UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
----------- --------------
Commission File Number 0-33027
HOUSTON AMERICAN ENERGY CORP
(Exact name of small business issuer as specified in its charter)
Delaware 76-0675953
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
801 Travis Street, Suite 2020, Houston, Texas 77002
(Address of principal executive offices)(Zip Code)
(713) 222-6966
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of July 24, 2006, we had 27,820,172 shares of $.001 par value Common
Stock outstanding.
Transitional Small Business Disclosure Format (check one) Yes [ ] No [X]
HOUSTON AMERICAN ENERGY CORP
----------------------------
FORM 10-QSB
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Balance Sheet as of June 30, 2006. . . . . . . . . . . . . . 3
Statements of Operations for the three months and six
months ended June 30, 2006 and June 30, 2005 . . . . . . . 4
Statements of Cash Flows for the six months
ended June 30, 2006 and June 30, 2005. . . . . . . . . . . 5
Notes to Financial Statements. . . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations. . . . . 12
Item 3. Controls and Procedures. . . . . . . . . . . . . . . . 17
PART II OTHER INFORMATION
Item 6. Exhibits . . . . . . . . . . . . . . . . . . . . . . . 18
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
HOUSTON AMERICAN ENERGY CORP
BALANCE SHEET
June 30, 2006
(Unaudited)
ASSETS
------
CURRENT ASSETS
Cash $ 14,276,823
Accounts receivable 369,721
Prepaid expenses 304,343
--------------
Total current assets 14,950,887
--------------
PROPERTY, PLANT AND EQUIPMENT
Oil and gas properties - full cost method
Costs subject to amortization 4,213,057
Costs not being amortized 1,729,547
Furniture and equipment 11,878
--------------
Total property, plant and equipment 5,954,482
Accumulated depreciation and depletion (1,552,563)
--------------
Total property, plant and equipment, net 4,401,919
--------------
OTHER ASSETS 3,167
--------------
Total Assets $ 19,355,973
==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 6,010
Accrued expenses 82,375
--------------
Total current liabilities 88,385
--------------
LONG-TERM LIABILITIES
Reserve for plugging costs 41,249
--------------
Total long-term liabilities 41,249
--------------
SHAREHOLDERS' EQUITY
Common stock, $0.001 par value; 100,000,000 shares
authorized; 27,820,172 shares outstanding 27,821
Additional paid-in capital 21,523,167
Treasury stock, at cost; 100,000 shares (85,834)
Accumulated deficit (2,238,815)
--------------
Total shareholders' equity 19,226,339
--------------
Total liabilities and shareholders' equity $ 19,355,973
==============
The accompanying notes are an integral part of these financial statements
3
HOUSTON AMERICAN ENERGY CORP
STATEMENT OF OPERATIONS
(Unaudited)
Six Months Ended Three Months Ended
June 30, June 30,
-------------------------- --------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
(Restated) (Restated)
Oil and gas revenue $ 1,489,564 $ 1,091,940 $ 823,392 $ 646,429
------------ ------------ ------------ ------------
Expenses of operations:
Lease operating expense and
severance tax 450,591 440,710 256,385 269,937
Joint venture expenses 81,568 27,424 31,644 13,601
General and administrative
expense 517,441 340,048 305,862 171,951
Depreciation and depletion 180,012 170,358 90,533 107,731
------------ ------------ ------------ ------------
Total operating expenses 1,229,612 978,540 684,424 563,220
------------ ------------ ------------ ------------
Income from operations 259,952 113,400 138,968 83,209
Other (income) expenses:
Interest income (77,883) (7,770) (61,664) (5,566)
Interest expense 57,278 26,920 14,778 28,624
Interest expense - derivative 37,773 292,436 20,883 292,436
Net change in fair value of
derivative liabilities 170,949 62,030 67,872 62,030
Interest expense - shareholders 20,440 36,000 4,240 18,000
Financing costs 110,683 4,045 104,298 4,045
------------ ------------ ------------ ------------
Total other expenses, net 319,240 413,661 150,407 399,569
------------ ------------ ------------ ------------
Net loss before taxes (59,288) (300,261) (11,439) (316,360)
Income tax expense 121,697 30,265 59,544 18,939
------------ ------------ ------------ ------------
Net loss $ (180,985) $ (330,526) $ (70,983) $ (335,299)
============ ============ ============ ============
Basic and diluted income (loss)
per share $ (0.01) $ (0.02) $ (0.00) $ (0.02)
============ ============ ============ ============
Basic and diluted weighted
average shares 22,297,527 19,968,089 24,598,895 19,968,089
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements
4
HOUSTON AMERICAN ENERGY CORP
STATEMENTS OF CASH FLOWS
(Unaudited)
For the Six Months Ended June 30,
-------------------------------------
2006 2005
----------------- ------------------
(Restated)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (180,985) $ (330,526)
Adjustments to reconcile net loss
to net cash from operations
Depreciation and depletion 180,012 168,858
Stock based compensation 45,200 -
Change in fair value of derivatives 170,949 62,030
Amortization of debt discounts and deferred financing costs 148,456 292,436
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable 203,601 (162,130)
(Increase) decrease in prepaid expense (294,378) 56,536
(Increase) decrease in other assets - (97,907)
Increase (decrease) in accounts payable and accrued expenses (447,279) 41,700
----------------- ------------------
Net cash provided by (used in) operations (174,424) 30,997
----------------- ------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of oil and gas properties (1,950,686) (947,939)
----------------- ------------------
Net cash used by investing activities (1,950,686) (947,939)
----------------- ------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of common stock, net of expenses 15,386,583 -
Issuance of debt - 2,125,000
Exercise of warrants 191,250 -
Repayment of shareholder loan (900,000) -
----------------- ------------------
Net cash provided by financing activities 14,677,833 2,125,000
----------------- ------------------
Increase in cash and equivalents 12,552,723 1,208,058
Cash, beginning of period 1,724,100 721,613
----------------- ------------------
Cash, end of period $ 14,276,823 $ 1,929,671
================= ==================
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 110,773 $ 36,000
================= ==================
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING
AND FINANCING ACTIVITIES:
Conversion of convertible notes to common stock $ 2,445,545 $ -
================= ==================
Warrants issued for financing fees $ - $ 162,562
================= ==================
Exercise of warrants $ 610,719 $ -
================= ==================
The accompanying notes are an integral part of these financial statements
5
HOUSTON AMERICAN ENERGY CORP
Notes to Financial Statements
June 30, 2006
(Unaudited)
NOTE 1. - BASIS OF PRESENTATION
The accompanying unaudited financial statements of Houston American Energy Corp,
a Delaware corporation (the "Company"), have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-QSB and Item
310(b) of Regulation S-B. They do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for a complete financial presentation. In the opinion of
management, all adjustments, consisting only of normal recurring adjustments,
considered necessary for a fair presentation, have been included in the
accompanying unaudited financial statements. Operating results for the periods
presented are not necessarily indicative of the results that may be expected for
the full year.
These financial statements should be read in conjunction with the financial
statements and footnotes, which are included as part of the Company's Form
10-KSB for the year ended December 31, 2005.
NOTE 2. - CHANGES IN PRESENTATION
Certain financial presentations for the periods presented for 2005 have been
reclassified to conform to the 2006 presentation.
NOTE 3. - RESTATED FINANCIAL STATEMENTS
In order to correct the financial statements so they comply with U.S. generally
accepted accounting principles, the financial statements have been restated for
the quarter and six month period ended June 30, 2005. The Company has determined
that certain financials instruments issued by the Company contain embedded
features that require the Company to account for these features as derivative
instruments. Accordingly, the embedded features with the Convertible Notes and
related warrants issued have been accounted for as derivative financial
instruments in accordance with SFAS 133 and EITF 00-19. The following is a
summary of the restatement adjustments.
6
As Previously
Reported Adjustments As Restated
--------------- ------------- -------------
Balance Sheet
-------------
Current assets
Prepaid expense 65,978 (32,567) 33,411
Total Current Assets 2,397,920 (32,567) 2,365,353
Other assets 225,913 (124,839) 101,074
Total Assets 4,809,470 (157,406) 4,652,064
Currently liabilities
Derivative liability - 2,472,577 2,472,577
Total Current Liabilities 282,261 2,472,577 2,754,838
Long term debt
Subordinated convertible notes 2,125,000 (2,118,111) 6,889
Total long term debt 3,169,456 (2,118,111) 1,051,345
Shareholder Equity
Additional paid in capital 2,962,589 (164,265) 2,798,324
Accumulated deficit (1,538,970) (347,606) (1,886,576)
Total Stockholders' Equity 1,357,753 (511,871) 845,882
Statement of Operations
Six Months Ended 6/30/05
------------------------
Other (Income) Expense
Interest expense-derivative - 292,436 292,436
Net change in fair value of derivative liabilities - 62,030 62,030
Financing costs 9,201 (5,156) 4,045
Interest expense 64,624 (1,704) 62,920
Total Other (Income) Expense 66,055 347,606 413,661
Income (loss) before income taxes 47,345 (347,606) (300,261)
Net Income (Loss) 17,080 (347,606) (330,526)
Basic and diluted income (loss) per share $ 0.00 $ (0.02) $ (0.02)
Three Months Ended 6/30/05
--------------------------
Other (Income) Expense
Interest expense-derivative - 292,436 292,436
Net change in fair value of derivative liabilities - 62,030 62,030
Financing costs 9,201 (5,156) 4,045
Interest expense -
Total Other (Income) Expense 50,259 349,310 399,569
Income (loss) before income taxes 32,950 (349,310) (316,360)
Net Income (Loss) 14,011 (349,310) (335,299)
Basic and diluted income (loss) per share $ 0.00 $ (0.02) $ (0.02)
7
NOTE 4. - ISSUANCES OF COMMON STOCK AND WARRANTS
April 2006 Private Placement
On April 28, 2006, the Company entered into Subscription Agreements (the
"Purchase Agreements") with multiple investors pursuant to which the Company
sold 5,533,333 shares of common stock (the "Shares") for $16,599,999.
The Shares were offered and sold in a private placement transaction pursuant to
the exemption from registration provided by Section 4(2) of the Securities Act
of 1933 and Rule 506 promulgated thereunder. Each investor was an "accredited
investor" as defined in Rule 501 promulgated under the Securities Act.
Pursuant to the terms of the Subscription Agreements, the Company and the
investors entered into Registration Rights Agreements under which the Company
agreed to file with the Securities and Exchange Commission, within 60 days, a
registration statement covering the Shares. In conjunction with the placement
of the Shares, John Terwilliger, O. Lee Tawes III and Edwin Broun III each
entered into lock-up agreements pursuant to which each agreed not to offer or
sell any shares of the Company's common stock until the earlier of the effective
date of the registration statement relating to the Shares or one year from the
sale of the Shares.
Sanders Morris Harris Inc. acted as placement agent in connection with the offer
and sale of the Shares. For its services as placement agent, Sanders Morris
Harris Inc. received commissions totaling $1,162,000 and a warrant (the
"Placement Agent Warrant") to purchase 415,000 shares of common stock at $3.00
per share. The Registration Rights Agreements provide that the shares of common
stock underlying the Placement Agent Warrant are to be included in the
registration statement to be filed.
Conversion of 8% Subordinated Convertible Notes
On May 2, 2006, the Company notified the holders of its 8% Subordinated
Convertible Notes (the "Convertible Notes") of its election to convert the
Convertible Notes into shares of the Company's common stock. As a result of
such election, the full principal amount of the Convertible Notes of $2,125,000
has been satisfied by conversion of the same into 2,125,000 shares of common
stock.
The shares of common stock issued on conversion of the Convertible Notes were
offered and issued pursuant to the exemption from registration provided by
Section 4(2) of the Securities Act of 1933. Each of the investors is an
"accredited investor", as defined in Rule 501 promulgated under the Securities
Act.
Exercise of Warrants
In May 2006, the holders of warrants issued in conjunction with the May 2005
private placement of the Convertible Notes exercised all 191,250 warrants and
were issued an aggregate of 191,250 shares of common stock for aggregate
consideration of $191,250.
The shares of common stock issued on exercise of the warrants were offered and
issued pursuant to the exemption from registration provided by Section 4(2) of
the Securities Act of 1933. Each of the investors is an "accredited investor",
as defined in Rule 501 promulgated under the Securities Act.
8
NOTE 5. - SUBORDINATED CONVERTIBLE NOTES AND WARRANTS - DERIVATIVE LIABILITIES
In conjunction with the issuance in May 2005 of Convertible Notes, the
conversion feature, the conversion price, reset provision and the Company's
optional early redemption right in the Convertible Notes were bundled together
as a single compound embedded derivative liability and, using a layered
discounted probability-weighted cash flow approach, were initially fair valued
at $2,368,485 at May 4, 2005. The fair value model comprises multiple
probability-weighted scenarios under various assumptions reflecting the
economics of the Convertible Notes, such as the risk-free interest rate,
expected Company stock price and volatility, likelihood of conversion and or
redemption, and likelihood default status and timely registration. At inception,
the fair value of this single compound embedded derivative was bifurcated from
the host debt contract and recorded as a derivative liability which resulted in
a reduction of the initial notional carrying amount of the Convertible Notes (as
unamortized discount which will be amortized over a five-year period under the
effective interest method). At inception the excess of the unamortized discount
over the notional amount of the Convertible Note in the amount of $285,547 was
charged to expense in the Company's statement of operations.
As noted above, the Convertible Notes were satisfied in full in May 2006 upon
the conversion of the same to common stock. As a result of conversion of the
Convertible Notes, the unamortized discount, in the amount of $2,053,060 and the
compound embedded derivative liability of $2,373,405, was reclassified as
Additional paid in capital for the periods ended June 30, 2006.
Also as noted above, the warrants issued in conjunction with the Convertible
Notes were exercised in full. As a result of exercise of the warrants, the
derivative liability associated with the warrants, in the amount of $610,719,
was reclassified as Additional paid in capital for the periods ended June 30,
2006.
NOTE 6. - SHAREHOLDER LOAN
Shareholder loans, in the principal amount of $900,000, were repaid in full from
the proceeds of the April 2006 private placement.
NOTE 7. - STOCK BASED COMPENSATION
We maintain performance incentive plans under which incentive stock options and
non-qualified stock options may be granted to employees, consultants and
non-employee directors. Stock options are granted at the market price on the
date of grant, vesting over varying periods, and generally expire ten years from
the date of grant. We issue new shares of common stock upon exercise of stock
options.
Effective January 1, 2006, the first day of our 2006 fiscal year, we adopted
Financial Accounting Standards Board ("FASB") Statement No. 123(R), "Share-Based
Payment" ("SFAS 123R"), using the modified prospective transition method, and as
a result, did not retroactively adjust results from prior periods. Under this
transition method, stock-based compensation was recognized for expense related
to the options vesting in the first two quarters of 2006 based on the grant date
fair value estimated in accordance with the provisions of SFAS 123R. We apply
the Black-Scholes valuation model in determining the fair value of share-based
payments to employees, non-employee directors and consultants. The resulting
compensation expense is recognized over the requisite service period, which is
generally the option vesting term. Options issued to non-employee directors are
vested 100% at grant date. Prior to fiscal 2006, stock-based compensation was
included as a pro forma disclosure in the Notes to the Consolidated Financial
Statements as permitted by SFAS 123.
Compensation expense is recognized only for those options expected to vest, with
forfeitures estimated based on our historical experience and future
expectations. Prior to the adoption of SFAS 123R, the effect of forfeitures on
the pro forma expense amounts was recognized as the forfeitures occurred.
9
20,000 options were granted to non-employee directors during the quarter ended
June 30, 2006. Adoption of SFAS 123R had no impact on the Statement of
Operations for the quarter or six months ended June 30, 2006. Similarly, as all
options granted prior to 2006 were granted to non-employees and were expensed
based on their Black-Scholes value at grant, the adoption of SFAS 123R would
have had no impact on the Statement of Operations for the quarter and six months
ended June 30, 2005 on a pro forma basis.
The expected term of the options represents the estimated period of time until
exercise and is based on historical experience of similar options, giving
consideration to the contractual terms, vesting schedules and expectations of
future employee behavior. For fiscal 2006, expected stock price volatility is
based on the historical volatility of our stock. The risk-free interest rate is
based on the U.S. Treasury yield in effect at the time of grant with an
equivalent remaining term. The Company has not paid dividends in the past and
does not currently plan to pay any dividends in the near future.
Stock option activity during the six months ended June 30, 2006 was as follows:
Weighted
Weighted Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Shares Price Term (in years) Value
------- --------- --------------- ----------
Outstanding at December 31, 2005 89,000 $ 2.42 9.2
Granted 20,000 4.10 9.9
Exercised -
Cancelled -
-------
Outstanding at June 30, 2006 109,000 2.73 9.3 $ 60,000
=======
Vested and expected to vest at
June 30, 2006 109,000 2.73 9.3 $ 60,000
Exercisable at June 30, 2006 109,000 2.73 9.3 $ 60,000
The aggregate intrinsic value in the table above represents the total pretax
intrinsic value (the difference between our closing stock price on June 30, 2006
and the exercise price, multiplied by the number of in-the-money options) that
would have been received by the option holders had all option holders exercised
their options on June 30, 2006. This amount changes based on the fair market
value of our stock. Total intrinsic value of options exercised for the six
months ended June 30, 2006 was zero. As of June 30, 2006, total unrecognized
stock-based compensation expense related to non-vested stock options was $0. As
of June 30, 2006 there were 391,000 shares of common stock available for
issuance pursuant to future stock option grants.
Additional information regarding options outstanding as of June 30, 2006 is as
follows:
Options Outstanding Options Exercisable
------------------------------------ -----------------------
Weighted-
Number Average Weighted- Number Weighted-
Outstanding Remaining Average Outstanding Average
at June 30, Contractual Exercise at June 30, Exercise
Range of Exercise Price 2006 Life Price 2006 Price
----------------------- ----------- ----------- ---------- ----------- ----------
2.00 60,000 9.1 $ 2.00 60,000 $ 2.00
3.30 29,000 9.4 $ 3.30 29,000 $ 3.30
4.10 20,000 9.9 $ 4.10 20,000 $ 4.10
10
NOTE 8. - COMMITMENTS AND CONTINGENCIES
In May 2006, the Company named an additional director to its board and revised
the compensation of its President and its non-employee directors.
Pursuant to a resolution adopted by the board of directors, the base salary of
the Company's president was increased, effective June 1, 2006 from $180,000
annually to $300,000 annually.
Pursuant to a resolution adopted by the board of directors, the Company fixed
the compensation of non-employee directors to consist of (1) an annual retainer
of $6,000 payable in quarterly installments, (2) an annual retainer of $2,000
per committee on which a director serves, payable in quarterly installments, (3)
an annual retainer of $2,500 for service as audit committee chair, payable in
quarterly installments, (4) an annual retainer of $1,500 for service as chair of
committees other than the audit committee, payable in quarterly installments,
(5) a grant of 20,000 stock options on initial election or appointment as a
director exercisable at fair market value on the date of grant for a term of 10
years, and (6) a grant of 10,000 stock options immediately following each
subsequent shareholders meeting at which a director stands for reelection and is
reelected.
NOTE 9. - EARNINGS PER SHARE
Pursuant to SFAS No. 128, "Earnings Per Share," basic net income per share is
computed by dividing the net income attributable to common shareholders by the
weighted-average number of common shares outstanding during the period. Diluted
net income per share is computed by dividing the net income attributable to
common shareholders by the weighted-average number of common and common
equivalent shares outstanding during the period. Common share equivalents
included in the diluted computation represent shares issuable upon assumed
exercise of stock options, warrants , and convertible notes using the treasury
stock and "if converted" method. Our securities do not have a contractual
obligation to share in the losses in any given period. As a result these
securities were not allocated any losses in the periods of net losses.
For the three and six months ended June 30, 2006, 109,000 options and 415,000
warrants to purchase common stock were excluded from the calculation of diluted
net loss per share because they were anti-dilutive. For the three and six
months ended June 30, 2005, 2,125,000 shares of common stock issuable upon
conversion of convertible notes and 191,250 warrants to purchase common stock
were excluded from the calculation of diluted net loss per share because they
were anti-dilutive.
NOTE 10. - SUBSEQUENT EVENTS
In July 2006, the Company appointed James "Jay" Jacobs as Chief Financial
Officer and fixed Mr. Jacobs' compensation as follows: (1) base salary of
$125,000; and (2) a stock option to purchase 200,000 shares of common stock at
$2.98 per share, the closing price on first day of employment, vesting over a 2
year period and exercisable over a period of ten years. The Company has agreed,
by the end of the 2nd quarter of 2007, to retain the services of an outside
compensation consulting firm to review and make recommendations with respect to
the compensation of Mr. Jacobs and each of the Company's executive officers and
directors.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
FORWARD-LOOKING INFORMATION
This Form 10-QSB quarterly report of Houston American Energy Corp (the
"Company") for the six months ended June 30, 2006, contains certain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, which are intended to be covered by the safe harbors created
thereby. To the extent that there are statements that are not recitations of
historical fact, such statements constitute forward-looking statements that, by
definition, involve risks and uncertainties. In any forward-looking statement,
where the Company expresses an expectation or belief as to future results or
events, such expectation or belief is expressed in good faith and believed to
have a reasonable basis, but there can be no assurance that the statement of
expectation or belief will be achieved or accomplished.
The actual results or events may differ materially from those anticipated and as
reflected in forward-looking statements included herein. Factors that may cause
actual results or events to differ from those anticipated in the forward-looking
statements included herein include the Risk Factors described in Item 1 of the
Company's Form 10-KSB for the year ended December 31, 2005.
Readers are cautioned not to place undue reliance on the forward-looking
statements contained herein, which speak only as of the date hereof. The
Company believes the information contained in this Form 10-QSB to be accurate as
of the date hereof. Changes may occur after that date, and the Company will not
update that information except as required by law in the normal course of its
public disclosure practices.
Additionally, the following discussion regarding the Company's financial
condition and results of operations should be read in conjunction with the
financial statements and related notes contained in Item 1 of Part 1 of this
Form 10-QSB, as well as the Risk Factors in Item 1 and the financial statements
in Item 7 of Part II of the Company's Form 10-KSB for the fiscal year ended
December 31, 2005.
CRITICAL ACCOUNTING POLICIES
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The Company believes certain critical accounting
policies affect its more significant judgments and estimates used in the
preparation of its financial statements. A description of the Company's
critical accounting policies is set forth in the Company's Form 10-KSB for the
year ended December 31, 2005. As of, and for the six months ended, June 30,
2006, there have been no material changes or updates to the Company's critical
accounting policies other than the following updated information relating to
Unevaluated Oil and Gas Properties:
-- UNEVALUATED OIL AND GAS PROPERTIES. Unevaluated oil and gas properties not
subject to amortization include the following at June 30, 2006:
June 30, 2006
Acquisition costs 220,969
Evaluation costs 1,508,578
--------------
Total $ 1,729,547
==============
The carrying value of unevaluated oil and gas prospects include $1,488,331
expended for properties in the South American country of Colombia at June 30,
2006. We are maintaining our interest in these properties and development has
or is anticipated to commence within the next twelve months.
12
CURRENT YEAR DEVELOPMENTS
Drilling Activity
During the six months ended June 30, 2006, the Company drilled 3 on-shore
domestic wells as follows:
- The Obenhaus #1, a 7,100 -foot well on the Obenhaus Prospect in Wilbarger
County, Texas was drilled and was a dry hole.
- The Riggins #1, a 6,400-foot test well on the West Fargo Prospect in
Wilbarger County, Texas was drilled and was deemed non-commercial.
- The DDD-Evans#1, a 8,500-foot test well on the West Turkey Prospect in
Hardeman County, Texas, was completed in April 2006 and began production in
May 2006.
At June 30, 2006, the Company had no domestic well being drilled.
At June 30, 2006, the Company had plans to drill 2 domestic wells during the
balance of 2006.
During the six months ended June 30, 2006, the Company drilled 6 international
wells in Colombia. Of the wells drilled in Colombia, 2 were successfully
drilled and producing at June 30, 2006, 1 was successfully drilled and being
completed at June 30, 2006 and 3 were dry holes.
At June 30, 2006, the Company had no wells being drilled in Colombia with plans
to drill 15 wells during the balance of 2006.
Leasehold Activity
During the six months ended June 30, 2006, the Company acquired interests in an
additional domestic prospect, a 10% working interest with a 7.5% net revenue
interest in the 91.375 acre West Turkey Prospect in Hardeman County, Texas.
During the 2006 period, the Company terminated its interest in the Green Jacket
Prospect in Iberville Parish, Louisiana.
Seismic Activity
During the six months ended June 30, 2006, the Company continued its ongoing
investment in acquiring and developing seismic data with respect to its
Colombian properties with shooting being completed on approximately 133 square
miles of prospect acreage during the period.
Capital Raising Activity
In April 2006, the Company sold, in a private placement, 5,533,333 shares of
common stock for gross proceeds of $16,599,999. In connection with the private
placement of shares, the Company paid to the placement agent commissions of
$1,162,000 and issued to the placement agent five year warrants to purchase
415,000 shares of common stock at $3.00 per share.
In May 2006, the Company repaid loans from its principal shareholder, in the
principal amount of $900,000, from the proceeds of the April 2006 private
placement.
13
In May 2006, the Company exercised its right to cause its outstanding
Subordinated Convertible Notes, in the aggregate principal amount of $2,125,000,
to be converted into 2,125,000 shares of common stock.
In May 2006, the holders of $1.00 warrants issued in connection with the
Subordinated Convertible Notes exercised all of the warrants resulting in the
issuance of 191,250 shares of common stock for aggregate consideration of
$191,250.
Corporate Developments
During May 2006, the Company's board of directors appointed an additional
non-employee director and revised the compensation of the Company's President
and non-employee directors. Effective June 1, 2006, the base salary of the
Company's President was increased from $180,000 to $300,000 annually. The board
fixed the compensation of non-employee directors to consist of (1) an annual
retainer of $6,000 payable in quarterly installments, (2) an annual retainer of
$2,000 per committee on which a director serves, payable in quarterly
installments, (3) an annual retainer of $2,500 for service as audit committee
chair, payable in quarterly installments, (4) an annual retainer of $1,500 for
service as chair of committees other than the audit committee, payable in
quarterly installments, (5) a grant of 20,000 stock options on initial election
or appointment as a director exercisable at fair market value on the date of
grant for a term of 10 years, and (6) a grant of 10,000 stock options
immediately following each subsequent shareholders meeting at which a director
stands for reelection and is reelected.
In July 2006, the Company appointed James "Jay" Jacobs as Chief Financial
Officer and fixed Mr. Jacobs' compensation, subject to review and adjustment by
mid-2007, as follows: (1) base salary of $125,000; and (2) a stock option to
purchase 200,000 shares of common stock at $2.98 per share, the closing price on
first day of employment, vesting over a 2 year period and exercisable over a
period of ten years.
RESULTS OF OPERATIONS
Oil and Gas Revenues. Total oil and gas revenues increased 36.4% to $1,489,564
in the six months ended June 30, 2006 when compared to the six months ended June
30, 2005. The increase in revenue is due to (1) increased production resulting
from the development of the Columbian fields and the new domestic wells that
have come on line since June 2005, and (2) increases in oil and gas prices. The
Company had interests in 20 producing wells in Colombia and 14 producing wells
in the U.S. during the 2006 period as compared to 13 producing wells in Columbia
and 7 producing wells in the U.S. during the 2005 period. Average prices from
sales were $57.62 per barrel of oil and $6.24 per mcf of gas during the 2006
period as compared to $38.22 per barrel of oil and $5.93 per mcf of gas during
the 2005 period.
Columbia U.S. Total
---------- -------- ----------
2006 Period
Oil sales $1,082,872 $ 51,593 $1,134,465
Gas sales - 355,099 355,099
2005 Period
Oil sales 844,210 42,640 886,850
Gas sales - 205,090 205,090
14
Lease Operating Expenses. Lease operating expenses, excluding joint venture
expenses relating to our Columbian operations discussed below, increased 2.2% to
$450,591 in the 2006 period from $440,710 in the 2005 period. The increase in
lease operating expenses was attributable to the increase in the number of wells
operated during the 2006 period (20 wells as compared to 13 wells) partially
offset by improved operating efficiencies. Following is a summary comparison of
lease operating expenses for the periods.
Columbia U.S. Total
--------- ------- --------
2006 Period $ 358,047 $92,544 $450,591
2005 Period 420,472 20,238 440,710
Joint Venture Expenses. The Company's allocable share of joint venture expenses
attributable to the Colombian Joint Venture totaled $81,568 during the 2006
period and $27,424 for the 2005 period. The increase in joint venture expenses
was attributable to an increase in operational activities of the joint venture
in acquiring new concessions.
Depreciation and Depletion Expense. Depreciation and depletion expense was
$180,012 and $170,358 for the six months ended June 30, 2006 and 2005,
respectively. The increase is due to increases in domestic and Colombian
production.
General and Administrative Expenses. General and administrative expense
increased by 52.2% to $517,441 during the 2006 period from $340,048 in the 2005
period. The increase in general and administrative expense was primarily
attributable to (1) professional fees, including fees relating to accounting for
derivatives ($59,150), (2) compensation expense relating to the grant of stock
options to a new director and director fees ($51,200), (3) an increase in
officers salary ($28,159), (4) an increase in travel and entertainment expense
($16,489), and (5) transfer agent fees and fees relating to the listing of the
Company's stock on the American Stock Exchange ($17,546). General and
administrative expense is expected to increase during the 3rd quarter of 2006
due to an increase in salary of the Company's President and the hiring of a
Chief Financial Officer.
Other Income/Expense, Net. Other income/expense, net, consists of interest
income and other non-operating income, net of financing costs in the nature of
interest and deemed interest associated with outstanding shareholder loans and
convertible notes and warrants issued in May 2005. Certain features of the
convertible notes and warrants resulted in the recording of a deemed derivative
liability on the balance sheet and periodic interest associated with the deemed
derivative liabilities and changes in the fair market value of those deemed
liabilities.
Other income/expenses, net, totaled $413,661 of net expenses in the 2005 period
compared to $319,240 of net expenses in the 2006 period. The improvement in
other income/expense, net, was attributable to interest earned on funds received
from the 2006 private placement, reduced interest on shareholder debt and
derivative interest expense partially offset by increases in financing costs,
total interest expense and change in fair market value of derivative
liabilities, which changes related to completion of the 2006 private placement
and application of the proceeds from the private placement and increases in the
Company's stock price that resulted in an increase in the value of derivative
liabilities. As a result of the retirement of the shareholder loans and the
convertible notes, interest expense is expected to decrease substantially, and
net change in fair market value of derivative liabilities will no longer be
recorded, beginning in the 3rd quarter of 2006.
Income Tax. Income taxes totaled $121,697 during the 2006 six month period as
compared to $30,265 during the 2005 six month period. Income taxes for both
periods relate to foreign taxes in connection with the Company's Colombian
operations. The increase in income tax expense was attributable to increased
production and profitability in Colombia. The Company had no provision for U.S.
income taxes for either period due to the availability of net operating losses.
15
FINANCIAL CONDITION
Liquidity and Capital Resources. At June 30, 2006 the Company had a cash
balance of $14,276,823 and working capital of $14,862,502 compared to a cash
balance of $1,724,100 and working capital of $1,771,722 at December 31, 2005.
The increase in cash and working capital during the period was primarily
attributable to the receipt of $15,386,583 of net proceeds from the April 2006
private placement of common stock as well as the receipt of $191,250 from the
exercise of warrants, partially offset by acquisitions of and investments in oil
and gas properties and the retirement of $900,000 of shareholder loans.
Derivative liabilities of $0 are recorded as current liabilities at June 30,
2006 as compared to $2,813,175 at December 31, 2005 but are not considered in
computing working capital. The decrease in derivative liabilities was
attributable to the conversion, during 2006, of the convertible notes and
warrants into common stock and the accompanying reclassification of the
derivative liability in the amount of $2,894,124 to additional paid in capital.
The derivative liabilities represented the deemed fair value of the embedded
derivatives included in the subordinated convertible notes and accompanying
warrants that were issued during 2005 as measured at June 30, 2006 and December
31, 2005.
Cash Flows. Cash flows used in operations for the 2006 period totaled $174,424
as compared to cash provided by operations during the 2005 period of $30,997.
The decrease in operating cash flow was primarily attributable to increased
operating income offset by decreases in accounts payable and accrued
liabilities, increases in prepaid expenses and changes in derivatives.
Investing activities used $1,950,686 during the 2006 period as compared to
$947,939 used during the 2005 period. The increase in funds used in investing
activities during the current quarter was primarily attributable to seismic
costs incurred in South America and drilling activity.
Financing activities provided $14,677,833 during the 2006 period as compared to
$2,125,000 provided during the 2005 period. Cash flows from financing
activities during 2006 related to the private placement of common stock
resulting in the receipt of net proceeds of $15,386,583 and the receipt of
$191,250 from the exercise of warrants partially offset by the repayment of
shareholder loans of $900,000.
Long-Term Liabilities. At June 30, 2006, the Company had long-term liabilities
of $41,249 as compared to $975,416 at December 31, 2005. Long-term liabilities
at June 30, 2006 consisted of a reserve for plugging costs. The change in
long-term debt was attributable to the retirement of shareholder loans of
$900,000 and the conversion of convertible notes into common stock.
Capital and Exploration Expenditures and Commitments. The Company's principal
capital and exploration expenditures relate to our ongoing efforts to acquire,
drill and complete prospects. With the receipt of additional financing in 2006
and prior years, and the increase in our revenues, profitability and operating
cash flows, the Company expects that future capital and exploration expenditures
will be funded principally through funds on hand and funds generated from
operations.
During the first six months of 2006, the Company invested approximately
$1,950,868 for the acquisition and development of oil and gas properties,
consisting of (1) drilling of 3 domestic wells ($363,690), (2) drilling 6 wells
in Colombia ($682,538), (3) acquisition of leases domestically ($184,694) and
(4) seismic activity in Colombia ($673,383).
At June 30, 2006, the Company's only material contractual obligations requiring
determinable future payments were a lease relating to the Company's executive
offices which was unchanged when compared to the 2005 Form 10-KSB.
16
At June 30, 2006, the Company's acquisition and drilling budget for the balance
of 2006 totaled approximately $1,764,500, consisting of (1) $1,228,500 for
drilling of 15 wells in South America on the Cara Cara, Cabiona and Simon
concessions, (2) $406,000 to drill 2 domestic wells, and (3) $130,000 for
seismic in Colombia. The Company's acquisition and drilling budget has
historically been subject to substantial fluctuation over the course of a year
based upon successes and failures in drilling and completion of prospects and
the identification of additional prospects during the course of a year.
Management anticipates that the Company's current financial resources will meet
our anticipated objectives and business operations, including our planned
property acquisitions and drilling activities, for at least the next 12 months
without the need for additional capital. Management continues to evaluate
producing property acquisitions as well as a number of drilling prospects. It
is possible, although not anticipated, that the Company may require and seek
additional financing if additional drilling prospects are pursued beyond those
presently under consideration.
OFF-BALANCE SHEET ARRANGEMENTS
The Company had no off-balance sheet arrangements or guarantees of third party
obligations at June 30, 2006.
INFLATION
The Company believes that inflation has not had a significant impact on
operations since inception.
ITEM 3. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we have evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures under the supervision and with the participation of our chief
executive officer ("CEO") and chief financial officer ("CFO"). Based on this
evaluation, our management, including the CEO and CFO, concluded that our
disclosure controls and procedures were not effective at June 30, 2006.
During the quarter ended June 30, 2006, there were no changes in our internal
controls over financial reporting that materially affected, or are reasonably
likely to materially affect, internal controls over financial reporting.
In connection with the audit of our financial statements for the fiscal year
ended December 31, 2005 and the quarterly review for the period ended June 30,
2006, our independent registered public accounting firm informed us that we have
significant deficiencies constituting material weaknesses as defined by the
standards of the Public Company Accounting Oversight Board. The material
weaknesses were in our internal controls over accounting for non-routine
transactions as well as in overall financial reporting functions. The accounting
firm noted that adequate segregation of duties do not exist in our financial
reporting process, as our President and CEO also functioned as our CFO. The
President performed these duties with assistance from a part time consultant.
Accordingly, the preparation of financial statements and the related monitoring
controls surrounding this process were not segregated.
In order to address the weakness identified by our outside accounting firm,
subsequent to June 30, 2006, we hired a full-time Chief Financial Officer to
oversee and manage the accounting and financial reporting functions.
17
PART II
ITEM 6. EXHIBITS
Exhibit
Number Description
------- -----------
31.1 Certification of CEO pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
31.2 Certification of CFO pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
32.1 Certification of CEO Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
32.2 Certification of CFO Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on behalf by the undersigned
thereunto duly authorized.
HOUSTON AMERICAN ENERGY CORP.
By: /s/ John Terwilliger
John Terwilliger
CEO and President
By: /s/ James Jacobs
James Jacobs
Chief Financial Officer
Date: August 14, 2006
18