TREATY ENERGY CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
NOTE 1 – ORGANIZATION AND NATURE OF BUSINESS
Information Regarding Forward-Looking Statements
This report contains forward-looking statements that involve risks and uncertainties. We generally use words such as "believe," "may," "could," "will," "intend," "expect," "anticipate," "plan," and similar expressions to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described below and elsewhere in this report. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made, and our future results, levels of activity, performance or achievements may not meet these expectations. We do not intend to update any of the forward-looking statements after the date of this document to conform these statements to actual results or to changes in our expectations, except as required by law.
History
Treaty Energy Corporation, (“Treaty”, “the Company”, “we”, or “us”) was incorporated in the State of Nevada in August, 1997. In December, 2008, we merged with Treaty Petroleum, Inc., a Texas Corporation under a transaction commonly referred to as a reverse merger.
We are a crude oil and natural gas producing company currently seeking to acquire producing oil and gas properties which have current production and development opportunities.
As is more thoroughly discussed in Note 4 to our annual report filed on Form 10-K as of December 31, 2009, during July, 2009, we lost our leases in Crockett County, Texas. Since those leases constituted the only oil and gas assets the Company had at the time, management has deemed the Company subsequent to that point an “Exploration Stage Company”.
Also discussed in Note 5 to this Form 10-Q is our acquisition activity during the nine months ended September 30, 2010. We acquired a 100 percent working interest in several leases in Tennessee, then subsequently sold various working interests to raise the capital to re-open the wells. We also entered into a 50/50 Joint Venture with Princess Petroleum Limited, a company organized under the laws of Belize, to develop approximately 200,000 on-shore acres and 1.8 million offshore acres. We subsequently sold a 10% (5% of the total) working interest in our Belize concession for $250,000 in cash.
NOTE 2 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Condensed Financial Statements
In the opinion of management, the accompanying financial statements includes all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations, and cash flows for the period ending September 30, 2010. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with information included in our audited financial statements for the period ended December 31, 2009, as reported in Form 10-K filed with the SEC on May 6, 2010.
Management further acknowledges that it is solely responsible for adopting sound accounting practices, establishing and maintaining a system of internal accounting control and preventing and detecting fraud. The Company's system of internal accounting control is designed to assure, among other items, that 1) recorded transactions are valid; 2) valid transactions are recorded; and 3) transactions are recorded in the proper period in a timely manner to produce financial statements which present fairly the financial condition, results of operations and cash flows of the Company for the respective periods being presented.
Use of Estimates
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates underlying these consolidated financial statements include the estimated quantities of proved oil reserves used to compute depletion of oil and natural gas properties and the estimated fair value of asset retirement obligations.
All of the Company’s accounting policies are not included in this Form 10-Q. A more comprehensive set of accounting policies adopted by the Company are included on our Form 10-K as of December 31, 2009 and are herein incorporated by reference.
Fair Value Measurement
The Company has adopted guidance contained in Codification Topic No. 820 which defines fair value, establishes a framework for measuring fair value and expands disclosure of fair value measurements. Topic 820 applies under other accounting pronouncements that require or permit fair value measurements and accordingly, does not require any new fair value measurements. Topic 820 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company believes that the adoption of Topic 820 will not have a material effect on its statements of operations and financial condition. Topic 820 requires disclosure of assets and liabilities measured at fair value within a three-tiered hierarchy.
The following table shows the Company’s fair value instruments, measured on a recurring basis:
|
Level
|
|
Amount
|
|
|
Level 1:
|
|
$ |
- |
|
|
Level 2: Notes payable and accrued interest to related parties and third parties
|
|
|
215,717 |
|
|
Level 3: Notes payable, long term and short term, net of discount
|
|
|
514,000 |
|
|
Totals
|
|
$ |
729,717 |
|
Revenue Recognition
Oil revenue is recognized when persuasive evidence of an arrangement exists, our oil is delivered, the fee is fixed and determinate and collectability is reasonably assured.
Stock-Based Compensation
In December of 2004, the Financial Accounting Standards Board issued guidance now codified as Topic 718 (“Topic 18”) which applies to transactions in which an entity exchanges its equity instruments for goods or services and also applies to liabilities an entity may incur for goods or services that are based on the fair value of those equity instruments. For any unvested portion of previously issued and outstanding awards, compensation expense is required to be recorded based on the previously disclosed Topic 18 methodology and amounts. Prior periods presented are not required to be restated. The Company adopted Topic 18 at its inception and applied the standard using the modified prospective method.
Oil and Gas Properties
We use the successful efforts method for crude oil and natural gas exploration and production activities. All costs for development wells, related plant and equipment, proved mineral interests in crude oil and natural gas properties, and related asset retirement obligation (ARO) assets are capitalized. Costs of exploratory wells are capitalized pending determination of whether the wells found proved reserves. Costs of wells that are assigned proved reserves remain capitalized. Costs also are capitalized for exploratory wells that have found crude oil and natural gas reserves even if the reserves cannot be classified as proved when the drilling is completed, provided the exploratory well has found a sufficient quantity of reserves to justify its completion as a producing well and the company is making sufficient progress assessing the reserves and the economic and operating viability of the project. All other exploratory wells and costs are expensed.
Long-lived assets to be held and used, including proved crude oil and natural gas properties, are assessed for possible impairment by comparing their carrying values with their associated undiscounted future net before-tax cash flows. Events that can trigger assessments for possible impairments include write-downs of proved reserves based on field performance, significant decreases in the market value of an asset, significant change in the extent or manner of use of or a physical change in an asset, and a more-likely-than-not expectation that a long-lived asset or asset group will be sold or otherwise disposed of significantly sooner than the end of its previously estimated useful life. Impaired assets are written down to their estimated fair values, generally their discounted future net before-tax cash flows. For proved crude oil and natural gas properties in the United States, the company generally performs the impairment review on an individual field basis. Outside the United States, reviews are performed on a country, concession, development area or field basis, as appropriate.
Long-lived assets that are held for sale are evaluated for possible impairment by comparing the carrying value of the asset with its fair value less the cost to sell. If the net book value exceeds the fair value less cost to sell, the asset is considered impaired and adjusted to the lower value.
As required under ASC 410, Asset Retirement and Environmental Obligations, the fair value of a liability for an asset retirement obligation (“ARO”) is recorded as an asset and a liability when there is a legal obligation associated with the retirement of a long-lived asset and the amount can be reasonably estimated. As of September 30, 2010, we have recorded no asset retirement obligations as we are still determining whether our efforts to re-open our recently-acquired shut-in wells in Tennessee will be successful and therefore we do not know if the liability is long-term (which would be the case if the wells are successful) or short-term (which would be the case if they are not). Once we have re-opened the wells and determined that their production is of commercial quantities, we will record the obligation as an increase in our carrying value of our oil and gas properties and an increase in our asset retirement obligation. As of September 30, 2010, the amount of our Asset Retirement Obligation cannot be reasonably estimated.
Depreciation and depletion of all capitalized costs of proved crude oil and natural gas producing properties, except mineral interests, are expensed using the unit-of-production method generally by individual field, as the proved developed reserves are produced. Depletion expenses for capitalized costs of proved mineral interests are recognized using the unit-of-production method by individual field as the related proved reserves are produced. Periodic valuation provisions for impairment of capitalized costs of unproved mineral interests are expensed. As of September 30, 2010, we have recorded only a de minimus amount of depreciation and depletion of our acquired oil and gas properties as we have only a small amount of production from those properties.
Gains and losses from dispositions of oil and gas properties is calculated by subtracting the pro-rata carrying value of the working interest in the property from the proceeds of the sale.
NOTE 3 – RECENT ACCOUNTING PRONOUNCEMENTS
In May 2008, the FASB issued a new accounting standard relating to the hierarchy of Generally Accepted Accounting Principles. This standard identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States (the GAAP hierarchy). This standard becomes effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board (“PCAOB”) amendment to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles” and is not expected to have a significant impact on our consolidated financial statements.
The Company has adopted a new accounting standard issued by the FASB related to fixed assets and impairments of fixed assets (“Topic 360”). This topic requires us to review for impairment long-lived assets, such as property, plant, equipment, and acquired intangible assets subject to amortization, whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be recoverable. We assess recoverability of assets to be held and used by comparing their carrying amount to the expected future undiscounted net cash flows they are expected to generate. If an asset or group of assets is considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset or group of assets exceeds fair value. We report long-lived assets meeting the criteria to be considered as held-for-sale at the lower of their carrying amount or fair value less anticipated disposal costs.
In May 2009, the FASB issued a new accounting standard relating to subsequent events (“Topic 855”). This pronouncement establishes standards for accounting for and disclosing subsequent events (events which occur after the balance sheet date but before financial statements are issued or are available to be issued). Topic 855 requires an entity to disclose the date subsequent events were evaluated and whether that evaluation took place on the date financial statements were issued or were available to be issued. It is effective for interim and annual periods ending after June 15, 2009. The Company has adopted this standard in the current report on Form 10-Q.
In general, the amount of an Asset Retirement Obligation (“ARO”) and the costs capitalized will be equal to the estimated future cost to satisfy the abandonment obligation using current prices that are escalated by an assumed inflation factor up to the estimated settlement date which is then discounted back to the date that the abandonment obligation was incurred using an assumed cost of funds for the Company. After recording these amounts, the ARO is accreted to its future estimated value using the same assumed cost of funds and the liability is increased each period as the retirement obligation approaches.
NOTE 4 – GOING CONCERN
The accompanying financial statements have been prepared assuming that Treaty will continue as a going concern. As shown in these financial statements, we have had continuing negative cash flows from operations and working capital deficits. Although we have acquired several leases in Tennessee which we are working to bring on line and render economical wells, as of September 30, 2010, we have had only minimal production from them. These conditions raise substantial doubt as to our ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. Management intends to finance these deficits by making additional shareholder notes and seeking additional outside financing through either debt or sales of its common stock.
NOTE 5 – OIL PRODUCING PROPERTIES
The history of our producing properties is found in Note 4 of our report on Form 10-K as of December 31, 2009, filed on April 15, 2010.
Acquisitions During the Nine Months Ended September 30, 2010.
Pickett County, Tennessee
On April 13, 2010, we acquired 100% undivided working interest (82.5% royalty interest) in eight leases in Pickett County, Tennessee in exchange for 1.5 million shares which were contributed by a major shareholder. These leases are: Herbert Groce #1, 77 acres; Herbert Groce #2, 80 acres; Leeta West, 20 acres; Joseph Schwallie, 47 acres; Byron Hill, 18.5 acres, Robin Moody, 18.5 acres, Terry Williams, 18.5 acres and Kimberly Hicks, 18.5 acres.
We valued the 1.5 million shares at the closing price on April 13, 2010 and valued the Tennessee properties at $19,500, or $0.013 per share. We then divided the purchase price, plus commissions and other costs, equally among the three properties expected to be developed during 2010, and arrived at a cost basis of $10,158 per well. Finally, we recorded a liability to the major shareholder in the amount of $19,500, the value of the shares given in exchange for the leases.
On June 11, 2010, we entered into an agreement to sell 35% of our working interest in the Joseph Schwallie #1 well to an investor for $20,000 cash.
Also on June 11, 2010, we entered into an agreement to sell another 20% of the Joseph Schwallie #1 well for $55,000 in cash. Under the terms of this agreement, we are obligated to increase the distributions of cash flows to this investor from 20% to 34% until such time as the investor has received $55,000, after which the distribution obligation will revert to the 20% working interest.
As a result of the two above sales, we recorded a reduction in our historical cost basis of the Joseph Schwallie well from $10,158 to $4,571, recorded a liability in the amount of $55,000 and a gain on the two sales in the amount of $14,413.
On May 27, 2010, we entered into an agreement to sell 50% of our working interest in the Robin Moody #1 well for $20,000 in cash. Under the terms of this agreement, we are obligated to increase the distributions of cash flows to this investor from 50% to 56% until such time as the investor has received $20,000, after which the distribution obligation will revert to the 50% working interest.
On June 11, 2010, we sold a 20% interest in the Robin Moody lease for $55,000 in cash. Under the terms of this agreement, we are obligated to increase the distributions of cash flows to this investor from 20% to 29% until such time as the investor has received $55,000, after which the distribution obligation will revert to the 20% working interest.
As a result of the two above sales of our interests in the Robin Moody well #1, we recorded a reduction in our historical cost basis of the Robin Moody lease from $10,158 to $3,047, recorded liabilities in the amount of $75,000 and a loss on the two sales in the amount of $7,111.
On June 18, 2010, we entered into an agreement to sell 50% of our working interest in the Herbert Groce #1 well for $45,000 in cash. We recorded the sale by reducing the carrying value of our interest in the Herbert Groce #1 well by an amount equal to the pro-rata portion of our historical cost in the property, and recorded a gain of $39,921.
Belize Concession and Joint Venture with Princess Petroleum Ltd.
On April 20, 2010, we entered into a 50/50 Joint Venture agreement with Princess Petroleum Limited, a company organized under the laws of Belize to explore for oil and gas on approximately 2 million acres in Belize. The country of Belize is located in Central America, in the south of the Yucatan Island to the southeast of Mexico. It is surrounded by Mexico in the north, by Guatemala in the west and south and by the Caribbean Sea in the east. Its old name was British Honduras.
A major shareholder of the Company paid $100,000 cash as required under the agreement. We have recorded our basis in the $100,000 property and the corresponding debt to our shareholder.
On July 15, 2010, we sold a 10% interest (5% total) working interest in our Belize concession for $250,000 in cash. We reduced our carrying value proportionally and recorded a gain on the sale of $244,750.
NOTE 6 – NOTES PAYABLE
At September 30, 2010, we have the following liabilities to related and unrelated parties:
|
Notes and Interest Payable
|
|
|
|
|
Notes and interest payable to previous officers and directors
|
|
|
166,011 |
|
|
Liability relating to Crockett County leases
|
|
|
85,049 |
|
|
Notes and interest payable related to our Tennessee acquisition
|
|
|
130,668 |
|
|
Total notes and interest payable
|
|
$ |
381,728 |
|
| |
|
|
|
|
|
Notes and Interest Payable to Related Parties
|
|
|
|
|
|
Advances from affiliates
|
|
|
38,755 |
|
|
Accrued compensation to officers and directors
|
|
|
309,234 |
|
|
Total related party notes and interest payable
|
|
$ |
347,989 |
|
Notes and Interest Payable to Previous Officers and Directors
These liabilities arose principally between January, 2007 and December, 2008 as cash contributions and accrued compensation to officers and directors of Treaty Petroleum, Inc. with whom Treaty Energy Corporation merged in December of 2008. Some additional compensation was accrued during 2009 until the Crockett County, Texas leases were lost.
On January 29, 2010, a lawsuit was filed in the 22nd Judicial District Court, Parish of St. Tammany, Louisiana naming Treaty Energy Corporation, among others, as a defendant. The liabilities here form a portion of the basis of this lawsuit. We continue to accrue interest on these amounts until the court system has determined what liability, if any, Treaty Energy Corporation may have to the previous officers and directors.
Liability relating to the Crockett County Leases
Upon assuming the rights to receive production revenues assigned to Treaty Energy Corporation from Treaty Petroleum, Inc., we agreed to service the note payable to the assignee of the working interest (Treaty Petroleum, Inc.) so long as the Company held the lease.
As is discussed more thoroughly in Note 4 to our annual report on Form 10-K as of December 31, 2009, we lost the Crockett County, Texas leases due to our failure to hold the leases by production. At the point the leases were lost, we had net note balance owed of $85,049. Although the Company has not issued a promissory note in this amount, we continue to carry this liability until we collect evidence that the original note made by Treaty Petroleum, Inc. has been retired.
Advances from an Affiliate
This liability relates to amounts contributed by shareholders to pay certain Company expenses and to acquire assets in Belize. The shareholder expects to be reimbursed in cash or stock.
Accrued Compensation to officers and directors
This liability arises from our contract with Randall Newton, our former Chairman and CEO and Andrew Reid, our current CEO pursuant to their employment agreement with the Company, and with Newton Collaboration, LLC, which provides accounting and corporate governance services to us.
NOTE 7 – SHAREHOLDERS’ EQUITY
We are authorized to issue 500 million shares of our common stock. At December 31, 2009, we had 496,605,424 shares issued and outstanding. During the nine months ended September 30, 2010, we issued no additional shares nor made any changes in our common stock.
Authorization of Preferred Stock
On February 16, 2010, we applied to and were granted a Certificate of Amendment to our Articles of Incorporation as follows:
The authorized capital stock of the Corporation shall include 50,000,000 shares of Class A Convertible Preferred Stock, par value $0.001 per share, whose terms and conditions may be expressly determined by resolution of the Corporation’s Board of Directors. These shares of preferred stock may be issuable in various series and may or may not be convertible to common stock, in accordance with the terms of the specific issued series. The Board of Directors shall have the authority to fix by resolution all other rights.
Shareholder Contribution of Capital
During the nine months ended September 30, 2010, an affiliate paid company expenses of $1,155 which was recorded as Additional Paid-In Capital.
Imputed Interest
Pursuant to our notes payable to our former corporate secretary and the former operator of the Crockett County leases, the aggregate principal amount of which is $156,545, and which forms a portion of the lawsuit discussed in Note 5 to our annual report filed on Form 10-K as of December 31, 2009, we accrue simple interest at 3% per year. This resulted in an interest charge collectively of $3,510 for nine months ended September 30, 2010.
Management believes that the stated interest on these notes is not equivalent to the Company’s realistic cost of capital. We therefore imputed an additional 5% interest and charged interest expense with an additional $5,859 for the nine months ended September 30, 2010.
Stock –Based Compensation
During 2009, the Company awarded certain officers and directors shares which were to be earned ratably over their respective contracts. During the nine months ended September 30, 2010, $41,742 of this amount was earned and accrued to compensation expense and included in General and Administrative Expenses. The unearned portion of these amounts at September 30, 2010 is $1,086 and will be earned in future periods.
Stock Payable Relating to our GeologicalWork in Belize
On July 28, 2010, we signed an agreement with a contractor to provide satellite data on Belize prospects, proprietary 3-S seismic and certain other geological data to determine the location of our first well in Belize. As part of the compensation package, we agreed to pay 15 million shares if our authorized capital would permit. We valued the promise to pay these 15 million shares at the closing price on the measurement date and charged Lease Operating Expenses with $204,000.
A major shareholder agreed to pay any amounts of shares that Treaty is unable to due to lack of authorized capital.
NOTE 8 – RELATED PARTY TRANSACTIONS
On July 1, 2009, we entered into a contract with Newton Collaboration, LLC, to provide accounting, corporate governance and statutory filing services to the Company. During the nine months ended September 30, 2010, we accrued $45,000 of costs relating to that contract. As of September 30, 2010, we have paid Newton Collaboration, LLC $12,500 towards the balance. Newton Collaboration, LLC is owned by our director, Randall Newton.
Additionally, Mr. Newton is owed $126,955 in unpaid services pursuant to our consulting agreement with him as of September 30, 2010.
Mr. Newton made short-term loans to the Company in the amount of $14,569 which are unpaid as of September 30, 2010.
NOTE 9 – SUBSEQUENT EVENTS
In October, 2010, we completed a private placement memorandum to offer up to $12 million of 12% Series A Senior Secured Convertible Bonds due December 1, 2017 (the “Convertible Bonds”). The Convertible Bonds are offered in denominations of $100,000 each, with a minimum purchase of 1 Convertible Bond. The Convertible Bonds are being issued at a discount of $7,500 to the face amount of $100,000. This discount, together with the 12% interest rate, produces an effective yield of 14%. The Convertible Bonds will pay interest semi-annually in arrears and will be secured by first mortgages or first deeds of trust on the properties acquired by the Company with the net proceeds of the Offering. The Convertible Bonds will be convertible, at the Holder’s option, beginning December 1, 2013.
As of the date of this report, we have not yet sold any of the Convertible Bonds.
We have evaluated subsequent events through the date of issuance of the financial statements.
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion in conjunction with management’s discussion and analysis contained in our 2009 Annual Report on Form 10-K, as well as the financial statements and notes hereto included in this quarterly report on Form 10-Q. The following discussion contains forward-looking statements that involve risks, uncertainties, and assumptions, such as statements of our plans, objectives, expectations, and intentions. Our actual results may differ materially from those discussed in these forward-looking statements because of the risks and uncertainties inherent in future events.
Results of Operations
Nine Months Ended September 30, 2010, compared with Nine Months Ended September 30, 2009
We had minor revenues in both years. In 2009, we lost the Crockett County leases and show a residual $423 in revenues. In 2010, we show revenues of $1,570 from one of our Tennessee wells
Transportation expense and production taxes are zero for the nine months ended September 30, 2010, compared to $455 for the same period in 2009. This is due to the fact that we have only begun to produce oil from our Tennessee properties as of the end of September, 2010, and we had small production from the Crockett County leases during the same period in 2009.
Our lease operating expenses for the nine months ended September 30, 2010 of $343,031 include the costs of working over the Robin Moody #1 and Joseph Schwallie #1 wells. Also included is $308,500 relating to our gathering of seismic date in Belize. The $27,813 expense for the same period in 2009 included costs of operating the Crockett County leases.
General and administrative expenses have increased dramatically. They increased from $277,823 for the nine months ended September 30, 2009 to $381,258 for same period in 2009. Most of this increase is a result of hiring executive officers and from the hiring of a consultant, and from costs associated with statutory compliance and reporting.
Our depreciation, depletion and amortization expenses for the nine months ended September 30, 2010 were $29 as compared to $1,520 for the same period in 2009 since the costs related to the Crockett County, Texas leases have been lost and therefore, no costs are recorded to depreciate on that property. Moreover, we have only begun to produce from our Tennessee wells and have recorded only a small amount of depreciation on that property.
Interest expense is significantly lower for the nine months ended September 30, 2010 than the same period in 2009 - $10,037 versus $20,324, respectively. This is principally due to the suspension of the amortization of discount related to our note payable in connection with the Crockett County, Texas leases. This debt is the subject of two lawsuits filed in Shelby County, Texas on which the Company was not named as a defendant (see Note 6).
Three Months Ended September 30, 2010, compared with Three Months Ended September 30, 2009
We had a small amount of production and sales during the three months ended September 30, 2010, compared with none during the same period in 2009.
Transportation expense and production taxes were zero for the three months ended September 30, 2010, and for the same period in 2009.
Our lease operating expenses for the three months ended September 30, 2010 of $330,806 include the costs of gathering seismic date in Belize and of working over the Robin Moody #1 and Joseph Schwallie #1 wells. We had no such activity during the same period in 2009.
General and administrative expenses have been reduced from $175,042 for the three months ended September 30, 2009 to $149,982 for the same period in 2010 owing mostly to reduced officer and director salaries.
Our depreciation, depletion and amortization expenses for the three months ended September 30, 2010 and 2009 were $29 and zero, respectively. In 2009 we had already lost the Crockett County leases and in 2010 we have only begun to produce from our Tennessee wells.
Interest expense is higher for the three months ended September 30, 2010 - $3,624 than the same period in 2009 - $3,123. This is due to the inclusion of the interest-bearing note on our Tennessee property.
Liquidity and Capital Resources
Our financial statements have been prepared on a going concern basis that contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business.
Currently, we are not able to maintain our existing operations through the existing cash balances and internally generated cash flows from sales of oil production. Additionally, we have lost the only oil and gas lease providing the Company cash flows from operations and have only recently acquired new properties to replace them. It is not certain that the properties in Tennessee will produce cash flows to cover some or all of our operating costs. Moreover, we have determined that our existing capital structure is not adequate to fund our planned growth.
We intend to finance our drilling, work over and acquisition program by bank debt, by joint venturing with other strategic partners, and by internally generated cash flows. There can be no assurance that we will be successful in procuring the financing or partnering we are seeking. Future cash flows are subject to a number of variables, including the level of production, natural gas prices and successful drilling efforts. There can be no assurance that operations and other capital resources will provide cash in sufficient amounts to maintain planned or future levels of capital expenditures.
Plan of Operation
Over the next twelve months we intend to develop the following initiatives:
Revenue Generation
Kansas - We expect that the Kansas oil and gas leases, if acquired and financing is obtained, will initially produce between 135 and 150 barrels per day which will immediately add positive cash flows from operations to our negative cash flows currently existing due to our corporate costs. We expect that our aggressive drilling program will provide additional cash flows in the future.
There is no guarantee that we can raise the funds to accomplish our production goals or consummate our intended acquisitions, or that the expenditures on our existing leases will produce the increases in production we anticipate.
Tennessee – In July, 2010, we completed the Robin Moody well #1 and Joseph Schwallie #1 wells. After initial flow rates that exceeded expectations, the Robin Moody #1 well declined to 1 barrel per day. We are currently evaluating whether to acidize the well to improve production. The Joseph Schwallie #1 well was acidized and is currently producing gas. We expect that the existence of the gas production is an indication that oil will be produced in the near future.
Belize - We intend to finance the drilling of one to three wells by selling additional interests in our Joint Venture with Princess Petroleum Limited and through the sale of debt. We are currently undertaking geological and geophysical studies in Belize to determine the location of our first well.
Drilling and Work-Over Programs
Kansas - We have identified approximately 600 locations in eastern Kansas on the oil and gas leases that we have under contract. If we close the acquisition and obtain the bank financing, we will plan on drilling approximately 400 of these wells in five years.
Several existing leases can be enhanced through water-flooding which will increase pressure and incremental production from existing wells.
We currently do not have adequate cash to undertake these plans. Unless we close our acquisition in Kansas and obtain the required bank financing, we will be unable to execute them.
Financing
We hope to finance our work over, drilling and acquisition programs by a combination of bank financing, owner financing and cash flows from operations.
As is discussed in Note 9, we completed a Private Placement Memorandum to raise a maximum of $12 million. We hope to use the proceeds of this offering to acquire the properties in Kansas, and Tennessee, and to drill our wells in Belize once the geological work is completed.
There is no guarantee that we can raise the required capital to make acquisitions, drill new wells, or repair equipment on any acquired properties, or that undertaking such repairs, acquisitions and drilling program will make us profitable or self-sustaining.
ITEM 3 - QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A smaller reporting company is not required to provide the information required by this item.
ITEM 4 – CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based upon that evaluation, our Chief Executive Officer and principal financial officer concluded that, as of the end of the period covered in this report, our disclosure controls and procedures were not effective to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officer, as appropriate to allow timely decisions regarding required disclosure.
Our management, including our principal executive officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error or fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. To address the material weaknesses, we performed additional analysis and other post-closing procedures in an effort to ensure our consolidated financial statements included in this annual report have been prepared in accordance with generally accepted accounting principles. Accordingly, management believes that the financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented.
Change In Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the nine months ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS
On January 29, 2010, a lawsuit (Highground et al. versus Ronald L. Blackburn et al.)was filed in the 22nd Judicial District Court, Parish of St. Tammany, Louisiana naming Treaty Energy Corporation, among others, as a defendant.
The lawsuit alleges certain wrongdoings by the defendants (other than Treaty) which have no bearing on our operations since inception. The lawsuit also alleges certain monies owed to some of the plaintiffs by the Company.
On March 11, 2010, we filed a Notice of Removal of the state action to the United States District Court, Eastern District of Louisiana, based upon the diversity of all the parties. The case has been moved to the United States District Court.
On April 11, 2010, the defendants filed a countersuit against the plaintiffs seeking damages against Highground, et al based on misrepresentation of the Crockett County, Texas leases.
We may be involved from time to time in ordinary litigation, negotiation and settlement matters that will not have a material effect on our operations or finances. We are not aware of any pending or threatened litigation against us or our officers and directors in their capacity as such that could have a material impact on our operations or finances, except as disclosed in this report.
ITEM 1A – RISK FACTORS
Our business has many risks. Factors that could materially adversely affect our business, financial condition, operating results or liquidity and the trading price of our common stock are described under “Risk Factors in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009, filed April 15, 2010.
This information should be considered carefully, together with other information in this report and other reports and materials we file with the Securities and Exchange Commission.
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES
We issued no common shares during the nine months ended September 30, 2010
Options and Warrants
During the nine months ended September 30, 2010, no options or warrants have been granted, expired or exercised.
Our options and warrants outstanding at September 30, 2010 are as follows:
|
Expiry Date
|
|
Average Strike Price
|
|
|
No. of
Options
or
Warrants
|
|
|
06/22/12
|
|
|
0.08 |
|
|
|
124,492 |
|
|
06/22/13
|
|
|
0.08 |
|
|
|
138,435 |
|
|
06/22/14
|
|
|
0.08 |
|
|
|
124,492 |
|
|
06/22/15
|
|
|
0.08 |
|
|
|
2,300,000 |
|
|
Total
|
|
|
|
|
|
|
2,687,419 |
|
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 – (REMOVED AND RESERVED)
ITEM 5 – OTHER INFORMATION
None.
ITEM 6 – EXHIBITS
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Exhibit No.
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Description of Exhibit
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3.1
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Articles of Incorporation, as filed August 1, 1997 (included as Exhibit 3.1 to the Form 10-SB12G filed November 10, 1999, and incorporated herein by reference).
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3.2
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Bylaws (included as Exhibit 3.2 to the Form 10-SB12G filed November 10, 1999, and incorporated herein by reference).
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3.3
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Articles of Amendment to the Articles of Incorporation, as filed August 23, 1997 (included as Exhibit 3.3 to the Form 10-SB12G filed November 10, 1999, and incorporated herein by reference).
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| |
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3.4
|
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Articles of Amendment to the Articles of Incorporation, as filed November 20, 1998 (included as Exhibit 3.4 to the Form 10-SB12G filed November 10, 1999, and incorporated herein by reference).
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| |
|
|
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3.5
|
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Articles of Amendment to the Articles of Incorporation, as filed May 16, 2003 (included as Exhibit 3.5 to the Form 10-SB12G filed November 10, 1999, and incorporated herein by reference).
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| |
|
|
|
4.1
|
|
2003 Stock Benefit Plan, dated July, 1, 2003 (included as Exhibit 4.1 to the Form S-8 filed July 23, 2003, and incorporated herein by reference).
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| |
|
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4.2
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Form of Class A Warrant (included as Exhibit 4 to the Form 8-K filed March 15, 2005, and incorporated herein by reference).
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| |
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4.3
|
|
Form of Class B Warrant (included as Exhibit 4 to the Form 8-K filed March 15, 2005, and incorporated herein by reference).
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| |
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|
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4.4
|
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Form of Class C Warrant (included as Exhibit 4 to the Form 8-K filed March 15, 2005, and incorporated herein by reference).
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|
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4.5
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Subscription Agreement between the Company and various subscribers (included as Exhibit 10.1 to the Form SB-2/A filed September 14, 2005, and incorporated herein by reference).
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4.6
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Subscription Agreement between the Company and various subscribers (included as Exhibit 4 to the Form 8-K filed March 15, 2005, and incorporated herein by reference).
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14.1
|
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Corporate Code of Ethics (included as Exhibit 14 to From 10-KSB filed March 16, 2004, and incorporated herein by reference).
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2.1
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Subsidiaries of the registrant (filed herewith).
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Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
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Certification of Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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Treaty Energy Corporation |
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Date: November 15, 2010
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By:
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/s/ Andrew V. Reid |
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Andrew V. Reid |
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Chief Executive Officer |
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