 2006.

 

Operating profit of the CO2 Segment in 2006 increased $375,000, or 40%, from the prior year, as a result of both increased production and higher pricing. The operating losses of the China Segment increased to $873,000 in 2006 compared to $787,000 for the prior year as the segment incurred increased costs associated with the ongoing operations of its first fertilizer plant in China. $510,000 of the losses incurred by the segment during the year were incurred by BEE/7HBF, LLC (the “LLC”) which owns our fertilizer manufacturing operations and by its wholly-owned subsidiary, Xianghe BH Fertilizer Co., Ltd. (“XBH”). The operating loss of the e-Commerce Segment decreased to $95,000 from $139,000 in 2005 due to lower salary expenses. The operating loss from

 

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corporate activities at the parent company level decreased $31,000, or 3%, primarily as a result of a $37,000 decrease in amortization expense. The Company’s overall results for 2006 were an improvement over the prior year but were still disappointing – a loss of $1,552,000 compared to $2,302,000 in 2005. Revenues increased $706,000 and expenses increased $271,000 compared to 2005. The Company recorded a decrease in equity in earnings of unconsolidated affiliates of $287,000 for 2006 compared to 2005. Gains on the disposition of assets and a portion of our interest in an LLC were $606,000 more in 2006 than in 2005 and the Company recorded $34,000 less income from minority interest in operations of unconsolidated affiliates in 2006 compared to 2005. The Company recorded a tax benefit of $17,000 in 2006 compared to tax expense of $35,000 for 2005, an improvement of $52,000.

 

Operating profit of the CO2 Segment in 2005 increased $364,000, or 62%, from the prior year, as a result of both increased production and higher pricing. The operating losses of the China Segment increased to $787,000 in 2005 compared to $549,000 for the prior year as the segment incurred increased costs associated with the construction and initial operations of its first fertilizer plant in China. $336,000 of the losses incurred by the segment during the year were incurred by the LLC and by XBH. The operating loss of the e-Commerce Segment increased to $139,000 from $124,000 the previous year as a result of increased expenses associated with its lawsuit against VISA. The operating loss from corporate activities at the parent company level increased $74,000, or 9%, primarily as a result of increased amortization of capitalized costs associated with debt. The Oil & Gas Segment recorded a profit of $12,000 compared to a loss of $35,000 in 2004 as 2005 was the initial year of production for the segment’s new gas wells. The Company’s overall results for 2005 were disappointing – a loss of $2,302,000 compared to earnings of $937,000 in 2004. While revenues for 2005 increased $407,000, expenses increased $424,000 compared to 2004 and the bottom line was severely impacted by a $305,000 increase in interest expense. Further, the results for 2004 reflected the receipt of $2,943,000 for the second and third installments of the McElmo Dome settlement with no comparable income amount in 2005.

 

Operating profit of the CO2 Segment in 2004 increased $222,000, or 61%, from the prior year, as a result of both increased production and higher pricing. The operating losses of the China Segment decreased to $549,000 in 2004 from $724,000 for the prior year as the segment incurred fewer administrative costs associated with the termination of a relationship with a former technology partner in China. The operating loss of the e-Commerce Segment increased to $124,000 from $100,000 the previous year as a result of increased expenses associated with its lawsuit against VISA. The operating loss in the Oil & Gas Segment decreased to $35,000 for 2004 compared to $116,000 for 2003 because the prior year included an $81,000 impairment of oil & gas leases held by the segment with no similar impairment in 2004. The operating loss from corporate activities at the parent company level decreased $150,000, or 15%, primarily as a result of lower professional fees and a reduction in amortization of capitalized costs associated with our debt offerings. The year reflected a reversal of our fortunes---going from a loss of $1,611,000 in 2003 to earnings of $937,000 in 2004, primarily reflecting (i) the receipt of $2,943,000 as the second and third installments of the McElmo Dome settlement versus $1,151,000 the prior year, (ii) a $379,000 increase in total revenues, and (iii) a reduction in operating costs of $59,000.

 

The recurring net losses and overall declines in financial condition and liquidity raise substantial doubts about our ability to continue as a going concern, as expressed in the independent auditors’ opinion on page 47.

 

Liquidity and capital resources

 

Capital resources. The Company's capital investment programs have required more cash than has been generated from operations during the past three years. Cash flows provided by (used in) operations during 2006, 2005 and 2004 were $(1,961,000), $(1,888,000), and $328,000, respectively, while capital additions from continuing operations (excluding the Pinnacle Project) were $154,000, $613,000, and $217,000, respectively, as indicated in the table below:

 

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* Capital additions to the Pinnacle Plant have been excluded since BPLLC is no longer a consolidated subsidiary, and certain amounts for 2005 have been restated.

 

Our 2007 capital expenditure budget has tentatively been set at $602,000. This does not include the capital cost of any coal recovery plants that may be constructed by the Coal Segment since the timing and dollar amount of such projects are uncertain and the projects are subject to the availability of financing. It includes our $537,000 share of the $100 million cost of expanding the production capacity of the McElmo Dome Field.* Our share of such costs is preliminarily targeted to come from our cash flow from the present production; however, we are currently exploring alternative sources of financing. No capital expenditures are contemplated in 2007 by the China, e-Commerce or Oil & Gas Segments.

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* After executing the original authorization for expenditures for the expansion in May of 2006, we were advised by the operator in March of 2007 that the owner of approximately 40% of the Unit has opted out of the expansion and that our share of the costs have increased to approximately $967,000. We and a number of other small working interest owners are currently protesting this increase. However, to date there has been no resolution of the matter.

 

Liquidity. Because of the cost over-runs on the Pinnacle Project and the reduction of our interest therein to 25%, our anticipated share of the profits from the Project, if any, have been significantly diminished. Failure of the fertilizer plant in China to achieve its market plan has further clouded our near-term picture. Sustaining the operating activities of our three unprofitable segments, plus our overhead, has resulted in a serious outflow of cash during the past three years. We have managed to survive this cash shortfall to date through a series of financings and the sale of various assets, principally those left over from our discontinued operations. A $2,783,000 long-term line of credit from an affiliate of the Chairman, secured by our working and overriding royalty interests in the McElmo Dome Field, has been periodically extended and currently matures in April of 2008.

 

Three private debt placements were completed in June and December of 2004 and January of 2005 for gross proceeds of $3,300,000, of which $1,455,000 was received in 2004. In addition, we borrowed $125,000 from a bank in the first quarter of 2004. Such funds were needed to “bridge the gap” until the distribution of the McElmo Dome settlement had been completed. Receipt of the second and third installments of the McElmo Dome settlement improved our balance sheet and income statement. We received $2,826,000 of the settlement in March and $117,000 in May of 2004, respectively. Upon receipt of the second installment, we were able to eliminate $2,620,000 of our total indebtedness. (See “Item 3. Legal Proceedings---McElmo Dome Litigation”).

 

We borrowed an additional $200,000 from an unconsolidated subsidiary in November of 2004 to provide needed working capital until the $2,100,000 private placement was completed in January of 2005. Another private placement was commenced in June of 2005 and $1,135,000 of notes were sold by year-end, including $624,000 of notes which were exchanged for an earlier issue of notes. We sold another $193,000 of these notes

 

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during the first quarter of 2006. On March 28, 2006, we obtained a $350,000 credit facility from a local bank, $290,000 of which was utilized to provide us with additional working capital since that date. In May of 2006, we borrowed $200,000 from a third party. In October of 2006, we initiated another private placement – selling $83,000 of notes due in August of 2008 and exchanging $568,000 of additional notes due in November of 2008 for the rights of the holders of a previous issue of our notes to receive a production payment due in November of 2006. In addition, $397,000 was borrowed by BEE/7HBF from our 50% partner in China. (See “PART I. Item 1. Business. General development of business. Private Debt Placements.” and “PART I. Item 1. Business. General development of business. Bank Credit Facility on Colorado Gas Wells” for additional details).

 

Our activities in 2004, 2005 and 2006 were primarily funded from the proceeds of the private debt placements described above. Future cash flows and availability of credit are subject to a number of variables, including demand for our coal reclamation services and technology, continuing demand for CO2 gas, demand for our fertilizer products in China, demand for our oil and gas production, and the e-Commerce Segment’s success (i) in developing licensing agreements and other fee based arrangements with companies implementing technology in conflict with its intellectual property or (ii) resulting from its ongoing Visa litigation.

 

During 2006 we reduced the deficit in our working capital position by $2,176,000 to $(272,000) at year-end 2006 from $(2,448,000) at year-end 2005. Most of the improvement in our working capital position resulted from the deconsolidation of BPLLC. There had been a significant buildup of short-term debt in BPLLC, with a corresponding increase in our working capital deficit, prior to its deconsolidation. The Coal Segment used $25,000 to purchase equipment and $755,000 to fund operating losses. The China Segment required $505,000 to fund net advances for operations and $30,000 to purchase equipment. Another $95,000 was used to fund the activities of the e-Commerce Segment. We repaid $309,000 in debt and $550,000 in accrued interest expense. Other corporate activities utilized approximately $938,000 of working capital. The bulk of these expenditures were funded by a net additional $1,133,000 in debt, $1,540,000 from the sale of carbon dioxide and $290,000 from the sale of assets.

 

As a result, at December 31, 2006, we were still in a negative working capital position with working capital of $(271,000), and a current ratio of 0.76 to 1. Our near-term outlook is uncertain. As a result of the deconsolidation our interest in the Pinnacle Project has been reduced to 25% and we anticipate that it will be eliminated. (See “PART I. Item 1. Business. General development of business---Recent Developments---Loans from and Agreements with PinnOak Resources” for additional details). Although the Coal Segment has just received a commitment for a new coal recovery project, we have not yet secured the necessary permits or the financing for it. We can not reasonably anticipate that any cash flow will be available from this project prior to 2008. The China fertilizer plant has been unable to generate sufficient cash flow to sustain its operations, and the outlook for near-term liquidity from this source is highly unlikely. (See “PART I. Item 1. Business. General development of business---Recent Developments---China Fertilizer Plant” for additional details).

 

Our outlook for near-term liquidity has been further clouded as a result of the expansion of production capacity currently underway at McElmo Dome. (See “Item 1. Business. General development of business. RECENT DEVELOPMENTS---Expansion of McElmo Dome Production Capacity”). In recent years our cash flow from McElmo Dome has been the primary source of the Company’s operating cash flow. The increased cost of our share of the expansion significantly impacted the availability of this source. Accordingly, we have determined that we must sell a portion of one of our investments in order to remedy our liquidity problem until such time as (i) the cash flow from McElmo Dome has increased sufficiently to do so, and/or (ii) cash flow from the coal recovery projects under development has increased enough to solve the problem.

 

Our principal business is coal reclamation, and this is where management’s operating attention remains primarily focused. The recent chronology of the Pinnacle Project has been disappointing. Despite the recent setbacks, the outlook for the Coal Segment remains bright. The segment is actively pursuing a number of other

 

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projects which it has under development. Although we have a signed letter of intent for the new project mentioned above, no definitive contracts have been signed and there is no assurance that the required financing will be obtained or that any of the projects will materialize.

 

We incurred losses from continuing operations totaling $2,887,000 during the past three years. We realized net earnings from discontinued operations totaling $110,000 during such period as the bulk of the assets of the four discontinued segments were sold. The problems from the discontinued segments are now behind us and management expects to dispose of the few assets remaining from such operations in 2007. We will pursue the sale of such assets as opportunities become available.

 

We expect to generate cash of at least $50,000 from the disposition of the remaining assets from two of our discontinued segments, and can sell certain other assets to generate cash if necessary. Moreover, we believe there is still a chance of receiving an award in connection with the binding arbitration we have on appeal. Even though we lost the arbitration, we and our counsel believe there are reasonable grounds for vacating the Opinion. However, there is no assurance that the matters in dispute will be resolved in our favor. See “Item 3. Legal Proceedings. McElmo Dome Litigation.”

 

In the near-term, it does not appear that the cash flow from our CO2 and Oil & Gas Segments will be sufficient to sustain our operations, and that we must generate funds from the sale of assets until the newly-committed coal project or other coal projects under development can generate positive cash flow or the anticipated increase in cash flow from McElmo Dome can cover the shortfall. Meanwhile, to the extent necessary, we must pursue additional outside financing, which would likely involve further dilution to our stockholders.

 

Our selected liquidity highlights for the past three years are summarized below:

 

 

In 2006, we had negative cash flow of $93,000. Operations of the Coal, China, and e-Commerce Segments and the discontinued operations resulted in cash outflows of $1,710,000, including $199,000 of operating losses for BPLLC before it became an unconsolidated equity investment. (See “Results of operations---Other corporate activities” below).

 

Our investing activities utilized cash of $10,244,000 in 2006. Proceeds from the sale of assets provided cash of $290,000. Net distributions from our investment in Cibola and a real estate partnership provided cash of

 

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$37,000. Acquisitions of property, plant and equipment and intangible assets used $10,689,000 of the cash outflow, including $10,535,000 for the coal fines recovery project.

 

Our financing activities provided cash flows of $12,112,000 in 2006. We received net cash of $12,419,000 from our borrowings and from the exercise of warrants and utilized $309,000 for payments on lines of credit and term notes. Included in the net cash received from our borrowings was $11,516,000 from PinnOak for the construction and operation of the coal fines recovery project.

 

At December 31, 2006 we had no available lines of credit. Our liquidity position temporarily benefited during the first quarter from a $150,000 short-term loan from a shareholder of a former affiliate, $39,000 of short-term loans from our 2008 and 2009 Note holders, and the sale of $105,000 of additional 2010 Notes.

 

Material Trends and Uncertainties. We recorded a net loss of $1,554,000 in 2006 compared to a net loss of $2,160,000 in 2005 and net earnings of $937,000 in 2004. 2004 results benefited from the $2,943,000 received from the McElmo Dome settlement. We have generated operating losses for eight consecutive years. The recent trend has been positive. With the exception of 2005, which recorded an operating loss of $1,717,000 versus an operating loss of $1,700,000 the prior year, there has been a significant improvement in our operating margin in each of the last four years, with the operating loss declining to $1,282,000 in 2006 from $3,057,000 in 2002. Despite the amount of debt that we have incurred in recent years, we believe that we have the ability to finance our Coal projects on a project financing basis, as demonstrated by the financing of the Pinnacle Project in West Virginia. At the corporate level, future borrowings will likely be dependent upon our ability to generate positive cash flows from operations. It is unlikely that additional borrowings will be made available to us from a related party. As discussed above, to the extent that the cash flow from our CO2 and Oil & Gas Segments, the McElmo Dome and Visa litigation fail to support our operations, we must generate funds from the sale of assets to cover the shortfall. If the sale of assets is not sufficient, we may be forced to raise additional capital, which would likely further dilute our shareholder holdings. We cannot assure you that we would be able to raise additional capital on acceptable terms, or at all.

 

Our 2006, 2005 and 2004 financial results were burdened by losses from discontinued operations totaling $32,000 and $121,000, respectively in 2006 and 2004 and benefited from earnings from discontinued operations totaling $142,000 in 2005. At year-end 2006 our total assets, net of current assets of $840,000, had been written down to $1,582,000. $384,000 of this amount consisted of our McElmo Dome properties which generated revenues of $1,540,000 and operating profits of $1,324,000 in 2006. We believe it is highly unlikely that there will be any significant impairments going forward. Nor do we anticipate having any significant additional losses from the operations of the discontinued segments going forward. On the other hand, 2004 financial results benefited from the McElmo Dome settlement in the gross amount of $2,943,000. The Settlement is a non-recurring item, so we will not have this benefit in the future except to the extent that McElmo Dome operating results may benefit from improved pricing or reduced pipeline charges as a result of the Settlement.

 

In addition, the Company recorded impairments of investments and other assets of $4,465,000 and $3,087,000 related to its investment in Cibola Corporation for the years 2005 and 2004, respectively. While the Company owned 80% of the common stock of Cibola through November 30, 2005, it did not have financial or operating control of this gas marketing subsidiary. After considering the impairments mentioned, the Company recorded net earnings of $51,000, $338,000, and $409,000 for 2006, 2005 and 2004, respectively, from its investment in Cibola which represented actual distributions to the Company under terms of an agreement with Cibola which was terminated on December 1, 2005.

 

One uncertainty we are facing is the amount of litigation expense the e-Commerce Segment will incur in 2007 and possibly 2008 related to the litigation against Visa. It is difficult to estimate how much the segment’s one-half of the out-of-pocket expenses (excluding legal fees) associated with such litigation may total.

 

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Results of operations

 

General. We discontinued four of our segments, all of which were unprofitable, during the period from 1998 to 2001. Management has since been focusing its attention on making the remaining operations profitable. Although we succeeded in bringing our initial fertilizer project in China on-line, its operating results to date have been disappointing. The Pinnacle Project began operations in the fourth quarter of 2006 and made its first coal shipment in November of 2006. However, for the reasons discussed above, we no longer expect it to contribute to our operating results. (See “PART I. Item 1. Business. General development of business---Recent Developments---Loans from and Agreements with PinnOak Resources” for additional details). Subject to obtaining the necessary financing, it appears that we will be bringing one of the other projects under development in the Coal Segment to reality later this year, but we do not anticipate any cash flow benefit from the project until 2008. Meanwhile, as mentioned above, we will need to pursue the sale of some of our assets and may also need to pursue additional outside financing, which would likely involve further dilution to our shareholders.

 

Operating profit (loss) for the last three years for our remaining segments is set forth below:

 

 

Following is a discussion of results of operations for the three-year period ended December 31, 2006.

 

Coal reclamation. We have focused most of our attention in recent years on coal reclamation. The following table depicts segment operating results for the last three years:

 

 

The Coal Segment’s operating loss for 2006 was $3,000 less than that of 2005 primarily due to a $90,000 reduction in operating costs. This was offset by a $27,000 decrease in revenues as we concentrated on the startup activities of the Pinnacle plant in West Virginia. Additionally, SG&A costs were $30,000 higher in 2006 compared to 2005 as the segment expensed a $20,000 fee paid to a consultant hired to assist in securing a USDA guaranty in connection with a proposed loan for the Pinnacle Project. Depreciation and amortization was $30,000 greater in 2006 compared to the prior year because of additional equipment purchased for the Pinnacle Plant which commenced production in October of 2006. The 2005 operating loss for the segment was $101,000 greater than that of 2004 largely due to commencement of the Pinnacle Project in the fourth quarter and the resulting increase in SG&A type expenses. Limited lab analysis activity in 2005 also contributed to the higher

 

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loss. The 2004 operating loss reflects the negative impact of the early termination of a contract that did not work out as expected. Except for the aforementioned contract, no new projects were undertaken during the three year period.

 

It had been contemplated that the Pinnacle Project would begin making a material contribution to the segment’s operating profit in late 2006 or early 2007. This will no longer be the case due to the deconsolidation of BPLLC, which will have a material unfavorable impact in terms of the revenues and cash flow from continuing operations that had been projected from the project.

 

Despite the loss of the contemplated contribution from the Pinnacle Project, the industry climate has improved during the last two years due to the increase in coal and natural gas prices, and the outlook for the segment has correspondingly improved, with a number of other projects currently under development.

 

Carbon dioxide. The primary component of revenues for this segment is the sale of CO2 gas from the working and overriding royalty interests of our two carbon dioxide producing units in Colorado and New Mexico. These units also provide very minor amounts of revenue from the sale of oil, natural gas and sulphur. The following table depicts operating results for the last three years:

 

 

The following table shows the trend in production volume, sales prices and lifting cost for the three years:

 

 

As evidenced by the above, revenues, production and sales prices per Mcf are all trending up relatively significantly, while lifting costs per Mcf have remained relatively static. More importantly, the operating margin has trended sharply upward. As a result of additional development drilling currently underway in the field, the increase in oil prices which has increased the demand for CO2, and anticipated continuing improvement in CO2 pricing as a result of the McElmo Dome settlement, we look for continuing improvement in the outlook for the CO2 Segment in 2007. As mentioned in the capital investments discussion above, the McElmo Dome Field is currently undergoing a $99.8 million expansion designed to increase production by approximately 18%.

 

China. In 2003 and most of 2004 the China Segment focused its attention on the financing and construction of fertilizer plants utilizing composting technology licensed from third parties. These efforts were unsuccessful; accordingly, in the fall of 2004 the segment shifted its focus to the concept of a much smaller mini-plant which would not utilize the licensed technology. The initial mini-plant was constructed in 2005 and began operations in the fourth quarter of 2005, recording the segment’s first revenues of $29,000. Revenues increased to $368,000 in 2006. The segment had no revenues in 2004 and recorded $1,205,000, $802,000 and $548,000 of operating and SG&A expenses in 2006, 2005 and 2004, respectively, while pursuing its various marketing efforts. The segment recorded operating losses of $873,000, $787,000, and $549,000 attributable to its operations in China for the years 2006, 2005 and 2004, respectively.

 

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As of March 31, 2007, all of the marketing initiatives undertaken by our China fertilizer manufacturing plant have been unsuccessful in terms of enabling the plant to reach the breakeven point. The Company is exploring its available alternatives including sale of the plant, merger of the operation with a competitor, or bringing in a new partner. Accordingly, the outlook and future direction of the China Segment is uncertain at this time. As a result, there is considerable uncertainty concerning the revenues and cash flow from continuing operations that had been projected from this initial plant, which has also clouded the outlook for building additional plants.

 

e-Commerce. In early 1999, we began developing our proprietary concept for an Internet payment system through starpay. starpay recorded revenues of $29,000 and $31,000 in 2004 and 2005, respectively. Revenues decreased to $5,000 in 2006, as the segment’s patent license agreement, which provided for an annual license fee of $25,000 during only its first three years, and the final fee was paid in the first quarter of 2005. The segment recorded $100,000, $168,000, and $147,000 of SG&A expenses, respectively, in 2006, 2005 and 2004. Operating results for 2004 and 2005 were burdened with additional expenses associated with the segment’s ongoing litigation against VISA and, as a result, operating losses increased from $124,000 in 2004 to $139,000 in 2005. Because, however, of the snail’s pace at which the VISA lawsuit had been progressing, in 2006 the Company granted the request of starpay’s managing member to spend a portion of his time assisting his spouse in a newly purchased business. Accordingly, he received only half his normal salary from February through September of that year. This was the primary reason the operating loss of starpay decreased $44,000 to $95,000 in 2006 compared to 2005.

 

Oil & Gas. Our newest segment, Oil & Gas, is a familiar one to management. In recent years we have acquired federal and state oil and gas leases in several states. Through a farmout arrangement with another entity, eight gas wells were drilled on one of these leases in Colorado and placed in production in the fourth quarter of 2005. We have a 22.5% working interest in seven of these wells and a 3.6% override until payout and a 22.5% working interest after payout in the other well. We also have overriding royalty interests in four wells located in Wyoming which began production in 2005. The segment recorded $147,000 in revenues for 2006 compared to $95,000 for 2005. Operating costs totaled $51,000, $72,000 and $33,000 for 2006, 2005 and 2004, respectively. The segment’s depreciation, depletion and amortization of its equipment and oil & gas leases totaled $16,000, $11,000 and $2,000 for 2006, 2005 and 2004, respectively. As a result, the segment contributed operating profits of $80,000 and $12,000 for 2006 and 2005, respectively, compared to a loss of $35,000 for 2004.

 

Other corporate activities. Other corporate activities include general and corporate operations, as well as assets unrelated to our operating segments or held for investment. These activities generated operating losses of $938,000 in 2006, $969,000 in 2005 and $895,000 in 2004. The $31,000 reduction in the operating loss for 2006 compared to 2005 was primarily the result of a $37,000 reduction in amortization of intangibles. The increased operating loss in 2005 compared to 2004 was due to higher professional fees associated with the search for project financing and increased amortization of capitalized costs associated with our subordinated debt, including a $51,000 charge for capitalized costs associated with an unsuccessful search for new financing.

 

Selling, general and administrative expenses. Selling, general and administrative expenses (“SG&A”) increased to $863,000 in 2006 from $861,000 in 2005 after decreasing from $870,000 in 2004. The $2,000 increase for 2006 compared to 2005 was the net result of increases and decreases in numerous types of expenses with the largest increase being a $40,000 charge for accounting fees in connection with the audit of Cibola in 2006. This was offset by a net decrease in numerous other SG&A expenses. The $9,000 decrease in 2005 compared to 2004 was the result of reductions in many types of expenses, none of which were individually significant.

 

Depreciation, depletion and amortization. Depreciation, depletion and amortization expenses increased to $214,000 in 2006 after increasing to $187,000 in 2005 from $92,000 in 2004. The increases in 2006 and 2005

 

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were due to higher depreciation costs associated with the plant in China, the coal plant operations in West Virginia and increased amortization expense associated with the issuance of debt in 2005 and 2006.

 

Interest income. Interest income increased to $25,000 in 2006 after increasing to $16,000 in 2005 from $3,000 in 2004. The increases are from short-term investments associated with increased levels of cash on hand as a result of our debt offerings.

 

Interest expense. Interest expense increased to $1,004,000 in 2006 from $999,000 in 2005 and from $694,000 in 2004 reflecting the increased level of debt in each year as we borrowed to meet our working capital and operating needs and to fund the activities of the Coal and China Segments. These amounts included $109,000 in 2005 and $119,000 in 2004 paid to Cibola Corporation for Beard’s investment in Cibola. There were no such amounts paid in 2006.

 

Equity in earnings of unconsolidated affiliates. Our equity in earnings of unconsolidated affiliates reflected net earnings of $49,000, $336,000 and $495,000 for 2006, 2005 and 2004, respectively, after the impairments discussed below.

 

In 2004, 2005 and through September 30, 2006, we had recorded 100% of the expenses of BPLLC inasmuch as the terms of the agreement governing the operation of the Project had not been finalized and we were in control of Project operations. The parties involved had been in the process of negotiating a loan based on the premise of obtaining a USDA guaranty of 70% thereof. In the interim and through September 30, 2006, our partner had advanced $10,805,000 to fund the construction of the Project’s physical plant. Effective September 30, 2006, affiliates of our partner (the investor group) elected to convert $2,800,000 of the partner’s loans to equity in BPLLC. Because the USDA-guaranteed loan had not been secured by such date, the investor group exercised their option to assume control of the Project effective October 1, 2006 and increased their ownership interest in BPLLC to 75%, at which point BPLLC ceased to be a consolidated subsidiary. The Company did not recognize any losses from this unconsolidated subsidiary for the period from October 1, 2006 through December 31, 2006 since the Company no longer had an investment at risk as the operations were funded by the 75% partner.

 

For 2006, the principal component of our earnings in unconsolidated affiliates was our share of the earnings of Cibola Corporation (“Cibola”). Although we owned 80% of the common stock of Cibola, we did not have operating or financial control of this gas marketing subsidiary which was formed in 1996. We recorded $4,803,000, and $3,496,000 representing our 80% share of the earnings of Cibola for 2005 and 2004, respectively. Due to the terms of an agreement with the minority and preferred shareholders of Cibola, however, that provided that the net worth of Cibola would have to reach $50,000,000 before we could begin to receive our 80% share of any excess over $50,000,000, we also recorded impairments of $4,451,000 and $3,087,000 for the years 2005 and 2004, respectively. Beard also wrote off $13,000 of its remaining investment in Cibola in the third quarter of 2005. Cibola, then, contributed a net $230,000 and $290,000 of our financial net income for fiscal years 2005 and 2004, respectively, after netting the interest charges above and these impairments against our 80% share of earnings, pursuant to this agreement. The agreement was terminated, according to its terms, by the minority common and preferred shareholders effective December 1, 2005. Cibola did not reach the aforementioned net worth position and accordingly we received from Cibola only the net amounts recorded above and already distributed. In 2006, we recorded $51,000 of earnings from Cibola according to terms of a negotiated settlement with the minority common and preferred shareholders of Cibola regarding the termination of the agreement above. In addition, in 2004, we recorded $86,000 in earnings from our investment in JMG-15, a real estate partnership in Texas that sold a parcel of land during the year, compared to losses of $2,000 for each of the years 2005 and 2006, respectively, from this partnership.

 

Gain on sale of controlling interest in subsidiary. When the investor group in BPLLC exercised their option to assume control of the operations and a 75% ownership interest in the Project, our interest in the LLC was reduced to 25%. The Company recorded a $383,000 gain as a result of being relieved of the debt obligations

 

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which had funded the previously recorded losses of $423,000 offset by $40,000 of intangible assets previously capitalized but now written off.

 

Gain on sale of assets. Gains from the sale of assets totaled $287,000, $64,000 and $14,000 in 2006, 2005 and 2004, respectively. The large increase in 2006 is attributable to the Coal Segment recording a $280,000 gain resulting from the sale of certain assets to the 25%-owned LLC now operating the coal fines recovery project in West Virginia. The remaining gains for 2006, 2005 and 2004 reflected proceeds from the sale of certain other assets sold in such years.

 

Impairment of investments and other assets. The Company recorded impairments of $0, $4,465,000, and $3,087,000 for the years 2006, 2005 and 2004, respectively, which reduced the recorded earnings attributable to the Company’s investment in Cibola to the actual distributions received under the terms of an agreement which was terminated by the minority and preferred shareholders on December 1, 2005.

 

Income taxes. We have approximately $44.1 million of net operating loss carryforwards and $3 million of depletion carryforwards to reduce future income taxes. Based on our historical results of operations, it is not likely that we will be able to fully realize the benefit of our net operating loss carryforwards which began expiring in 2006. At December 31, 2006 and 2005, we have not reflected as a deferred tax asset any future benefit we may realize as a result of our tax credits and loss carryforwards. Our future regular taxable income for the next three years will be effectively sheltered from federal income tax as a result of our substantial tax credits and loss carryforwards. Continuing operations reflect foreign and state income and federal alternative minimum tax expense (benefit) of $(17,000), $35,000 and $118,000 for 2006, 2005 and 2004, respectively. It is anticipated that we may continue to incur minor alternative minimum tax in the future, despite our carryforwards and credits.

 

Discontinued operations. Bolstered by gains totaling $155,000 from the sales of equipment, discontinued operations recorded net earnings of $142,000 for the year 2005. As mentioned in the Overview above, our financial results from the discontinuance of these four segments were burdened by losses of $-0- and $32,000, respectively, in 2004 and 2006. As of December 31, 2006, the assets and liabilities of discontinued operations held for resale totaled $20,000 and $40,000, respectively. We believe that all of the assets of the discontinued segments have been written down to their realizable value. See Note 4 to the financial statements.

 

Forward looking statements. The previous discussions include statements that are not purely historical and are “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including statements regarding our expectations, hopes, beliefs, intentions and strategies regarding the future. Our actual results could differ materially from its expectations discussed herein, and particular attention is called to the discussion under “Liquidity and Capital Resources---Effect of Recent Developments on Liquidity” and “Material Trends and Uncertainties” contained in this Item 7.

 

Impact of Recently Adopted Accounting Standards

 

In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS No. 155”), which amends FASB Statements No. 133 and 140. This Statement permits fair value remeasurement for any hybrid financial instrument containing an embedded derivative that would otherwise require bifurcation, and broadens a Qualified Special Purpose Entity’s (“QSPE”) permitted holdings to include passive derivative financial instruments that pertain to other derivative financial instruments. This Statement is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring after the beginning of an entity’s first fiscal year beginning after September 15, 2006. This Statement has no current applicability to the Company’s financial statements. Management plans to adopt this Statement on January 1, 2007 and it is anticipated that the initial adoption of this Statement will not have a material impact on the Company’s financial position, results of operations, or cash flows.

 

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In June 2006, the FASB issued Interpretation 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 clarifies the accounting and reporting for income taxes where the interpretation of the law is uncertain. FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. This Statement has no current applicability to the Company’s financial statements. Management plans to adopt this Statement on January 1, 2007 and it is anticipated that the initial adoption of FIN 48 will not have a material impact on the Company’s financial position, results of operations, or cash flows.

 

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. Management is assessing the impact of the adoption of this Statement.

 

In September 2006, the Securities Exchange Commission issued Staff Accounting Bulletin No. 108 (“SFAS No. 108”). SAB No. 108 addresses how the effects of prior year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB No. 108 requires companies to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. When the effect of initial adoption is material, companies will record the effect as cumulative effect adjustment to beginning of year retained earnings and disclose the nature and amount of each individual error being corrected in the cumulative adjustment. SAB No. 108 is effective for years ending after November 15, 2006. The Company adopted this staff accounting bulletin for 2006 and its adoption did not have a material impact on the Company’s financial position, results of operations, or cash flows.

 

In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115” (“SFAS No. 158”). SFAS No. 158 permits entities to choose to measure many financial instruments and certain other items at fair value. It requires companies to provide information helping financial statement users to understand the effect of a company’s choice to use the fair value on its earnings, as well as to display the fair value of the assets and liabilities a company has chosen to use fair value for on the face of the balance sheet. Additionally, SFAS No. 158 establishes presentation and disclosure requirements designed to simplify comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The Statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Management is assessing the impact of this statement.

 

Critical Accounting Policies

 

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. For example, unexpected changes in market conditions or a downturn in the economy could adversely affect actual results. Estimates are used in accounting for, among other things, the allowance for doubtful accounts, valuation of long-lived assets, legal liability, depreciation, taxes, and contingencies. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.

 

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Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

 

Receivables and Credit Policies

Accounts receivable include amounts due from the sale of CO2 from properties in which we own an interest and from the sales of inventory produced by our fertilizer plant in China, accrued interest receivable and uncollateralized customer obligations due under normal trade terms requiring payment within 30 days from the invoice date. Notes receivable are stated at principal amount plus accrued interest and are normally not collateralized. Payments of accounts receivable are allocated to the specific invoices identified on the customers remittance advice or, if unspecified, are applied to the earliest unpaid invoices. Payments of notes receivable are allocated first to accrued but unpaid interest with the remainder to the outstanding principal balance. Trade accounts and notes receivable are stated at the amount management expects to collect from outstanding balances. The carrying amounts of accounts receivable are reduced by a valuation allowance that reflects management’s best estimate of the amounts that will not be collected. Management individually reviews all notes receivable and accounts receivable balances that exceed 90 days from invoice date and based on an assessment of current creditworthiness, estimates the portion, if any, of the balance that will not be collected. Management provides for probable uncollectible accounts through a charge to earnings and a credit to a valuation allowance based on its assessment of the current status of individual accounts. Balances that are still outstanding after management has used reasonable collection efforts are written off through a charge to the valuation account and a credit to trade accounts receivable. Changes to the valuation allowance have not been material to the financial statements.

 

Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of

Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

 

Revenue Recognition

We recognize revenue when it is realized or receivable and earned. Revenue from the CO2 Segment is recognized in the period of production. Revenue from Coal Segment projects is recognized in the period the projects are performed. Revenue from the sale of inventory produced by our China Segment is recognized when the product is shipped or delivered and is recorded net of the applicable value-added tax. License fees from the e-Commerce segment are recognized over the term of the agreement.

 

Off-Balance Sheet Arrangements

 

We do not have any material off-balance sheet arrangements.

 

Contractual Obligations

 

The table below sets forth our contractual cash obligations as of December 31, 2006:

 

 

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^A Amounts include interest due to be paid on long-term debt obligations.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

 

At December 31, 2006, we had notes receivable of $13,000 and total debt of $8,997,000, including accrued interest to related parties of $391,000. Debt in the amount of $8,346,000 has fixed interest rates; therefore, our interest expense and operating results would not be affected by an increase in market interest rates for this amount. Another $260,000 note is accruing interest at Wall Street Journal Prime plus 1.5%, or 9.75%, at year-end. A 10% increase in market interest rates above the year-end rates would have increased our interest expense by less than $3,000. At December 31, 2006, a 10% increase in market rates above the 10% floor would have reduced the fair value of our long-term debt by $95,000.

 

We have no other market risk sensitive instruments.

 

 

 

Item 8.  Financial Statements and Supplementary Data

 

The Beard Company and Subsidiaries

Index to Financial Statements

Forming a Part of Form 10-K Annual Report

to the Securities and Exchange Commission

 

 

 

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REPORT OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

 

 

The Board of Directors and Stockholders of

The Beard Company

Oklahoma City, Oklahoma

 

We have audited the accompanying consolidating balance sheets of The Beard Company and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, shareholders’ equity (deficiency) and cash flows for each of the years in the three-year period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with 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 financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Beard Company and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

 

The accompanying consolidated financial statements have been prepared assuming that The Beard Company and subsidiaries will continue as a going concern. As discussed in Note 2 to the financial statements, The Beard Company and subsidiaries’ recurring losses and negative cash flows from operations raise substantial doubt about its ability to continue as a going concern. Management’s plans as to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that may result from the outcome of this uncertainty.

 

 

 

Oklahoma City, Oklahoma

April 17, 2007

 

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