1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended June 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANCE ACT OF 1934
FOR THE TRANSITION PERIOD From __________ to __________.
Commission File Number 000-32439
ARENA RESOURCES, INC.
---------------------
(Exact name of registrant as specified in its charter)
Nevada 73-1596109
------ ----------
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
4920 South Lewis Street, Suite 107
Tulsa, Oklahoma 74105
---------------------
(Address of principal executive officers)
(918) 747-6060
--------------
(Issuer's telephone number)
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date:
As of July 29, 2003, the Company had outstanding 7,100,697 shares of common
stock ($0.001 par value).
1
INDEX
Arena Resources, Inc.
For the Quarter Ended June 30, 2003
Part I. Financial Information
Page
Item 1. Financial Statements (Unaudited) 3
Condensed Balance Sheets as of June 30, 2003 and
December 31, 2002 (Unaudited) 4
Condensed Statements of Operations for the Three and
Six Months Ended June 30, 2003 and 2002 (Unaudited) 5
Condensed Statements of Cash Flows for the Six Months
Ended June 30, 2003 and 2002 (Unaudited) 6
Notes to Condensed Financial Statements (Unaudited) 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Item 3. Controls and Procedures 16
Part II. Other Information
Item 1. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
2
Part I - Financial Information
Item I. Financial Statements:
The condensed financial statements included herein have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant to such rules
and regulations, although the Company believes that the disclosures are adequate
to make the information presented not misleading.
In the opinion of the Company, all adjustments, consisting of only normal
recurring adjustments, necessary to present fairly the financial position of the
Company and the results of its operations and its cash flows have been made. The
results of its operations and its cash flows for the three months ended June 30,
2003 are not necessarily indicative of the results to be expected for the year
ending December 31, 2003.
3
ARENA RESOURCES, INC.
CONDENSED BALANCE SHEETS
(UNAUDITED)
June 30, December 31,
2003 2002
------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash $1,453,905 $ 796,915
Account receivable 345,021 269,436
Subscription receivable - 157,500
Prepaid expenses 58,408 1,128
------------------------------------------------------------------------------------------
Total Current Assets 1,857,334 1,224,979
------------------------------------------------------------------------------------------
Property and Equipment, Using Full Cost Accounting
Oil and gas properties subject to amortization 6,572,301 4,884,804
Equipment 48,480 21,794
Office equipment 15,315 14,672
------------------------------------------------------------------------------------------
Total Property and Equipment 6,636,096 4,921,270
Less: Accumulated depreciation and amortization (296,303) (172,258)
------------------------------------------------------------------------------------------
Net Property and Equipment 6,339,793 4,749,012
------------------------------------------------------------------------------------------
Long-Term Deposits 76,502 76,502
------------------------------------------------------------------------------------------
Total Assets $8,273,629 $6,050,493
==========================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 180,402 $ 173,174
Accrued liabilities 7,127 -
Accrued preferred dividends - 114,685
------------------------------------------------------------------------------------------
Total Current Liabilities 187,529 287,859
------------------------------------------------------------------------------------------
Long-Term Liabilities
Put option 14,214 50,604
Notes payable to officers 400,000 400,000
Asset retirement obligation 476,651 -
Deferred income taxes 415,235 187,193
------------------------------------------------------------------------------------------
Total Long-Term Liabilities 1,306,100 637,797
------------------------------------------------------------------------------------------
Stockholders' Equity
Preferred stock - $0.001 par value; 10,000,000 shares
authorized; no shares issued or outstanding - -
Common stock - par value $0.001 per share; 100,000,000
shares authorized; 6,843,697 shares and 6,282,056 shares
outstanding, respectivel 6,844 6,282
Additional paid-in capital 6,283,084 5,287,189
Options and warrants outstanding 654,788 382,040
Accumulated deficit (164,716) (550,674)
------------------------------------------------------------------------------------------
Total Stockholders' Equity 6,780,000 5,124,837
------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $8,273,629 $6,050,493
==========================================================================================
See accompanying notes to unaudited condensed financial statements.
4
ARENA RESOURCES, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
------------------------- ---------------------------
2003 2002 2003 2002
------------------------------------------------------------------------------------------------------------
Oil and Gas Revenues $841,619 $ 167,682 $1,648,640 $ 311,013
------------------------------------------------------------------------------------------------------------
Costs and Operating Expenses
Oil and gas production costs 281,546 49,516 523,618 96,072
Oil and gas production taxes 57,374 8,247 111,324 15,475
Depreciation, depletion and amortization 69,615 18,644 120,706 41,292
General and administrative expense 120,451 55,485 264,082 102,306
------------------------------------------------------------------------------------------------------------
Total Costs and Operating Expenses 528,986 131,892 1,019,730 255,145
------------------------------------------------------------------------------------------------------------
Other Income (Expense)
Gain from change in fair value of put options 31,615 - 36,390 -
Accretion expense (7,843) - (12,624) -
Interest expense (9,973) - (19,836) -
------------------------------------------------------------------------------------------------------------
Net Other Income 13,799 - 3,930 -
------------------------------------------------------------------------------------------------------------
Income Before Provision for Income Taxes and
Cumulative Effect of Change in Accounting
Principle 326,432 35,790 632,840 55,868
Provision for Deferred Income Taxes 120,780 - 235,069 -
------------------------------------------------------------------------------------------------------------
Income Before Cumulative Effect of Change
in Accounting Principle 205,652 35,790 397,771 55,868
Cumulative Effect of Change in Accounting
PrincipL3 - - 11,813 -
------------------------------------------------------------------------------------------------------------
Net Income 205,652 35,790 385,958 55,868
Preferred Stock Dividends - 171,451 - 211,157
------------------------------------------------------------------------------------------------------------
Income (Loss) Attributable to Common Shares $205,652 $ (135,661) $ 385,958 $(155,289)
------------------------------------------------------------------------------------------------------------
Basic Income (Loss) Per Common Share
Before cumulative effect of change in
accounting principle $ 0.03 $ (0.04) $ 0.06 $ (0.04)
Cumulative effect of change in accounting
principle - - - -
------------------------------------------------------------------------------------------------------------
Net Income (Loss) Attributable to Common Share $ 0.03 $ (0.04) $ 0.06 $ (0.04)
============================================================================================================
Diluted Income (Loss) Per Common Share
Before cumulative effect of change in
accounting principle $ 0.03 $ (0.04) $ 0.06 $ (0.04)
Cumulative effect of change in accounting
principle - - - -
------------------------------------------------------------------------------------------------------------
Net Income (Loss) Attributable to Common Share $ 0.03 $ (0.04) $ 0.06 $ (0.04)
============================================================================================================
See accompanying notes to unaudited condensed financial statements.
5
ARENA RESOURCES, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended June 30 2003 2002
--------------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 385,958 $ 55,868
Adjustments to reconcile net income to net cash
provided by operating activities:
Shares issued for services 75,040 -
Depreciation and depletion 120,705 41,292
Gain from change in fair value of put option (36,390) -
Cumulative effect of change in accounting principle 11,813 -
Accretion of discounted liabilities 12,625 -
Changes in assets and liabilities:
Accounts receivable (75,585) (32,969)
Prepaid expenses (57,280) (222)
Accounts payable and accrued liabilities 14,355 73,878
Deferred income tax payable 235,069 -
--------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 686,310 137,847
--------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchase of oil and gas properties (1,186,971) (995,214)
Purchase of office equipment (643) (2,208)
Purchase of held to maturity investment - (25,000)
Purchase of property, plant & equipment (26,686) -
--------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (1,214,300) (1,022,422)
--------------------------------------------------------------------------------------
Cash Flows From Financing Activities
Proceeds from issuance of common stock and warrants, net 1,135,165 -
Proceeds from warrant exercise 7,000 -
Collection of common stock subscription receivable 157,500 -
Proceeds from issuance of preferred stock, net of offeri - 1,135,488
Payment on note payable - (18,000)
Payment of dividends to preferred stockholders (114,685) (75,850)
--------------------------------------------------------------------------------------
Net Cash Provided by Financing Activities 1,184,980 1,041,638
--------------------------------------------------------------------------------------
Net Increase in Cash 656,990 157,063
Cash at Beginning of Period 796,915 444,564
--------------------------------------------------------------------------------------
Cash at End of Period $1,453,905 $ 601,627
======================================================================================
Supplemental Cash Flows Information
Cash paid for interest $ 19,836 $ -
======================================================================================
Non-Cash Investing and Financing Activities
Common stock issued for properties $ 52,000 $ 255,000
Asset retirement obligation incurred in property acquisi 227,308 -
Accrual of preferred stock dividends - 57,049
Beneficial conversion feature on convertible preferred s - 114,402
Value of warrants included as offering costs - 254,889
Preferred stock issued for receivable from stockholders - 448,385
======================================================================================
See accompanying notes to unaudited condensed financial statements.
6
ARENA RESOURCES, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
JUNE 30, 2003
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Condensed Financial Statements - The accompanying condensed financial statements
have been prepared by the Company and are unaudited. In the opinion of
management, the accompanying unaudited financial statements contain all
adjustments necessary for fair presentation, consisting of normal recurring
adjustments, except as disclosed herein.
The accompanying unaudited interim financial statements have been condensed
pursuant to the rules and regulations of the Securities and Exchange Commission;
therefore, certain information and disclosures generally included in financial
statements have been condensed or omitted. The condensed financial statements
should be read in conjunction with the Company's annual financial statements
included in its annual report on Form 10-KSB as of December 31, 2002. The
financial position and results of operations for the six months ended June 30,
2003 are not necessarily indicative of the results to be expected for the full
year ending December 31, 2003.
Nature of Operations - The Company owns interests in oil and gas properties
located in Oklahoma, Texas, Kansas and New Mexico. The Company is engaged
primarily in the acquisition, exploration and development of oil and gas
properties and the production and sale of oil and gas.
Use of Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Long-Term Deposits - The Company has complied with a requirement to maintain a
$51,502 certificate of deposit at a federally insured institution in order to do
business in the state of Texas. The certificate matured in July 2003 and was
replaced with a $50,000 letter of credit. The Company has also complied with a
requirement to maintain a $25,000 certificate of deposit at a federally insured
institution in order to do business in the state of Oklahoma. The maturity date
of the investment is August 2004. The Company has also complied with a
requirement to have a letter of credit issued in the amount of $95,000 in order
to do business in the state of New Mexico.
Oil and Gas Properties - The Company uses the full cost method of accounting for
oil and gas properties. Under this method, all costs associated with
acquisition, exploration, and development of oil and gas reserves are
capitalized. Costs capitalized include acquisition costs, geological and
geophysical expenditures, lease rentals on undeveloped properties and costs of
drilling and equipping productive and non-productive wells. Drilling costs
include directly related overhead costs. Capitalized costs are categorized
either as being subject to amortization or not subject to amortization.
All capitalized costs of oil and gas properties, including the estimated future
costs to develop proved reserves and estimated future costs of site restoration,
are amortized on the unit-of-production method using estimates of proved
reserves as determined by independent engineers. Investments in unproved
properties and major development projects are not amortized until proved
reserves associated with the projects can be determined. The Company evaluates
oil and gas properties for impairment at least quarterly. If the results of an
assessment indicate that the properties are impaired, the amount of the
impairment is added to the capitalized costs to be amortized. Amortization
expense for the six months ended June 30, 2003 was $115,939 based on depletion
at the rate of $2.06 per barrel of oil equivalent compared to $40,616 based on
depletion at the rate of $2.69 per barrel of oil equivalent for the six months
ended June 30, 2002.
7
ARENA RESOURCES, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
JUNE 30, 2003
In addition, capitalized costs are subject to a ceiling test which limits such
costs to the estimated present value of future net revenues from proved
reserves, discounted at a 10-percent interest rate, based on current economic
and operating conditions, plus the lower of cost or fair market value of
unproved properties. Consideration received from sales or transfers of oil and
gas property is accounted for as a reduction of capitalized costs. Revenue is
not recognized in connection with contractual services performed in connection
with properties in which the Company holds an ownership interest.
Income (Loss) Per Common Share - Basic income (loss) per common share is
computed by dividing net income (loss) available to common stockholders by the
weighted-average number of common shares outstanding during the period. Diluted
income (loss) per share reflects the potential dilution that could occur if all
contracts to issue common stock were converted into common stock.
Concentration of Credit Risk and Major Customer - The Company currently has cash
in excess of federally insured limits at June 30, 2003. During the six months
ended June 30, 2003, sales to three customers represented 56%, 19% and 7% of
total sales, respectively. At June 30, 2003, these three customers made up 45%,
17% and 22% of accounts receivable, respectively.
Stock-Based Employee Compensation - On April 1, 2003, the Company issued stock
options to directors and employees, which are described more fully in Note 7.
The Company applies the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB
25) and related interpretations in accounting for its stock-based compensation
awards. Under APB 25, no stock-based compensation expense was charged to
earnings, as all options granted had an exercise price equal to or greater than
the adjusted fair value of the underlying common stock on the grant date.
Alternately, Statement on Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS No. 123), allows companies to recognize
compensation expense over the related service period based on the grant date
fair value of the stock option awards. The following table illustrates the
effect on net income and basic and diluted income (loss) per common share if the
Company had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
---------------------- ----------------------
2003 2002 2003 2002
------------------------------------------------------------------------------------------
Net income, as reported $205,652 $ 35,790 $385,958 $55,868
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method for all
awards, net of related tax effects (131,564) - (131,564) -
------------------------------------------------------------------------------------------
Pro Forma Net Income $ 74,088 $ 35,790 $254,394 $55,868
==========================================================================================
Income (Loss) per Common Share
Basic, as reported $ 0.03 $ (0.04) $ 0.06 $ (0.04)
Basic, pro forma $ 0.01 $ (0.04) $ 0.04 $ (0.04)
Diluted, as reported $ 0.03 $ (0.04) $ 0.06 $ (0.04)
Diluted, pro forma $ 0.01 $ (0.04) $ 0.04 $ (0.04)
==========================================================================================
Under SFAS 123, the pro forma estimated compensation expense, after tax, for the
years ending December 31, 2003, 2004 and 2005 will be approximately $395,000,
$353,000 and $209,000, respectively.
8
ARENA RESOURCES, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
JUNE 30, 2003
Cumulative Effect of Change in Accounting Principle - The Company adopted SFAS
No. 143, Accounting for Asset Retirement Obligations, effectively on January 1,
2003. In accordance with the transition provisions of SFAS No. 143, the Company
recorded asset retirement liabilities and a cumulative-effect adjustment of
$11,813 as a reduction in earnings, which had no effect on basic and diluted
income per common share.
NOTE 2 - EARNINGS PER SHARE INFORMATION
For the Three Months For the Six Months
Ended June 30, Ended June 30,
--------------------------- ---------------------------
2003 2002 2003 2002
-----------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of change in accounting
principle $ 205,652 $ 35,790 $ 397,771 $ 55,868
Less: Preferred stock dividends - (171,451) - (211,157)
-----------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of change in accounting
principle 205,652 (135,661) 397,771 (155,289)
Cumulative effect of change in accounting principle - - (11,813) -
-----------------------------------------------------------------------------------------------------------------------
Income (Loss) Attributable to Common Shares $ 205,652 $(135,661) $ 385,958 $(155,289)
=======================================================================================================================
Basic weighted-average common shares outstanding 6,477,230 3,653,896 6,402,833 3,629,334
Effect of dilutive securities
Warrants 187,154 - 146,015 -
Stock options 306,298 - 153,995 -
-----------------------------------------------------------------------------------------------------------------------
Diluted Weighted-Average Common Shares Outstanding 6,970,682 3,653,896 6,702,843 3,629,334
=======================================================================================================================
Basic Income (Loss) Per Common Share
Before cumulative effect of change in accounting principle $ 0.03 $ (0.04) $ 0.06 $ (0.04)
Cumulative effect of change in accounting principle - - - -
-----------------------------------------------------------------------------------------------------------------------
Net Income (Loss) Attributable to Common Shares $ 0.03 $ (0.04) $ 0.06 $ (0.04)
=======================================================================================================================
Diluted Income (Loss) Per Common Share
Before cumulative effect of change in accounting principle $ 0.03 $ (0.04) $ 0.06 $ (0.04)
Cumulative effect of change in accounting principle - - - -
-----------------------------------------------------------------------------------------------------------------------
Net Income (Loss) Attributable to Common Shares $ 0.03 $ (0.04) $ 0.06 $ (0.04)
=======================================================================================================================
At June 30, 2003, warrants to purchase 437,464 shares of common stock at $5.00
per share were outstanding, but were not included in the computation of diluted
income per common share because the exercise prices of these warrants were
greater than the average market price of the common stock during the period.
NOTE 3 - ACQUISITION OF OIL AND GAS PROPERTIES
Seven Rivers Queen Unit acquisition - On April 4, 2003, the Company entered into
an agreement to purchase a 70.60% working interest, 56.48% net revenue interest,
in the Seven Rivers Queen Unit mineral lease located in Lea County, New Mexico.
Total consideration provided by the Company was a cash payment of $900,000. The
Company also issued 10,000 shares of the Company's restricted common stock
valued at $5.20 per share, or $52,000, as a finder's fee relating to this
acquisition
NOTE 4 - NOTES PAYABLE
On February 3, 2003, the Company established a $10,000,000 revolving credit
facility with a bank with an initial borrowing base of $2,000,000. The interest
rate is a floating rate equal to the JP Morgan Chase prime rate plus 1% with
interest payable monthly. Annual fees for the facility are 1/2 of one percent of
the unused portion of the borrowing base. Amounts borrowed under the revolving
9
ARENA RESOURCES, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
JUNE 30, 2003
credit facility will be due in February 2005. The revolving credit facility is
secured by the Company's principal mineral interests. In order to obtain the
revolving credit facility, loans from two officers were subordinated to the
position of the bank and the credit facility was guaranteed by two of the
Company's officers. The Company is required under the terms of the credit
facility to maintain a tangible net worth of $4,000,000, maintain a 5-to-1 ratio
of income before interest, taxes, depreciation, depletion and amortization to
interest expense and maintain a current asset to current liability ratio of
1-to- 1. As of June 30, 2003, no amounts are owed under this credit facility.
NOTE 5 - ASSET RETIREMENT OBLIGATION
Effective January 1, 2003, the Company adopted SFAS No. 143, Accounting for
Asset Retirement Obligations, which requires entities to record the fair value
of a liability for an asset retirement obligation when it is incurred which, for
the Company, is typically when an oil or gas well is drilled or purchased. The
standard applies to legal obligations associated with the retirement of long-
lived assets that result from the acquisition, construction, development or
normal use of the asset. The Company's asset retirement obligations relate
primarily to the obligation to plug and abandon oil and gas wells and support
wells at the conclusion of their useful lives.
SFAS No. 143 requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred, if a reasonable
estimate of fair value can be made. When the liability is initially recorded,
the related cost is capitalized by increasing the carrying amount of the related
oil and gas property. Over time, the liability is accreted upward for the
change in its present value each period until the obligation is settled and the
initial capitalized cost is amortized by the unit-of-production method as
described in Note 1.
At January 1, 2003, the implementation of SFAS No. 143 resulted in a net
increase in property and equipment of $217,878. Liabilities increased by
$236,718, which represents the establishment of an asset retirement obligation
liability. The cumulative effect on prior years of the change in accounting
principle of $11,813, net of $7,027 of related tax effects, was recorded in the
first quarter of 2003 as a reduction in earnings. The effect of adopting this
accounting principle was an $11,386 decrease in net income during the six months
ended June 30, 2003.
The following presents pro forma net income and basic and diluted income (loss)
per common share as if SFAS No. 143 had been applied retroactively for all
periods presented:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
-------------------- -------------------
2003 2002 2003 2002
-----------------------------------------------------------------------------
Net Income $205,652 $ 35,560 $385,958 $52,051
Income (Loss) Per Common Share
Basic $ 0.03 $ (0.04) $ 0.06 $ (0.04)
Diluted $ 0.03 $ (0.04) $ 0.06 $ (0.04)
=============================================================================
The pro forma amount of the liability for the asset retirement obligation was
$80,140 at December 31, 2001, $83,395 at March 31, 2002 and $85,047 at June 30,
2002. The asset retirement obligation is adjusted each quarter for any
liabilities incurred or settled during the period, accretion expense and any
revisions made to the estimated cash flows. The reconciliation of the asset
retirement obligation for the six months ended June 30, 2003 is as follows:
10
ARENA RESOURCES, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
JUNE 30, 2003
Balance, January 1, 2003 $236,718
Liabililities incurred 227,309
Accretion expense 12,624
-------------------------------------------------------
Balance, June 30, 2003 $476,651
=======================================================
NOTE 6 - STOCKHOLDERS' EQUITY
The Company is authorized to issue 100,000,000 common shares, with a par value
of $0.001 per share, and 10,000,000 Class "A" convertible preferred shares, with
a par value of $0.001 per share.
Private Placement Offering of Common Stock and Warrants - On August 22, 2002,
the Company initiated a $3,000,000 private placement offering of the Company's
common stock at $2.50 per share with a detachable warrant exercisable at $5.00
per share through September 30, 2005. During the six months ended June 30, 2003,
the Company issued 534,294 shares of common stock and 534,294 warrants for
$1,135,165 in net cash proceeds (net of cash offering costs of $200,570). In
addition, 79,596 warrants exercisable at $5.00 per share through September 30,
2005 were issued as consulting fees and for services to placement agents. The
net proceeds received were allocated to the common stock and the warrants based
upon their relative fair values, with $874,019 allocated to the common stock and
$261,146 allocated to the warrants. The fair value of the warrants issued was
$797,373, or $1.30 per warrant, which was determined using the Black-Scholes
option pricing model with the following weighted-average assumptions: risk-free
interest rate of 1.32%, expected dividend yield of 0%, volatility of 34.7% and
an expected life of 2.25 years.
In addition, during the six months ended June 30, 2003, Arena issued 52,433
additional warrants, with the same terms, as consulting fees and for services
relating to the shares of common stock and warrants issued during 2002. During
the six months ended June 30, 2003, $15,922 of the proceeds from the 2002 cash
offering proceeds were allocated to the additional warrants, based upon their
relative fair value. Through June 30, 2003, the Company had issued 820,294
units of common stock and warrants to investors under the offering for
$1,793,065 in net cash proceeds (net of cash offering costs of $257,670) and had
issued 132,029 warrants as consulting fees and for services to placement agents.
Stock issued for services - During the six months ended June 30, 2003, the
company issued shares of restricted common stock for services. A total of
13,847 shares were issued for services with 1,120 shares, valued at $4.50 per
share or $5,040, for consulting services and 12,727 shares, valued at $5.50 per
share or $70,000, were issued for research work. Both contracts have a 1 year
term.
NOTE 7 - EMPLOYEE STOCK OPTIONS
On April 1, 2003, the Company granted options to directors and employees to
purchase 1,000,000 shares of common stock at $3.70 per share through April 1,
2008. The options vest at the rate of 20% each year over five years. The
exercise price is 85% of the market value of the Company's common stock on the
date issued. In accordance with FASB Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation, the 15% discount from the
market price of the Company's common stock used in determining the fair value of
the common stock is considered reasonable and the options are not compensatory.
Accordingly, the Company did not recognize any compensation expense from the
grant of these stock options.
11
ARENA RESOURCES, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
JUNE 30, 2003
The fair value of the options granted was $1,837,935, or $1.84 per share, and
was estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions: dividend yield of 0% percent,
expected volatility of 36.3%, risk-free interest rate of 2.8% and expected lives
of 5.0 years.
NOTE 8 - CONTINGENCIES AND COMMITMENTS
Standby Letters of Credit - A commercial bank has issued standby letters of
credit on behalf of the Company to the states of Texas, Oklahoma and New Mexico
totaling $170,000 to allow the Company to do business in those states. The
standby letters of credit are valid through August 2004 and are collateralized
by an assignment of certificates of deposit totaling $76,502. The Company
intends to renew the standby letters of credit for as long as the Company does
business in those states. No amounts have been drawn under the standby letters
of credit.
NOTE 9 - SUBSEQUENT EVENT
On July 15, 2003 the Company closed its $3,000,000 private placement offering of
the Company's common stock at $2.50 per share with a detachable warrant
exercisable at $5.00 per share through September 30, 2005. During July 2003,
the Company issued 256,000 shares of common stock and 256,000 warrants. In
addition, warrants to purchase 25,600 shares of commons stock at $5.00 per share
were issued as consulting fees and for services to placement agents. The gross
proceeds received were $640,000 before $119,730 of cash offering costs. In the
private placement, the Company issued 1,076,294 units of common stock and
warrants to investors under the offering for $2,313,335 in net cash proceeds
(net of cash offering costs of $377,400) and had issued 157,629 warrants as
consulting fees and for services to placement agents.
On July 2, 2003, the Company entered into an agreement to purchase a 100%
working interest, 80.5% net revenue interest, in the Beals Prospect mineral
lease located in Comanche County, Kansas. Total consideration provided by the
Company was a cash payment of $60,000. This is proven undeveloped acreage. The
company has not yet completed any mineral revenue studies for this property.
Subsequent to June 30, 2003, the Company has received $1,750 from exercise of
1,000 warrants that had an exercise price of $1.75.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
For the three months ended June 30, 2003, the Company realized $841,619 in
revenue compared to $167,682 in revenue for the same period in 2002. Income
before accrual for deferred income taxes for the three months ended June 30,
2003 was $326,432 compared to $35,790 for the same period in 2002. Net income
after income taxes and preferred stock dividends was $205,652 for the three
months ended June 30, 2003 compared to a loss of $135,661 for the same period in
2002.
Oil and gas production costs for the three months ended June 30, 2003 were
$281,546, compared to $49,516 for the same period in 2002. Production taxes for
the three months ended June 30, 2003 were $57,374, compared to $8,247 for the
same period in 2002. Depreciation and depletion for the three months ended June
30, 2003 was $69,615, compared to $18,644 for the same period in 2002. General
and administrative expenses for the three months ended June 30, 2003 were
$120,451, consisting franchise taxes and payroll salaries and taxes, compared to
$55,485 for the same period in 2002, consisting primarily of payroll salaries
and taxes.
For the six months ended June 30, 2003, the Company realized $1,648,640 in
revenue compared to $311,013 in revenue for the same period in 2002. Income
before accrual for deferred income taxes for the six months ended June 30, 2003
was $632,840 compared to $55,868 for the same period in 2002. Net income after
income taxes, cumulative effect of change in accounting principle and preferred
stock dividends was $385,958 for the six months ended June 30, 2003 compared to
a loss of $155,289 for the same period in 2002.
Oil and gas production costs for the six months ended June 30, 2003 were
$523,618, compared to $96,072 for the same period in 2002. Production taxes for
the six months ended June 30, 2003 were $111,324, compared to $15,475 for the
same period in 2002. Depreciation and depletion for the six months ended June
30, 2003 was $120,706, compared to $41,292 for the same period in 2002. General
and administrative expenses for the six months ended June 30, 2003 were
$264,082, consisting primarily of bank line of credit fees, stock exchange
listing fees, franchise taxes and payroll salaries and taxes, compared to
$102,306 for the same period in 2002, consisting primarily of payroll salaries
and taxes.
Revenues Year to Date by Geographic section
Arena reports its net oil and gas revenues for the year to date as applicable to
the following geographic sectors:
OIL
Net Production Volume Net Revenue
Texas Leases 11,178 BBLS $ 342,719
Oklahoma Leases 36,714 BBLS $ 1,093,545
New Mexico Leases 3,962 BBLS $ 104,197
GAS
Net Production Volume Net Revenue
Texas Leases 2,866 MCF $ 9,411
Oklahoma Leases 21,103 MCF $ 85,328
New Mexico Leases 3,360 MCF $ 13,440
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Arena is also looking at various other oil and gas opportunities, as generally
outlined in its earlier periodic reports, in Oklahoma and other geographic
areas, but has entered no definitive or binding agreements, except as otherwise
reported in this filing.
Significant Subsequent Events occurring after June 30, 2003:
On July 15, 2003 the Company closed its $3,000,000 private placement offering of
the Company's common stock at $2.50 per share with a detachable warrant
exercisable at $5.00 per share through September 30, 2005. During July 2003,
the Company issued 256,000 shares of common stock and 256,000 warrants. In
addition, warrants to purchase 25,600 shares of commons stock at $5.00 per share
were issued as consulting fees and for services to placement agents. The gross
proceeds received were $640,000 before $119,730 of cash offering costs. In the
private placement, the Company issued 1,076,294 units of common stock and
warrants to investors under the offering for $2,313,335 in net cash proceeds
(net of cash offering costs of $377,400) and had issued 157,629 warrants as
consulting fees and for services to placement agents.
On July 23, 2003 the Company held its first annual shareholders meeting. The
following items were approved by majority shareholder vote: (i) election of
directors, (ii) approval of its proposed executive stock option incentive
program and (iii) ratification of the appointment of Hansen, Barnett & Maxwell
as independent auditors through the end of the year. Any party wishing to
review the minutes of this meeting can obtain a copy from the Company.
On July 2, 2003, the Company entered into an agreement to purchase a 100%
working interest, 80.5% net revenue interest, in the Beals Prospect mineral
lease located in Comanche County, Kansas. Total consideration provided by the
Company was a cash payment of $60,000. This is proven undeveloped acreage. The
company has not yet completed any mineral revenue studies for this property.
Subsequent to June 30, 2003, the Company has received $1,750 from exercise of
1,000 warrants that had an exercise price of $1.75.
Capital Resources and Liquidity
As shown in the financial statements for the six months ended June 30, 2003, the
Company had cash on hand of $1,453,905, compared to $796,915 as of December 31,
2002. The Company had positive net cash flows from operations for the six
months ended June 30, 2003 of $686,310, compared to $137,847 for the same period
2002. Other significant sources of cash inflow in 2003 were the common stock
private placement with net proceeds in 2003 of $1,137,165 and the collection of
a common stock subscription receivable, in the amount of $157,500. Another
significant source of cash inflow in 2002 was the Class A preferred stock
private placement (which closed June 30, 2002) with net proceeds of $1,135,488.
The most significant cash outflows during the six months ended June 30, 2003 and
2002 were capital expenditures of $1,186,971 in 2003 and $995,214 in 2002 and
payment of preferred stock dividends of $114,685 in 2003 and $75,850 in 2002.
On February 3, 2003, the Company established a $10,000,000 revolving credit
facility with a bank with an initial borrowing base of $2,000,000. The interest
rate is a floating rate equal to the JP Morgan Chase Prime rate plus 1% with
interest payable monthly. Annual fees for the facility are 1/2 of 1% of the
unused portion of the borrowing base. Amounts borrowed under the revolving
credit facility will be due in February 2005. The revolving credit facility is
secured by the Company's principal mineral interests. In order to obtain the
revolving credit facility, loans from two officers were subordinated to the
position of the bank and the credit facility was guaranteed by two of the
Company's officers. The Company is required under the terms of the credit
facility to maintain a tangible net worth of $4,000,000, maintain a 5-to-1
ratio of income before interest, taxes, depreciation, depletion and
amortization to interest expense and maintain a current asset to current
liability ratio of 1-to-1.
14
On August 22, 2002, the Company initiated a $3,000,000 private placement
offering of the Company's common stock at $2.50 per share with a detachable
warrant exercisable at $5.00 per share through September 30, 2005. During the
six months ended June 30, 2003, the Company issued 534,294 shares of common
stock and 534,294 warrants for $1,135,165 in net cash proceeds (net of cash
offering costs of $200,570). In addition, 79,596 warrants exercisable at $5.00
per share through September 30, 2005 were issued as consulting fees and for
services to placement agents. Through June 30, 2003, the Company had issued
820,294 units of common stock and warrants to investors under the offering for
$1,793,065 in net cash proceeds (net of cash offering costs of $257,670) and had
issued 132,029 warrants as consulting fees and for services to placement agents.
Management plans to continue to make acquisitions, using net cash flows from
operations and possibly the above referenced credit facility and additional
equity capital.
Disclosures About Market Risks
Like other natural resource producers, Arena faces certain unique market risks.
The two most salient risk factors are the volatile prices of oil and gas and
certain environmental concerns and obligations.
Oil and Gas Prices
Current competitive factors in the domestic oil and gas industry are unique.
The actual price range of crude oil is largely established by major
international producers. Pricing for natural gas is more regional. Because
domestic demand for oil and gas exceeds supply, there is little risk that all
current production will not be sold at relatively fixed prices. To this extent
Arena does not see itself as directly competitive with other producers, nor is
there any significant risk that the company could not sell all production at
current prices with a reasonable profit margin. The risk of domestic
overproduction at current prices is not deemed significant. The primary
competitive risks would come from falling international prices which could
render current production uneconomical.
Secondarily, Arena is presently committed to use the services of the existing
gatherers in its present areas of production. This gives to such gatherers
certain short term relative monopolistic powers to set gathering and
transportation costs, because obtaining the services of an alternative gathering
company would require substantial additional costs since an alternative gatherer
would be required to lay new pipeline and/or obtain new rights of way in the
lease.
It is also significant that more favorable prices can usually be negotiated for
larger quantities of oil and/or gas product, such that Arena views itself as
having a price disadvantage to larger producers. Large producers also have a
competitive advantage to the extent they can devote substantially more resources
to acquiring prime leases and resources to better find and develop prospects.
Environmental
Oil and gas production is a highly regulated activity which is subject to
significant environmental and conservation regulations both on a federal and
state level. Historically, most of the environmental regulation of oil and gas
production has been left to state regulatory boards or agencies in those
jurisdictions where there is significant gas and oil production, with limited
direct regulation by such federal agencies as the Environmental Protection
Agency. However, while the Company believes this generally to be the case for
its production activities in Texas, Oklahoma, Kansas and New Mexico, it should
be noticed that there are various Environmental Protection Agency regulations
which would govern significant spills, blow-outs, or uncontrolled emissions.
15
In Oklahoma, Texas, Kansas and New Mexico specific oil and gas regulations exist
related to the drilling, completion and operations of wells, as well as disposal
of waste oil. There are also procedures incident to the plugging and
abandonment of dry holes or other non-operational wells, all as governed by the
Oklahoma Corporation Commission, Oil and Gas Division, the Texas Railroad
Commission, Oil and Gas Division, the Kansas Corporation Commission, Oil and Gas
Division or the New Mexico Oil Conservation Division.
Compliance with these regulations may constitute a significant cost and effort
for Arena. No specific accounting for environmental compliance has been
maintained or projected by Arena to date. Arena does not presently know of any
environmental demands, claims, or adverse actions, litigation or administrative
proceedings in which it or the acquired properties are involved or subject to or
arising out of its predecessor operations.
In the event of a breach of environmental regulations, these environmental
regulatory agencies have a broad range of alternative or cumulative remedies to
include: ordering a clean up of any spills or waste material and restoration of
the soil or water to conditions existing prior to the environmental violation;
fines; or enjoining further drilling, completion or production activities. In
certain egregious situations the agencies may also pursue criminal remedies
against the Company or its principals.
Forward-Looking Information
Certain statements in this Section and elsewhere in this report are forward-
looking in nature and relate to trends and events that may affect the Company's
future financial position and operating results. Such statements are made
pursuant to the safe harbor provision of the Private Securities Litigation
Reform Act of 1995. The terms "expect," "anticipate," "intend," and "project"
and similar words or expressions are intended to identify forward-looking
statements. These statements speak only as of the date of this report. The
statements are based on current expectations, are inherently uncertain, are
subject to risks, and should be viewed with caution. Actual results and
experience may differ materially from the forward-looking statements as a result
of many factors, including changes in economic conditions in the markets served
by the company, increasing competition, fluctuations in raw materials and energy
prices, and other unanticipated events and conditions. It is not possible to
foresee or identify all such factors. The company makes no commitment to update
any forward-looking statement or to disclose any facts, events, or circumstances
after the date hereof that may affect the accuracy of any forward-looking
statement.
Item 3. Controls and Procedures
(a) The Company maintains controls and procedures designed to ensure that
information required to be disclosed in the reports that the Company files
or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the rules and
forms of the Securities and Exchange Commission. Based upon their evaluation
of those controls and procedures performed within 90 days of the filing date
of this report, the chief executive officer and the principal financial
officer of the Company concluded that the Company's disclosure controls and
procedures were adequate.
(b) Changes in internal controls. The Company made no significant
changes in its internal controls or in other factors that could
significantly affect these controls subsequent to the date of the
evaluation of those controls by the chief executive officer and principal
financial officer.
16
Part II - Other Information
Item 1. Legal Proceedings
Arena is not presently engaged in any legal proceedings, nor does it know of any
claims for or against the company by any party.
Item 4. Submission of Matters to a Vote of Security Holders
On July 23, 2003 the Company held its first annual shareholders meeting. The
following items were approved by majority shareholder vote: election of
directors, approval of its proposed executive stock option incentive program and
ratification of the appointment of Hansen, Barnett & Maxwell as independent
auditors through the end of the year. Any party wishing to review the minutes
of this meeting can obtain a copy from the Company.
Item 5. Other Information
As of April 15, 2003, Arena has traded on the American Stock Exchange, under the
trading symbol, ARD. The shares have traded in the range of $4.50 to $5.99
during the second quarter, 2003. Prior to April 15, 2003, Arena had established
a limited trading market on the NASD Electronic Bulletin Board beginning
approximately March 28, 2001.
Mr. Robert J. Morley resigned as director and officer effective July 31, 2003.
Mr. Morley's resignation was prompted by the concerns of both Mr. Morley and
Arena that the Company was going to continue to engage in oil and gas activities
with a controlled entity of Mr. Morley's, known as Petro Consultants, Inc. Both
parties thought it was in the best interest of the Company to avoid potential
future conflicts and related party transactions that Mr. Morley resign from the
Board of Directors and his position as an officer.
Mr. Morley will continue in his capacity as the principal of Petro Consultants,
Inc to work with Arena in oil and gas acquisition and development as an industry
participant. Mr. Morley is no longer considered an affiliate but does continue
to hold 136,340 shares of the Company's common stock. There existed no
disagreements or conflicts between Mr. Morley and Arena and the Company wishes
to thank him for his services.
Management is not aware of any other pertinent or relevant information other
than discussed above in Managements Discussion and Analysis of Financial
Condition and Results of Operations. Shareholders are advised that as the
Company completes future significant drilling and completion activities for oil
and gas acquisitions that it will report such matters through press releases
and/or the filing of 8-K reports where appropriate. Such information will be
further summarized in the next applicable periodic filing with the Securities
and Exchange Commission.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350,
As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley
Act of 2002
(b) Exhibit 99.2 CEO and CFO certification
(c) There were no 8-K filings during the quarter ending June 30, 2003.
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
REGISTRANT: ARENA RESOURCES, INC.
Dated: August 8, 2003 By: /s/ Lloyd Tim Rochford
----------------------------
Lloyd Tim Rochford
President, Chief Executive Officer
Dated: August 8, 2003 By: /s/ Stanley McCabe
----------------------------
Stanley McCabe
Treasurer, Secretary
Dated: August 8, 2003 By: /s/ William R. Broaddrick
-------------------------------
William R. Broaddrick
Vice President, Chief Financial Officer
18