-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ab1TxQlp0+f3yzhTcGcjAXg4SDgEeXl/ak7ieH1uJ0uoK+hQ1BALyUK65AURp7sR 7tC0xmPKml3Esd4dQ2pHcA== 0000950129-96-001052.txt : 19960529 0000950129-96-001052.hdr.sgml : 19960529 ACCESSION NUMBER: 0000950129-96-001052 CONFORMED SUBMISSION TYPE: SB-2 PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 19960528 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: MIDCOAST ENERGY RESOURCES INC CENTRAL INDEX KEY: 0000276327 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 760378638 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: SB-2 SEC ACT: 1933 Act SEC FILE NUMBER: 333-04643 FILM NUMBER: 96573266 BUSINESS ADDRESS: STREET 1: 1100 LOUISIANA STE 3030 CITY: HOUSTON STATE: TX ZIP: 77002 BUSINESS PHONE: 7136508900 MAIL ADDRESS: STREET 1: 1100 LOUISANA STREET 2: SUITE 3030 CITY: HOUSTON STATE: TX ZIP: 77002 FORMER COMPANY: FORMER CONFORMED NAME: NUGGET OIL CORP DATE OF NAME CHANGE: 19920703 SB-2 1 MIDCOAST ENERGY RESOURCES, INC. - SB-2 1 As filed with the Securities and Exchange Commission on May 28, 1996 Registration No. 333- ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------- FORM SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------------- MIDCOAST ENERGY RESOURCES, INC. (Name of small business issuer in its charter) NEVADA 4922 76-0378638 (State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer of Classification Code Number) Identification No.) incorporation or organization)
1100 LOUISIANA, SUITE 2950 HOUSTON, TEXAS 77002 PHONE: (713) 650-8900 FAX: (713) 650-3232 (Address and telephone number of principal executive office and principal place of business) DAN C. TUTCHER PRESIDENT AND CHIEF EXECUTIVE OFFICER MIDCOAST ENERGY RESOURCES, INC. 1100 LOUISIANA, SUITE 2950 HOUSTON, TEXAS 77002 PHONE: (713) 650-8900 FAX: (713) 650-3232 (Name, address and telephone number of agent for service) --------------------- Copies to: ROBERT G. REEDY, ESQ. HENRY I. ROTHMAN, ESQ. PORTER & HEDGES, L.L.P. PARKER CHAPIN FLATTAU & KLIMPL, L.L.P. 700 LOUISIANA, 35TH FLOOR 1211 AVENUE OF THE AMERICAS HOUSTON, TEXAS 77002-2764 NEW YORK, NEW YORK 10036 PHONE: (713) 226-0600 PHONE: (212) 704-6000 FAX: (713) 228-1331 FAX: (212) 704-6288
--------------------- Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective. If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. / / --------------------- CALCULATION OF REGISTRATION FEE
================================================================================================ PROPOSED PROPOSED AMOUNT MAXIMUM MAXIMUM AMOUNT OF TITLE OF EACH CLASS OF TO BE OFFERING PRICE AGGREGATE REGISTRATION SECURITIES TO BE REGISTERED REGISTERED PER SHARE(1) OFFERING PRICE FEE - ------------------------------------------------------------------------------------------------ Common Stock(2)................... 1,150,000 $11.00 $12,650,000 $4,362.07 - ------------------------------------------------------------------------------------------------ Representative's Warrants(3)(4)... -- -- -- (5) - ------------------------------------------------------------------------------------------------ Common Stock Underlying Representative's Warrants(4).... 100,000 $13.20 $1,320,000 $455.17 - ------------------------------------------------------------------------------------------------ TOTAL................... $4,817.24 ================================================================================================
(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(a). (2) Includes a maximum of 150,000 shares that may be issued to the Underwriters pursuant to an over-allotment option. (3) The Representative's Warrants allow the holder to purchase 100,000 shares of Common Stock. (4) The registration statement also covers any additional securities which may become issuable pursuant to anti-dilution provisions of the Representative's Warrants. (5) Pursuant to Rule 457(g), no registration fee is required for the Representative's Warrants. --------------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. ================================================================================ 2 MIDCOAST ENERGY RESOURCES, INC. Cross-reference sheet pursuant to Rule 404(a) of Regulation C
ITEM NUMBER FORM SB-2 CAPTION LOCATION IN PROSPECTUS - ------ ----------------------------------------- ----------------------------------------- 1. Front of Registration Statement and Outside Front Cover Page of Prospectus............................. Facing Page; Outside Front Cover Page of Prospectus 2. Inside Front and Outside Back Cover Pages of Prospectus.......................... Inside Front and Outside Back Cover Pages of Prospectus 3. Summary Information and Risk Factors..... Prospectus Summary; Risk Factors 4. Use of Proceeds.......................... Use of Proceeds 5. Determination of Offering Price.......... Outside Front Cover Page of Prospectus; Underwriting 6. Dilution................................. Dilution 7. Selling Security Holders................. Not applicable 8. Plan of Distribution..................... Outside Front Cover Page of Prospectus; Underwriting 9. Legal Proceedings........................ Legal Proceedings 10. Directors, Executive Officers, Promoters and Control Persons.................... Management; Principal Stockholders 11. Security Ownership of Certain Beneficial Owners and Management.................. Management; Principal Stockholders 12. Description of Securities................ Description of Securities 13. Interest of Named Experts and Counsel.... Not applicable 14. Disclosure of Commission Position on Indemnification for Securities Act Liabilities............................ Not applicable 15. Organization Within Last Five Years...... Business and Properties 16. Description of Business.................. Business and Properties 17. Management's Discussion and Analysis or Plan of Operation...................... Management's Discussion and Analysis of Financial Condition and Results of Operations 18. Description of Property.................. Business and Properties 19. Certain Relationships and Related Transactions........................... Management 20. Market for Common Equity and Related Stockholder Matters.................... Market for the Company's Common Stock; Description of Securities 21. Executive Compensation................... Management 22. Financial Statements..................... Consolidated Financial Statements 23. Changes in and Disagreements With Accountants and Financial Disclosure... Not applicable
3 *************************************************************************** * * * INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A * * REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED * * WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT * * BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE * * REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT * * CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY * * NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH * * SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO * * REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH * * STATE. * * * *************************************************************************** SUBJECT TO COMPLETION -- DATED MAY 28, 1996 PROSPECTUS 1,000,000 Shares MIDCOAST ENERGY RESOURCES, INC. Common Stock --------------------------- ALL OF THE SHARES OF COMMON STOCK OFFERED HEREBY (THE "COMMON STOCK") ARE BEING SOLD BY THE COMPANY. PRIOR TO THIS OFFERING, THERE HAS BEEN NO PUBLIC MARKET FOR THE COMMON STOCK. IT IS CURRENTLY ANTICIPATED THAT THE PUBLIC OFFERING PRICE WILL BE BETWEEN $10.00 AND $11.00 PER SHARE. SEE "UNDERWRITING" FOR A DISCUSSION OF THE FACTORS CONSIDERED IN DETERMINING THE OFFERING PRICE. THE COMPANY INTENDS TO FILE A LISTING APPLICATION FOR ITS COMMON STOCK ON THE NASDAQ STOCK MARKET'S NATIONAL MARKET ("THE NASDAQ NATIONAL MARKET") UNDER THE SYMBOL "MERY." --------------------------- SEE "RISK FACTORS" ON PAGE 7 FOR CERTAIN INFORMATION THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS. --------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ---------------------------
Underwriting Price to Discounts and Proceeds to Public Commissions(1) Company(2) ----------------------------------------------------- Per Share...................................... $ $ $ Total(3)....................................... $ $ $
(1) Does not include additional compensation to Coleman and Company Securities, Inc. (the "Representative") in the form of a non-accountable expense allowance payable to the Representative. In addition, the Company has agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended (the "Securities Act"). See "Underwriting." (2) Before deducting offering expenses payable by the Company, estimated at $465,000, including the Representative's non-accountable expense allowance. (3) The Company has granted the Underwriters a 30-day option to purchase up to 150,000 additional shares of Common Stock on the same terms as set forth above for the purpose of covering over-allotments, if any. If the Underwriters exercise such option in full, the total Price to Public, Underwriting Discounts and Commissions, and Proceeds to Company will be $ , $ , and $ , respectively. See "Underwriting." --------------------------- The Common Stock is offered by the several Underwriters subject to prior sale, when, as and if issued to and accepted by the Underwriters and on the approval of certain legal matters by counsel for the Underwriters, and subject to certain other conditions. It is expected that delivery of certificates representing the securities will be made in New York, New York against payment therefor on or about , 1996. --------------------------- COLEMAN AND COMPANY SECURITIES, INC. NOLAN SECURITIES CORPORATION The date of this Prospectus is , 1996 4 IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED IN THE NASDAQ STOCK MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. AVAILABLE INFORMATION The Company is subject to the information requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and, in accordance therewith, files reports and other information with the Securities and Exchange Commission (the "Commission"). Reports, proxy and information statements filed by the Company with the Commission pursuant to the informational requirements of the Exchange Act may be inspected and copied at the public reference facilities maintained by the Commission, at Room 1024, Judiciary Plaza Building, 450 Fifth Street N.W. Washington, D.C. 20549, and the Regional offices of the Commission: Seven World Trade Center, Suite 1300, New York, New York 10048, and Kluczynskie Federal Building, 230 South Dearborn Street, Room 3190, Chicago, Illinois 60604. Copies of such material may be obtained at prescribed rates from the Public Reference Section of the Commission at Room 1025, Judiciary Plaza Building, 450 Fifth St., N.W. Washington, D.C. 20549. The Company has applied for listing of the Common Stock on The Nasdaq National Market and, if listed, its reports and other Company information will be available for inspection at the offices of Nasdaq, 1735 K Street N.W., Washington, D.C. 20006. The Company has filed with the Commission a Registration Statement on Form SB-2 (the "Registration Statement") under the Securities Act, with respect to the Common Stock offered hereby. This Prospectus, filed as a part of the Registration Statement, does not contain all the information set forth in the Registration Statement and the exhibits and schedules thereto, certain portions of which have been omitted in accordance with the rules and regulations of the Commission. For further information with respect to the Company and the Common Stock offered hereby, reference is made to the Registration Statement and to the exhibits and schedules thereto, which may be inspected at the Commission's offices without charge or copies of which may be obtained from the Commission upon payment of the prescribed fees. Statements made in the Prospectus as to the contents of any contract, agreement or document referred to are not necessarily complete, and in each instance, reference is made to the copy of such contract or other document filed as an exhibit to the Registration Statement, and each such statement is qualified in its entirety by such reference. The Company will provide its stockholders with annual reports containing audited financial statements and interim quarterly reports containing unaudited financial information. The Company will provide without charge to each person who receives a copy of this Prospectus, upon written or oral request of such person, a copy of any of the information that is incorporated by reference in this Prospectus (not including exhibits to the information that is incorporated by reference unless the exhibits are themselves specifically incorporated by reference). Such request should be directed to: Midcoast Energy Resources, Inc., Attn: Dan C. Tutcher, 1100 Louisiana, Suite 2950, Houston, Texas 77002, (713) 650-8900. 2 5 PROSPECTUS SUMMARY The following summary is qualified in its entirety by and should be read in conjunction with the more detailed information and consolidated financial statements and related notes appearing elsewhere in this Prospectus. Unless otherwise indicated, all information in this Prospectus gives effect to a 4.460961 for 1 split in the Company's Common Stock that will be effected immediately prior to the effective date of the Offering and assumes that the Underwriters' over-allotment option is not exercised. For definitions of certain terms used in this Prospectus see "Glossary." THE COMPANY The Company is a rapidly growing pipeline company primarily engaged in the construction, acquisition, disposition, and operation of pipelines for end-users, as well as the transmission and gathering of natural gas and crude oil. Thirty-nine intrastate pipeline systems are owned or operated by the Company in Alabama, Alaska, Kansas, Louisiana, Mississippi, New York, Oklahoma, Tennessee and Texas, with 26 of the Company's pipelines being acquired or constructed since June 1994. Natural gas marketing operations and, to a lesser degree, oil and gas production supplement the Company's pipeline business. The Company's principal growth and business strategy is to acquire or build pipelines to serve the end-user market while also continuing to pursue acquisition and divestiture opportunities in transmission and gathering of natural gas, other hydrocarbons and nonhydrocarbon fluids or gases. The natural gas industry has undergone dramatic change over the past decade largely due to the course of deregulation by the federal government. This has resulted in increased competition in the natural gas industry. The impact of these changes has been particularly felt in the natural gas pipeline industry over the last several years. The key part of this regulatory shift, to ensure a more competitive natural gas market, was the implementation of the Federal Energy Regulatory Commission's ("FERC") Order 636. This order generally opened previously restricted access to interstate pipelines by requiring the operators of such pipelines to "unbundle" their transportation services from their sales services, allowing customers to choose their provider for such services as gathering, storage, and transportation. This unbundling essentially eliminated the pipeline's traditional merchant function and caused a major restructuring of this relationship between the major interstate pipelines and their customers. For the most part, regulators at the state level have followed the FERC's lead and allowed increased competition with local distribution companies ("LDCs"), and allowed the phenomenon of the construction of bypass pipelines to end-users. In addition to the issuance of Order 636, the implementation of more stringent environmental laws, such as the Clean Air Act of 1990 and the Energy Policy Act of 1992, has also affected the overall demand for natural gas by encouraging the use of cleaner burning fuels, such as natural gas. Accordingly, these regulatory changes have impacted the growth in domestic consumption of natural gas which has increased from approximately 16,200 billion cubic feet in 1986 to an estimated 21,600 billion cubic feet in 1995. See "Business and Properties -- Markets and Major Customers." The Company believes that its experience in the strategic location, design, engineering, construction and operation of pipelines, as well as in federal, state and local regulatory matters involving pipelines, makes it well positioned to continue to take full advantage of these changes in the natural gas industry, primarily through aggressively pursuing the industrial end-user market by acquiring and constructing new pipeline systems. The Company is currently one of the few independent companies in the industry which has pursued supplying the industrial end-user market by providing new pipeline connections to this market. As more chemical and manufacturing companies seek alternative natural gas suppliers other than their LDC's, the Company and its personnel will continue to offer the expertise they have gained through their involvement in the regulatory permitting, construction and operation of 15 end-user pipelines reaching customers in six states. The Company will also continue to expand its current market base by working with many of its existing customers, such as Mid-America Pipeline Company ("Mapco"), a publicly traded company, Owens-Corning Fiberglas Corporation ("Owens"), a publicly traded company, and Tyson Foods, Inc. ("Tyson"), a publicly traded company, to provide natural gas service to additional facilities operated by these customers. The Company typically designs its systems to transport greater volumes than needed in the immediate future to provide capacity to accommodate growth in natural gas consumption and production in proximity to the pipeline systems. As a result, the Company believes that under existing conditions, its pipeline systems can 3 6 quickly increase their volumes with little capital expenditure should additional demand develop in these areas. The Company also benefits from lower overhead than major interstate carriers and LDCs and the resultant ability to offer reduced rates which should allow it to compete effectively with entrenched LDCs and gas transmission carriers for their existing and new end-user customers. A secondary impact of these regulatory changes has been an overall consolidation of the gathering and transmission pipeline segments in the industry. These consolidations have resulted in increased opportunities for pipeline acquisitions by the Company as major pipeline companies divest themselves of pipeline systems only incidentally acquired by them in connection with larger acquisitions or as a result of their divestitures of such pipeline systems due to internal changes in their strategic focus. For example, in 1995 and 1996, the Company acquired ownership of, or interests in, 19 pipeline systems, including gathering systems and transmission lines, from major pipeline companies. Moreover, the Company's recent acquisitions of Magnolia Pipeline Company ("Magnolia" or the "Magnolia System"), a former subsidiary of The Williams Companies, Inc. ("Williams"), a publicly traded company, and Five Flags Pipe Line Company ("Five Flags" or the "Five Flags System"), from an affiliate of The Coastal Corporation ("Coastal"), a publicly traded company, the acquisition, by an affiliate, of six pipeline systems from Seahawk Natural Gas Company ("Seahawk"), a wholly-owned subsidiary of Tejas Power Corporation ("Tejas"), a publicly traded company, as well as the acquisition by the Company, through its wholly-owned subsidiary, Magnolia, of ten pipeline systems from Texas Southeastern Gas Gathering Company ("TSGGC") further illustrate the existence of such opportunities in the market place and the Company's ability to rapidly capitalize on them. Not only has the industry trend to consolidate increased the availability of attractive acquisitions in the market place but the overall consolidation in the industry has also presented the Company with advantageous opportunities to sell pipeline systems which the Company owns, such as the Five Flags System and the Tasco Cavasos System, which were divested by the Company on favorable terms. The Company will continue to consider and evaluate such divestiture opportunities as the Company receives favorable offers for their existing systems or assets which are suited to other companys' strategic focus. See "Business and Properties -- Pipeline Construction, Acquisition and Disposition" and "Business and Properties -- Pipeline Systems." The Company's principal executive offices are located at Suite 2950, 1100 Louisiana Street, Houston, Texas 77002, and its telephone number and fax numbers are (713) 650-8900 and (713) 650-3232, respectively. THE OFFERING SECURITIES OFFERED...................... 1,000,000 shares of Common Stock COMMON STOCK OUTSTANDING PRIOR TO THE OFFERING................. 1,500,000 AFTER THE OFFERING.................... 2,500,000(1) USE OF PROCEEDS......................... The Company anticipates that the net proceeds of this offering (the "Offering") will be used for: (i) the purchase of the Olmitos System, (ii) the repayment of interim financing incurred in connection with recent acquisitions, (iii) the repayment of certain outstanding indebtedness, and (iv) working capital including the future acquisition of pipelines and related assets. See "Use of Proceeds." The Nasdaq National Market Symbol....... MERY - --------------- (1) Does not include (i) 100,000 shares of Common Stock issuable upon the exercise of the Representative's Warrants, (ii) 34,349 shares issuable upon exercise of outstanding warrants to purchase Common Stock exercisable at $7.85 per share ("Outstanding Warrants"), (iii) the issuance of up to 200,000 shares of Common Stock reserved for issuance in connection with the Company's stock option plan, or (iv) the issuance of shares of Common Stock on exercise of the over-allotment option granted to the Underwriters. See "Management -- Executive Compensation," "Description of Securities -- Outstanding Warrants," and "Underwriting." 4 7 SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA(1)
THREE MONTHS ENDED MARCH FOR THE YEAR ENDED DECEMBER 31, 31, ----------------------------------------- ------------------------ 1993 1994 1995 1995 1996 ----------- ----------- ----------- ---------- ---------- Statements of Operations Data: Revenues: Gas marketing, transportation and production sales.......... $13,029,421 $14,908,124 $11,529,440 $2,904,840 $5,141,266 Sale of pipeline............ 2,400,000 60,586 4,092,850 -- 22,500 Refined products revenue.... 2,327,258 -- -- -- -- ----------- ----------- ----------- ---------- ---------- Total.................. 17,756,679 14,968,710 15,622,290 2,904,840 5,163,766 ----------- ----------- ----------- ---------- ---------- Cost and Expenses: Cost of natural gas, transportation and production................ 11,796,711 13,462,248 9,907,337 2,502,063 4,326,969 Cost of pipeline sold....... 1,244,217 48,606 1,909,624 -- 2,153 Cost of refined products.... 2,289,103 -- -- -- -- Depreciation, depletion and amortization.............. 264,249 259,440 451,551 85,320 136,328 General and administrative............ 888,965 849,002 784,653 181,809 190,720 ----------- ----------- ----------- ---------- ---------- Total.................. 16,483,245 14,619,296 13,053,165 2,769,192 4,656,170 ----------- ----------- ----------- ---------- ---------- Operating Income............... 1,273,434 349,414 2,569,125 135,648 507,596 Non-operating Expense.......... 455,635 201,689 375,724 70,259 133,914 ----------- ----------- ----------- ---------- ---------- Income before income taxes and cumulative effect of a change in accounting principle................... 817,799 147,725 2,193,401 65,389 373,682 Provision for income taxes..... (52,833) -- -- -- -- Cumulative effect of a change in accounting principle(1)................ -- (120,936) -- -- -- ----------- ----------- ----------- ---------- ---------- Net Income..................... $ 764,966 $ 26,789 $ 2,193,401 $ 65,389 $ 373,682 =========== =========== =========== ========== ========== 5% Cumulative Preferred Stock Dividends................... (59,183) (59,183) (59,183) (14,593) (14,755) ----------- ----------- ----------- ---------- ---------- Net Income (Loss) applicable to Common Shareholders......... $ 705,783 $ (32,394) $ 2,134,218 $ 50,796 $ 358,927 =========== =========== =========== ========== ========== Net Income (Loss) per common share(2): Operations..................... $ 0.52 $ 0.07 $ 1.48 $ 0.04 $ .24 Change in accounting principle................... -- (0.09) -- -- -- ----------- ----------- ----------- ---------- ---------- Net Income per common share.... $ 0.52 $ (0.02) $ 1.48 $ 0.04 $ .24 =========== =========== =========== ========== ========== Weighted average number of common shares outstanding(2).............. 1,362,595 1,393,371 1,442,523 1,405,176 1,468,797 =========== =========== =========== ========== ==========
5 8
DECEMBER 31, MARCH 31, 1996 ---------------------------------------- ---------------------------- 1993 1994 1995 ACTUAL AS ADJUSTED(3) ---------- ----------- ----------- ---------- -------------- Balance Sheet Data: Working capital (deficit)..... $ (392,738) $(1,104,829) $ (98,870) $ (441,129) $ Total assets.................. $6,438,791 $ 7,272,330 $11,088,588 $11,887,041 $ Long-term debt, excluding current portion(4)......... $ 669,560 $ 1,780,771 $ 3,960,769 $3,442,410 $ 1,749,961 Shareholders' equity(5)....... $2,028,809 $ 2,006,555 $ 4,157,436 $4,522,363 $
DECEMBER 31, MARCH 31, -------------------------------------- ---------- 1993 1994 1995 1996 --------- --------- ---------- ---------- Operating Data: Miles of pipeline (end of period)(6).... 39.0 51.1 162.1 247.2 Volumes transported and sold, net (MMBtu)(7)........................... 5,077,538 9,577,787 14,602,371 10,028,755(8) Number of operating systems (end of period)...................... 15 20 21 27
- --------------- (1) The summary historical consolidated financial information for the fiscal years ended December 31, 1993, 1994 and 1995, and for the three month periods ended March 31, 1995 and 1996, set forth above is derived from and should be read in conjunction with the Company's Consolidated Financial Statements and accompanying notes appearing elsewhere in this Prospectus. The data for the three month periods ended March 31, 1995 and 1996 are derived from and qualified by reference to the Company's consolidated financial statements appearing elsewhere herein and, in the opinion of management of the Company includes all adjustments that are of a normal recurring nature and necessary for a fair presentation. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Consolidated Financial Statements." (2) See Note 3 to the Company's "Consolidated Financial Statements." (3) Share amounts have been adjusted for the 4.460961 to 1 stock split which will be completed prior to the effective date of the Offering. (4) As adjusted gives effect to the Offering, the 4.460961 to 1 stock split, the application of the net proceeds of the Offering (assuming a public offering price of $ per share), and the redemption of the Company's 5% cumulative preferred stock for $118,367 in May 1996, but excludes the exercise of the Underwriter's over-allotment option. See "Use of Proceeds," "Capitalization," and "Underwriting." (5) See Note 7 to the Company's "Consolidated Financial Statements." (6) As of December 31, 1995, the Company had net operating loss ("NOL") carryforwards of approximately $15,071,000 expiring in various amounts from 1999 through 2008, and investment tax credit ("ITC") carryforwards of approximately $354,000 which principally expire in 1997. These carryforwards were generated by the Company's predecessor. The Company believes, however, that the amount of the NOL carryforwards will be reduced after consideration of the income generated by the Company for the tax year ending April 30, 1996. The ability of the Company to utilize the carryforwards is dependent upon the Company generating sufficient taxable income and avoiding limitations on the use of such carryforwards due to a change in stockholder control under the Internal Revenue Code. See "Risk Factors -- Limits of Use of Net Operating Losses and Credit Carryovers." (7) Includes all of the miles of pipeline of the various pipelines that the Company owns an interest in or operates. However, such amounts do not include the ten systems comprising 113 miles of pipeline acquired by the Company through its wholly-owned subsidiary, Magnolia, from TSGGC or the Company's two systems presently under construction. (8) Includes only volumes transported or sold through the Company's pipeline systems since the Company's ownership of any system. Transported oil volumes have been converted to an equivalent unit basis which is 6 MMBtu to 1 bbl, consistent with industry standards. (9) Includes only volumes transported or sold through the Company's pipeline systems for the three month period ended March 31, 1996. 6 9 RISK FACTORS In addition to the other information contained in this Prospectus, prospective investors should carefully consider each of the following risk factors in evaluating an investment in the Company. Dependence on Key Systems. The Company derived over 32%, 18% and 14%, respectively, of its operating income for the three month period ended March 31, 1996 from the Magnolia System, Lake Charles System and Cook Inlet System. The loss of operating income from any one of these systems for any appreciable period, whether or not from insured causes, could have an immediate and adverse effect on the Company's business and financial condition. See "Business and Properties -- Pipeline Systems." Acquisition and Construction of Pipelines. The Company has experienced substantial growth since June 1994 due to its acquisition and construction of a number of pipelines. The Company's growth strategy is capital intensive in nature and depends in large measure on its ability to successfully acquire or construct additional pipeline systems. The financial position and results of operations of the Company will depend to a large extent on the Company's ability to integrate these acquired operations effectively and to realize expected efficiencies and economies of scale. There can be no assurance that the Company's efforts to integrate these acquired operations will be effective, or that expected efficiencies and economies of scale will be realized. Failure to effectively integrate acquired operations could have a material adverse effect on the Company's future results of operations. As the Company continues to pursue its acquisition and construction strategy in the future, its financial position and results of operations may fluctuate significantly from period to period. See "Business and Properties -- Business Growth and Strategy" and "Business and Properties -- Pipeline Construction, Acquisition and Disposition." Reliance on Officers, Directors and Key Employees. The Company is dependent on the services of certain key management personnel, the loss of whose services could have a material adverse effect on the Company. In particular, the Company depends on the services of Dan C. Tutcher, Chairman and Chief Executive Officer, Richard A. Robert, Chief Financial Officer and Treasurer, and I. J. Berthelot, II, Vice President of Operations and Chief Engineer. Although the Company has entered into employment contracts with Mr. Tutcher, Mr. Robert and Mr. Berthelot, there can be no assurance that any of these persons will remain employed by the Company, or that these persons will not participate in businesses that compete with the Company in the future. In seeking qualified personnel, the Company will be required to compete with companies having greater financial and other resources than the Company. Since the Company's future success will be dependent on its ability to attract and retain qualified personnel, the inability to do so could have a materially adverse affect on its business. See "Management." Limits of Use of Net Operating Losses and Credit Carryovers. As of December 31, 1995, the Company had NOL carryforwards of approximately $15,071,000 expiring in various amounts from 1999 through 2008, and ITC carryforwards of approximately $354,000 which principally expire in 1997. These NOLs were generated by the Company's predecessor. The Company believes, however, that the amount of the NOL carryforwards will be reduced after consideration of the income generated by the Company for the tax year ending April 30, 1996. The ability of the Company to utilize the carryforwards is dependent upon the Company generating sufficient taxable income and avoiding limitations on the use of such carryforwards due to a change in stockholder control under the Internal Revenue Code. The Offering is not expected to result in a limitation on the Company's annual use of its NOL and credit carryovers under Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"). However, the Company's future issuances of equity securities beyond the requirements of the Offering could trigger such a limitation, which might allow all or a material part of such carryovers to expire unused. Thus, there is no assurance that the Company will be able to utilize its NOL and credit carryovers prior to expiration, due to the lack of sufficient income to absorb such carryovers, a future limitation under Section 382 of the Code, or both. Hazards and Operating Risks of Pipeline Operations. The Company's operations are subject to the many hazards inherent in the natural gas transmission industry. These include damage to pipelines, related equipment and surrounding properties caused by hurricanes, floods, fires and other acts of God, inadvertent damage from construction and farm equipment, leakage of natural gas and other hydrocarbons, fires and explosions, and other hazards that could also result in personal injury and loss of life, pollution and suspension 7 10 of operations. The Company maintains such insurance protection as it believes to be adequate against normal risks in its operations. There is no assurance that any such insurance protection will be sufficient or effective under all circumstances or against all hazards to which the Company may be subject. The occurrence of a significant event not fully insured against could materially and adversely affect the Company's operations and financial condition. Moreover, no assurance can be given that the Company will be able to maintain adequate insurance in the future at rates it considers reasonable. See "Business and Properties -- Insurance." Should catastrophic conditions occur which interrupt delivery of gas for any reason, such occurrence could have a material impact on the profitability of the Company's operations. See "Business and Properties -- Markets and Major Customers." Risks of Inadequate Gas Supplies. While the Company considers its gas supplies adequate, it has historically purchased substantially all of its gas from unaffiliated third parties. These purchase contracts may be affected by factors beyond both the Company's and the gas suppliers' control such as capacity restraints, temporary regional supply shortages, and with regard to its gathering systems, other parties having control over the drilling of new wells, inability of wells to deliver gas at required pipeline quality and pressure, and depletion of reserves. The future performance of the Company will depend to a great extent on the throughput levels achieved by the Company with respect to its existing pipelines and the pipelines acquired or constructed by it in the future. In order to maintain its throughput at currently adequate levels, the Company must access new natural gas supplies to offset the natural decline in reserves as such supplies are utilized. See "Business and Properties -- Gas Supply." Risks of Competition from Larger Competitors. The Company's competitors include major integrated oil companies, affiliates of major interstate and intrastate pipelines and national and local natural gas gatherers, brokers, marketers and distributors. Many of these competitors, particularly those affiliated with major integrated oil and interstate and intrastate pipeline companies, have financial resources substantially greater than those of the Company and have access to supplies of natural gas substantially greater than those available to the Company. See "Business and Properties -- Competition." Risk of Adverse Price Changes or Gas Imbalancing on Gas Marketing Operations. The Company buys natural gas on the spot market for customers served by pipeline systems owned by the Company and for sales to those customers. Generally, gas is purchased under contracts that contain terms allowing prices to be determined by prevailing market conditions. Concurrently, the Company resells the gas at higher prices under sales contracts which are compatible as to term, price escalation, renegotiation and other material matters. The Company earns the difference between the gas purchase price it pays and the sales price it receives. Gas marketing is characterized by a high degree of competition and narrow margins. The profitability of the natural gas marketing operations of the Company depends in large part on the ability of the Company's management to assess and respond to changing market conditions in negotiating these natural gas purchase and sales agreements. As a consequence of the increase in competition in the industry and volatility of natural gas prices there has been a reluctance of end-users to enter into long-term purchase contracts. Moreover, consumers have shown an increased willingness to switch fuels between gas and oil in response to relative price fluctuations in the market. To adapt there has been a growing use of gas purchase contracts that require price adjustments in response to market conditions. The inability of management to respond appropriately to changing market conditions could have a negative effect on the Company's profitability. The Company's gas marketing activities which utilize third-party transporters also exposes the Company to economic risk resulting from imbalances or nominated volume discrepancies which can result either in penalties having a negative impact on earnings or a transaction gain, depending on how and when imbalances are corrected. See "Business and Properties -- Markets and Major Customers." Risks of Changes in Government Regulation and Continuing Industry Transition. Recent changes in the regulatory environment for the natural gas transportation industry, most notably FERC Order 636, have profoundly affected the economics and structure of the natural gas transmission industry, and may continue to do so in the future. The Company believes these regulatory changes have created and will continue to create significant opportunities for marketing-oriented independent gas pipeline companies such as the Company. There can be no assurance that such evolution will ultimately result in greater opportunities for smaller gas pipeline companies. Although FERC's present intention, as promulgated in Order 636, is to stimulate industry 8 11 competition and to create a level playing field for all natural gas buyers and sellers, there can be no assurance that such regulations will be effective in meeting these goals. Moreover, FERC could issue new regulations which may subject the Company or some portion of the Company's business activity to FERC regulation or adversely affect the conduct of the Company's business. The construction, operation, maintenance and safety of the Company's pipelines are typically regulated by the state regulatory commissions with jurisdictional authority. As in the case of potential federal regulatory changes, there can be no assurances that state regulatory measures will not adversely affect the Company's business and financial condition. In such events, the state's regulatory authorities could temporarily suspend or hinder operations in a particular state, depending on the authority's view of its jurisdiction. Although, regulators at the state level have generally followed the FERC's lead by allowing increased competition behind LDCs, there can be no assurance that every state will follow this practice without the pressure of litigation. See "Business and Properties -- Government Regulation." Risks of Liabilities and Costs Under Environmental Laws. The Company is subject to federal, state and local laws, regulations and ordinances relating to the environment, health and safety, waste management, and transportation of hydrocarbons and chemical products. Various governmental authorities have the power to enforce compliance with these regulations and the permits issued pursuant to them, and violators are subject to civil and criminal penalties, including civil fines, injunctions, or both. Private parties, including the owners of property through which the Company's pipelines pass, may also have the right to pursue legal actions to enforce compliance and seek damages for noncompliance with environmental laws and regulations. The Company will make expenditures in connection with environmental matters as part of its normal operations and capital expenditures and the possibility exists that stricter laws, regulations or enforcement policies could significantly increase the Company's compliance costs and the cost of any remediation which may become necessary. Moreover, as with other companies engaged in similar businesses, there is inherent risk of environmental costs and liabilities in the Company's business due to its handling of oil, gas and petroleum products, and there can be no assurance that material environmental costs and liabilities will not be incurred by the Company. Furthermore, there can be no assurance that the Company's environmental impairment insurance will provide sufficient coverage in the event an environmental claim were made against the Company. An uninsured or underinsured claim of sufficient magnitude could have a material adverse effect on the Company's financial condition. See "Business and Properties -- Government Regulation" and "Business and Properties -- Insurance." Payment of Dividends. The Company has historically paid dividends on its 5% cumulative preferred stock which was redeemed in May 1996, but has not paid dividends on its Common Stock since its inception. The Board of Directors (the "Board") intends to declare a dividend of $.08 per share of Common Stock for the first fiscal quarter after the completion of the Offering. While it is the intention of the Board to continue to pay a quarterly dividend, the ability of the Company to pay regular quarterly dividends will depend on the earnings and financial condition of the Company, and payment of future dividends may be restricted by the Company's financial condition and the Company's credit agreements. Therefore, there can be no assurances that future dividends will be paid. Under the Company's revolving line of credit with Compass Bank, N.A. ("Compass"), Magnolia is precluded from declaring or making dividend payments unless consent is obtained by Compass. Except for Compass' line of credit restriction on one of the Company's subsidiaries, there are no other restrictions, contractual or otherwise, on the Company's right to declare and pay dividends to the holders of Common Stock in accordance with applicable state laws. The Company had $706,493 of unrestricted cash as of March 31, 1996, which management believes was available as of such date for the payment of dividends. See "Dividend Policy," and "Description of Securities -- Common Stock." No Assurance of Market for Common Stock; Arbitrary Offering Price. There has been no public market for the Common Stock before this Offering. The Company has applied for a listing of the Common Stock on The Nasdaq National Market. There can be no assurance as to the liquidity of any markets that may develop for the Common Stock, or the price at which holders may be able to sell Common Stock. The public offering price of the Common Stock was determined by negotiations between the Company and the Representative and may not be indicative of the prices that may prevail in the public market. The factors considered in determining the public offering price and such terms, in addition to prevailing market conditions, were the 9 12 history of and prospects for the industry in which the Company competes, the market for the Company's Common Stock, an assessment of the Company's management, the prospects of the Company, and the demand for similar securities of comparable companies. See "Market for the Company's Common Stock" and "Underwriting." Control by Certain Stockholders. Prior to the Offering, approximately 86.4% of the Common Stock is owned by members of the Board, officers or their affiliates. All such stockholders, if they vote together, will likely be able to influence the outcome of all matters submitted to a vote of the Company's stockholders. See "Description of Securities," "Shares Eligible for Future Sale" and "Underwriting." Representative's Warrants. The Company will sell to the Representative, for nominal consideration, warrants to purchase up to an amount equal to 10% of the total number of shares of Common Stock sold in this Offering for a period of four years, commencing 18 months from the effective date of the Registration Statement, at an exercise price of 120% of the public offering price per share of Common Stock. The holders of the Representative's Warrants are likely to exercise or convert them at a time when the Company would be able to obtain additional equity capital on terms more favorable than those provided by such Representative's Warrants. The Representative's Warrants also grant to the holders certain demand registration rights and "piggy back" registration rights. These obligations may hinder the Company's ability to obtain future financing. See "Underwriting." Shares Eligible for Future Sale. A substantial number of outstanding shares of Common Stock and shares of Common stock issuable upon exercise of Outstanding Warrants will become eligible for future sale in the public market at prescribed times. Sales of significant amounts of Common Stock in the public market following this Offering could adversely affect prevailing market prices. Holders of approximately 92% of the outstanding Common Stock and the Company (including all officers and directors of the Company), have agreed not to sell such shares for 18 months after the date of this Prospectus. Upon the expiration of such agreements, approximately 1,352,530 shares will be eligible for sale pursuant to Rule 144 under the Securities Act and 32,697 and 4,014 shares will be eligible for sale pursuant to Rule 144 after 24 and 30 months, respectively, from the date of this Prospectus. Additionally, holders of 110,759 shares of Common Stock not subject to such lockup agreements may be sold pursuant to Rule 144 or 144(k) under the Securities Act. See "Description of Securities" and "Underwriting." Dilution. Purchasers of shares of Common Stock offered hereby will incur immediate and substantial dilution of $4.72 per share in the net tangible book value of their investments. See "Dilution." [BALANCE OF THIS PAGE INTENTIONALLY LEFT BLANK] 10 13 USE OF PROCEEDS The estimated net proceeds to the Company after deducting underwriting commissions and the other expenses of this Offering will be approximately $ (or $ if the Underwriter's over-allotment option is exercised in full). The Company expects to apply these proceeds approximately as follows:
APPLICATION AMOUNT ------------------------------------------------------------------------- ---------- Purchase of Olmitos System -- See "Business and Properties -- Pipeline Construction, Acquisition and Disposition"............................. $ 707,000 Repayment of interim financing obtained in connection with recent acquisitions(1)........................................................ 943,000 Repayment of certain outstanding indebtedness(2)......................... 1,900,000 Working capital including any future acquisition of pipelines and related assets................................................................. ---------- Total.......................................................... $ ==========
- --------------- (1) The interim financing includes: (i) $343,000 of debt incurred in connection with the Company's construction costs of both the South Fulton System in Obion County, Tennessee and the Power Paper System in Roane County, Tennessee. The note payable to a bank bears interest at the prime rate plus 1% and is payable in 60 monthly installments of $7,185 including accrued interest beginning August 15, 1996 with a final maturity of July 15, 2001. The note is secured by an assignment of revenues from both the Power Paper and South Fulton Systems, with a negative pledge on the systems. (ii) $100,000 of debt incurred in connection with the Company's equity contribution in March 1996 to Pan Grande Pipeline L.L.C. ("Pan Grande") evidenced by a note payable to Rainbow Investments Company, a Texas corporation ("Rainbow") which is controlled by Stevens G. Herbst, a director of the Company. The note, as amended, bears interest at the prime rate plus 2.5% and is payable in 59 installments of $1,667 and accrued interest and a final installment at March 15, 2001 in the amount of the remaining principal plus accrued interest then outstanding and unpaid. The note is secured by the Company's interest in Pan Grande. See "Management -- Certain Transactions." (iii) $150,000 to repurchase the 5% net revenue interest in Magnolia's earnings before interest, income taxes and depreciation granted to Rainbow in connection with financing provided by Rainbow to the Company for the Company's acquisition of Magnolia. See "Management -- Certain Transactions." (iv) $350,000 of debt incurred in connection with Magnolia's acquisition of ten gas gathering systems from TSGGC in May 1996. See "Business and Properties -- Pipeline Construction, Acquisition and Disposition." The funds were obtained by amending the Company's existing credit facility with a bank to reflect an increase in availability from $1,428,560 to $1,778,560. The credit facility, as amended, provides for a $23,000 monthly reduction in the amount of available credit. Interest accrues at the prime rate plus 1%. Upon maturity at January 15, 1999, the balance of principal plus accrued interest then remaining outstanding is payable in full. The credit facility is secured by a $50,000 certificate of deposit and all of Magnolia's stock. (2) The Company anticipates repayment of the following outstanding indebtedness: (i) Note payable to a bank entered into in October 1994 under a term loan bearing interest at the bank's prime rate plus 1% (9.25% at March 31, 1996); principal and accrued interest are payable in 59 monthly installments of $6,915 with a final estimated payment at maturity of $8,364 on October 13, 1999; note secured by the Quindaro System's transportation revenues. The estimated balance to be repaid from proceeds of the Offering approximates $259,073. (ii) Note payable to a bank entered into in November 1994, and amended in 1995 and 1996, under a term loan bearing interest at the bank's prime rate plus 1% (9.25% at March 31, 1996); principal of $3,438 and accrued interest are payable in monthly installments, with a final lump sum payment of the remaining unpaid principal due on February 15, 1998; note secured by the Albany System's transportation revenue. The estimated balance to be repaid from proceeds of the Offering approximates $110,000. 11 14 (iii) Note payable to a bank entered into in December 1994 under a term loan bearing interest at the bank's prime rate plus 1.5% (9.75% at March 31, 1996); principal of $27,778 and accrued interest are payable in 35 monthly installments, with a final payment due at maturity of $27,998 plus accrued interest on December 15, 1997; note secured by the Cook Inlet System's transportation revenues. The estimated balance to be repaid from proceeds of the Offering approximates $583,375. (iv) Revolving credit line with a bank entered into in October 1995 under a $1.25 million reducing promissory note bearing interest at the bank's prime rate plus 1.5% (9.75% at March 31, 1996). Available credit is reduced monthly by $20,833 beginning December 1, 1995. Accrued interest and any principal amounts as may be required to cause the outstanding principal to not exceed the amount of credit then available are payable monthly, with a final maturity of November 1, 1998; note secured by transportation revenues on eight of the Company's pipeline systems. The estimated balance to be repaid from proceeds of the Offering approximates $607,504 after which an outstanding principal balance of $500,000 will remain under this revolving credit line. (v) Note payable to Texline Gas Company, a Texas corporation ("Texline"), which is controlled by Stevens G. Herbst and Kenneth B. Holmes, Jr., directors of the Company, entered into in December 1994, and as amended, bears interest at the Mercantile Bank, Corpus Christi prime rate plus 1.5% (10.75% at March 31, 1996); accrued interest is payable monthly and principal and remaining accrued interest are due in full at maturity on April 1, 1997; note is unsecured. The proceeds of such indebtedness were used by the Company for general corporate purposes including the repayment of indebtedness associated with project financings for the construction of certain pipeline systems and for various pipeline system acquisitions. The estimated balance to be repaid from proceeds of the Offering approximates $200,000. See "Management -- Certain Transactions." (vi) Note payable to Texline, entered into in May 1995, and amended in March 1996 bearing interest at the Mercantile Bank, Corpus Christi prime rate plus 1% (10.25% at March 31, 1996); monthly payments equal to 25% of the net revenue derived from the Exxon oil and gas production acquisition. Any remaining principal and accrued interest is due in full at maturity on April 1, 1997. The proceeds of such indebtedness were used by the Company for the acquisition of the Exxon oil and gas production property located in Starr County, Texas. The estimated balance to be repaid from proceeds of the Offering approximates $173,822. See "Management -- Certain Transactions." The Company continues to evaluate numerous projects for development or acquisition, however, at the present time, it does not have any understandings or agreements with respect to any such projects other than those noted above. Accordingly, the actual application of the remaining proceeds of this Offering will be subject to the continuing evaluation of such opportunities and the Company's determination of the best use of such proceeds which will likely include the construction or acquisition of new end-user, gathering or transmission pipelines. Exact allocation of the proceeds for such purposes and timing of the expenditures will vary depending on numerous factors, including the ability to identify systems for acquisition or construction meeting the Company's financial and operating criteria, purchasing those systems at acceptable prices, the cost and timing of governmental approvals to conduct operations, the Company's ability to design and complete construction of pipelines in a timely manner without material cost overruns, the terms of any collaborative arrangements entered into by the Company and the status of competition in the market. Such expenditures are likely to be substantial and to exceed the proceeds of this Offering. Accordingly, the Company may find it necessary or advisable to reallocate some of the proceeds within the above-described categories or to use portions thereof for other purposes. Pending ultimate application, the net proceeds will be invested in interest-bearing securities issued or guaranteed by the U.S. government or its agencies. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Capital Resources and Liquidity." 12 15 MARKET FOR THE COMPANY'S COMMON STOCK The Company is a successor to Nugget Oil Corporation ("Nugget") which was traded on The Nasdaq National Market until October 30, 1986 when Nugget's stock was delisted from The Nasdaq National Market. See "Business and Properties -- General." There has been no market for the Company's Common Stock since October 30, 1986. The public offering price of the Common Stock was determined by negotiations between the Company and the Representative and may not be indicative of the prices that may prevail in the public market. The factors considered in determining the public offering price and such terms, in addition to prevailing market conditions, were the history of and prospects for the industry in which the Company competes, the market for the Company's Common Stock, an assessment of the Company's management, the prospects of the Company, and the demand for similar securities of comparable companies. The Company intends to apply for a listing of its Common Stock on The Nasdaq National Market under the symbol "MERY," on the effectiveness of the Offering. Despite the increase in the number of shares of Common Stock to be publicly held as a result of this Offering, there can be no assurance that trading in the Common Stock will develop. See "Risk Factors -- No Assurance of Market For Common Stock." DIVIDEND POLICY The Company has historically paid dividends on its 5% cumulative preferred stock, which was redeemed in May 1996, but has never paid dividends on its Common Stock. However, holders of shares of Common Stock are entitled to receive cash dividends out of funds of the Company legally available therefor, subject to the qualification that dividends need not be declared or paid by the Board if to do so would be in violation of law or of restrictions under contractual arrangements (including credit agreements) to which the Company is, or may hereafter become, a party. The Board intends to declare a dividend of $.08 per share of Common Stock for the first fiscal quarter after the completion of the Offering. While it is the intention of the Board to continue to pay a quarterly dividend, the ability of the Company to pay regular quarterly dividends will depend on the earnings and financial condition of the Company, and payment of future dividends may be restricted by the Company's financial condition and the Company's credit agreements. Therefore, there can be no assurances that future dividends will be paid. Under the Company's revolving line of credit with Compass, Magnolia is precluded from declaring or making dividend payments unless consent is obtained by Compass. Except for Compass' line of credit restriction on Magnolia, there are no other restrictions, contractual or otherwise, on the Company's right to declare and pay dividends to the holders of Common Stock in accordance with applicable state laws. The Company had $706,493 of unrestricted cash as of March 31, 1996, which management believes was available as of such date for the payment of dividends. See "Risk Factors -- Payment of Dividends." [BALANCE OF THIS PAGE INTENTIONALLY LEFT BLANK] 13 16 DILUTION The net tangible book value of the Company's Common Stock at March 31, 1996 was $4,176,084 or $2.84 per share. Net tangible book value per share represents the total tangible assets of the Company reduced by its total liabilities and divided by the number of outstanding shares of Common Stock after giving effect to the 4.460961 for 1 stock split of the outstanding Common Stock. After giving effect to the sale of the Common Stock offered hereby (assuming a public offering price of $10.00 per share and no exercise of the over-allotment option), the 4.460961 to 1 stock split, and the redemption of the Company's 5% cumulative preferred stock in May 1996 for $118,367, the as adjusted net tangible book value of the Common Stock at March 31, 1996 would have been $5.28 per share. This represents an immediate increase in net tangible book value of $2.44 per share to existing holders of Common Stock and an immediate dilution of $4.72 per share to new investors purchasing shares of Common Stock in this Offering. "Dilution per share" represents the difference between the price per share of Common Stock sold in this Offering, and the as adjusted net tangible book value per share at March 31, 1996. The following table illustrates the dilution per share described above: Assumed public offering price per share.................................... $10.00 Net tangible book value per share at March 31, 1996............ $2.84 Increase attributable to purchases of Common Stock by new investors..................................................... 2.44 ----- As adjusted net tangible book value at March 31, 1996 after giving effect to this Offering, the stock split, and redemption of 5% cumulative preferred stock.......................................................... 5.28 ------ Dilution to new investors.................................................. $ 4.72 ======
Utilizing the foregoing assumptions, the following table summarizes on a pro forma basis, at March 31, 1996, the number of shares purchased from the Company, the total consideration paid to the Company and the average price per share paid by existing holders of Common Stock and by new investors purchasing shares of Common Stock in this Offering.
SHARES PURCHASED TOTAL CONSIDERATION -------------------- --------------------- AVERAGE PRICE POSITION NUMBER PERCENT AMOUNT PERCENT PER SHARE - ----------------------------------------- --------- ------- ---------- ------- ------------- Existing Stockholders.................... 1,470,141(1) 60% $1,201,765(2) % $ .82 New Investors............................ 1,000,000 40% $ --------- --- ---------- --- ---- Total.......................... 2,473,120 100% $ 100% ========= === ========== === ====
- --------------- (1) Share number represents the outstanding shares of Common Stock at March 31, 1996, as adjusted for the 4.460961 to 1 stock split, which will be completed prior to the effective date of the Offering. (2) Amount represents total consideration paid by existing stockholders, in cash, property or services rendered, including $95,414 in notes payable forgiven or converted to Common Stock pursuant to Nugget's plan of reorganization and as adjusted for a deduction of the cash payment of $118,367 in May 1996 for the redemption of the 5% cumulative preferred stock. This amount does not include consideration paid by the original Nugget stockholders prior to Nugget's plan of reorganization. See "Business and Properties -- General." The foregoing tables assume that (i) the Underwriters do not exercise their over-allotment option, (ii) Outstanding Warrants and the Representative's Warrants are not exercised, and (iii) none of the 200,000 shares of Common Stock reserved for issuance in connection with the Company's stock option plan are issued. New investors purchasing shares of Common Stock will experience further dilution as a result of the exercise of any such options or warrants. See "Management -- Executive Compensation," "Description of Securities -- Outstanding Warrants" and "Underwriting." 14 17 CAPITALIZATION The following table sets forth (a) the capitalization of the Company as of March 31, 1996; and (b) the adjusted capitalization of the Company after giving effect to (i) the issuance and sale of 1,000,000 shares of the Company's Common Stock pursuant to this Offering (but no exercise of the over-allotment option); (ii) the effect of a 4.460961 to 1 stock split to be effected immediately prior to the effective date of the Offering; (iii) the receipt of the estimated $ in net proceeds of this Offering; and (iv) the redemption of the 5% cumulative preferred stock in May 1996 for $118,367. This table should be read in conjunction with "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations," and "Consolidated Financial Statements."
AS OF MARCH 31, 1996 ----------------------------- ACTUAL AS ADJUSTED ------------ ------------ LONG-TERM DEBT PAYABLE(1): Long-term notes payable to banks.............................. $ 2,988,588 $ 1,749,961 Shareholders and affiliates................................... 453,822 -- ------------ ------------ Total......................................................... $ 3,442,410 $ 1,749,961 ------------ ------------ SHAREHOLDERS' EQUITY(2): 5% Cumulative Preferred Stock; $1.00 par value; 1,000,000 shares authorized; 200,000 shares issued and outstanding ($1,183,665 liquidation preference)(3)..................... $ 200,000 $ -- Common Stock, $.01 par value; 6,000,000 shares authorized; 1,470,141 shares issued and outstanding, 2,500,000 issued and outstanding as adjusted(4)(5).......................... 14,701 25,000 Paid-in capital............................................... 18,830,637 -- Accumulated deficit........................................... (14,416,175) (14,416,175) Unearned compensation......................................... (106,800) (106,800) ------------ ------------ Total shareholders' equity.................................... $ 4,522,363 $ -- ------------ ------------ Total capitalization.................................. $ 7,964,773 $ -- ============ ============
- --------------- (1) See Note 7 to the Company's "Consolidated Financial Statements." (2) See Note 10 to the Company's "Consolidated Financial Statements." (3) In May 1996, all shares of the 5% cumulative preferred stock were redeemed by the Company for $118,367. Subsequent to the redemption of the 5% cumulative preferred stock, a majority of the stockholders approved an amendment to the Articles of Incorporation to reflect only one class of outstanding securities, the Company's Common Stock. (4) In May 1996, a majority of the stockholders approved an amendment to the Articles of Incorporation to increase the authorized number of shares of Common Stock, $.01 par value to 10,000,000 shares of Common Stock, $.01 par value. (5) Share number represents the outstanding shares of Common Stock at March 31, 1996, as adjusted for the 4.460961 to 1 stock split, which will be completed prior to the effective date of the Offering. 15 18 SELECTED FINANCIAL DATA The selected historical consolidated financial information for the fiscal years ended December 31, 1993, 1994 and 1995, and for the three month periods ended March 31, 1995 and 1996, set forth below is derived from and should be read in conjunction with the Company's consolidated financial statements and accompanying notes appearing elsewhere in this Prospectus. The data for the three month periods ended March 31, 1995 and 1996 are derived from and qualified by reference to the Company's consolidated financial statements appearing elsewhere herein and, in the opinion of management of the Company includes all adjustments that are of a normal recurring nature and necessary for a fair presentation.
THREE MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31, MARCH 31, ----------------------------------------- ------------------------ 1993 1994 1995 1995 1996 ----------- ----------- ----------- ---------- ---------- STATEMENT OF OPERATIONS DATA: Revenues.................... $17,756,679 $14,968,710 $15,622,290 $2,904,098 $5,163,766 Operating Expenses.......... 16,483,245 14,619,296 13,053,165 2,769,192 4,656,170 ----------- ----------- ----------- ---------- ---------- Operating Income............ $ 1,273,434 $ 349,414 $ 2,569,125 $ 135,648 $ 507,596 =========== =========== =========== ========== ========== Net Income.................. $ 764,966 $ 26,789 $ 2,193,401 $ 65,389 $ 373,682 =========== =========== =========== ========== ==========
DECEMBER 31, MARCH 31, ---------------------------------------- ----------- 1993 1994 1995 1996 ---------- ----------- ----------- ----------- BALANCE SHEET DATA: Working capital deficit................. $ (392,738) $(1,104,829) $ (98,870) $ (441,129) Property and equipment, net............. $2,780,325 $ 4,994,416 $ 8,206,161 $ 8,171,207 Total assets............................ $6,438,791 $ 7,272,330 $11,088,508 $11,887,041 Long-term debt, net of current portion(1)........................... $ 669,560 $ 1,780,771 $ 3,960,769 $ 3,442,410 Shareholders' equity(2)................. $2,028,809 $ 2,006,555 $ 4,157,436 $ 4,522,363
- --------------- (1) See Note 7 to the Company's "Consolidated Financial Statements." (2) As of December 31, 1995, the Company had NOL carryforwards of approximately $15,071,000 expiring in various amounts from 1999 through 2008, and ITC carryforwards of approximately $354,000 which principally expire in 1997. These loss carryforwards were generated by the Company's predecessor. The Company believes, however, that the amount of the NOL carryforwards will be reduced after consideration of the income generated by the Company for the tax year ending April 30, 1996. The ability of the Company to utilize the carryforwards is dependent upon the Company generating sufficient taxable income and avoiding limitations on the use of such carryforwards due to a change in stockholder control under the Code. See "Risk Factors -- Limits of Use of Net Operating Losses and Credit Carryovers." 16 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with "Selected Financial Data" and the Company's "Consolidated Financial Statements" and the notes thereto, included elsewhere herein. GENERAL Since its formation the Company has grown significantly as a result of the construction and acquisition of new pipeline facilities. The Company's long term strategy is to continue this expansion by capitalizing on changing regulatory and industry dynamics to construct or acquire new end-user, gathering and transmission pipelines, market natural gas, as well as to take advantage of favorable opportunities to sell pipeline systems which the Company owns. In pursuit of this strategy, the Company has since June 1994 acquired or constructed 26 pipelines. "See Business and Properties -- Pipeline Construction, Acquisition and Disposition." All acquisitions were accounted for under the purchase method for business combinations and, accordingly, the results of operations for such acquired businesses are included in the Company's financial statements only from the applicable date of acquisition. As a result, the Company believes its historical results of operations for the periods presented are not directly comparable. The Company believes the acquisitions will have a positive impact on its future results of operations, and more importantly, the Company believes that the historical results of operations do not fully reflect the operating efficiencies and improvements that are expected to be achieved by integrating the acquired and newly constructed pipeline systems and realizing other synergies. "See Business and Properties -- Pipeline Construction, Acquisition and Disposition." The Company's results of operations are determined primarily by the volumes of gas transported or purchased and sold through its pipeline systems and the results of its divestiture activities. Most of the Company's operating costs do not vary directly with volume on existing systems, thus increases or decreases in transported volumes on existing systems generally have a direct effect on net income. Also, the addition of new pipeline systems should result in a larger percentage of revenues being added to operating income because fixed overhead components are allocated over more systems. The Company derives its revenues from three primary sources: (i) transportation fees from pipeline systems owned by the Company; (ii) the marketing of natural gas and, (iii) the purchase and resale of pipeline systems. Transportation fees are received by the Company for transporting gas owned by other parties through the Company's pipeline systems. Typically, there is very little incremental operating or administrative overhead cost incurred by the Company to transport gas through its pipeline systems and thus, a substantial portion of transportation revenues can be recognized as operating income by the Company. The Company's gas marketing revenues are realized through the purchase and resale of natural gas to the Company's customers. Generally, gas marketing activities will generate higher revenues and correspondingly higher expenses, than those revenues and expenses associated with transportation activities. This relationship exists because, unlike revenues derived from transportation activities, gas marketing revenues, and associated expenses, include the full commodity price of the natural gas acquired. The operating income the Company recognizes from its gas marketing efforts is the difference between the price at which the gas was purchased and the price at which it was sold to the Company's customers. It is the Company's strategy to focus its marketing activities where the Company has a fixed asset investment rather than on third party off-systems sales. The Company's marketing activities have historically varied greatly in response to market fluctuations. The Company also derives its revenues by capitalizing upon opportunities in the industry to sell pipeline systems or assets associated with the Company's pipeline systems on favorable terms as the Company receives offers for such systems which are suited to another company's pipeline network. The Company will from time to time solicit bids for selected properties which are no longer suited to its business strategy. Although no substantial divestitures are currently under consideration, the Company does hold one pipeline system, the H&W System, for resale. See "Business and Properties -- Revenue Components" and "Business and Properties -- Pipeline Systems." 17 20 The Company has also had quarter to quarter fluctuations in its results in the past due to the fact that the Company's natural gas sales and transportation fees can be affected by changes in demand for natural gas primarily because of weather. RESULTS OF OPERATIONS COMPARISON OF THREE MONTH PERIODS ENDED MARCH 31, 1996 AND 1995. Operating Revenues. Operating revenues generated during the three months ended March 31, 1996 totaled approximately $5.2 million as compared to $2.9 million in 1995 which represents a 78% increase in 1996. The increase is primarily attributable to increased marketing opportunities where the Company has a fixed asset investment. Marketing of gas to the Company's pipeline customers increased from $1.9 million to $3.6 million during the three months ended March 31, 1995 and 1996, respectively. In addition, Magnolia was acquired in August 1995, and contributed $413,548 in transportation revenue for the first quarter of 1996. Magnolia's impact, however, is more evident with respect to earnings as discussed in the "Earnings" section below. Operating Expenses. Operating expenses for the three months ended March 31, 1996 totaled approximately $4.7 million, or 68% higher than the comparable 1995 period, primarily due to increased gas marketing transactions where the Company has a fixed asset investment. Depreciation, depletion, and amortization expense was approximately $136,000 in 1996, as compared to approximately $85,000 in 1995. The increase in 1996 can be attributed to the acquisition of Magnolia, effective August 1, 1995. General and administrative expenses incurred for the three months ended March 31, 1996 were approximately $191,000, or 5% higher than for the same period in the first quarter of 1995. The small increase in general and administrative expenses in 1996, despite the Company's significant growth, is a result of the Company's ongoing effort to control expenses and effectively assimilate new business using existing resources. Interest expense for the first quarter of 1996 and 1995, was approximately $115,000 and $64,000, respectively. The Company was servicing an average of approximately $4.3 million in debt during the first quarter of 1996 as compared to an average of $2.8 million in debt during the first quarter of 1995. The increased debt service in 1996 is attributable to the acquisition of Magnolia, effective August 1995. Earnings. The Company recognized operating income and net income of $507,596 and $358,927 respectively, for the three months ended March 31, 1996 as compared to operating income and net income of $135,648 and $50,796 for the three months ended March 31, 1995. Despite a 60% increase in depreciation, depletion and amortization expense in 1996 operating income increased by $371,948 over 1995. The primary factor which contributed to the increase in operating earnings in 1996 was the transportation revenue generated by Magnolia. During the three months ended March 31, 1996, Magnolia generated income (before depreciation, general and administrative expenses, and interest) of approximately $267,000. The Company anticipates Magnolia's income levels to be seasonal in nature with the greatest income to be generated during the winter months. Another factor which contributed to higher earnings in 1996 versus 1995 were the increased gas sales to customers where the Company has a fixed asset investment. The colder than expected winter temperatures forced gas prices and demand higher. As a result, the Company was able to sell gas at slightly higher margins than is typical of gas marketing transactions. COMPARISON OF YEARS ENDED DECEMBER 31, 1995 AND 1994. Operating Revenues. Operating revenues generated during the twelve months ended December 31, 1995 totaled approximately $15.6 million dollars as compared to $15 million dollars in 1994 which represented a 4% increase in 1995. The increase was primarily attributable to the acquisition and subsequent sale of the Five Flags System mitigated by a 23% decrease in sales of natural gas and transportation fees during 1995. 18 21 In September 1995, the Company and an affiliate owned by an officer and director of the Company jointly acquired 100% of the outstanding capital stock of Five Flags, which the Company had previously owned until September 1993, from a non-affiliated company. Total cash consideration of $2,052,000 was paid on September 13, 1995 of which The Company's share was $1,872,450 for 91.25% of Five Flags' capital stock and the affiliate's share was $179,550 for 8.75% of Five Flags' capital stock. The acquisition of Five Flags stock was made as an investment to be resold to another non-affiliated company pursuant to an agreement for purchase and sale of stock dated September 6, 1995. On October 2, 1995, the Company and the affiliate jointly sold 100% of the capital stock of Five Flags for cash consideration of which the Company's share was $4,092,850. The decrease in sales of natural gas and transportation fees in 1995 was primarily attributable to a decline in gas marketing transactions. The decrease in gas marketing transactions in 1995 was in response to declining profit margins and the Company's decision to focus its marketing activities on servicing customer gas requirements where the Company has a fixed asset investment, rather than on off-system transactions. Despite the decline in sales of natural gas, the Company's operating income increased by $2.2 million dollars over 1994 as discussed in the Earnings section below. Operating Expenses. Operating expenses for the year ended December 31, 1995 totaled approximately $13.1 million dollars, or 11% lower than the comparable 1994 period. As explained in the preceding section, the primary explanation for the decrease can be attributed to reduced gas marketing transactions mitigated by the cost of purchasing and subsequently selling Five Flags. Depreciation, depletion, and amortization expense was approximately $452,000 in 1995, as compared to $259,000 in 1994. The increase in 1995 can be attributed to the acquisition of Magnolia, effective August 1995, the construction of two new pipelines during the fourth quarter of 1994 and the Company's investment in Alaska which has been depreciated since July 1994. General and administrative expenses incurred for the year ended December 31, 1995 were approximately $785,000, or 8% lower than 1994. The reduction of general and administrative expenses in 1995 was a result of the Company's ongoing effort to control expenses and effectively assimilate new business using existing resources. Interest expense totaled approximately $339,000 and $189,000 for 1995 and 1994, respectively. The Company was servicing an average of approximately $3.3 million in debt during 1995 as compared to an average of $2.1 million in debt during 1994. The increased debt service in 1995 was attributable to the construction of two new pipelines during the fourth quarter of 1994, investing in the Cook Inlet Systems in Alaska during the second quarter of 1994 and the acquisition of Magnolia, effective August 1995. Additionally, the interest rates on the Company's debt are adjusted for any changes to the prime rate, and therefore, the increase in interest rates during 1994 and 1995 adversely affected interest costs. Earnings. The Company recognized operating income and net income of approximately $2,569,125 and $2,134,218, respectively, for the year ended December 31, 1995 as compared to operating income of $349,414 and a net loss of $32,394 for the year ended December 31, 1994. Despite a 74% increase in depreciation, depletion and amortization expense in 1995 and despite sales of natural gas decreasing by 23% in 1995, operating income increased by $2,219,711 over 1994. The decrease in natural gas sales did not have a significant impact on operating earnings because the decrease is related to gas marketing activities which are characterized by large dollar sales but small earnings margins. Furthermore, 1995 earnings were not adversely affected, as in 1994, by a non-recurring charge of $120,936 when the Company changed the method of accounting for its transportation and exchange gas imbalances. The primary factors which contributed to the increase in operating earnings in 1995 were the revenue generated by the Company's investment in Alaska, five months of revenue derived from the acquisition of Magnolia and a $2,183,226 gain on the sale of Five Flags as discussed in the Operating Revenue section above. 19 22 COMPARISON OF YEARS ENDED DECEMBER 31, 1994 AND 1993. Operating Revenues. Operating revenues generated during the twelve months ended December 31, 1994 totaled approximately $14.9 million as compared to $16.5 million in 1993 which represents a 10% decrease in 1994. The decrease in 1994 revenues was primarily attributable to two factors: there were no sales of refined products and a significant difference in the amount of income generated from sales of pipelines. These two factors were mitigated by a 15% increase in sales of natural gas and transportation fees during 1994. The sale of refined products accounted for approximately $2.3 million dollars in revenue during 1993 whereas in 1994 there were no sales of refined products. During the latter part of 1993 and during 1994, the Company ceased its efforts in the sale of refined products in response to limited marketing opportunities as well as declining profit margins and product supply problems. The sale of Five Flags in September 1993 contributed approximately $2.4 million to operating revenue in 1993 compared with the Company's sale of its 40% interest in a gathering system which contributed approximately $12,000 in 1994. On the other hand, the sale of natural gas and transportation fees in 1994 posted a 15% increase over 1993. This increase in 1994 can be attributed to: (i) the throughput fees received since July 1994 on the Company's investment in Alaska; (ii) the construction of two new facilities late in 1993; (iii) increased gas usage at a customer's fractionation facility; and (iv) an increase in the volume of gas required to fuel the pump stations of a major customer (further discussed in the Earnings section below). Operating Expenses. Operating expenses for the year ended December 31, 1994 totaled approximately $14.6 million, or 4% lower than the comparable 1993 period. As explained in the preceding section, the explanation for the decrease can be attributed to no refined products purchases offset by an increase in gas marketing transactions. Depreciation, depletion, and amortization expense was approximately $259,000 in 1994, as compared to $264,000 in 1993. The slightly lower 1994 amount can be attributed to the absence of the Five Flags subsidiary which was sold in September 1993. Five Flags contributed approximately $49,000 of depreciation, depletion, and amortization in the first three quarters of 1993. The Five Flags reduction was largely offset in 1994 by increases related to construction of new pipelines during the latter part of 1993, and the Company's investment in Alaska during the second quarter of 1994. General and administrative expenses incurred for the year ended December 31, 1994 were approximately $849,000, or 5% lower than the 1993 period. The reduction of general and administrative expenses in 1994 was a result of the sale of Five Flags and the Company's ongoing effort to control expenses. The reduction in expenses as a result of the Five Flags sale was offset by an increase in personnel costs. Interest expense of approximately $189,000 and $178,000 was incurred during the years ended December 31, 1994 and 1993, respectively. The relatively small difference is primarily attributable to the timing of debt additions and repayments related to Five Flags in 1993 and the investment in transmission facilities in 1994. Debt related to the acquisition of Five Flags was outstanding between January 1, 1993 through September 2, 1993. Approximately an equal amount of debt related to the Company's investment in transmission facilities has been outstanding since May 1, 1994, although rising interest rates in 1994 resulted in a slightly higher interest expense. Earnings. The Company recognized a loss of approximately $32,000 for the year ended December 31, 1994 as compared to net income of approximately $706,000 for the 1993 period. In September 1993, all of the outstanding capital stock of Five Flags was sold to Sunshine Interstate Pipeline Partners ("Sunshine") for cash consideration of $2,400,000. During the Company's eight months of ownership, Five Flags contributed approximately $96,000 of income before income taxes, from normal operations, as well as contributing a net gain of $1,155,783 from the sale of the capital stock. This large gain was partially offset when the Company elected to write-off its investment in a pipeline located in Tuscaloosa County, Alabama due to regulatory problems and write-off an inactive gas gathering 20 23 system. See Note 16 of the Notes to the Company's "Consolidated Financial Statements." The write-offs lowered the Company's income in 1993 by approximately $247,000. Another factor which reduced earnings during the latter half of 1993 and through May 1994 was lower volumes of gas liquids transported by the Company's largest customer due primarily to ethane rejection in the Rocky Mountain area. Ethane rejection occurs when natural gas pricing makes extraction of ethane from the natural gas stream uneconomical due to either a decline in the price of ethane or an increase in the price of natural gas. Through May 1994, ethane prices were low in comparison to natural gas prices, and therefore, the amount of natural gas transported by the Company to fuel five of the ten Seminole pump stations was reduced. However, the fuel requirements of the Seminole pump stations improved during the remainder of 1994. See "Business and Properties -- Pipeline Systems." As discussed in Note 3 to the Notes to the Consolidated Financial Statements, another one time charge which adversely affected earnings during 1994 occurred when the Company changed the method of accounting for its transportation and exchange gas imbalances. As a result, approximately a $121,000 reduction in income for the current year was recorded which related to prior year transactions. As discussed in the Operating Revenue section, sales of natural gas increased by 15% in 1994 over 1993. This increase, however, did not have a significant impact on earnings because the increase related to gas marketing activities which are characterized by large dollar volume sales figures but small earnings margins. CAPITAL RESOURCES AND LIQUIDITY Historically, the Company has funded its capital requirements through cash flow from operations and borrowings from affiliates and commercial lenders. For the year ended December 31, 1995, the Company generated cash flow from operations of approximately $2,361,000. For the three months ended March 31, 1996, the Company generated cash flow from operations of approximately $1,308,201 and had an aggregate of approximately $809,164 available to the Company through two of its credit facilities at March 31, 1996. In December 1992, the Company entered into a financing agreement which included a $400,000 line of credit. The line of credit was renewed in September 1994, and amended in May 1996, with an available line of $750,000. The line of credit expires on August 1, 1996, however, the Company expects that it will be renewed or a new facility will be in place prior to that date, as discussed below. Borrowings under this credit facility are collateralized by the Company's non-transportation based accounts receivable and the entire facility has been personally guaranteed by Dan C. Tutcher, Stevens G. Herbst, and Kenneth B. Holmes, Jr., directors and stockholders of the Company. At March 31, 1996, the Company had $750,000 of available funds under this credit facility. In October 1995, the Company entered into a new financing agreement with an existing bank lender. The new agreement provides for an initial $1,250,000 revolving line of credit with the amount of available credit being reduced by $20,833 per month beginning December 1, 1995. Upon maturity at November 1, 1998, the balance of principal plus accrued interest then remaining outstanding and unpaid is payable in full. The note is secured by transportation revenues from eight of the Company's pipeline systems which are also subject to a negative pledge to keep the pipelines free and clear of all liens and encumbrances. The facility has been personally guaranteed by Dan C. Tutcher, Stevens G. Herbst, and Kenneth B. Holmes, Jr. At March 31, 1996, the Company had $59,164 of available funds under this credit facility. In December 1995, the Company entered into a new financing agreement with a bank. The agreement provided for an initial $1,500,000 revolving line of credit with the amount of available credit being reduced by $17,860 per month beginning February 1, 1996. In May 1996, the agreement was amended to increase the available credit by $350,000 and adjust the monthly reduction of availability from $17,860 to $23,000. The Company used $350,000 under this facility to fund the acquisition of ten gas gathering pipelines from TSGGC in May 1996. Upon maturity at January 15, 1999, the balance of principal plus accrued interest then remaining outstanding and unpaid is payable in full. In connection with this financing agreement, a $50,000 certificate of deposit and 100% of Magnolia's stock has been pledged as collateral. The Magnolia System is subject to a negative pledge to keep the pipeline free and clear of all liens and encumbrances and Dan C. Tutcher, Stevens 21 24 G. Herbst, and Kenneth B. Holmes, Jr. have personally guaranteed the facility. At March 31, 1996, the Company had no funds available under this credit facility. The Company believes that its existing credit facilities and funds provided by operations are sufficient for it to meet its operating cash needs for the foreseeable future. At March 31, 1996, the Company was committed to make capital expenditures of $265,000 during 1996. The Company has historically arranged for project financing with various banks to fund between 75% and 90% of the construction or acquisition costs of its new projects. Management of the Company believes that project financing and funds from operations will continue to be available to the Company to fund pipeline acquisition and construction opportunities which exceed the capital available after the Offering. The Company is presently negotiating with several commercial banks to obtain a comprehensive credit facility which will facilitate financing of future construction projects or acquisitions. Such facility will likely include a working capital line of credit and a revolving facility. There can, however, be no assurance that the Company will be able to obtain such financing. Forward looking statements made herein are based on current expectations of the Company that involve a number of risks and uncertainties and should not be considered as guarantees of future performance. These statements are made under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. The factors that could cause actual results to differ materially include interruption or cancellation of existing contracts, the impact of competitive products and services and pricing of and demand for such products and services, market acceptance risks and the presence of competitors with greater financial resources. [BALANCE OF THIS PAGE INTENTIONALLY LEFT BLANK] 22 25 BUSINESS AND PROPERTIES GENERAL The Company is a rapidly growing pipeline company primarily engaged in the construction, acquisition, disposition, and operation of pipelines for end-users, as well as the transmission and gathering of natural gas and crude oil. Thirty-nine intrastate pipeline systems are owned or operated by the Company in Alabama, Alaska, Kansas, Louisiana, Mississippi, New York, Oklahoma, Tennessee and Texas, with 26 of the Company's pipelines being acquired or constructed since June 1994. Natural gas marketing operations and, to a lesser degree, oil and gas production supplement the Company's pipeline business. The Company's principal growth and business strategy is to acquire or build pipelines to serve the end-user market while also continuing to pursue acquisition and divestiture opportunities in transmission and gathering of natural gas, other hydrocarbons and nonhydrocarbon fluids or gases. The natural gas industry has undergone dramatic change over the past decade largely due to the course of deregulation by the federal government. This has resulted in increased competition in the natural gas industry. The impact of these changes has been particularly felt in the natural gas pipeline industry over the last several years. The key part of this regulatory shift, to ensure a more competitive natural gas market, was the implementation of the FERC Order 636. This order generally opened previously restricted access to interstate pipelines by requiring the operators of such pipelines to "unbundle" their transportation services from their sales services, allowing customers to choose their provider for such services as gathering, storage, and transportation. This unbundling essentially eliminated the pipeline's traditional merchant function and caused a major restructuring of this relationship between the major interstate pipelines and their customers. For the most part, regulators at the state level have followed the FERC's lead and allowed increased competition with LDCs, and allowed the phenomenon of the construction of bypass pipelines to end-users. In addition to the issuance of Order 636, the implementation of more stringent environmental laws, such as the Clean Air Act of 1990 and the Energy Policy Act of 1992, has also affected the overall demand for natural gas by encouraging the use of cleaner burning fuels, such as natural gas. Accordingly, these regulatory changes have impacted the growth in domestic consumption of natural gas which has increased from approximately 16,200 billion cubic feet in 1986 to an estimated 21,600 billion cubic feet in 1995. See "-- Markets and Major Customers." The Company believes that its experience in the strategic location, design, engineering, construction and operation of pipelines, as well as in federal, state and local regulatory matters involving pipelines, makes it well positioned to continue to take full advantage of these changes in the natural gas industry, primarily through aggressively pursuing the industrial end-user market by acquiring and constructing new pipeline systems. The Company is currently one of the few independent companies in the industry which has pursued supplying the industrial end-user market by providing new pipeline connections to this market. As more chemical and manufacturing companies seek alternative natural gas suppliers other than their LDC's, the Company and its personnel will continue to offer the expertise they have gained through their involvement in the regulatory permitting, construction and operation of 15 end-user pipelines reaching customers in six states. The Company will also continue to expand its current market base by working with many of its existing customers, such as Mapco, Owens and Tyson, to provide natural gas service to additional facilities operated by these customers. The Company typically designs its systems to transport greater volumes than needed in the immediate future to provide capacity to accommodate growth in natural gas consumption and production in proximity to the pipeline systems. As a result, the Company believes that under existing conditions, its pipeline systems can quickly increase their volumes with little capital expenditure should additional demand develop in these areas. The Company also benefits from lower overhead than major interstate carriers and LDCs and the resultant ability to offer reduced rates which should allow it to compete effectively with entrenched LDCs and gas transmission carriers for their existing and new end-user customers. A secondary impact of these regulatory changes has been an overall consolidation of the gathering and transmission pipeline segments in the industry. These consolidations have resulted in increased opportunities for pipeline acquisitions by the Company as major pipeline companies divest themselves of pipeline systems only incidentally acquired by them in connection with larger acquisitions or as a result of their divestitures of such pipeline systems due to internal changes in their strategic focus. For example, in 1995 and 1996, the 23 26 Company acquired ownership of, or interests in, 19 pipeline systems, including gathering systems and transmission lines, from major pipeline companies. Moreover, the Company's recent acquisitions of Magnolia and Five Flags, as well as the acquisition, by an affiliate, of six pipeline systems from Seahawk and the acquisition by the Company, through its wholly-owned subsidiary, Magnolia, of ten pipeline systems from TSGGC, further illustrate the existence of such opportunities in the market place and the Company's ability to rapidly capitalize on them. Not only has the industry trend to consolidate increased the availability of attractive acquisitions in the market place but the overall consolidation in the industry has also presented the Company with advantageous opportunities to sell pipeline systems which the Company owns, such as the Five Flags System and the Tasco Cavasos System, which were divested by the Company on favorable terms. The Company will continue to consider and evaluate such divestiture opportunities as the Company receives favorable offers for their existing systems or assets which are suited to other companies' strategic focus. See "-- Pipeline Construction, Acquisition and Disposition" and "-- Pipeline Systems." In November 1989, Dan C. Tutcher, Stevens G. Herbst and Kenneth B. Holmes, Jr. formed Midcoast Venture I (the "Venture"), as a joint venture by and between Midcoast Transmission Company ("Transmission"), a Texas corporation controlled by Stevens G. Herbst and Kenneth B. Holmes, Jr., two of the Company's present directors, and Magic Gas Corp., a Texas corporation controlled by Dan C. Tutcher, ("Magic") (f/k/a Midcoast Natural Gas, Inc.). The founders of the Venture agreed in 1992 to contribute their respective interests in the Venture to the Company which was formed as a Nevada corporation in May 1992. The purpose of the formation of the Company was to acquire Nugget by means of a merger. At the time of the merger, Mr. Tutcher, Mr. Herbst and Mr. Holmes had been directors of Nugget since 1990. Nugget was a publicly-held Minnesota corporation, incorporated in 1976, that had previously been involved in the oil and gas industry and which had filed for protection under federal bankruptcy laws in April 1992. The principal asset of Nugget was an NOL of approximately $15,230,000 prior to Nugget's reorganization. In September 1992, the Company became the successor to Nugget through a merger pursuant to the Nugget reorganization (the "Plan") as approved by the United States Bankruptcy Court for the Southern District of Texas, Corpus Christi Division. In accordance with the terms of the Plan, 130,335 shares of Company's Common Stock were issued to the then existing stockholders of Nugget who tendered their Nugget stock for exchange. Additionally, 1,222,481 shares of the Company's Common Stock were issued to Nugget's then existing note holders in exchange for the cancellation of their notes payable totaling $32,000. All other creditors under the Plan were paid ninety to one-hundred cents on the dollar pursuant to the Plan. Furthermore, all of the outstanding common stock of Nugget which had been issued prior to the Plan was cancelled as specified in the Nugget Plan. The Plan also authorized a merger with Transmission. Under the terms of the merger with Transmission (the "Transmission Merger"), the Company issued 100,000 shares of 5% cumulative preferred stock to the then existing stockholders of Transmission, Mr. Herbst and Mr. Holmes, in exchange for all the issued and outstanding common stock of Transmission. The principal asset of Transmission was its 50% joint venture interest in Venture. Concurrent with the Transmission Merger, Magic contributed the remaining 50% joint venture interest in the Venture to the Company, in exchange for the issuance of 100,000 shares of the Company's 5% cumulative preferred stock and the assumption of Magic's joint venture obligations with respect to the Venture. Prior to the redemption of the Company's 5% cumulative preferred stock by the Company, all such shares were held by Magic (beneficially owned by Mr. Tutcher), Mr. Herbst and Mr. Holmes. See "Certain Transactions." These contributed assets represented substantially all of the Company's assets upon completion of the merger and the Company then embarked on its current business strategy. REVENUE COMPONENTS The Company derives its revenues from three primary sources: (i) transportation fees from pipeline systems owned by the Company; (ii) the marketing of natural gas and, (iii) the purchase and resale of pipeline systems. 24 27 Transportation fees are received by the Company for transporting gas owned by other parties through the Company's pipeline systems. Typically, there is very little incremental operating or administrative overhead cost incurred by the Company to transport gas through its pipeline systems and thus, a substantial portion of transportation revenues can be recognized as operating income by the Company. The Company's gas marketing revenues are realized through the purchase and resale of natural gas to the Company's customers. Generally, gas marketing activities will generate higher revenues, and correspondingly higher expenses, than those revenues and expenses associated with transportation activities. This relationship exists because, unlike revenues derived from transportation activities, gas marketing revenues, and associated expenses, include the full commodity price of the natural gas acquired. The operating income the Company recognizes from its gas marketing efforts is the difference between the price at which the gas was purchased and the price at which it was sold to the Company's customers. The Company also derives its revenues by capitalizing upon opportunities in the industry to sell pipeline systems or assets associated with the Company's pipeline systems on favorable terms as the Company receives offers for such systems which are suited to another company's pipeline network. CONSTRUCTION OF SYSTEMS In most instances, the Company contracts for the construction of its pipeline projects on the basis of a competitive bidding process. The bids received are usually based on a price per foot for the installation of the pipeline, boring under roads or railroads, other directional bores and environmental restoration services. Usually, the same contractor is also retained on most construction projects to install the meter stations for volume measurements at either end of the pipeline system on a cost plus basis. During the actual construction phase of a project, the Company has at least one and in most instances two Company project managers or inspectors at the construction site, who are in charge of ensuring that the engineering specifications are implemented and managing the day-to-day construction activities. Depending on the size of the particular construction project, the Company may hire additional contract inspectors to support and work with the Company's personnel in the management of the construction project. BUSINESS AND GROWTH STRATEGY The Company's principal business and growth strategy is to acquire or build pipelines to serve the end-user market while also continuing to pursue acquisition, construction or disposition opportunities in transmission and gathering of natural gas, other hydrocarbons and nonhydrocarbon fluids. The Company will continue to seek to implement its strategy by taking advantage of a number of market conditions and competitive factors, including: (i) pursuing natural gas users in the chemical and manufacturing industries who are seeking alternative suppliers to their LDCs, due to new opportunities that may arise, based on regulatory changes, and (ii) capitalizing on the fact that many of the Company's existing pipeline systems have the capacity to deliver increased volumes of natural gas which enable it to meet natural gas demand increases in the area, or to enable electrical generation facilities to utilize gas turbines to satisfy peak loads without requiring construction of additional capacity. The various operations of the Company, whether involving acquisitions, construction or dispositions involve the following activities: End-Users. A large portion of the Company's revenue is derived from contracting with industrial end-users or electrical generating facilities to provide natural gas transportation services to their facilities through interconnect or bypass gas pipelines constructed by the Company. End-user pipelines provide the Company's customers with a natural gas supply as an alternative to their current energy source, which are usually LDCs. Frequently, the Company is able to offer its end-user customers rates lower than the customer's LDC. The Company's contracts with end-user customers typically provide for the payment of a transportation fee by the customer based on the volume of gas transported through the Company's pipeline. In many of the Company's contracts the customer has guaranteed a minimum amount of natural gas to be transported. The Company also offers its end-user customers gas marketing services enabling them to purchase their gas supply from the Company but without any obligation to do so. The Company strives to structure the terms and transportation 25 28 fees for its end-user systems in such a way as to provide an acceptable rate of return regardless of any gas marketing revenues. Fifteen of the Company's systems are end-user pipelines. Transmission. The Company's three transmission pipelines primarily receive and deliver natural gas to and from other pipelines, but may also involve some gathering functions. Effective August 1995, the Company significantly expanded its gas transmission pipeline activities by acquiring Magnolia, the principal asset of which was the Magnolia System, an approximately 111-mile natural gas transmission line and compressor station located in central Alabama. Gathering. The Company's gathering systems typically consist of a network of small diameter pipelines which collect gas or crude oil from points near producing wells and transport it to larger pipelines for further transmission. Gathering systems may include meters, separators, dehydration facilities, and other treating equipment owned by the Company or others. The Company derives revenues from gathering systems by transporting gas or crude oil owned by others through its pipelines for a transportation fee, by purchasing gas and utilizing its pipelines to transport the gas to a customer in another location where the gas is resold or, in certain instances, by purchasing gas and arranging for the delivery and resale of an equivalent quantity of gas to a customer not directly served by the Company's pipelines. Transactions with customers not directly served by the Company's pipelines are typically accomplished by entering into agreements whereby the Company exchanges gas in its pipelines for gas in the pipelines of other transmission companies. The Company currently owns an interest in or operates 21 gathering systems. Gas Marketing. The majority of the Company's gas marketing activities occur on pipeline systems owned by the Company and for those customers served by the Company's pipeline systems. The Company's marketing activities include providing gas supply and sales services to some of its end-user customers by purchasing the gas supply from other marketers or pipeline affiliates and reselling the gas to the end-user. The Company also purchases gas directly from well operators on many of the Company's gathering systems and resells the gas to other marketers or pipeline affiliates. Typically, there are more marketing opportunities associated with the Company's gathering systems since many of the well operators wish to only obtain the prevailing market price for their gas and because they lack the desire or expertise to effectively market their product. Many of the contracts pertaining to the Company's gas marketing activities are month-to-month spot market transactions with numerous gas suppliers or producers in the industry. Such contracts contain no ongoing obligation by the Company to provide for or purchase future gas supplies from any party. Generally, the Company purchases the gas under contracts that contain terms which provide for a price determination based upon prevailing market conditions. Simultaneous with the purchase of gas by the Company, the Company resells the gas at a higher price under a sales contract which is comparable in its terms to the purchase contract, including the price escalation provision. The Company earns a margin on such contracts equal to the difference between the purchase price paid by the Company for such gas supply and the price at which the gas is then sold. Typically, gas marketing is characterized by narrow margins since there are numerous companies of greatly varying size and financial capacity who compete with the Company in the marketing of natural gas. Accordingly, historical operating income associated with this revenue stream has varied greatly depending on market conditions. The Company believes gas marketing will become a more significant component of the Company's business because the Company believes the marketing of gas is an important complement to its transportation services, and many of the Company's recent acquisitions have been gathering pipelines which historically carry more marketing opportunities. PIPELINE CONSTRUCTION, ACQUISITION AND DISPOSITION Since June 1994, the Company constructed or acquired ownership of, or interests in, 26 pipelines, 19 of which were gathering systems, two of which were transmission lines and five of which were end-user pipelines. See "-- Pipeline Systems." The Company remains actively engaged in seeking pipeline acquisitions and construction opportunities. The Company plans to evaluate investments in pipelines which involve not only natural gas, but also liquefied petroleum gas, as well as both hydrocarbon and non-hydrocarbon finished products, such as nitrogen. Management believes that more acquisition opportunities will become available as major pipeline companies divest systems due to regulatory considerations or need to spin-off smaller non- 26 29 strategic systems acquired in connection with larger acquisitions. The Company believes it can capitalize on these opportunities due to the strategic locations of its pipelines and proximity to other companies' pipeline systems and in large part to the Company's experience and relationships with others in the pipeline industry. The Company's recent activities in pursuit of acquisition, construction or disposition opportunities in transmission and gathering of natural gas include the following: Magnolia System Acquisition. Effective August 1995, the Company acquired 100% of the outstanding capital stock of Magnolia. Magnolia's principal asset consists of approximately 111 miles of 6 inch to 24 inch gas pipelines and an approximately 4000 horsepower compressor station, located in central Alabama. Magnolia was purchased from a subsidiary of Williams for a total purchase price of $3,200,000, and the Company assumed the operations of the pipeline in September 1995. Williams had acquired Magnolia as part of its acquisition of Transco Energy Company ("Transco"), a publicly traded company, earlier in 1995. The Magnolia System is primarily a transmission pipeline with interconnections to one major interstate pipeline and one major intrastate pipeline. The system also includes some gathering lines which connect coal-seam gas production in the Black Warrior Basin with the Magnolia System. There is the potential for several interconnections to other pipelines in the area which could provide additional supply or market options for gas on the Magnolia System. These additional interconnections could enhance Magnolia's revenues and will be pursued by the Company. See "Management -- Certain Transactions" for information relating to the financing of the Magnolia System Acquisition. See also "-- Pipeline Systems. Five Flags System Acquisition and Disposition. In September 1995, the Company and Rainbow jointly re-acquired 100% of the outstanding capital stock of Five Flags, which the Company had previously owned until September 1993, from Five Flags Holding Company, an affiliate of Coastal. Total cash consideration of $2,052,000 was paid to Five Flags Holding Company, of which the Company's share was $1,872,450 for 91.25% of Five Flags' capital stock. In October 1995, the Company and Rainbow jointly sold 100% of the capital stock of Five Flags to Koch Gateway Pipeline Company ("Koch") for cash consideration of $4,664,865. After retiring the purchase money note, the net proceeds to the Company from the sale of Five Flags was $2,183,226. See "Management -- Certain Transactions." Seahawk Acquisition. In February 1996, the Company formed Pan Grande with Resource Energy Development Company, L.L.C., a North Carolina limited liability company ("Resource") which is affiliated with Piedmont Natural Gas Co., Inc., a publicly traded company. The Company and Resource each own 50% of Pan Grande. Subsequent to its formation, Pan Grande entered into an agreement with Seahawk to acquire six onshore gas gathering and transmission systems. Seahawk was acquired by Tejas, as part of Tejas' acquisition of substantially all of the pipeline systems owned by Seagull Energy Corporation, a publicly traded company. The six systems, (including the Allen Hill, Chapa, Guadalupe, Guerra, Loma Novia, and Puckett Systems), are located in Tom Green, Live Oak, Culberson and Loving, Webb and Duval, Duval and McMullen and Pecos counties, Texas, respectively. A seventh system, the Salt Creek, located in Kent and Scurry counties in Texas, is also under contract to be acquired by Pan Grande pending completion of satisfactory due diligence. Together the seven systems comprise approximately 116 miles of natural gas gathering and transmission lines with a design throughput of 200 million cubic feet of natural gas per day. The purchase of the six systems by Pan Grande was financed with capital contributions from the Company and Resource and with a five-year note from a bank to Pan Grande at the prime rate plus 1%, secured by each of the systems and their associated contracts. Each of the Company and Resource has guaranteed 50% of the note, and personal guarantees were also obtained from Dan C. Tutcher, Stevens G. Herbst and Kenneth B. Holmes, Jr., directors and stockholders of the Company. See "-- Pipeline Systems" and "Management -- Certain Transactions." Flores System. In January 1996, the Company entered into a joint venture with Esenjay Petroleum Corporation, Trijon Gas Pipeline Corporation, and Brazos Resources, Inc. Shortly after its formation, the joint venture, Starr County Gathering System, acquired a pipeline which has connections to ten wells with a capacity of 5,000 MMBtu/d and has pipeline connections to Valero Transmission Company ("Valero"), a subsidiary of Valero Energy Corporation, a publicly traded company, Tennessee Gas Pipeline Company ("Tennessee Gas"), a subsidiary of Tenneco, Inc. ("Tenneco"), a publicly traded company, Florida Gas 27 30 Transmission Co. ("Florida Gas"), a subsidiary of Enron Corp., a publicly traded company, and Tejas Gas Corporation ("Tejas Gas"), a publicly traded company, (the "Flores System"), from Gulfstream Pipeline Company. The Flores System is operated by the Company and consists of approximately 9.9 miles of pipeline located in southeast Starr County, Texas. The system purchases and transports gas from five producers in the Rincon and Flores fields. See "-- Pipeline Systems." Texas Southeastern Gas Gathering Corporation. In May 1996, the Company, through its wholly-owned subsidiary, Magnolia, acquired nine gathering pipeline systems and one transmission pipeline system from TSGGC. The systems were acquired pursuant to a purchase and sales agreement dated March 12, 1996 for a total purchase price of $390,000 less purchase price adjustments giving effect to operating income since the effective date of January 1, 1996. These systems total approximately 113 miles of 2 inch to 10 inch diameter pipeline with associated equipment. Five systems (Fayette, Happy Hill, Moores Bridge, Detroit and Sizemore) are located in Alabama, and five systems (Millbrook, Greenwood Springs, Heidelberg-TGP, Heidelberg-Koch and Baxterville) are located in Mississippi. The bulk of the systems are located within 100 miles of the Magnolia System and it is the Company's intention to integrate the operation of these systems with the Magnolia System. TSGGC had acquired these systems in 1994 as part of a larger acquisition package. South Fulton System. The South Fulton System in Obion County, Tennessee is currently being constructed and is anticipated to be placed in service in May 1996 to supply 100% of Tyson's natural gas requirements to Tyson's newly constructed feedmill in South Fulton, Tennessee. The pipeline has a capacity of 1,500 MMBtu/d and consists of .6 miles of 4 inch pipeline connecting the feedmill to the City of South Fulton's local gas distribution system. The City of South Fulton, as the owner, operates and maintains the pipeline. The agreement between Tyson and the Company (the "Tyson Agreement") guarantees a minimum monthly transportation fee to the Company until such time as Tyson has transported 300,000 MMBtus of natural gas under the Tyson Agreement (the "Primary Term") as well as a monthly service fee to be paid to the Company during the same period. More particularly, the Tyson Agreement provides for a monthly fee to be paid to the Company for all volumes transported by the Company amounting to or in excess of 60,000 MMBtu annually through the end of the Primary Term. For years under the Primary Term where less than 60,000 MMBtus are transported annually, the Company is guaranteed a minimum fee for the difference in volumes transported. The agreement is cancelable by Tyson, with written notice to the Company, but such cancellation will not relieve Tyson's obligation of payment under the Tyson Agreement for amounts due under the Primary Term. Tyson's anticipated gas requirements are approximately 60,000 MMBtu per year and as of March 31, 1996, 300,000 MMBtu remain to be transported under the Primary Term of the Tyson Agreement. The Tyson Agreement does not provide for a secondary term. See "-- Pipeline Systems." Power Paper. The Power Paper System in Roane County, Tennessee is currently being constructed and is anticipated to be placed in service in June 1996 to supply natural gas to Power Paper Company's ("Power Paper") paper plant. The pipeline has a capacity of 5,000 MMBtu/d and consists of 2.1 miles of 3 inch pipeline connecting East Tennessee Natural Gas Company's pipeline ("East Tennessee"), a subsidiary of Tenneco, to Power Paper's paper plant in Roane County under an agreement by which Power Paper has agreed to transport 100% of their gas requirements with certain minimum guaranteed volumes. See "-- Pipeline Systems." Tasco Cavasos Disposition. In March 1996, the Company sold the Tasco Cavasos System, an inactive system consisting of 1.6 miles of 2 inch pipeline along with a second inactive system which consisted primarily of a meter station to an unrelated third party for consideration of $22,500. Olmitos System. The Olmitos System is a 16.8 mile 8 inch and 4 inch gas gathering pipeline system located in Webb County, Texas which gathers and transports gas for Texaco Exploration and Production, Inc., a subsidiary of Texaco, Inc. ("Texaco"), a publicly traded company, Conoco, Inc., a subsidiary of E. I. Nemours & Co., a publicly traded company, and Cox Exploration, Inc. with delivery interconnections to Valero, Houston Pipe Line Company ("Houston Pipe Line"), a subsidiary of Enron Corp., a publicly traded company, and MidCon-Texas Pipeline Corp., a subsidiary of MidCon Corporation ("MidCon"), a publicly traded company. The system is owned by Olmitos System Joint Venture ("OSJV") which is currently wholly- 28 31 owned by Texline. Texline owned a 34% interest in OSJV until December 1995 and March 1996 when Texline acquired the remaining 66% joint venture interest from the other two nonaffiliated joint venture partners, based on a system valuation of $700,000. Texline has an original cost basis in the property of approximately $795,000. The Company has agreed to acquire the Olmitos System, subject to Board approval, for $700,000 based on the same system valuation and on the same terms as Texline's purchase of the system from the other nonaffiliated joint venture partners, plus approximately $7,000 in due diligence and closing costs incurred by Texline related to this acquisition. Texline will recognize a tax gain on the sale of the Olmitos System to the Company of approximately $117,000 attributable to the reduction in the historical cost basis due to depreciation charges of approximately $205,000 through the date of disposition. The purchase price will be paid with the net proceeds of the Offering. See "Use of Proceeds." PIPELINE SYSTEMS The Company owns an interest in or operates thirty-nine intrastate end-user pipelines, gathering systems and gas transmission systems situated in the states of Alabama, Alaska, Kansas, Louisiana, Mississippi, New York, Oklahoma, Tennessee, and Texas. Certain information concerning the Company's pipelines is summarized in the table below:
DATE OF AVERAGE DAILY PERCENTAGE ACQUISITION DAILY VOLUME OWNERSHIP OR OR INITIAL LENGTH VOLUME(1) CAPACITY(1) INTEREST PIPELINE SYSTEM OPERATION LOCATION IN MILES (MMBTU/D) (MMBTU/D) IN SYSTEM - ------------------------ --------------- ----------------------- -------- --------- --------- ------------ END-USER: Burnet................ December 1989 Burnet Co., TX 1.3 498 3,000 100% Conway................ December 1989 Rice Co., KS --(2) 8,574 14,000 100% Turkey Creek.......... January 1991 Fort Bend Co., TX 15.6 833 5,000 100% OCPL.................. July 1991 Wyandotte Co., KS 1.0 2,363 6,500 100% Cat Springs........... December 1991 Austin Co., TX 1.1 54 3,000 100% Clemens Dome.......... February 1992 Brazoria Co., TX --(2) 100 3,000 100% Stratton Ridge........ February 1992 Brazoria Co., TX 1.2 132 3,000 100% Tuscaloosa(3)......... September 1992 Tuscaloosa, AL 2.6 --(3) 1,500 100% Augusta............... July 1993 Butler Co., KS 0.5 245 5,000 100% Lake Charles.......... November 1993 Calcasieu Parish, LA 1.3 4,104 50,000 100% Quindaro.............. November 1994 Wyandotte Co., KS 3.1 505 60,000 100% Albany................ December 1994 Albany Co., NY 0.5 1,199 3,000 100% Guadalupe............. February 1996 Culberson & Loving 9.1 307 10,000 50%(4) Cos., TX South Fulton.......... May 1996 Obion Co., TN 0.6 NAV 1,200 --(5) Power Paper........... June 1996 Roane Co., TN 2.1 NAV 5,000 100% ------ ------ ------- 40.0 18,914 173,200 TRANSMISSION: H&W................... October 1993 Escambia Co., AL 9.0 Inactive 15,000 100% Magnolia.............. September 1995 Central AL 111.0 27,501 120,000 100% Moores Bridge......... May 1996 Tuscaloosa Co., AL 4.5 630 4,000 100% ------ ------ ------- 124.5 28,131 139,000 GATHERING: Sinton................ July 1992 San Patricio Co., TX 2.8 Inactive 3,000 100% Fitzsimmons........... April 1993 Duval Co., TX --(2) 111 3,000 100% Zmeskal............... June 1994 Victoria Co., TX --(2) 216 3,000 100% Cook Inlet Gas........ July 1994 Cook Inlet, AK 2.7 Inactive 15,000 --(5) Cook Inlet Oil........ July 1994 Cook Inlet, AK 2.7 3,164(6) 20,000(6) --(5) Foss.................. December 1994 Custer Co., OK 4.1 448 5,000 100% Flores................ January 1996 Starr Co., TX 9.9 1,555 5,000 60%(7) Allen Hill............ February 1996 Tom Green Co., TX 5.5 304 10,000 50%(4) Chapa................. February 1996 Live Oak Co., TX 24.7 1,769 50,000 50%(4) Guerra................ February 1996 Webb & Duval Cos., TX 18.8 7,930 50,000 50%(4) Loma Novia............ February 1996 Duval & McMullen Cos., TX 15.2 3,843 25,000 50%(4) Puckett............... February 1996 Pecos Co., TX 3.5 810 10,000 50%(4) Baxterville........... May 1996 Lamar Co., MS 1.4 Inactive 2,000 100% Detroit............... May 1996 Lamar Co., AL 16.5 101 3,000 100% Fayette............... May 1996 Fayette Co., AL 62.8 1,195 10,000 100% Greenwood Springs..... May 1996 Monroe Co., MS 7.9 114 5,000 100% Happy Hill............ May 1996 Fayette Co., AL 5.5 109 3,000 100% Heidelberg-Koch....... May 1996 Jasper Co., MS 1.0 158 3,000 100% Heidelberg-TGP........ May 1996 Jasper Co., MS 3.5 523 2,500 100% Millbrook............. May 1996 Wilkinson Co., MS 8.9 241 5,000 100% Sizemore.............. May 1996 Lamar Co., AL 1.0 153 3,000 100% ------ ------ ------- 198.4 22,744 235,500 ------ ------ ------- Total 362.9 69,789 547,700 ====== ====== =======
(See notes on following page) 29 32 - --------------- (1) All volume and capacity information is approximate. Average daily volumes are based on total volumes transported during the twelve month period ended March 31, 1996, except for certain systems noted on the above table which were acquired or placed in service after March 31, 1995, in which case such average daily volumes are based on total volumes transported from the date of acquisition or initial operation through March 31, 1996. NAV means that the information is not available since the pipeline is currently under construction. (2) This system is less than a quarter-mile in length. (3) Construction suspended pursuant to an injunction prohibiting the completion of the pipeline. (4) This system is owned by Pan Grande, of which the Company owns a 50% interest in and is operated by the Company. (5) The Company receives throughput charges from these systems. (6) Volume is reflected in barrels of oil production per day. (7) This system is owned by Starr County Gathering System, a joint venture of which the Company owns a 60% interest and is operated by the Company. The Burnet System supplies, Seminole Pipeline Company's ("Seminole"), an affiliate of Mapco, LPG mainline pump station in Burnet County, Texas with 100% of their gas requirements through a 1.3 mile 3 inch pipeline system containing two measuring stations and pressure regulating equipment, which connects the Seminole mainline pump station to Lone Star Gas Co.'s intrastate pipeline ("Lone Star"), a subsidiary of Enserch Corporation, a publicly traded company. The system was constructed and placed in service during December 1989 by the Company's predecessor and provides gas supply to the pump station under an agreement entered into in May 1993. Seminole has also frequently purchased its gas supply from the Company since the inception of the contract. As of March 31, 1996 approximately 1,083,940 MMBtus remain to be transported under the agreement's guaranteed minimum cumulative volume requirements. The Conway System supplies a Mapco LPG Fractionation facility in Rice County, Kansas with 100% of their gas requirements through a 4 inch pipeline from an interconnection with Williams Natural Gas Company's interstate pipeline ("Williams Pipeline"), a subsidiary of Williams. The system began serving Mapco during December 1989 and currently provides gas supply to the facility under an agreement entered into in July 1992. In August 1993 the Conway System also began serving a Koch Industries Incorporated's Isomerization unit on a month to month basis. The Turkey Creek System supplies Seminole's LPG mainline pump station in Fort Bend County, Texas with 100% of their gas requirements through a 15.6 mile 6 inch and 4 inch pipeline system containing eight measuring stations and pressure regulating equipment. The Company also sells a small volume of gas through this system to a local rice farmer. Additionally, the system gathers, transports and redelivers natural gas from several producing wells to Gulf Coast Natural Gas Company's intrastate pipeline. The system was acquired during January 1991 by the Company's predecessor and provides gas supply to the pump station under an agreement entered into in May 1993. Seminole has also frequently purchased its gas supply from the Company since the inception of the contract. As of March 31, 1996 approximately 1,305,861 MMBtus remain to be transported under the agreement's guaranteed minimum cumulative volume requirements. The OCPL System supplies an Owens plant in Wyandotte County, Kansas with minimum of 80% of their gas requirements through a 1 mile 6 inch pipeline system connected to Williams Pipeline. The system was constructed by the Company's predecessor and placed in service during July 1990 and provides gas supply to the plant under an agreement entered into in September 1991. The plant is located in an industrial park with other similar plants nearby which could be potential customers for the system. The note payable to a bank entered into in October 1995 is secured by all transportation revenues pertaining to this system. The Cat Springs System supplies Seminole's LPG mainline pump station in Austin County, Texas with 100% of their gas requirements through a 1.1 mile 2 inch pipeline system containing two measuring stations and pressure regulating equipment, connecting the Seminole LPG mainline pump station to Tennessee Gas' 30 33 interstate pipeline. The system was constructed and placed in service during December 1991 by the Company's predecessor and provides gas supply to the pump station under an agreement entered into in July 1993. Seminole has also frequently purchased its gas supply from the Company since the inception of the contract. As of March 31, 1996 approximately 480,175 MMBtus remain to be transported under the agreement's guaranteed minimum cumulative volume requirements. The Clemens Dome System supplies a Seminole plant in Brazoria County, Texas with 100% of their gas requirements through a 3 inch pipeline system containing a measuring station and pressure regulating equipment, which connects a Seminole LPG mainline pump station to Seagas Pipeline Company's pipeline, a subsidiary of Phillips Petroleum Company ("Phillips"), a publicly traded company. The system also includes 3,000 feet of 6 inch pipeline that was deeded to Phillips, as part of the construction contract. The system was constructed and placed in service during February 1992 by the Company's predecessor and provides gas supply to the pump station under an agreement entered into in August 1993. Seminole has also frequently purchased its gas supply from the Company since the inception of the contract. As of March 31, 1996 approximately 157,019 MMBtus remain to be transported under the agreement's guaranteed minimum cumulative volume requirements. The Stratton Ridge System supplies a Seminole plant in Brazoria County, Texas with 100% of their gas requirements through a 1.2 mile 2 inch pipeline system containing a measuring station and pressure regulating equipment, which connects a Seminole LPG mainline pump station to a pipeline owned by Amoco Gas Company, a subsidiary of Amoco Corporation, a publicly traded company. The system was constructed and placed in service during February 1992 by the Company's predecessor and provides gas supply to the pump station under an agreement entered into in May 1993. Seminole has also frequently purchased its gas supply from the Company since the inception of the contract. As of March 31, 1996 approximately 1,098,812 MMBtus remain to be transported under the agreement's guaranteed minimum cumulative volume requirements. The agreements under which the Burnet, Conway, Turkey Creek, Cat Springs, Clemens Dome, and Stratton Ridge Systems operate provide for five-year terms commencing upon the initial delivery of natural gas, with the exception of the Conway System agreement which provides for a one-year term. The various agreements continue thereafter on a year-to-year basis unless terminated by either party upon 90 days written notice with the exception of the Conway System agreement which, unless otherwise notified, will expire on June 30, 1996. These agreements also provide for guaranteed minimum cumulative volumes which can serve to extend the contracts should the minimum volumes not be met within the particular contract term, with the exception of the Conway System agreement which provides for a fixed price for one year and a reduced transportation rate after certain volumes have been transported by the Company. The note payable to a bank entered into in October 1995 is secured by all transportation revenues pertaining to these systems. The Tuscaloosa System is a substantially completed 2.6 mile 2.5 inch pipeline in Tuscaloosa County, Alabama constructed by the Company in September 1992 which connects Lawter International, Inc.'s chemical plant in Moundsville, Alabama to the Magnolia System. The system is subject to a five-year agreement, under which the Company plans to provide the facility plant 100% of its gas requirements. Because of litigation which ensued during the construction phase of the project, the Company did not receive certification of this pipeline, and as a result, the Company elected to write-off its investment in this system in 1993. See Note 16 to the Company's "Consolidated Financial Statements." The Augusta System supplies the City of Augusta's #2 electric generating power plant in Butler County, Kansas with 100% of their gas requirements through a .5 mile 3 inch pipeline system connected to Williams Pipeline. The system was constructed by the Company and placed in service during July 1993 and provides gas supply to the plant under an agreement entered into in April 1992 and amended in November 1992 and April 1993. The agreement provides for a five-year primary term commencing upon the initial delivery of natural gas. The agreement continues thereafter on a year-to-year basis unless terminated by either party upon 30 days written notice. The agreement provides for a higher transportation fee in the first two years of the contract and a reduced transportation rate for the remaining term, however, both terms are based on a certain minimum amount MMBtus used. The #2 plant is primarily used for peaking and back-up power generation 31 34 utilizing gas-fired reciprocating engines. The load has historically been seasonal with peak loads during the summer months. The Lake Charles System supplies a Westlake Petrochemicals Corporation ("Westlake") ethylene/styrene plant complex in Calcasieu Parish, Louisiana with a portion of their gas requirements through a 1.3 mile 8 inch pipeline system connected to Sabine Pipeline Company's interstate pipeline, a subsidiary of Texaco. The system was constructed by the Company and placed in service during November 1993 and provides gas supply to the plant under an agreement entered into in June 1993. The agreement provides for a three-year primary term commencing upon the initial delivery of natural gas, followed by a seven-year secondary term. At the expiration of the secondary term, Westlake retains ownership of the pipeline. The agreement also provides for a guaranteed minimum volume of 7,500 MMBtu/day and an option to purchase the pipeline for a nominal fee at the end of the primary term, with notice to the Company, should an event impair Westlake's ability to transport gas to their facilities. The agreement also provides that Westlake pay a monthly operations fee to the Company. In addition, Westlake has periodically purchased a portion of its gas supply from the Company. The note payable to a bank entered into in October 1995 is secured by all transportation revenues pertaining to this system. The Quindaro System supplies the Kansas City Board of Public Utilities Quindaro Power Plant ("BPU") in Wyandotte County, Kansas through a 3.1 mile 8 inch pipeline system connected to Williams Pipeline. The system was constructed by the Company and placed in service during November 1994 under an agreement entered into in January 1993. The agreement provides for a five-year primary term commencing upon the initial delivery of natural gas, followed by a second five-year optional term at a reduced transportation rate. The agreement will continue thereafter on a year-to-year basis unless terminated by either party upon 30 days written notice. The agreement provides that the Company shall supply 100% of BPU's natural gas requirements up to 250,000 MMBtu per year and a guaranteed minimum of 80% of BPU's natural gas requirements in excess of 250,000 MMBtus, subject to certain usage ceilings provided for in the agreement. The note payable to a bank entered into in October 1994 is secured by all transportation revenues pertaining to this system. The Quindaro Power Plant is primarily coal-fired with natural gas typically being utilized for start-up or, in the event of disruptions in coal-handling equipment or the supply of coal. However, as a result of the Quindaro system's ability to deliver gas at a higher pressure than the previous supplier, BPU has recently initiated utilization of a peaking gas turbine at the facility for supplemental power generation. BPU also has plans to convert two oil fired turbines to natural gas which could significantly increase the overall gas requirements for the facility. The Albany System supplies an Owens plant in Albany County, New York through a .5 mile 3 inch pipeline system connected to Tennessee Gas' pipeline. The system was constructed by the Company and placed in service during December 1994 and provides gas supply to the plant under an agreement entered into in July 1994, and amended in March 1996. The note payable to a bank entered into in November 1994, and amended in November 1995 is secured by all transportation revenues pertaining to this system. The agreements under which the OCPL System and the Albany Systems operate provide for six and seven-year primary terms, respectively, commencing upon the initial delivery of natural gas. The Albany System agreement also provides for an eight-year secondary term. Both agreements continue after their primary and secondary terms, respectively, on a year-to-year basis unless terminated by either party upon 30 days written notice. The Albany System agreement also provides for a quarterly amortization fee to be paid over the primary term as well as an operation and maintenance fee to be paid for the life of the contract, adjusted annually by the percentage increase or decrease in the Producer Price Index for Intermediate Materials, Supplies and Components. Under the Albany System agreement, the party terminating the agreement prior to the expiration of the primary and secondary terms shall be obligated to pay a lump sum amount, varying from year to year, as set forth in the agreement. The Guadalupe System supplies one of the largest Sulfur Recovery mines in North America, which is located in Culberson and Loving Counties, Texas. The mine was developed by Pennzoil Company, a publicly traded company, and is now owned by Freeport-McMoRan. This system was built in 1986 and was acquired 32 35 by Pan Grande in February 1996. The system supplies a portion of Freeport-McMoRan's gas requirements through approximately 2 miles of 8 inch pipeline transporting those volumes for producers and marketers having sales contracts with the plant. The system also includes two interconnect pipelines consisting of 3 miles of 4 inch and 4 miles of 8 inch pipeline, respectively, which deliver gas to or from Western Gas Resources Inc.'s pipelines, a publicly traded company. The note payable to a bank entered into by Pan Grande in March 1996 in connection with the acquisition of this system and the Allen Hill, Chapa, Guerra, Loma Novia and Puckett Systems is secured by all of the assets of each respective system and all transportation revenues pertaining to such systems. See "-- Pipeline Construction, Acquisition and Disposition." The South Fulton System in Obion County, Tennessee was recently constructed and is expected to be placed in service in May 1996 to supply 100% of Tyson's natural gas requirements to Tyson's newly constructed feedmill in South Fulton, Tennessee. The pipeline has a capacity of 1,500 MMBtu/d and consists of .6 miles of 4 inch pipeline connecting to the City of South Fulton's local gas distribution system. The City of South Fulton, as the owner, operates and maintains the pipeline. The note payable to a bank entered into in March 1996 is secured by all transportation revenues pertaining to this system. See "-- Pipeline Construction, Acquisition and Disposition." The Power Paper System in Roane County, Tennessee is currently being constructed and is expected to be placed in service in June 1996 to supply natural gas to Power Paper's paper plant. The pipeline has a capacity of 5,000 MMBtu/d and consists of 2.1 miles of 3 inch pipeline connecting East Tennessee's pipeline to Power Paper's paper plant in Roane County under an agreement by which Power Paper has agreed to transport 100% of their gas requirements. The note payable to a bank entered into in March 1996 is secured by all transportation revenues pertaining to this system. See "-- Pipeline Construction, Acquisition and Disposition." The H&W System in Escambia County, Alabama connects a gas sweetening plant with a liquids extraction plant through a 9 mile 6 inch pipeline. The system has been inactive since its acquisition. The Company has no contracts with customers to transport gas through this system. The Company is engaged in finding a buyer for the system as it has the potential to transport gas between the two plants, transport gas to or for a local gas utility who has a system adjacent to the east end of the pipeline, or make deliveries to an industrial end-user who has a pipeline that culminates at the west end of the pipeline system. As a result, this pipeline is classified as an asset held for resale in the Consolidated Financial Statements and valued at the lower of cost or market in the amount of $210,447. See the Company's "Consolidated Financial Statements." Magnolia System transports gas for Sonat Marketing Company ("Sonat Marketing"), a subsidiary of Sonat, Inc. ("Sonat"), a publicly traded company, Transco Gas Marketing Company ("Transco Marketing"), a subsidiary of Transco, Meridian Oil, Inc. ("Meridian"), a subsidiary of Burlington Resources, Inc., a publicly traded company, and Perry Gas Companies, Inc. ("Perry Gas") in the Black Warrior Basin, Alabama through a system consisting of 77 miles of 24 inch pipeline, 20 miles of 16 inch pipeline, and 14 miles of 8 inch and 12 inch pipeline. The Magnolia System is located in central Alabama and also includes a compressor station which has three Solar gas turbines with C160 gas compressors, each rated at 1,340 horsepower. The system was acquired by the Company from Williams pursuant to an agreement with an effective date of August 1995. The Company assumed the operations of the pipeline during September 1995. The system also connects coal-seam gas production in the Black Warrior Basin with Transco's interstate pipeline. The note payable to a bank entered into in December 1995 is secured by all of the capital stock of Magnolia. See "Back Cover" of the Prospectus. Magnolia currently has long-term contracts with Sonat Marketing, Transco Marketing, Meridian and Perry Gas. The Company transports gas for Sonat Marketing under an agreement entered into in July 1990 (the "Sonat Agreement"), for Transco Marketing under an agreement entered into in July 1990 and amended in August 1995 (the "Transco Agreement"), for Meridian under an agreement entered into in August 1991 (the "Meridian Agreement") and for Perry Gas under an agreement entered into in November 1995 (the "Perry Gas Agreement"). The Sonat and Perry Gas Agreements provide for one-year primary terms commencing upon the initial delivery of natural gas and continue thereafter on a month-to-month basis unless terminated by either party upon 30 days written notice. The Transco Agreement, as amended, provides for a ten-year term from the date of amendment, and the Meridian Agreement provides for a twelve-year term, 33 36 commencing upon the initial delivery of natural gas. The Transco Agreement continues thereafter on a month-to-month basis. The Moores Bridge System is a 4.5 mile 10 inch transmission pipeline with a 130 horsepower compressor, located in Tuscaloosa County, Alabama. The system has a receipt point with Northwest Alabama Gas District ("NWAGD") and delivery interconnections with both Alagasco, a subsidiary of Energen Corp., a publicly traded company, and Sonat. The system was built in or about 1979 and was acquired by Magnolia in May 1996. The note payable to a bank entered into in December 1995 and amended in May 1996 is secured by the capital stock of Magnolia. The Sinton System is an inactive 2.8 mile 3 inch gas gathering pipeline located in San Patricio County, Texas. The prospect for placing this line in service is uncertain, and is dependent on an increase in gas exploration in the area. The Fitzsimmons System consists of gas delivery facilities located in Duval County, Texas which connect a gas well to Valero's intrastate system. The Company purchases the gas from the producer and resells the gas to a third party. The Zmeskal System consists of delivery facilities in Victoria County, Texas which connect three producing gas wells to an intrastate gathering system. The Company purchases and resells the wells' production to a third party. The Cook Inlet Gas and Crude Oil Systems consists of two separate lines, a 2.7 mile 6 inch natural gas gathering pipeline and a 2.7 mile 8 inch crude oil gathering pipeline. The pipeline was placed in service during July 1994 and connects the West McArthur River Unit ("WMRU") Production Facility, operated by Stewart Petroleum Company ("Stewart"), to a delivery point at the Unocal Oil Trading Bay Production Facility on the west side of Cook Inlet near Anchorage, Alaska. The Company receives a throughput charge from Stewart for all oil and gas transported through the system for the life of the WMRU wells, subject to guaranteed minimum volumes, by Stewart for the first two years the pipeline is in service. All gas is presently utilized on site as fuel for production equipment and as such, the gas gathering system is presently inactive. Stewart has a development program to identify several other potential locations which would be dedicated to the Company's pipeline, if commercially productive. The note payable to a bank entered into in December 1994 is secured by the throughput fees pertaining to this system. The Foss System gathers gas from four Anadarko Basin gas wells in Custer County, Oklahoma through a 4.1 mile 2 and 4 inch pipeline system connected to ANR Pipeline Company's interstate pipeline, a subsidiary of Coastal. The system was acquired by the Company in December 1994. A portion of the gas is purchased and resold while the remainder is transported for a fee. The Flores System purchases or transports gas for five operators from ten wells in Starr County, Texas, through 9.9 miles of pipeline system consisting of 2.5 inch to 4.5 inch pipe. The system has receipt points with Merit Energy Company ("Merit Energy"), Carl Oil & Gas Company, Tasca Exploration Company, Hanson Production Company, and Marquee Corporation with delivery interconnections to Valero, Tennessee Gas, Florida Gas, and Tejas Gas. The system was acquired, effective January 1, 1996, by Starr County Gathering System, a joint venture, of which the Company owns 60%. The note payable to a bank entered into by Starr County Gathering System in January 1996 is secured by all of the assets of this system and all transportation revenues pertaining to the system. See "-- Pipeline Construction, Acquisition and Disposition." The Allen Hill System gathers and transports gas for one operator from one lease and purchases and resells gas from one other operator in Tom Green County, Texas through a 5.5 mile pipeline system consisting of 4 inch pipe. The system has receipt points with Merit Energy, and Charter Petroleum Company with delivery interconnections to Lone Star. The system was built in 1981 and was acquired by Pan Grande in February 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Chapa System gathers and transports gas for three operators from eight wells in Live Oak County, Texas through a 24.7 mile pipeline system consisting of 2 inch to 10 inch pipe. The system has receipt points with Midstates Corporation, Hunter Petroleum, Inc. and Phillips, with delivery interconnections to Valero and 34 37 Houston Pipe Line. The system was built in 1978 and was acquired by Pan Grande in February 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Guerra System gathers and transports gas for two operators from wells in Webb and Duval Counties, Texas through an 18.8 mile pipeline system consisting of 3 inch to 6 inch pipe. The system has receipt points with Marquee Corporation, Phillips, Tri-C Resources, Inc. and Amerac Energy Corporation with delivery interconnections to Valero and Houston Pipe Line. The system was built in 1978 and was acquired by Pan Grande in February 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Loma Novia System gathers and transports gas for three parties from wells located in Duval and McMullen Counties, Texas through a 15.2 mile pipeline system consisting of 4 inch and 6 inch pipe. The system has numerous wellhead receipt points and delivery interconnections with Houston Pipe Line and Natural Gas Pipeline Company of America, a subsidiary of MidCon. The system was acquired by Pan Grande in February 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Puckett System gathers and transports gas for one operator from one well in Pecos County, Texas through a 3.5 mile pipeline system consisting of 4 inch pipe. The system has receipt points with Maynard Oil Company, a publicly traded company, with delivery interconnections to El Paso Natural Gas Company, a publicly traded company. The system was built in 1983 and was acquired by Pan Grande in February 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Baxterville System is a presently inactive 1.4 mile gathering pipeline system consisting of 2 inch to 3 inch pipeline, located in Lamar County, Mississippi. The system was built in 1990 and was acquired by Magnolia in May 1996. The note payable to a bank entered into in December 1995 in connection with the acquisition of this system and the Detroit, Fayette, Greenwood Springs, Happy Hills, Heidelberg-Koch, Heidelberg-TGP, Millbrook and Sizemore Systems and amended in May 1996 is secured by the capital stock of Magnolia. See "-- Pipeline Construction, Acquisition and Disposition." The Detroit System gathers and transports gas from three wells in Lamar County, Alabama through a 16.5 mile pipeline system consisting of 2 inch to 8 inch pipe. The system has a delivery interconnection with NWAGD. The system was build in 1981 and was acquired by Magnolia in May 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Fayette System gathers and transports gas from 18 wells in Fayette County, Alabama through a 62.8 mile pipeline system consisting of 2 inch to 6 inch pipe. The system has delivery interconnections with the City of Fayette municipal gas system, NWAGD, Associated Natural Gas Company, a subsidiary of PanEnergy, Inc., a publicly traded company, and Sonat Intrastate Alabama, Inc., a subsidiary of Sonat. The system was built in various stages between 1978 and 1985 and was acquired by Magnolia in May 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Greenwood Springs System gathers and transports gas from 2 wells in Monroe County, Mississippi through a 7.9 mile pipeline system consisting of 2 inch to 6 inch pipe. The system has a delivery interconnection with Tennessee Gas. The system was build in 1982 and was acquired by Magnolia in May 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Happy Hill System gathers and transports gas from producing wells in Fayette County, Alabama through a 5.5 mile 4 inch pipeline. The system has delivery interconnections with NWAGD and the Fayette System. The system was built in 1986 and was acquired by Magnolia in May 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Heidelberg-Koch System gathers and transports gas from 2 wells in Jasper County, Mississippi through a 1 mile pipeline system consisting of 3 inch to 4 inch pipe. The system has a delivery interconnection with Koch. The system was built in 1990 and was acquired by Magnolia in May 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Heidelberg-TGP System gathers and transports gas from 4 wells in Jasper County, Mississippi through a 3.5 mile pipeline system consisting of 2 inch and 4 inch pipe with a 225 horsepower compressor. The 35 38 system has a delivery interconnection with Tennessee Gas. The system was built in 1989 and was acquired by Magnolia in May 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Millbrook System is an 8.9 mile pipeline system consisting of 2 inch to 6 inch pipe located in Wilkinson County, Mississippi. The system is currently under lease to a producer through 1997. The lease requires payments based on the system volumes subject to a monthly minimum, and the producer has the option to purchase the system for $450,000 less the sum of any previous lease payments. The lessee also has an option to extend the lease for an additional five years on the same terms. The system was built in 1983 and was acquired by Magnolia in May 1996. See "-- Pipeline Construction, Acquisition and Disposition." The Sizemore System gathers and transports gas from producing wells in Lamar County, Alabama through a 1 mile, 2 inch pipeline. The system has a delivery interconnection with NWAGD. The system was built in 1989 and was acquired by Magnolia in May 1996. See "-- Pipeline Construction, Acquisition and Disposition." TITLE TO PROPERTIES The Company, as part of its construction process, must obtain certain right of way agreements from landowners whose property the proposed pipeline will cross. The terms and cost of these agreements can vary greatly due to a number of factors. In addition, as part of its acquisition process, the Company will typically evaluate the underlying right of way agreements for the particular pipeline to be acquired to determine that the pipeline owner has met all terms and conditions of the underlying right of way agreement and that the agreement is still in full force and effect. The Company typically relies upon outside service organizations to review the right-of-way agreements and to make suggestions to the seller as to any curative work required before closing. The Company typically does not receive a title opinion or title policy as to these right-of-way agreements due to the complexity of the records and attendant expense. Occasionally, the Company may seek to initiate condemnation proceedings where permitted under state law, to obtain a right-of-way necessary for pipeline construction projects. The Company believes that this process is consistent with standards in the pipeline industry, and that it holds good title to its pipeline systems, subject only to defects which the Company believes are not material to the ownership of its properties or results of operations. Substantially all of the Company's pipeline systems are pledged to secure loans obtained to finance the purchase or construction of the respective system. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Capital Resources and Liquidity." [BALANCE OF THIS PAGE INTENTIONALLY LEFT BLANK] 36 39 MARKETS AND MAJOR CUSTOMERS The natural gas industry has undergone major transformations, which have included significant changes in government regulation. These regulatory changes have impacted growth in the domestic consumption of natural gas as seen in the chart below: UNITED STATES NATURAL GAS CONSUMPTION BY END-USER SECTOR(1)
DELIVERED TO CONSUMERS ------------------------------------------------------- LEASE AND PIPELINE ELECTRIC TOTAL PLANT FUEL FUEL(2) RESIDENTIAL COMMERCIAL(3) INDUSTRIAL UTILITIES TOTAL CONSUMPTION ---------- -------- ----------- ------------- ---------- --------- ------ ----------- 1986 Total........... 923 485 4,314 2,318 5,579 2,602 14,814 16,221 1987 Total........... 1,149 519 4,315 2,430 5,953 2,844 15,542 17,211 1988 Total........... 1,096 614 4,630 2,670 6,383 2,636 16,320 18,030 1989 Total........... 1,070 629 4,781 2,718 6,816 2,787 17,102 18,801 1990 Total........... 1,236 660 4,391 2,623 7,018 2,787 16,820 18,716 1991 Total........... 1,129 601 4,556 2,729 7,231 2,789 17,305 19,035 1992 Total........... 1,171 588 4,690 2,803 7,527 2,766 17,785 19,544 1993 Total........... 1,172 624 4,956 2,862 7,981 2,682 18,482 20,278 1994 Total........... 1,161 685 4,848 2,895 8,178 2,987 18,908 20,754 1995 Total........... 1,228 713 4,844 3,096 8,520 3,194 19,654 21,596
Sources: 1973-1988: Energy Information Administration ("EIA"), Natural Gas Annual 1994, Volume 1, Table 101; 1989 forward: EIA, Natural Gas Monthly, March 1996, Table 3. - --------------- (1) Measured in billion cubic feet. (2) Natural gas consumed in the operation of pipelines, primarily in compressors. (3) Small quantities of natural gas delivered for use as vehicle fuel are included in the 1993 and 1994 annual totals. As a consequence, the industry has experienced a marked increase in competition and volatility in natural gas prices. The result has been an increase in gas sold directly to end-users by producers and other nontraditional suppliers, and an increasing reluctance of end-users to enter into long-term contracts. Consumers have shown an increased willingness to switch fuels between gas and oil in response to their relative price fluctuations, and there is a growing use of gas purchase contracts that require price adjustments in response to market conditions. During the three month period ended March 31, 1996, the Company derived approximately 31% and 34% of its revenues from Mapco and Westlake, respectively. Mapco is a Fortune 500 natural gas liquids pipeline company. The Company furnishes natural gas to Mapco and its affiliates through various pipeline systems in several states for fuel to ten turbine pump stations and a main fractionation facility of Mapco under several long-term agreements. Westlake is an international petrochemicals company. The Company supplies Westlake's ethylene/styrene plant complex in Louisiana through the Lake Charles System under an agreement entered into in June 1993 containing a three-year primary and seven-year secondary term, respectively. A majority of the Mapco and Westlake agreements provide for guaranteed minimum cumulative volume restrictions and additional transportation fees to be paid to the Company for actual volumes transported, except for the Conway System agreement. The Westlake agreement also provides for an option to purchase the pipeline for a nominal fee at the end of the primary term, with notice to the Company, should an event impair Westlake's ability to transport gas to their facilities. Furthermore, the Westlake agreement provides that Westlake pay a fixed monthly operations fee to the Company, adjusted annually by current price indices. In addition, Westlake has periodically purchased a portion of its gas supply from the Company. The Company has many other long-term commitments with significant customers. See "-- Pipeline Systems." SALES AND MARKETING The Company aggressively pursues end-user customers. As such, the Company relies on its management team to identify suitable construction or acquisition projects involving end-user customers either through 37 40 direct sales efforts, referrals, or existing relationships within the industry. The Company has two full-time employees whose primary responsibilities are to identify and develop new end-user pipeline projects. Furthermore, the Company's senior management devotes much of its time and effort to develop such projects and works with both new and existing customers to meet their gas supply needs. Management also benefits from their relationships with others in the industry who often notify the Company of assets which are being offered for sale, or of new gathering or end-user construction opportunities in addition to those opportunities, sought after by management. NATURAL GAS SUPPLY The Company's end-user pipelines have connections with major interstate and intrastate pipelines which management believes have ample supplies of natural gas in excess of the volumes required for these systems. In connection with the construction and acquisition of its gathering systems, evaluations were made of well and reservoir data furnished by producers to determine the availability of gas supply for the systems. Based on those evaluations, it is management's belief that there should be adequate gas supply for the Company to recoup its investment with an adequate rate of return. As such, management does not routinely obtain independent evaluation of reserves dedicated to its systems due to the cost of such evaluations. Accordingly, the Company does not have estimates of total reserves dedicated to its systems or estimates of the anticipated life of such producing reserves. COMPETITION The gas transmission, gathering and marketing industries are highly competitive. In marketing gas, the Company has numerous competitors, including marketing affiliates of interstate pipelines, the major integrated oil companies, and local and national gas gatherers, brokers and marketers of widely varying sizes, financial resources and experience. Local utilities and distributors of gas are, in some cases, engaged directly, and through affiliates, in marketing activities that compete with the Company. The Company competes against other companies in the transmission, gathering and marketing businesses for supplies of gas and for sales customers. Competition for gas supplies is primarily based on efficiency, reliability, availability of transportation and the ability to offer a competitive price for the gas. Competition for customers is primarily based upon reliability and price of deliverable gas. For customers that have the capability of using alternative fuels, such as oil and coal, the Company also competes against companies capable of providing these alternative fuels at a competitive price. OIL AND GAS PROPERTIES The Company owns a number of minor non-operated working interests in producing and non-producing oil and gas properties. For the three month period ended March 31, 1996, revenues from the Company's oil and gas properties were less than 1% of its total revenues and for the same period the Company's oil and gas properties represented less than 3% of its total assets. The Company owns working interests in 3,558 gross acres of oil and gas leases on which are located 13 producing wells. In 1994, the Company acquired a 21.5% working interest in two leases together covering approximately 1,700 gross acres in Starr County, Texas on which are located eight active and one shut-in wells previously owned by Exxon Corporation ("Exxon"), a publicly traded company. The Company anticipates that the operator of the property may recommend further developmental drilling or remedial work on the leases, although the extent, timing and cost to the Company of any such operations is presently unknown. Although it is not expected to become a major line of business for the Company, management expects that acquisition and ownership of non-operated oil and gas interests will remain a facet of the Company's business for the foreseeable future. GOVERNMENT REGULATION Various aspects of the transportation, sale and marketing of natural gas are subject to or affected by extensive federal regulation under the Natural Gas Act ("NGA"), the Natural Gas Policy Act of 1978 38 41 ("NGPA"), the Natural Gas Wellhead Decontrol Act of 1989 ("Decontrol Act") and regulations promulgated by FERC. Natural Gas Transmission Industry. Historically, interstate pipeline companies acted as wholesale merchants by purchasing natural gas from producers, transporting that natural gas from the fields to their markets, and reselling the natural gas to LDCs and large end-users. Prior to the enactment of the NGPA in 1978 and the Decontrol Act of 1989, all sales of natural gas for resale in interstate commerce, including sales by producers, were subject to the rates and service jurisdiction of the FERC under the NGA and NGPA. However, as a result of the NGPA and the Decontrol Act, all so-called "first sales" of natural gas were federally deregulated, thus allowing all types of non-pipeline and non-local distribution sellers to market their natural gas free from federal controls. Moreover, pursuant to Section 311 of the NGPA, the FERC promulgated regulations by which wholly-intrastate natural gas pipeline companies could engage in interstate transactions without becoming subject to the FERC's full rates and service jurisdiction under the NGA. At the same time, however, the FERC has retained its traditional jurisdiction over the activities of interstate pipelines. Thus, under the NGA and NGPA, the transportation and sale of natural gas by interstate pipeline companies have been subject to extensive regulation, and the construction of new facilities, the extension of existing facilities and the commencement and cessation of sales or transportation services by pipeline companies generally have required prior FERC authorization. The NGA exempts gas gathering facilities from the direct jurisdiction of FERC. Interstate transmission facilities, on the other hand, remain subject to FERC jurisdiction. FERC has historically distinguished between these two types of facilities on a fact-specific basis. The Company believes that its gathering facilities and operations meet the current tests that FERC uses to grant nonjurisdictional gathering facility status. Some of the recent cases applying these tests in a manner favorable to the determination of the Company's nonjurisdictional status are, however, still subject to rehearing and appeal. In addition, FERC's articulation and application of the tests used to distinguish between jurisdictional pipelines and nonjurisdictional gathering facilities have varied over time. While the Company believes the current definitions create nonjurisdictional status for the Company's gathering facilities, no assurance is available that such facilities will not, in the future, be classified as regulated transmission facilities and thus, the rates, terms, and conditions of the services rendered by those facilities would become subject to regulation by FERC. Commencing in 1985, the FERC adopted regulatory changes that have significantly altered the transportation, sale and marketing of natural gas. These changes were intended to foster competition in the natural gas industry by, among other things, transforming the role of the interstate pipeline companies from wholesale marketers of natural gas to primarily natural gas transporters, and mandating that interstate pipeline companies provide open and nondiscriminatory transportation services to all producers, distributors, marketers and other shippers that seek such services (so-called "open access" requirements). As an incentive to cause the interstate pipeline companies to revamp their services, the FERC also sought to expedite the certification process for new services, facilities and operations of those pipeline companies providing "open access" services. Throughout the early years of this process, the FERC's actions in these areas were subject to extensive judicial review and generated significant industry comment and proposals for modification to existing regulations. In April 1992, the FERC issued its most comprehensive restructuring ruling, Order 636, a complex regulation that has had a major impact on natural gas pipeline operations, services and rates. Among other things, Order 636 generally required each interstate pipeline company to "unbundle" its traditional wholesale services and make available on an open and nondiscriminatory basis numerous constituent services (such as gathering services, storage services and firm and interruptible transportation services) and to adopt a new rate making methodology to determine appropriate rates for those services. To the extent the pipeline company or its sales affiliate makes natural gas sales as a merchant in the future, it will do so pursuant to a blanket sales certificate that puts those entities in direct competition with all other sellers pursuant to private contracts, however, pipeline companies were not required by Order 636 to remain merchants of natural gas, and several of the interstate pipeline companies have elected to become transporters only. The FERC required that each pipeline company develop the specific terms of service in individual restructuring proceedings by means of a compliance filing that set forth the pipeline company's new, detailed procedures. In subsequent orders, the 39 42 FERC largely affirmed the significant features of Order 636 and denied requests for stay of the implementation of the new rules pending judicial review. Order 636, as well as the FERC orders approving the individual pipeline restructuring proceedings, are the subject of numerous appeals to the United States Courts of Appeals. The outcome of such proceedings and the ultimate impact that they may have on the Company's business is uncertain. Regulation of the Company's Facilities. The Company's operations can be affected significantly by government regulation. Its pipeline systems are regulated by federal, state and local regulatory agencies. These regulations are extremely complex and subject to changing administrative interpretations. The Company's pipeline operations are generally not subject to regulation by the FERC which is an independent commission within the Department of Energy that has authority over the transportation and marketing of various categories of natural gas sold in interstate commerce. The production and sale of oil and gas is subject to federal, state and local governmental regulations including the imposition of excise taxes, the prevention of waste, pollution controls, conservation of natural resources and maximum daily production allowables for oil and gas wells. The Company's operations are further subject to regulation by various agencies of the states in which the Company operates. As in the case of potential federal regulatory changes, there can be no assurances that state regulatory measures will not adversely affect the Company's business and financial condition. In such events, the state's regulatory authorities could temporarily suspend or hinder operations in a particular state, depending on the authority's view of its jurisdiction. Although, regulators at the state level have generally followed the FERC's lead by allowing increased competition behind LDCs, there can be no assurance that every state will follow this practice without the pressure of litigation. State regulatory requirements and policies vary from state to state. The regulatory requirements of Texas, Kansas, Louisiana, Mississippi, New York, Alabama and Tennessee have the greatest impact on the Company due to the concentration of the Company's operations in those states. See "Risk Factors." The Company's operations in Texas are subject to the Texas Gas Utility Regulatory Act, as implemented by the Texas Railroad Commission. Generally, the Texas Railroad Commission is vested with authority to ensure that rates charged for natural gas sales and transportation services are just and reasonable. The Company must make filings with the Texas Railroad Commission for all new and increased rates. The Company's operations in Kansas are subject to the jurisdiction of the Kansas Corporation Commission (the "KCC") with regard to pipeline safety standards and certification procedures. The KCC has granted the Company Certificates of Public Convenience and Necessity for its pipelines in Kansas. The State of Louisiana Office of Conservation, Pipeline Division has safety and certification jurisdiction over the Company's operations in Louisiana. The Company was granted Certificates of Transportation, to Interconnect, and to Construct and Operate its system in Louisiana. The State of New York Public Service Commission has safety and certification jurisdiction over the Company's New York operations and has granted a Certificate of Public Necessity and Convenience for the Albany system. The Magnolia System in Alabama is subject to the jurisdiction of the FERC with respect to the transportation rates under Section 311(a)(2) of the NGA. This pipeline and the Company's other pipelines in Alabama are subject to the jurisdiction of the Alabama Public Service Commission-Pipeline Safety Section with regard to operational, environmental and safety considerations. The Company's operations in Mississippi, Oklahoma and Tennessee are subject to the jurisdiction of these state's respective Public Service Commissions with regard to operational, environmental and safety considerations. Environmental and Safety Matters. The Company's activities in connection with the operation and construction of pipelines and other facilities for transporting, processing, treating or storing natural gas and other products are subject to environmental and safety regulation by numerous federal, state and local authorities. This can include ongoing oversight regulation as well as construction or other permits and 40 43 clearances which must be granted in connection with new projects or expansions. On the federal level, these agencies can include the Environmental Protection Agency ("EPA"), the Occupational Safety and Health Administration, the U.S. Army Corp of Engineers, the U.S. Fish and Wildlife Service and others. State regulatory agencies or boards can include various air and water quality control boards, historical and cultural resources offices, fish and game services and others. These regulations can increase the cost of planning, designing, initial installation and the operations of such facilities. Sanctions for violation of these regulations include a variety of civil and criminal enforcement measures including monetary penalties, assessment and remediation requirements and injunctions as to future compliance. The following is a discussion of certain environmental and safety concerns related to the Company. It is not intended to constitute a complete discussion of the various federal, state and local statutes, rules, regulations, or orders to which the Company's operations may be subject. In most instances, the regulatory requirements of, including, without limitation, those state agencies mentioned above and the EPA, relate to the release of substances into the environment and include measures to control water and air pollution. Moreover, the Company, without regard to fault, could incur liability under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, or state counterparts, in connection with the disposal or other releases of hazardous substances. Further, the recent trend in environmental legislation and regulations is toward stricter standards, and this will likely continue in the future. Environmental laws and regulations may also require the acquisition of a permit before certain activities may be conducted by the Company. Further, these laws and regulations may limit or prohibit activities on certain lands lying within wilderness areas, wetlands, areas providing habitat for certain species or other protected areas. As an employer, the Company is required to maintain a workplace free of recognized hazards likely to cause death or serious injury and to comply with specific safety standards. The Company is also subject to other federal, state and local laws covering the handling, storage or discharge of materials used by the Company, or otherwise relating to protection of the environment, safety and health. Management believes, based on its current knowledge, that the Company has obtained and is in current compliance with all necessary and material permits and that the Company is in substantial compliance with applicable material environmental and safety regulations. The Company maintains insurance coverages that it believes are customary in the industry, although it is not fully insured against all environmental and safety risks. The Company is not aware of any existing environmental or safety claims that would have a material impact upon its financial position or results of operations. See "-- Insurance." INSURANCE The Company presently maintains general comprehensive liability insurance coverage with aggregate policy limits of $21,000,000 and per accident policy limits of $11,000,000 which includes, among other items and subject to certain conditions, coverage for pollution and waste disposal. The Company maintains property insurance considered to be customary in the industry. There can be no assurance, though, that insurance coverage will be available or adequate for any particular risk or loss. Although, management believes that the Company's assets are adequately covered by insurance, a substantial uninsured loss could have a materially adverse impact on the Company and its financial position. LEGAL PROCEEDINGS The Company is currently involved in certain routine litigation. Management believes that all such litigation arose in the ordinary course of business and that costs of settlements or judgments arising from such suits will not have a material adverse effect on the Company's consolidated financial position or results of operations. 41 44 EMPLOYEES, CONTRACT EMPLOYEES AND CONTRACT SERVICE ORGANIZATIONS As of May 15, 1996, the Company had 14 full-time employees, three part-time employees, and two month-to-month contract employees. The Company also has arrangements with ten other nonaffiliated independent pipeline operating companies, or individuals performing a similar service, who service and operate the Company's extensive field operations and provide for emergency response measures. The Company is not party to any collective bargaining agreements. There have been no significant labor disputes in the past and the Company considers its relations with employees to be excellent. [BALANCE OF THIS PAGE INTENTIONALLY LEFT BLANK] 42 45 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The directors and executive officers of the Company and their respective ages and positions with the Company are set forth in the following table:
OFFICER OR DIRECTOR NAME AGE POSITION SINCE -------------------------------- --- -------------------------------- ---------- Dan C. Tutcher.................. 47 Chairman of the Board, President 1992 and Chief Executive Officer Stevens G. Herbst............... 59 Executive Vice President, 1992 Director Kenneth B. Holmes, Jr........... 64 Director 1992 E.P. Marinos(1)................. 53 Director 1996 Richard N. Richards(1).......... 49 Director 1996 Duane S. Herbst................. 32 Secretary 1992 I.J. Berthelot, II.............. 36 Vice President of Operations and 1995 Chief Engineer Richard A. Robert............... 30 Chief Financial Officer and 1996 Treasurer
- --------------- (1) Agreed to serve as a director commencing prior to the effective date of the Offering. Dan C. Tutcher has been Chairman of the Board, President and Chief Executive Officer since the Company's incorporation in 1992 and Treasurer from 1995 to 1996. Since 1989 Mr. Tutcher has also been President and Chief Executive Officer of Magic Gas. Prior to its merger into the Company, in 1992, Mr. Tutcher served as a Director of Nugget, from 1990 to 1992. See "Business and Properties -- General." He also has held various positions in companies which constructed pipelines and marketed gas, such as Gulf Gas Utilities, Inc. and Wildhorn Corporation, where he served as Vice President from 1987 through 1989 and as President from 1984 through 1993, respectively. Mr. Tutcher holds a Bachelors of Business Administration degree in General Business from Washburn University. Stevens G. Herbst is an officer of the Company in a part-time capacity. As such, he has been Executive Vice President since the Company's incorporation in 1992. From 1989 to 1992 Mr. Herbst was President of Transmission. Prior to its merger into the Company, in 1992, Mr. Herbst served as a Director of Nugget for the period from 1990 to 1992. See "Business and Properties -- General." In 1985, Mr. Herbst formed Texline with Mr. Holmes. Mr. Herbst is currently President of Texline and has been President since 1985. Mr. Herbst has also been President of Rainbow since 1977. He is a Professional Engineer licensed in Texas and Louisiana and is a member of the Natural Gas Association of Houston and the Natural Gas Transportation Association. Mr. Herbst holds a Bachelors of Science degree in Petroleum and Natural Gas Engineering from Texas A&I University. Kenneth B. Holmes, Jr. was Vice President of the Company in a part-time capacity from 1992 until 1996 and Treasurer from 1992 until 1995. From 1989 to 1992 Mr. Holmes was Vice President of Transmission. Prior to its merger into the Company, in 1992, Mr. Holmes served as a Director of Nugget for the period from 1990 to 1992. See "Business and Properties -- General." In 1985, Mr. Holmes formed Texline jointly with Mr. Herbst where he currently is Vice President. Mr. Holmes has also been President of Promac Corporation since 1976. He holds a Bachelors of Business Administration degree in General Business from Texas A&M University. E. P. Marinos has agreed to serve as a director commencing prior to the effective date of the Offering. Mr. Marinos is currently the President, Chief Executive Officer and Director of Arrhythmia Research Technology, Inc., a publicly traded medical device manufacturing company. From 1991 to 1995, Mr. Marinos was President and Chief Executive Officer of AMT/EMP Associates, a consulting company which provided strategic planning, mergers and acquisition consulting and organizational restructuring consulting services to 43 46 its clients. Prior to 1991, he served as Senior Vice President of Finance and Administration of Cornerstone Natural Gas, Inc. (formerly Endevco, Inc.), a publicly traded integrated natural gas gathering, transmission and marketing pipeline company. Mr. Marinos was also a partner in the accounting firm of Deloitte & Touche LLP (formerly Touche Ross & Co.) from 1975 to 1982. He holds a Bachelors of Science degree in Economics and Finance from Wayne State University. Mr. Marinos is a certified public accountant and is a member of the Texas Society of Certified Public Accountants and the Michigan Society of Certified Public Accountants. Mr. Marinos has provided consulting services to the Company from time to time. Richard N. Richards, Captain, U.S. Navy (retired,) has agreed to serve as a director commencing prior to the effective date of the Offering. Mr. Richards has been with NASA since 1980. Mr. Richards was an astronaut with NASA until 1995 and flew one mission as pilot and commanded three missions of the space shuttles Discovery and Columbia. Since 1995, Mr. Richards has been designated as the Mission Director/Manager for the second Hubbel Space Telescope Servicing Space Shuttle Mission and Mission Manager for the second Tethered Satellite System Space Shuttle Mission. He holds a Bachelors of Science degree in Chemical Engineering from University of Missouri and a Masters of Science in Aeronautical Systems from the University of West Florida. Duane S. Herbst is an officer of the Company in a part-time capacity. As such, he has been Secretary of the Company since its incorporation in 1992. From April 1992 until its merger with the Company in September 1992 he held the office of President of Nugget. See "Business and Properties -- General." From 1989 to the date hereof he has been Vice President of Rainbow. Mr. Herbst has also held the office of Secretary of Texline since 1993. He holds a Masters of Business Administration from the University of Texas and a Bachelors of Science degree in Finance from Trinity University. He is the son of Stevens G. Herbst. I. J. "Chip" Berthelot, II is Vice President of Operations and Chief Engineer and has been with the Company since the Company's incorporation in 1992. Mr. Berthelot joined the Company as Chief Engineer and became Vice President of Operations and Chief Engineer in 1995. From 1991 to 1992 he was a gas contracts representative with Mitchell Energy & Development Co., a publicly traded company. Prior to 1991 Mr. Berthelot was with Texline as a gas contracts representative and engineer for the period from 1990 to 1991. He is a Professional Engineer, licensed in Texas and holds a Bachelors of Science degree in Petroleum and Natural Gas Engineering from Texas A&I University. Richard A. Robert is Chief Financial Officer and Treasurer and has been with the Company since 1992. Mr. Robert joined the Company as Controller and became Chief Financial Officer and Treasurer in 1996. From 1988 to 1992 Mr. Robert was an audit associate in the energy audit division of Arthur Anderson and Co. Mr. Robert is a certified public accountant and is a member of the Texas State Society of Certified Public Accountants. He holds a Bachelors of Business Administration degree in Accounting from Southwest Texas State University. EXECUTIVE COMPENSATION The following table reflects all forms of compensation for services to the Company for the years ended December 31, 1995, 1994 and 1993 of the Chief Executive Officer of the Company. During 1993 and 1994 the only executive officer to receive a salary was Mr. Tutcher. During 1995, 1994 and 1993 no other executive officers received compensation, including bonuses, which exceeded $100,000.
ANNUAL COMPENSATION NAME AND PRINCIPAL -------------------------- POSITION YEAR SALARY BONUS ----------------------------------------------------------- ---- -------- ------ Dan C. Tutcher, (Chief Executive Officer)(1)............................. 1995 $125,000 $6,000 1994 $125,000 $6,000 1993 $ 62,000 $6,000
- --------------- (1) The Company provides Mr. Tutcher certain personal benefits including payments for a car allowance. Since the value of such benefits did not exceed the lesser of $50,000 or 10% of annual compensation, the amounts are omitted. 44 47 Additionally, the Company has not granted any options to any officers or directors of the Company. Furthermore, the Company does not propose to issue any such options in the foreseeable future, other than those options that may be granted pursuant to the 1996 Incentive Stock Plan. Pursuant to separate shareholder's agreements dated April 30, 1994 by and between the Company and I.J. Berthelot, II, Richard A. Robert and Duane S. Herbst, each officer was respectively, issued 11,152, 11,152, and 6,691 shares, of the Company's Common Stock as additional consideration for their services to the Company. Such shares, reduced each year pursuant to a vesting schedule, are subject to the Company's repurchase upon the termination of the respective officer's employment, for any reason, after a 30-day notice period. Executive Employment Contracts. In January 1993, and as subsequently amended in April 1993, Mr. Tutcher, the Chief Executive Office and President of the Company, entered into a five-year employment agreement with the Company pursuant to which he is to receive an annual base salary of $125,000, beginning July 1, 1993, and may participate in any such executive level bonuses or salary increases as the Board may approve. Mr. Tutcher is also entitled to reimbursement for reasonable automobile expenses not to exceed $500 each month and is eligible for participation in the Company's group insurance plans. Mr. Tutcher is required to devote his full business time and attention to the Company. In April 1995, and subsequently amended in December 1995, I.J. Berthelot, II, Vice President of Operations and Chief Engineer, entered into a four-year employment agreement with the Company. Pursuant to the employment agreement Mr. Berthelot is to receive an annual base salary of $55,200, to be increased a minimum of 10% annually, beginning on April 17, 1996. Mr. Berthelot was also awarded 57,992 shares of the Company's Common Stock as consideration for executing the agreement. Such shares, reduced each year pursuant to a vesting schedule, are subject to the Company's repurchase upon the termination of Mr. Berthelot's employment with the Company for any reason. Mr. Berthelot is required to devote his full business time and attention to the Company. In April 1994, and subsequently amended in April 1996, Richard A. Robert, Chief Financial Officer and Treasurer, entered into a three-year employment agreement with the Company. Pursuant to the employment agreement, Mr. Robert is to receive an annual base salary of $69,000, to be increased a minimum of 10% annually, beginning on April 8, 1997. Mr. Robert was also awarded 8,921 shares of the Company's Common Stock as consideration for executing the agreement. Such shares, reduced each year pursuant to a vesting schedule, are subject to the Company's repurchase upon the termination of Mr. Robert's employment with the Company for any reason. Mr. Robert is required to devote his full business time and attention to the Company. In May 1996, Duane S. Herbst, Secretary, began receiving an annual salary from the Company of $24,000 per year for his part-time services as Secretary. Previously, the Company had a month-to-month arrangement which provided a monthly payment of $1,050 to compensate Rainbow for the Company's use of the time of Mr. Herbst. DIRECTOR COMPENSATION AND BOARD COMMITTEES During the year ended December 31, 1995, the Board met 14 times. Each director attended all Board meetings either in person or by telephonic conference. In the past directors have not received any compensation for serving as directors. However, Messrs. Marinos and Richards will each be issued a stock grant, in consideration for their future services, of 2,007 shares of the Company's Common Stock. These stock grants will vest ratably over a three-year period. Subsequent to the effective date of the Offering, the Company intends to pay quarterly and meeting fees to the directors for their services. Audit Committee. The Company's Board has established an Audit Committee. The Committee's functions will include reviewing internal controls and recommending to the Board the engagement of the Company's independent certified public accountants, reviewing with such accountants a plan for and results of their examination of the financial statements, and determining the independence of such accountants. As of 45 48 the date hereof, no members have been appointed to the committee, but it is expected that the Audit Committee will consist of Messrs. Holmes, Marinos and Richards. Compensation Committee. The Company's Board has established a Compensation Committee. The Compensation Committee will propose and administer the Company's 1996 Incentive Stock Plan. In this capacity, the Compensation Committee will recommend all option grants or awards to Company officers, executives and employees. The Compensation Committee will also recommend the establishment of policies dealing with various compensation, including compensation of executive officers, and pension and profit sharing plans, although at this time no such plans have been created. As of the date hereof, no members have been appointed to the committee, but it is expected that the Compensation Committee will consist of Messrs. Marinos, Holmes and Richards. Executive Committee. The Company's Board has established an Executive Committee. The Executive Committee will be authorized to exercise, to the extent permitted by law, the power of the full Board when a meeting of the full Board is not practicable or necessary. As of the date hereof, no members have been appointed to the committee, but it is expected that the Executive Committee will consist of Messrs. Tutcher, Herbst and Holmes. 1996 Incentive Stock Plan. In 1996, the Board adopted the Midcoast Energy Resources, Inc. 1996 Incentive Stock Plan (the "Incentive Plan"). The purpose of the Incentive Plan is to (i) align the personal financial incentives of the employees and consultants of the Company and its subsidiaries ("Participants") with the long-term growth of the Company and the interests of the Company's stockholders through the ownership and performance of the Company's Common Stock and (ii) enhance the ability of the Company and its subsidiaries to attract and retain employees who share primary responsibility for the Company's management and growth. All employees, including officers (whether or not directors) and consultants of the Company and its subsidiaries are currently eligible to participate in the Incentive Plan. Persons who are not in an employment or consulting relationship with the Company or any of its subsidiaries, including non-employee directors, are not eligible to participate in the Incentive Plan. Under the Incentive Plan, the Compensation Committee may grant Participants incentive awards (the "Incentive Awards") with respect to a number of shares of Common Stock that in the aggregate does not exceed 200,000 shares of Common Stock, subject to adjustment upon the occurrence of certain recapitalizations of the Company. The Incentive Plan provides for the grant of (i) options, both incentive stock options and non-qualified options, (ii) shares of restricted stock, (iii) performance awards payable in cash or Common Stock, (iv) shares of phantom stock, and (v) stock bonuses (collectively, the "Incentive Awards"). In addition, the Incentive Plan provides for the grant of cash bonuses payable when a Participant is required to recognize income for federal income tax purposes in connection with the vesting of shares of restricted stock or the issuance of shares of Common Stock upon the grant of a performance award or a stock bonus, provided, that such cash bonus may not exceed the fair market value (as defined) of the shares of Common Stock received on the grant or exercise, as the case may be, of an Incentive Award. No Incentive Award may be granted under the Incentive Plan after ten years from the Incentive Plan adoption date. All options granted to consultants shall be non-qualified options. The Compensation Committee is authorized to make Incentive Awards under the Incentive Plan to all Participants, including officers (whether or not they are also directors), of the Company and its subsidiaries. The Compensation Committee determines which persons receive grants of Incentive Awards, the type of Incentive Award granted and the number of shares subject to each Incentive Award. The Incentive Plan does not prescribe, and the Compensation Committee has not adopted, any fixed criteria to be evaluated in determining the number of shares of Common Stock subject to any Incentive Award; provided, however, that the maximum number of shares of Common Stock which can be granted to any one individual during any calendar year is 50,000 shares. This maximum limitation is intended to comply with Section 162(m) of the Code, so as to preserve the deductibility by the Company of compensation generated by the exercise of non- qualified stock options (or a disqualifying disposition of incentive stock options) granted to certain executive officers of the Company. Subject to the terms of the Incentive Plan, the Compensation Committee also 46 49 determines the prices, expiration dates, vesting schedules and other material features of the Incentive Awards granted under the Incentive Plan. The Compensation Committee has the authority to interpret and construe any provision of the Incentive Plan and to adopt such rules and regulations for administering the Incentive Plan as it deems necessary. All decisions and determinations of the Compensation Committee are final and binding on all parties. The Company has agreed to indemnify each member of the Compensation Committee against any cost, expense or liability arising out of any action, omission or determination relating to the Incentive Plan, unless such action, omission or determination was taken or made in bad faith and without reasonable belief that it was in the best interest of the Company. Each stock option is exercisable on such date or dates as determined by the Compensation Committee at the time of grant (subject to earlier termination under the Incentive Plan); provided, however, no option is exercisable prior to six months from the date of grant or after ten years from such date of grant. The exercise price of each stock option is determined by the Compensation Committee, but such price may not be less than the fair market value (as defined) of the shares of Common Stock as of the date of grant. On the occurrence of a change in control (as defined), each such option becomes immediately exercisable. A grant of shares of restricted stock represents the promise of the Company to issue shares of Common Stock on a predetermined date, which shares vest on a second predetermined date. On the occurrence of a change in control (as defined), any unvested grants will vest automatically. A grant of a Performance Award (as defined) represents the promise of the Company to pay a certain amount in cash or Common Stock (as determined by the Committee), which award is contingent upon the future performance of the Company, its subsidiaries or any division, department, or combination thereof. The Committee establishes (i) the maximum value to be granted pursuant to such Performance Award (as defined), (ii) the performance period to which the award relates and (iii) the performance measures and targets associated with the applicable performance period. A share of phantom stock represents the right to receive the economic equivalent of a grant of restricted stock and is subject to the same vesting requirements. The value of a share of phantom stock is payable immediately on the occurrence of a change in control (as defined). Bonuses payable in stock may be granted by the Compensation Committee and may be payable at such times and subject to such conditions as the Compensation Committee determines. The Incentive Plan provides for an adjustment in the number of shares of Common Stock to be issued under the Incentive Plan, the number of shares subject to any Incentive Award and the exercise prices of certain Incentive Awards on a subdivision or consolidation of shares of the Company or the payment of a stock dividend without receipt of consideration by the Company. The Incentive Plan provides for certain other adjustments and rights to cash out holders of Incentive Awards on the occurrence of certain transactions involving the Company including, without limitation, a merger, consolidation or recapitalization of the Company, or other similar event that affects the issued and outstanding shares of Common Stock. CERTAIN TRANSACTIONS The Company has obtained financing from certain officers and directors and affiliates in connection with the acquisition and construction of pipelines. This financing enabled the Company to take advantage of pipeline acquisition opportunities that would have otherwise been unavailable to the Company because no other source or no less costly source of financing may have been available to the Company at the time such opportunities arose. It is management's belief that under such circumstances these transactions with affiliates were fair and equitable to the Company. All indebtedness to non-affiliated third parties has been personally guaranteed by Dan C. Tutcher, Stevens G. Herbst, and Kenneth B. Holmes, Jr. No future transaction will be entered into between the Company and members of management or affiliates. Set forth below are descriptions of such transactions: Five Flags System. In December 1992, the Company acquired 100% of the outstanding capital stock of Five Flags from Harbert Holdings No. One, Inc. for a cash payment of $1,078,409. The principal assets of Five Flags consisted of approximately 57 miles of natural gas pipelines located in Escambia and Santa Rosa Counties, Florida. In September 1993, all of the outstanding capital stock of Five Flags was sold to Sunshine. 47 50 In 1995, the Company and Rainbow jointly re-acquired 100% of the outstanding capital stock of Five Flags from Five Flags Holding Company. Total cash consideration of $2,052,000 was paid for the stock, of which the Company's share representing 91.25% interest in Five Flags capital stock was acquired for $1,872,450. Rainbow's ownership interest amounted to an 8.75% interest in the stock acquired for $179,550. To finance this transaction, the Company borrowed funds from Stevens G. Herbst, an officer and director of the Company (the "Herbst Note"). The promissory note between the Company and Mr. Herbst called for monthly payments of interest beginning April 1, 1996 through December 31, 1996 at which time both principal and all accrued interest would be due in full. Interest on the Herbst Note accrued at the prime rate plus 2%. Shortly after acquiring Five Flags stock the Company and Rainbow sold 100% of the capital stock of Five Flags to Koch for $4,664,865. A portion of the proceeds from the sale were used to repay the Herbst Note of $1,872,450 plus accrued interest and certain other notes associated with the acquisition of Magnolia. See "Business and Properties -- Pipeline Construction, Acquisition and Disposition." Project Refinancing. In December, 1994, Texline loaned the Company $275,000 pursuant to an unsecured promissory note between Texline and the Company (as amended, the "Texline Note"). The Texline Note provides for monthly payments of accrued interest at Mercantile Bank, N.A. -- Corpus Christi prime plus 1.5% (10.75% at March 31, 1996). The Texline Note matures on April 1, 1997. Total payments of principal and interest amounted to $75,000 and $30,057 in 1995 and 1996, respectively. The principal balance due to Texline at March 31, 1996, was $200,000. The proceeds of such indebtedness were used by the Company for general corporate purposes, including the repayment of indebtedness associated with project financings for the construction of certain pipeline systems and for various pipeline system acquisitions. All amounts outstanding under this note will be repaid with the net proceeds of this Offering. See "Use of Proceeds." Cook Inlet Pipeline Construction. In addition to the Texline Note, Texline provided short-term loans to fund the Company's investment in Alaska until the Company could obtain long-term bank financing. During 1994, short-term loans were made by Texline for such purpose, accruing at the prime rate plus 5%. A total of $316,250 in principal was loaned to the Company which was subsequently repaid to Texline in 1994, including interest in the amount of $4,005. Texline and Rainbow also provided approximately $1,000,000 in certificates of deposit and U.S. Treasury Bills as security for obtaining the initial long-term bank financing for the Company's Alaska investment. In consideration for providing such security, the Company assigned a 3% and a 2% net revenue interest to Texline and Rainbow, respectively, on the net income derived from the Company's investment in the Cook Inlet Systems. However, the net revenue interests apply only after all costs associated with the investment have been recouped by the Company. As a result, at the date hereof, no amounts have been paid under either assignment of the net revenue interests. The collateral was subsequently released after approximately eight months when the Company obtained new bank financing in December 1994. Magnolia System Acquisition. In connection with the acquisition of Magnolia in 1995, the Company borrowed $1,200,000 from Rainbow (the "Rainbow Note") to finance the purchase price of the stock of Magnolia. Funds from the Rainbow Note together with proceeds from the sale of the Five Flags stock to Koch, were used to repay the owner financing from Williams, for the purchase of Magnolia. See "Business and Properties -- Pipeline Construction, Acquisition and Disposition." The Rainbow Note provided for interest at the prime rate plus 5% and was due and payable monthly beginning April 1, 1996, with a final maturity of January 31, 1997. As additional consideration for extending the funds borrowed under the Rainbow Note, the Company granted Rainbow a 5% net revenue interest in Magnolia's earnings before interest, income taxes and depreciation, to be paid on a monthly basis. The net revenue interest, as amended in May 1996, applies only after all costs associated with the acquisition have been recouped by the Company. The Company has the right to repurchase this net revenue interest from Rainbow for a cash payment of $25,000. However, the repurchase amount is increased an additional $25,000 on November 1, 1995 and each following month up to a maximum of $500,000. The Rainbow Note was paid in full on December 20, 1995, including accrued interest in the amount of $35,260. To date, no payments have been made towards the net revenue interest. The Company intends to repurchase this net revenue interest from Rainbow with net proceeds of this Offering. See "Use of Proceeds." 48 51 Additional Project Refinancing. Rainbow also loaned the Company a total of $660,000 in December 1995 for general corporate purposes pursuant to an unsecured promissory note accruing interest at the prime rate plus 5%. All amounts under this note were due and payable on January 1, 1997. On January 12, 1996 the Company repaid all principal amounts due under the note to Rainbow as well as accrued interest in the amount of $4,039. The proceeds of such indebtedness were used by the Company for general corporate purposes including the repayment of indebtedness associated with project financings for the construction of certain pipeline systems and for various pipeline system acquisitions. Seahawk Acquisition. In connection with the acquisition of certain pipeline systems in March 1996, the Company borrowed $100,000 from Rainbow for its equity contribution to Pan Grande pursuant to a promissory note between the Company and Rainbow (as amended, the "Pan Grande Note"). The Pan Grande Note bears interest at the prime rate plus 2.5%. The Pan Grande Note is secured by the Company's interest in Pan Grande and is payable in 59 monthly installments of $1,667 and accrued interest and a final installment at March 15, 2001 in the amount of the remaining principal plus accrued interest. All amounts outstanding under the Pan Grande Note will be repaid with the net proceeds of this Offering. See "Use of Proceeds." Rainbow has committed to loan up to an additional $75,000 in the event the Salt Creek System is purchased. In consideration for the financing of the equity contribution and the commitment for additional financing, the Company issued Rainbow 4,460 shares of the Company's Common Stock. See "Business and Properties -- Pipeline Construction, Acquisition and Disposition." Exxon Production Acquisition. In May 1995, Texline provided a $173,822 loan to partially finance the acquisition of a working interest in oil and gas production from two leases located in Starr County, Texas from Exxon. The loan, as amended in March 1996, matures on April 1, 1997. No collateral was required to obtain this loan, although, as additional consideration for obtaining the loan, Texline was assigned a .5% working interest in the oil and gas properties. Monthly note payments in the amount of 25% of the Company's net revenue from the production from these properties are paid to Texline. An additional .5% working interest in the properties will be assigned to Texline if all principal and interest amounts due under the loan are not paid by August 1, 1996. Total payments of interest amounted to $3,346 and $7,477 in 1995 and through March 31, 1996, respectively. All amounts outstanding under this note will be repaid with the net proceeds of this Offering. See "Use of Proceeds." Redemption of 5% Cumulative Preferred Stock. In May 1996, the Board approved the redemption of the 5% cumulative preferred stock for $118,367, which was 10% of the liquidation value, held by Magic (Dan Tutcher is the beneficial owner of such shares), Stevens G. Herbst and Kenneth B. Holmes, Jr. As a result of the redemption of the 5% cumulative preferred stock by the Company, Magic, Mr. Herbst and Mr. Holmes were paid $59,183, $29,592, and $29,592 for the redemption of 100,000, 50,000 and 50,000 shares, respectively. Subsequently, no shares of the Company's preferred stock remain outstanding. Following the redemption of the Company's 5% cumulative preferred stock, a majority of the stockholders approved an amendment to the Articles of Incorporation to reflect only one class of outstanding securities, the Company's Common Stock. [BALANCE OF THIS PAGE INTENTIONALLY LEFT BLANK] 49 52 PRINCIPAL STOCKHOLDERS The following table sets forth information based upon the records of the Company and filings with the Commission as of May 15, 1996, with respect to (i) each person known to be the beneficial owner of more than 5% of the Company's Common Stock, (ii) each executive officer and director of the Company, and (iii) all directors and executive officers as a group.
COMMON STOCK ---------------------------------------------- NUMBER OF PERCENTAGE OF NAME AND ADDRESS SHARES OUTSTANDING PERCENTAGE AFTER OF BENEFICIAL OWNER OWNED(1) SHARES OFFERING(2) ----------------------------------------------- --------- ------------- ---------------- Magic Gas Corp.(3)............................. 611,240 40.7 24.4 1100 Louisiana, Suite 2950 Houston, Texas 77002 Dan C. Tutcher(4).............................. 611,240 40.7 24.4 1100 Louisiana, Suite 2950 Houston, Texas 77002 Stevens G. Herbst(5)........................... 285,902 19.1 11.4 710 Buffalo, Suite 800 Corpus Christi, Texas 78401 Kenneth B. Holmes, Jr. ........................ 283,195 18.9 11.3 710 Buffalo, Suite 800 Corpus Christi, Texas 78401 I.J. Berthelot, II(6)(7)....................... 78,064 5.2 3.1 1100 Louisiana, Suite 2950 Houston, Texas 77002 Richard A. Robert(8)........................... 22,303 1.5 * 1100 Louisiana, Suite 2950 Houston, Texas 77002 Duane S. Herbst(9)............................. 11,151 * * 710 Buffalo, Suite 800 Corpus Christi, Texas 78401 E.P. Marinos(10)............................... 2,007 * * 2901 Sargent Street Seabrook, Texas 77586 Richard A. Richards(10)........................ 2,007 * * 18610 Upper Bay Road Houston, Texas 77058 All Directors and Executive Officers as a group (8 persons).................................. 1,295,869 86.4 51.8
- --------------- * Denotes less than 1%. (1) Except as otherwise noted, shares beneficially owned by each person as of the record date were owned of record and each person had sole voting and investment power with respect to all shares beneficially held by such person. (2) Excludes the issuance of shares of Common Stock on exercise of the over-allotment option granted to the Underwriters. (3) All of the outstanding stock of Magic is owned by Dan C. Tutcher and Kimberly Tutcher as husband and wife. (4) Includes 611,240 shares of Common Stock held of record by Magic, an affiliate of Mr. Tutcher. (5) Includes 4,460 shares held of record by Rainbow which is controlled by Stevens G. Herbst. (6) Includes 50,185 shares which are subject to certain vesting requirements. (7) Mr. Berthelot holds 1,338 shares as custodian for minor children under the Uniform Gift to Minors Act. (8) Includes 15,613 shares which are subject to certain vesting requirements. (9) Includes 4,014 shares which are subject to certain vesting requirements. (10) Messrs. Marinos and Richards will each be issued a stock grant of 2,007 shares on the effective date of their service as directors. See "-- Directors Compensation and Board Committees." 50 53 SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this Offering, the Company will have outstanding 2,500,000 shares of Common Stock. A substantial number of outstanding shares of Common Stock and shares of Common Stock issuable upon exercise of Outstanding Warrants will become eligible for future sale in the public market at prescribed times. Sales of significant amounts of Common Stock in the public market following this Offering could adversely affect prevailing market prices. Holders of approximately 92% of the outstanding Common Stock and the Company (including all officers and directors of the Company), have agreed not to sell such shares for 18 months after the date of this Prospectus. Upon the expiration of such agreements, approximately 1,352,530 shares will be eligible for sale pursuant to Rule 144 under the Securities Act and 32,697 and 4,014 shares will be eligible for sale pursuant to Rule 144 after 24 and 30 months, respectively, from the date of this Prospectus. Additionally, holders of 110,759 shares of Common Stock not subject to such lockup agreements may be sold pursuant to Rule 144 or 144(k) under the Securities Act. See "Description of Securities" and "Underwriting." Rule 144 governs resales of "restricted securities" for the account of any person (other than an issuer), and restricted and unrestricted securities for the account of an "affiliate" of the issuer. Restricted securities generally include any securities acquired directly or indirectly from an issuer or its affiliate which were not issued or sold in connection with a registered public offering under the Securities Act. An affiliate of the issuer is any person who directly or indirectly controls, is controlled by, or is under common control with, the issuer. Affiliates of the Company generally include its directors, executive officers, and persons directly or indirectly owning 10% or more of the outstanding Common Stock. Under Rule 144, unregistered resales of restricted Common Stock cannot be made until it has been held two years from the later of its acquisition from the Company or an affiliate of the Company. Thereafter, shares of restricted Common stock may be resold without registration subject to Rule 144's volume limitation, aggregation, broker transaction, notice-filing requirements, and requirements concerning publicly available information about the Company (the "Applicable Requirements"). Resales by the Company's affiliates of restricted and unrestricted Common Stock are subject to the Applicable Requirements. The volume limitations provide that a person (or persons who must aggregate their sales) cannot, within any three-month period, sell more than the greater of 1% of then outstanding shares, or the average weekly reported trading volume during the four calendar weeks preceding each such sale. A nonaffiliate may resell restricted Common stock which has been held for three years free of the Applicable Requirements. The Company intends to register securities reserved for issuance under the Incentive Plan on a Form S-8 filed with the Commission after the Registration Statement on which this Prospectus is a part is declared effective by the Commission. The registration statement on Form S-8 will automatically become effective upon filing. Thus, shares registered under the registration statement on Form S-8 will be available for sale in the open market, unless such shares are subject to vesting restrictions with the Company. Any options held by officer and directors of the Company will be subject to the contractual lockup restrictions described above. [BALANCE OF THIS PAGE INTENTIONALLY LEFT BLANK] 51 54 DESCRIPTION OF SECURITIES GENERAL In May 1996, a majority of the stockholders approved an amendment to the Articles of Incorporation (the "Articles") to increase the authorized number of shares from 6,000,000 shares of Common Stock, to 10,000,000 shares of Common Stock and to eliminate all of the authorized number of shares of preferred stock, par value $1.00 per share ("Preferred Stock"). The following summary description of the Company's capital stock is not intended to be complete and is subject to, and is qualified in its entirety by reference to, the Company's Articles, as amended, and the Company's Bylaws, copies of which are filed as exhibits to the Registration Statement of which this Prospectus forms a part. COMMON STOCK Holders of Common Stock are entitled to one vote per share on all matters submitted to a vote of the stockholders of the Company. Except as may be required by applicable law, holders of Common Stock will not vote separately as a class, but will vote together with the holders of outstanding shares of other classes of capital stock. A majority of the issued and outstanding Common Stock constitutes a quorum at any meeting of stockholders and the vote by the holders of a majority of the outstanding shares is required to effect certain fundamental corporate changes such as liquidation, merger or amendment of the Articles. Holders of shares of Common Stock are entitled to receive dividends, if, as, and when declared by the Board out of funds legally available therefore, after payment of dividends required to be paid on any outstanding shares of Preferred Stock. Upon liquidation of the Company, holders of shares of Common Stock are entitled to share ratably in all assets of the Company remaining after payment of liabilities, subject to the liquidation preferences rights of any outstanding shares of Preferred Stock. Holders of shares of Common Stock have no preemptive rights or other rights to subscribe for unissued or treasury shares or securities convertible into shares. The outstanding shares of Common Stock are fully paid and nonassessable. PREFERRED STOCK In May 1996, the Board approved the redemption of all outstanding shares of the Preferred Stock for $118,367, which represents 10% of the liquidation value. In May 1996, a majority of the stockholders approved an amendment to the Articles to eliminate the Preferred Stock as authorized capital stock of the Company. OUTSTANDING WARRANTS The Company has issued Outstanding Warrants to purchase 34,419 shares of Common Stock at $7.85 per share, to be adjusted for any future split in the shares of Common Stock, that expire in February 1999 in consideration for services which have been and will continue to be provided by a consultant in connection with the conventional, commercial financing or sale/leaseback of certain Magnolia assets. The Outstanding Warrants are the subject of an 18 month lockup agreement and have certain "piggyback" registration rights. In connection with this Offering, the Company has agreed to sell to the Representative, for nominal consideration, Representative's Warrants to purchase from the Company up to an amount equal to 10% of the total number of shares of Common Stock sold in this Offering for a period of four years, commencing 18 months from the effective date of the registration statement, at an exercise price equal to 120% of the public offering price. See "Underwriting." CERTAIN CORPORATE GOVERNANCE PROVISIONS Limitation on Director Liability. As permitted by Section 78.037 of the General Corporation Law of Nevada (the "NGCL"), the Company's Articles of Incorporation eliminate the liability of its directors and officers to the Company and its stockholders for damages for breach of fiduciary duty, except for acts or omissions which involve intentional misconduct, fraud of a knowing violation of law, or for the payment of dividends in violation of the NGCL; if such a violation is willful or grossly negligent. To the extent that this provision limits the remedies of the Company and its stockholders to equitable remedies it might reduce the 52 55 likelihood of derivative litigation and discourage the Company's management or stockholders from initiating litigation against its directors or officers for breach of their fiduciary duties. Additionally, equitable remedies may not be effective in many situations. If a stockholder's only remedy is to enjoin the completion of an action, such remedy would be ineffective if the stockholder does not become aware of a transaction or event until after it has been completed. In such a situation, it is possible that the Company and its stockholders would have no effective remedy against the directors and officers. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the Company's Common Stock is KeyCorp Shareholder Services, Inc., which will also be the initial transfer agent, registrar and dividend disbursing agent for the Common Stock. [BALANCE OF THIS PAGE INTENTIONALLY LEFT BLANK] 53 56 UNDERWRITING Subject to the terms and conditions set forth in the underwriting agreement by and among the Company and the Underwriters (the "Underwriting Agreement"), each of the Underwriters named below, has severally agreed to purchase from the Company, and the Company has agreed to sell to the Underwriters, the aggregate number of shares of Common Stock set forth below opposite each such Underwriter's name, at the public offering price less the underwriting discounts and commissions set forth on the cover page of this Prospectus.
NUMBER OF SHARES OF UNDERWRITERS COMMON STOCK --------------------------------------------------------------------- ------------ Coleman and Company Securities, Inc.................................. Nolan Securities Corporation......................................... ------------ Total...................................................... 1,000,000 ===========
The Underwriting agreement provides that the obligations of the several Underwriters to pay for and accept delivery of shares of Common Stock are subject to certain conditions precedent, and that the several Underwriters will purchase all of the Common Stock shown above if any of such shares of Common Stock are purchased. The Representative has advised the Company that the Underwriters propose initially to offer the shares of Common Stock directly to the public at the public offering price set forth on the cover page of this Prospectus and to certain dealers at such price less a concession not in excess of $ per share. The Underwriters may allow, and such dealers may reallow, a concession not in excess of $ per share to certain other dealers. After the Offering, the public offering price, concession and re-allowance may be changed. The Company has granted to the Underwriters an option exercisable during the 30-day period after the date of this Prospectus, to purchase up to an aggregate of 150,000 additional shares of Common Stock at the public offering price set forth on the cover page of the Prospectus, less the underwriting discounts and commissions set forth on the cover page of this Prospectus. The Underwriters may exercise this option only to cover over-allotments, if any, made in connection with the sale of the shares of Common Stock offered hereby. To the extent that the Underwriters exercise this option, each Underwriter will be obligated, subject to certain conditions, to purchase the number of the additional shares of Common Stock proportionate to such Underwriters initial commitment reflected in the foregoing table. The Company has agreed to pay the Representative a non-accountable expense allowance equal to 1.75% of the gross proceeds of this Offering, $35,000 of which has already been paid to cover some of the underwriting costs and due diligence expenses related to this Offering. The Company has agreed to permit the Representative to have an observer attend the meetings of the Company's Board for a period of three years from the date hereof. The Company and the Underwriters have agreed to indemnify each other against, or to contribute to losses arising out of, certain civil liabilities in connection with this Offering, including liabilities under the Securities Act. The Company and all current officers, directors, certain stockholders of the Company and the holder of the Outstanding Warrants have agreed not to publicly offer, sell, contract to sell or otherwise dispose of any shares of Common Stock or rights to acquire shares of Common Stock without the prior written consent of the Representative for a period of 18 months after the date of this Prospectus. See "Risk Factors." Prior to this Offering there has been no public trading market for the Company's shares of Common Stock. The public offering price of the shares of Common Stock has been determined by negotiation between the Company and the Representative. Factors considered in determining the public offering price, in addition to prevailing market conditions, included the history of and prospects for the industry in which the Company 54 57 competes, an assessment of the Company's management, the prospects of the Company, its capital structure and such other factors as were deemed relevant. The foregoing includes a summary of the principal terms of the Underwriting Agreement and does not purport to be complete. Reference is made to the copy of the Underwriting Agreement that is on filed as an exhibit to the Registration Statement of which this Prospectus is a part. REPRESENTATIVE'S WARRANTS The Company has agreed to sell the Representative's Warrants to the Representative at a price of $.001 per warrant for each share of Common Stock covered by the Representative's Warrants. The Representative's Warrants entitle the Representative to purchase shares of Common Stock in an amount equal to 10% of the total number of shares of Common Stock sold in this Offering (excluding the Underwriter's over-allotment option). The shares of Common Stock subject to the Representative's Warrants will be in all respects identical to the shares of Common Stock offered to the public hereby. The Representative's Warrants will be exercisable for a four year period commencing 18 months after the effective date of the Registration Statement, of which this Prospectus is a part, at a per share exercise price equal to 120% of the public offering price set forth on the cover page of this Prospectus. The Representative's Warrants may not be sold, assigned, transferred, pledged or hypothecated for a period of 12 months from the effective date of the Registration Statement except to the Representative or its officers. Pursuant to the terms of the Underwriting Agreement, the Company is registering the shares of Common Stock issuable upon exercise of the Representative's Warrants on the Registration Statement of which this Prospectus is a part. The Company has agreed to file, at its expense, during the period beginning one year from the effective date of the Registration Statement of which this Prospectus is a part, and ending five years after such date, on no more than one occasion at the request of the holders of a majority of the Representative's Warrants and the underlying shares of Common Stock, and to use its best efforts to cause to become effective, a post-effective amendment to the Registration Statement or a new registration statement under the Securities Act, as required to permit the public sale of the shares of Common Stock issued or issuable upon exercise of the Representative's Warrants. In addition, the Company has agreed to give advance notice to holders of the Representative's Warrants of its intention to file certain registration statements commencing one year and ending five years after the effective date of the Registration Statement, and in such case, holders of such Representative's Warrants or underlying shares of Common Stock shall have the right to require the Company to include all or part of such Common Stock underlying such Representative's Warrants in such registration statement at the Company's expense. For the life of the Representative's Warrants, the holders thereof are given the opportunity to profit from a rise in the market price of the shares of Common Stock, which may result in a dilution of the interests of other stockholders. As a result, the Company may find it more difficult to raise additional equity capital if it should be needed for the business of the Company while the Representative's Warrants are outstanding. The holders of the Representative's Warrants might be expected to exercise them at a time when the Company would, in all likelihood, be able to obtain additional equity capital on terms more favorable to the Company than those provided by the Representative's Warrants. Any profit realized on the sale of the shares of Common Stock issuable upon the exercise of the Representative's Warrants may be deemed additional underwriting compensation. LEGAL MATTERS The validity of the issuance of the Common Stock offered hereby has been passed on for the Company by Porter & Hedges, L.L.P., Houston, Texas. Certain legal matters related to this Offering will be passed on for the Underwriters by Parker Chapin Flattau & Klimpl, LLP of New York, New York. EXPERTS The consolidated financial statements of the Company as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995 included in this Prospectus have been audited by Hein + Associates LLP, certified public accountants, as set forth in their report and is included herein in reliance upon the authority of said firm as experts in accounting and auditing. 55 58 GLOSSARY Certain terms used in this Prospectus have the meanings set forth below: "Barrel or Bbl" means one stock tank barrel, or 42 U.S. gallons liquid volume, and represents the basis unit for measuring crude oil or other liquid hydrocarbons. "BOPD" means barrels of oil per day. "Bypass pipeline" means a pipeline built to provide an end-user of quantities of natural gas, typically a chemical or manufacturing plant, an alternative natural gas supply source to that offered by the local distribution company or "LDC" by connecting the end-user to major pipelines, thus by passing the LDC. "Gross acre" means an acre in which a working interest is owned. "Gross well" means a well in which a working interest is owned. "LPG" means liquefied petroleum gas. "Mcf" means thousand cubic feet of natural gas expressed, where gas sales contracts are in effect, in terms of contractual temperature and pressure bases and, where contracts are nonexistent, at 60 degrees Fahrenheit and 14.65 pounds per square inch absolute. "Mcf/d" means thousand cubic feet per day. "MMBtu" means million British Thermal Units. "MMBtu/d" means million British Thermal Units per day. "MMcf" means million cubic feet. "Mmcf/d" means million cubic feet per day. "NASDAQ" means the National Association of Securities Dealers, Inc. Automated Quotation system. "Net" when used in connection with the transportation of a quantity of natural gas, means the total amount of gas transported multiplied by the Company's interest in the joint venture or other entity that owns the gathering and transportation system. "Net acres or net wells" means the sum of the fractional working interests owned in gross acres or gross wells. "Oil" means crude oil and condensate. "Spot" means purchase or sale arrangements which are "best efforts" or "interruptible" in nature and are typically for 30 days or less. "Throughput" means the volume of gas transported or passing through a pipeline or other facility. "Volumes" as used herein means the amount of gas sold or transported by the Company, unless otherwise stated. All volumes of natural gas referred to in this Prospectus are stated at a pressure base of 14.65 pounds per square inch and a 60 degrees Fahrenheit and in most instances are rounded to the nearest major multiple. "Working interest" means the operating interest under an oil and gas lease which gives the owner the right to drill, produce and conduct operating activities on the property and a share of production, subject to all royalties, overriding royalties and other burdens and to all costs of exploration, development and operations and all risks in connection therewith. 56 59 MIDCOAST ENERGY RESOURCES, INC. INDEX TO FINANCIAL STATEMENTS
PAGE ----- Independent Auditor's Report.......................................................... F-2 Consolidated Balance Sheets, December 31, 1994, 1995 and unaudited as of March 31, 1996................................................................................ F-3 Consolidated Statements of Operations for the Years Ended December 31, 1993, 1994, 1995 and unaudited for the three months ended March 31, 1995 and 1996............... F-4 Consolidated Statement of Shareholders' Equity for the Years Ended December 31, 1993, 1994, 1995 and unaudited for the three months ended March 31, 1996.................. F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1993, 1994, 1995 and unaudited for the three months ended March 31, 1995 and 1996............... F-6 Notes to Consolidated Financial Statements............................................ F-7
F-1 60 INDEPENDENT AUDITOR'S REPORT Board of Directors and Shareholders Midcoast Energy Resources, Inc. Houston, Texas We have audited the accompanying consolidated balance sheets of Midcoast Energy Resources, Inc. and subsidiaries as of December 31, 1994 and 1995, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Midcoast Energy Resources, Inc., and subsidiaries as of December 31, 1994 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995 in conformity with generally accepted accounting principles. As discussed in Note 3 to the consolidated financial statements, the Company changed its method of accounting for transportation and exchange imbalances. HEIN + ASSOCIATES LLP Certified Public Accountants Houston, Texas February 12, 1996 F-2 61 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS
DECEMBER 31, DECEMBER 31, MARCH 31, 1994 1995 1996 ------------ ------------ ------------ (UNAUDITED) CURRENT ASSETS: Cash and cash equivalents........................ $ 65,921 $ 106,152 $ 939,500 Accounts receivable, no allowance for doubtful accounts...................................... 1,996,087 2,319,667 2,116,775 Asset held for resale............................ -- 210,447 210,447 ------------ ------------ ------------ Total current assets..................... 2,062,008 2,636,266 3,266,722 ------------ ------------ ------------ PROPERTY, PLANT AND EQUIPMENT, at cost: Natural gas transmission facilities.............. 3,990,406 7,365,421 7,422,770 Investment in transmission facilities............ 1,284,609 1,284,609 1,284,609 Oil and gas properties, using the full-cost method of accounting.......................... 69,499 302,293 309,556 Other property and equipment..................... 84,679 85,819 108,167 ------------ ------------ ------------ 5,429,193 9,038,142 9,125,102 ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION..................................... (434,777) (831,981) (953,895) ------------ ------------ ------------ 4,994,416 8,206,161 8,171,207 DEFERRED CONTRACT COSTS AND OTHER ASSETS, net of amortization..................................... 215,906 246,081 449,112 ------------ ------------ ------------ Total assets............................. $ 7,272,330 $ 11,088,508 $ 11,887,041 ============ ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable and accrued liabilities......... $ 1,943,145 $ 2,086,138 $ 2,726,206 Current portion of deferred income............... 83,000 83,000 83,000 Short-term borrowing from bank................... 210,000 25,000 -- Current portion of long-term debt payable to: Banks......................................... 930,692 540,998 878,645 Shareholders and affiliates................... -- -- 20,000 ------------ ------------ ------------ Total current liabilities................ 3,166,837 2,735,136 3,707,851 ------------ ------------ ------------ LONG-TERM DEBT PAYABLE TO: Banks............................................ 1,505,771 2,926,947 2,988,588 Shareholders and affiliates...................... 275,000 1,033,822 453,822 ------------ ------------ ------------ Total long-term debt..................... 1,780,771 3,960,769 3,442,410 ------------ ------------ ------------ DEFERRED INCOME.................................... 318,167 235,167 214,417 COMMITMENTS AND CONTINGENCIES (Note 9) SHAREHOLDERS' EQUITY (Note 10): 5% cumulative preferred stock, $1 par value, 1 million shares authorized, 200,000 shares issued and outstanding with a liquidation preference of $1,183,665...................... 200,000 200,000 200,000 Common stock, $.01 par value, 6 million shares authorized, 1,402,334, 1,465,680 and 1,470,141 shares issued and outstanding at December 31, 1994, 1995 and March 31, 1996, respectively... 14,023 14,657 14,701 Paid-in capital.................................. 18,740,252 18,824,681 18,830,637 Accumulated deficit.............................. (16,909,320) (14,775,102) (14,416,175) Unearned compensation............................ (38,400) (106,800) (106,800) ------------ ------------ ------------ Total shareholders' equity............... 2,006,555 4,157,436 4,522,363 ------------ ------------ ------------ Total liabilities and shareholders' equity................................. $ 7,272,330 $ 11,088,508 $ 11,887,041 ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-3 62 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED THREE MONTHS ENDED DECEMBER 31, MARCH 31, ----------------------------------------- -------------------------- 1993 1994 1995 1995 1996 ----------- ----------- ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) OPERATING REVENUES: Sale of natural gas and transportation fees.................................... $13,010,776 $14,901,222 $11,469,394 $ 2,903,098 $ 5,090,497 Sale of pipelines.......................... 2,400,000 60,586 4,092,850 -- 22,500 Sale of refined products................... 2,327,258 -- -- -- -- Oil and gas revenue........................ 18,645 6,902 60,046 1,742 50,769 ----------- ----------- ----------- ---------- ---------- Total operating revenues........... 17,756,679 14,968,710 15,622,290 2,904,840 5,163,766 ----------- ----------- ----------- ---------- ---------- OPERATING EXPENSES: Cost of natural gas and transportation charges................................. 11,792,889 13,459,465 9,895,793 2,501,151 4,304,681 Cost of pipelines sold..................... 1,244,217 48,606 1,909,624 -- 2,153 Cost of refined products................... 2,289,103 -- -- -- -- Production of oil and gas.................. 3,822 2,783 11,544 912 22,288 Depreciation, depletion and amortization... 264,249 259,440 451,551 85,320 136,328 General and administrative................. 888,965 849,002 784,653 181,809 190,720 ----------- ----------- ----------- ---------- ---------- Total operating expenses........... 16,483,245 14,619,296 13,053,165 2,769,192 4,656,170 ----------- ----------- ----------- ---------- ---------- Operating income................... 1,273,434 349,414 2,569,125 135,648 507,596 NON-OPERATING ITEMS: Abandonment of pipelines (Note 16)......... (246,668) -- -- -- -- Interest expense........................... (177,566) (188,623) (339,324) (64,424) (114,669) Other income (expense), net................ (31,401) (13,066) (36,400) (5,835) (19,245) ----------- ----------- ----------- ---------- ---------- INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE.................................. 817,799 147,725 2,193,401 65,389 373,682 PROVISION FOR INCOME TAXES (Note 11)......... (52,833) -- -- -- -- CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE (Note 3)......................... -- (120,936) -- -- -- ----------- ----------- ----------- ---------- ---------- Net income......................... 764,966 26,789 2,193,401 65,389 373,682 5% CUMULATIVE PREFERRED STOCK DIVIDENDS...... (59,183) (59,183) (59,183) (14,593) (14,755) ----------- ----------- ----------- ---------- ---------- NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS............................... $ 705,783 $ (32,394) $ 2,134,218 $ 50,796 $ 358,927 =========== =========== =========== ========== ========== NET INCOME (LOSS) PER COMMON SHARE (Note 2) Operations................................. $ .52 $ .07 $ 1.48 $ .04 $ .24 Accounting principle change................ -- (.09) -- -- -- ----------- ----------- ----------- ---------- ---------- $ .52 $ (.02) $ 1.48 $ .04 $ .24 =========== =========== =========== ========== ========== PRO FORMA AMOUNTS ASSUMING THE CHANGE IN ACCOUNTING PRINCIPLE IS APPLIED RETROACTIVELY: Net income................................. $ 644,030 $ 147,725 Net income to common shareholders.......... $ 584,847 $ 88,542 Net income per common share................ $ .43 $ .06 =========== =========== WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING (Note 2)....................... 1,359,839 1,390,553 1,439,606 1,402,334 1,465,827 =========== =========== =========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. F-4 63 MIDCOAST ENERGY RESOURCES INC., AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND THREE MONTHS ENDED MARCH 31, 1996
5% CUMULATIVE TOTAL PREFERRED COMMON PAID-IN ACCUMULATED UNEARNED SHAREHOLDERS' STOCK STOCK CAPITAL DEFICIT COMPENSATION EQUITY ---------- ------- ----------- ------------ ------------ ------------- BALANCE, January 1, 1993.............. $200,000 $13,528 $18,683,957 $(17,582,709) $ -- $ 1,314,776 Issuance of 13,381 shares in connection with employee stock bonuses............................. -- 134 8,116 -- -- 8,250 Net income............................ -- -- -- 764,966 -- 764,966 5% cumulative preferred stock dividends........................... -- -- -- (59,183) -- (59,183) -------- ------- ----------- ------------ --------- ---------- BALANCE, December 31, 1993............ $200,000 $13,662 $18,692,073 $(16,876,926) $ -- $ 2,028,809 Issuance of 35,686 shares of which 7,137 shares are vested in connection with employee shareholder agreements (Note 15)................ -- 357 47,643 -- (38,400) 9,600 Issuance of 446 shares in connection with an employee stock bonus........ -- 4 536 -- -- 540 Net income............................ -- -- -- 26,789 -- 26,789 5% cumulative preferred stock dividends........................... -- -- -- (59,183) -- (59,183) -------- ------- ----------- ------------ --------- ---------- BALANCE, December 31, 1994............ $200,000 $14,023 $18,740,252 $(16,909,320) $ (38,400) $ 2,006,555 Issuance of 57,991 shares which are subject to a four year vesting schedule in connection with an employment agreement (Note 15)...... -- 580 77,420 -- (78,000) -- Issuance of 5,352 shares in connection with employee stock bonuses......... -- 54 7,009 -- -- 7,063 Vesting of 7,137 shares in connection with employee shareholder agreements (Note 15)........................... -- -- -- -- 9,600 9,600 Net income............................ -- -- -- 2,193,401 -- 2,193,401 5% cumulative preferred stock dividends........................... -- -- -- (59,183) -- (59,183) -------- ------- ----------- ------------ --------- ---------- BALANCE, December 31, 1995............ $200,000 $14,657 $18,824,681 $(14,775,102) $ (106,800) $ 4,157,436 Issuance of 4,460 shares in connection with a financing agreement with an affiliate (Note 8).................. -- 44 5,956 -- -- 6,000 Net income (Unaudited)................ -- -- -- 373,682 -- 373,682 5% cumulative preferred stock dividends........................... -- -- -- (14,755) -- (14,755) -------- ------- ----------- ------------ --------- ---------- BALANCE, March 31, 1996 (Unaudited) $200,000 $14,701 $$18,830,637 $(14,416,175) $ (106,800) $ 4,522,363 ======== ======= =========== ============ ========= ==========
The accompanying notes are an integral part of these consolidated financial statements. F-5 64 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED THREE MONTHS ENDED DECEMBER 31, MARCH 31, --------------------------------------- ------------------------- 1993 1994 1995 1995 1996 ----------- ----------- ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) applicable to common shareholders.................................. $ 705,783 $ (32,394) $ 2,134,218 $ 50,796 $ 358,927 Adjustments to arrive at net cash provided (used) in operating activities -- Depreciation, depletion and amortization...... 264,249 259,440 451,551 85,320 136,328 Gain on sale of operating pipelines........... (1,155,783) (11,980) -- -- (20,347) Abandonment of pipelines...................... 246,668 -- -- -- -- Recognition of deferred income................ -- 401,167 (83,000) (20,750) (20,750) Increase in deferred tax asset................ -- -- (43,868) -- -- Cumulative effect of a change in accounting principle................................... -- 120,936 -- -- -- (Income) loss from partnership investments.... 14,839 (5,575) -- -- (26,300) Issuance of common stock to employees......... 8,250 10,140 16,663 -- -- Changes in working capital accounts -- (Increase) decrease in accounts receivable............................... (903,508) 339,787 (321,155) 629,202 227,967 Increase (decrease) in accounts payable and accrued liabilities...................... 1,634,494 (1,596,036) 206,455 (272,138) 652,376 ----------- ----------- ----------- --------- ----------- Net cash provided (used) in operating activities............................. 814,992 (514,515) 2,360,864 472,430 1,308,201 ----------- ----------- ----------- --------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Sale of operating pipelines...................... 2,400,000 -- -- -- -- Investment in transmission facilities............ -- (1,284,609) -- -- -- Capital expenditures............................. (955,237) (1,088,117) (3,885,282) (248,929) (104,823) Other............................................ (91,604) (5,917) (40,655) -- (184,318) ----------- ----------- ----------- --------- ----------- Net cash provided (used) in investing activities............................. 1,353,159 (2,378,643) (3,925,937) (248,929) (289,141) ----------- ----------- ----------- --------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Bank debt borrowings............................. 1,899,000 5,448,000 5,857,505 715,000 1,653,000 Bank debt repayments............................. (2,395,303) (3,836,317) (5,011,023) (933,777) (1,278,712) Proceeds from notes payable to shareholders and affiliates.................................... -- 591,250 3,906,272 -- 100,000 Repayments on notes payable to shareholders and affiliates.................................... (1,041,047) (316,250) (3,147,450) -- (660,000) Issuance of notes payable........................ -- -- 3,200,000 -- -- Repayments on notes payable...................... -- -- (3,200,000) -- -- ----------- ----------- ----------- --------- ----------- Net cash provided (used) in financing activities............................. (1,537,350) 1,886,683 1,605,304 (218,777) (185,712) ----------- ----------- ----------- --------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS...................................... 630,801 (1,006,475) 40,231 4,724 833,348 ----------- ----------- ----------- --------- ----------- CASH AND CASH EQUIVALENTS, beginning of period.............................. 441,595 1,072,396 65,921 65,921 106,152 ----------- ----------- ----------- --------- ----------- CASH AND CASH EQUIVALENTS, end of period.................................... $ 1,072,396 $ 65,921 $ 106,152 $ 70,645 $ 939,500 =========== =========== =========== ========= =========== CASH PAID FOR INTEREST............................. $ 180,271 $ 177,355 $ 323,376 $ 74,586 $ 137,722 =========== =========== =========== ========= =========== CASH PAID FOR INCOME TAXES......................... $ 48,834 $ -- $ -- $ -- $ -- =========== =========== =========== ========= ===========
The accompanying notes are an integral part of these consolidated financial statements. F-6 65 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The accompanying financial information as of March 31, 1996 and for the three months ended March 31, 1995 and 1996 has been prepared, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission. The financial information reflects all adjustments, consisting of normal recurring accruals, which are, in the opinion of management, necessary to fairly present such information in accordance with generally accepted accounting principles. 1. BACKGROUND AND INFORMATION: Midcoast Energy Resources, Inc. ("Midcoast" or "the Company") was formed on May 11, 1992, as a Nevada corporation and, in September 1992, became the successor to Nugget Oil Corporation. The merger was accounted for as a pooling of interests. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. Certain reclassification entries were made to the 1993 Consolidated Financial Statements so that the presentation of the information is consistent with reporting for the 1994 and 1995 Consolidated Financial Statements. As of December 31, 1995, the Company's subsidiaries include Magnolia Pipeline Corporation ("Magnolia"), H&W Pipeline Corporation, Midcoast Holdings No. One, Inc. ("Midcoast Holdings"), Midcoast Marketing, Inc. and Nugget Drilling Corporation, of which Magnolia and Midcoast Holdings are currently active. All significant intercompany transactions and balances have been eliminated. Investments (reported in other assets) that are 20% to 50% owned are accounted for using the equity method of accounting. Investments that are greater than 50% owned are consolidated. INCOME TAXES Midcoast and its subsidiaries file a consolidated federal income tax return. Midcoast accounts for income taxes under the provisions of Statement of Financial Accounting Standards (SFAS) No. 109 -- "Accounting for Income Taxes." Under SFAS 109, the Company recognizes deferred income taxes for the differences between the financial and income tax bases of its assets and liabilities. PROPERTY, PLANT AND EQUIPMENT Natural gas transmission and distribution facilities and other equipment are depreciated by the straight-line method at rates based on the following estimated useful lives of the assets: Natural gas transmission facilities................................... 15 -- 25 years Pipeline right-of-ways................................................ 17.5 years Other property and equipment.......................................... 3 -- 7 years
Repairs and maintenance are charged to expense as incurred; renewals and betterments are capitalized. The Company accounts for its oil and gas production activities using the full cost method of accounting. Under this method of accounting, all costs, including indirect costs related to exploration and development activities, are capitalized as oil and gas property costs. No gains or losses are recognized on the sale or disposition of oil and gas reserves, except for sales which include a significant portion of the total remaining reserves. F-7 66 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) CASH AND CASH EQUIVALENTS For purposes of the statement of cash flows, the Company considers short-term, highly liquid investments that have a maturity of three months or less as of the date of purchase as cash equivalents except for a $50,000 certificate of deposit which is pledged as collateral on the $1.5 million credit facility (see Note 7). ASSET HELD FOR RESALE Assets for which the Company anticipates consummating a sales transaction within one year of the balance sheet date are valued at the lower of cost or market and classified as current assets. TRANSPORTATION AND EXCHANGE IMBALANCES Transportation and exchange gas imbalance volumes are accounted for using the sales method of accounting (see Note 3). DEFERRED CONTRACT COSTS Costs incurred to construct natural gas transmission facilities pursuant to long-term natural gas sales or transportation contracts, which upon completion of construction are assigned to the contracting party, are capitalized as deferred contract costs. These costs are amortized over the life of the initial contract on a straight-line basis. DEFERRED STOCK ISSUANCE COSTS Direct costs incurred by the Company in connection with its offering of securities (see Note 17) have been deferred and will be applied as a reduction of the offering proceeds. RECENT ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board ("FASB") issued SFAS No. 121 entitled "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" which is effective for fiscal years beginning after December 15, 1995. SFAS No. 121 specifies certain events and circumstances which indicate the cost of an asset or assets may be impaired, the method by which the evaluation should be performed, and the method by which writedowns, if any, of the asset or assets are to be determined and recognized. Management does not believe that adoption of this pronouncement in 1996 will have a material impact on the Company's financial condition or operating results. The FASB also issued SFAS No. 123, "Accounting for Stock Based Compensation," effective for fiscal years beginning after December 15, 1995. This statement allows companies to choose to adopt the statement's new rules for accounting for employee stock-based compensation plans. For those companies who choose not to adopt the new rules, the statement requires disclosures as to what earnings per share would have been if the new rules had been adopted. Management intends to adopt the disclosure requirements of this statement in 1996. USE OF ESTIMATES The preparation of the Company's consolidated financial statements in conformity with generally accepted accounting principles requires the Company's management to make estimates and assumptions that effect the amounts reported in these financial statements and accompanying notes. Actual results could differ from those estimates. F-8 67 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) EARNINGS PER COMMON SHARE Net income (loss) per share was computed by dividing net income (loss) applicable to common shareholders by the weighted average common shares outstanding. All share and per share amounts in the accompanying consolidated financial statements have been adjusted to reflect an approximate 4.46 to 1 stock split authorized by the Board of Directors ("Board") in May 1996 (see Note 17). The effect of the change in accounting principle is reflected separately in the earnings per share information. 3. ACCOUNTING POLICY CHANGE: Transportation and exchange imbalances occur when volumes delivered to a pipeline for transportation are different than those delivered by the pipeline to its ultimate destination or during an exchange of gas where amounts exchanged differ. Parties to imbalances include producers, marketers, customers and other pipelines. Transportation and exchange gas imbalance volumes were being accounted for using the entitlements method of accounting. The Company has elected to change its accounting to the sales method. Under the sales method of accounting, the Company recognizes sales revenue as the customer uses the gas and recognizes cost of sales as the Company delivers gas to the pipeline. The effect of this change was to decrease net income by $120,936 in 1994 and is reflected in the Statement of Operations on a separate line item labeled "Cumulative Effect of a Change in Accounting Principle." 4. PIPELINE ACQUISITION AND SUBSEQUENT SALE: In December 1992, the Company agreed to acquire 100% of the outstanding capital stock of Five Flags Pipe Line Company, a Florida corporation ("Five Flags"), from an unaffiliated company for cash consideration of $1,078,409. This acquisition, pursuant to the Agreement for Purchase and Sale of Stock dated November 20, 1992, was effective as of January 1, 1993. The principal assets of Five Flags consisted of approximately 57 miles of natural gas pipelines located in Escambia and Santa Rosa Counties, Florida. In September 1993, all of the outstanding capital stock of Five Flags was sold to an unaffiliated partnership. Pursuant to the Agreement for Purchase and Sale of Stock dated July 15, 1993, Midcoast received cash consideration of $2,400,000 for the capital stock of Five Flags. During the Company's eight months of ownership in 1993, Five Flags contributed approximately $96,000 of income before income taxes. In September 1995, the Company and an affiliate owned by an officer and director of the Company jointly reacquired 100% of the outstanding capital stock of Five Flags from an unaffiliated company. Total cash consideration of $2,052,000 was paid on September 13, 1995 of which Midcoast's share was $1,872,450 for 91.25% of Five Flags capital stock and the affiliate's share was $179,550 for 8.75% of Five Flags capital stock. The investment was financed by an officer and director of the Company (see Note 8). The acquisition of Five Flags' stock was made as an investment to be resold to another unaffiliated company pursuant to an agreement for purchase and sale of stock dated September 6, 1995. On October 2, 1995, Midcoast and the affiliate jointly sold 100% of the capital stock of Five Flags for cash consideration of which the Company's share was $4,092,850. A portion of the proceeds from the sale were used to repay a related party promissory note of $1,872,450 plus accrued interest (see Note 8). The remainder of the proceeds were used to partially finance Midcoast's acquisition of Magnolia (see Note 5). 5. PIPELINE CONSTRUCTION AND ACQUISITIONS: Construction of a three-mile pipeline in Kansas City, Kansas commenced in July 1994. The pipeline was constructed pursuant to a long-term transportation agreement and was completed in November 1994 at a cost of $1,114,000. The project is being partially funded by the customer through prepaid transportation fees of $415,000 with the remainder being funded through long-term bank financing (see Note 7) and cash generated F-9 68 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) from operations. The prepaid transportation fees are classified as liabilities on the Company's balance sheet under the caption "Deferred Income." The fees are being recognized as income over the life of the contract. In April 1994, the New York Public Service Commission gave approval for the issuance of a certificate of public convenience and necessity which allows for the construction of a pipeline providing natural gas transportation to an industrial customer in Albany, New York pursuant to a long-term transportation agreement. The pipeline was completed in December 1994 at a cost of $294,000. The construction was financed through cash generated from operations and long-term bank financing (see Note 7). In June 1995, Midcoast acquired a 23% working interest in two oil and gas production leases located in Starr County, Texas, which together comprise approximately 1,700 acres. The $194,000 purchase price was partially funded by a $173,822 loan from an affiliated company owned by certain officers and directors of the Company (see Note 8). As consideration for advising the Company in the acquisition of the working interest, a consultant to the Company was assigned one percent of the Company's working interest. In addition, a one-half percent working interest was assigned to the affiliated company which extended the loan for the acquisition. In September 1995, Midcoast acquired 100% of the outstanding capital stock of Magnolia, an Alabama corporation, from Williams Holdings of Delaware, Inc. ("Williams") an unaffiliated company. The acquisition was made pursuant to the Agreement for Sale and Purchase of Stock dated July 27, 1995 and had an effective date of August 1, 1995. The acquisition was accounted for under the purchase method of accounting. The total purchase price of $3,200,000 was allocated to property, plant, and equipment as the principal asset of Magnolia consists of approximately 111 miles of natural gas pipeline located in central Alabama. Initially, the acquisition was financed by Midcoast issuing a $500,000 subordinated debenture ("Debenture") and a $2,700,000 nonrecourse promissory note ("Note") to Williams. The Debenture accrued interest at 10% and had a final maturity of September 15, 1996 but was redeemable at the option of Midcoast. The Note was non-interest bearing and was due on October 9, 1995. However, the Debenture and the Note were paid in full on October 2, 1995 using the proceeds from the sale of Five Flags (see Note 4) and borrowings of $1,200,000 from an affiliate owned by an officer and director of the Company (see Note 8). In December 1995, the $1,200,000 related party note was repaid using a new $1,500,000 credit facility with a commercial lender (see Note 7). In January 1996, the Company and three unaffiliated parties jointly formed Starr County Gathering System, a Joint Venture (the "Joint Venture"). The companies joined together for the purpose of acquiring, owning and operating pipelines. Effective January 1, 1996, the Joint Venture acquired a gas gathering system consisting of approximately 10 miles of pipeline located in Starr County, Texas from an unaffiliated third party. The Joint Venture paid cash consideration of $164,400 for the system. The Joint Venture financed the entire purchase price with a credit facility obtained from a commercial lender. Midcoast as 60% owner of the Joint Venture has guaranteed 60% of the loan value. Midcoast will act as manager of the Joint Venture and operate the systems. On February 28, 1996, the Company and Resource Energy Development Company, L.L.C. ("Resource"), an unaffiliated third party, jointly formed Pan Grande Pipeline, L.L.C. ("Pan Grande") a Texas Limited Liability Company each owning a 50% interest. The companies joined together for the purpose of acquiring, owning and operating pipelines. On March 1, 1996, Pan Grande acquired six pipeline systems consisting of approximately 77 miles of pipeline located in Texas from an unaffiliated third party. Cash consideration of $1,000,000 was paid by Pan Grande for the systems. Pan Grande financed $800,000 of the acquisition with a credit facility obtained from a commercial lender. Midcoast as 50% owner of Pan Grande has guaranteed 50% of the loan value. The remaining $200,000 of the purchase price was obtained through equal $100,000 capital contributions from Midcoast and Resource. Midcoast's $100,000 capital contribution was financed through a loan from an affiliate owned by an officer and director of the Company (see Note 8). Midcoast will act as manager of Pan Grande and operate the systems. F-10 69 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Construction of a one-half mile pipeline in Obion County, Tennessee commenced in March 1996. The pipeline is being constructed pursuant to a long-term transportation agreement with an industrial customer and is expected to be completed in May 1996. Construction costs are estimated to be $65,000. The construction is being financed through cash generated from operations and long-term bank financing (see Note 7). Construction of a two-mile pipeline in Roane County, Tennessee commenced in March 1996. The pipeline is being constructed pursuant to a long-term transportation agreement with an industrial customer and is expected to be completed in June 1996. Construction costs are estimated to be $370,000. The construction is being financed from cash generated from operations and long-term bank financing (see Note 7). 6. INVESTMENTS: In March 1994, the Company signed an agreement to fund $1,265,000 which represents half of the construction costs of a crude oil gathering pipeline and a natural gas gathering pipeline near Cook Inlet, Alaska. The agreement provided for the funds to be advanced in five payments due upon the completion of certain stages of the pipeline construction. In consideration for the Company's contribution of funds for construction, Midcoast receives a throughput fee based on the volumes of barrels/MCF transported through the pipelines. These fees are subject to certain minimum guaranteed volumes for the first two years which began upon completion of the pipeline in July 1994. The payments were being financed with available cash on hand and through short-term loans with an affiliated company owned by certain officers and directors of the Company. The short-term loans were replaced with long-term bank financing in May 1994 (see Note 7). 7. DEBT OBLIGATIONS: At December 31, 1994 and 1995 and March 31, 1996, the Company had outstanding debt obligations as follows (in thousands):
DECEMBER 31, 1994 DECEMBER 31, 1995 MARCH 31, 1996 ------------------- ------------------- ------------------- CURRENT LONG-TERM CURRENT LONG-TERM CURRENT LONG-TERM ------- --------- ------- --------- ------- --------- (UNAUDITED) Note payable to a bank under a term loan bearing interest at the bank's prime rate plus 1%, principal of $30,435 and accrued interest are payable in 35 monthly installments, with a final lump sum payment of the remaining unpaid principal and interest due on December 1, 1995..................................... $ 365 $ 304 $ -- $ -- $ -- $ -- Note payable to a bank under a $750,000 working capital line of credit expiring August 1, 1996. Advanced and unpaid principal bears interest at the bank's prime rate plus 1% (10.25% at March 31, 1996) which is accrued and paid monthly............................. 210 -- 25 -- -- -- Note payable to a bank under a term loan bearing interest at the bank's prime rate plus 1%, principal and accrued interest are payable in 32 monthly installments of $12,720, with a final maturity of December 15, 1996.................................... 134 145 -- -- -- -- Note payable to a bank under a term loan bearing interest at the bank's prime rate plus 1% (9.25% at March 31, 1996), principal and accrued interest are payable in 59 monthly installments of $6,915, with a final lump sum payment of the remaining unpaid principal and interest due on October 13, 1999..................................... 57 270 59 215 62 197 Note payable to a bank under a term loan bearing interest at the bank's prime rate plus 1% (9.25% at March 31, 1996), principal of $3,438 and accrued interest are payable in monthly installments with a final lump sum payment of the remaining unpaid principal and interest due on February 15, 1998...... 42 120 41 79 42 68
F-11 70 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1994 DECEMBER 31, 1995 MARCH 31, 1996 CURRENT LONG-TERM CURRENT LONG-TERM CURRENT LONG-TERM ------ ------ ---- ------ ---- ------ (UNAUDITED) Note payable to a bank under a term loan bearing interest at the bank's prime rate plus 1.5% (9.75% at March 31, 1996), principal of $27,778 and accrued interest are payable in 35 monthly installments, with a final lump sum payment of the remaining unpaid principal and interest due on December 15, 1997...... 333 667 333 333 333 250 Revolving credit line with a bank under a $1.25 million reducing promissory note bearing interest at the bank's prime rate plus 1.5% (9.75% at March 31, 1996). Available credit is reduced monthly by $20,833 beginning December 1, 1995. Accrued interest and any principal amounts as may be required to cause the outstanding principal to not exceed the amount of credit then available are payable monthly, with a final maturity of November 1, 1998................... -- -- 108 1,000 191 917 Revolving credit line with a bank under a $1.5 million reducing promissory note bearing interest at the bank's prime rate plus 1% (9.25% at March 31, 1996). Available credit is reduced monthly by $17,860 beginning February 1, 1996. Accrued interest and any principal amounts as may be required to cause the outstanding principal to not exceed the amount of credit then available are payable monthly, with a final maturity of January 15, 1999 (Amended in May 1996. See Note 17)................................... -- -- -- 1,300 214 1,250 Note payable to a bank under a term loan bearing interest at the bank's prime rate plus 1% (9.25% at March 31, 1996), principal and accrued interest are payable in 60 monthly payments of $7,185, with a final maturity of July 15, 2001...................... -- -- -- -- 37 306 Note payable to an affiliate owned by certain officers and directors bearing interest at the Mercantile Bank, Corpus Christi prime rate plus 1.5% (10.75% at March 31, 1996). Principal and accrued interest are due in full at maturity on April 1, 1997............. -- 275 -- 200 -- 200 Note payable to an affiliate owned by certain officers and directors bearing interest at the Mercantile Bank, Corpus Christi prime rate plus 1% (10.25% at March 31, 1996). Monthly payments equal to 25% of the net revenue derived from the oil and gas production acquisition (see Note 5) shall be allocated to interest then principal. Any remaining principal and accrued interest shall be due in full at maturity on April 1, 1997........................................ -- -- -- 174 -- 174 Note payable to an affiliate owned by an officer and director bearing interest at the Mercantile Bank, Corpus Christi prime rate plus 5% (14.5% at December 31, 1995). Principal and accrued interest are due in full at maturity on January 1, 1997.................. -- -- -- 660 -- -- Note payable to an affiliate owned by an officer and director bearing interest at the prime rate plus 2.5% (10.75% at March 31, 1996), principal of $1,667 and accrued interest are payable in 59 monthly installments with a final lump sum payment of the remaining unpaid principal and interest due on March 15, 2001............................................. -- -- -- -- 20 80 ------ ------ ---- ------ ---- ------ $1,141 $ 1,781 $ 566 $ 3,961 $ 899 $ 3,442 ====== ====== ==== ====== ==== ======
In December 1992, the Company entered into a financing agreement with a bank under which the Company could borrow up to $1,800,000. This credit facility included a term loan of $1,400,000 which was payable in 36 monthly installments, the first 35 installments being the amount of $30,435 principal plus accrued interest, and the 36th and final installment being the amount of the balance of principal ($334,775) plus accrued interest then remaining outstanding and unpaid. In conjunction with obtaining a new debt facility F-12 71 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) with another bank as discussed in a subsequent paragraph, the term loan was repaid in full on October 31, 1995. In addition to the term loan discussed above, the Company had a line of credit of $400,000 under the bank financing agreement. In September 1994, the line of credit was renewed and the available line raised to $750,000. The line of credit, as amended in May 1996, expires on August 1, 1996. Borrowings under this credit facility are collateralized by the Company's non-transportation based accounts receivable. At March 31, 1996, the Company had $750,000 of available funds under this credit facility. In July 1993, the same bank provided the Company with an additional $360,000 facility under which the Company obtained advances of funds as needed for construction of pipelines. In conjunction with obtaining a new debt facility with another bank as discussed in a subsequent paragraph, the term loan was repaid in full on October 31, 1995. In May 1994, the Company obtained a $1,000,000 credit facility for financing of the Company's investment in transmission facilities in Alaska. Under this facility, the Company was able to repay the short-term loans of $316,250 advanced by an affiliate owned by certain officers and directors, as discussed in Note 8 herein, as well as obtain the funds as needed for the Company's investment in Alaska. The agreement called for monthly payments of accrued interest with the principal due in full at maturity on January 15, 1996. Borrowings under this facility bore interest at the bank's prime rate. Affiliates owned by certain officers and directors of the Company pledged U.S. Treasury Bills and Certificates of Deposit as collateral for this facility for which they were compensated as discussed in Note 8. In December 1994, this facility was repaid and replaced with a long-term financing agreement with a new bank. Under the new agreement, principal and accrued interest are paid in 35 monthly installments of $27,778 plus accrued interest with a final lump sum payment of the remaining unpaid principal and interest due on December 15, 1997. This facility is secured by the throughput fee the Company is receiving on its investment in Alaska (see Note 6). In October 1994, the Company obtained $335,000 under a long-term financing from a bank. The funds were utilized to partially finance the construction of a three-mile pipeline in Kansas City, Kansas. In connection with this financing agreement, one of the Company's pipeline systems is subject to a negative pledge to keep the pipeline free and clear of all liens and encumbrances. In November 1994, $165,000 was extended by a bank to partially finance the construction of a pipeline in Albany, New York. Under this agreement, the term loan, as amended, is payable in monthly installments of $3,438 principal plus accrued interest and the final installment on February 15, 1998 being the amount of the balance of principal and accrued interest of $34,653 then remaining outstanding and unpaid. In connection with this financing agreement, one of the Company's pipeline systems is subject to a negative pledge to keep the pipeline free and clear of all liens and encumbrances. In October 1995, the Company entered into a new financing agreement with an existing bank lender. The new agreement provides for an initial $1,250,000 revolving line of credit with the amount of available credit being reduced by $20,833 per month beginning December 1, 1995. Upon maturity at November 1, 1998, the balance of principal plus accrued interest then remaining outstanding and unpaid is payable on full. The funds were used to repay existing bank debt. In connection with this financing agreement, eight of the Company's pipeline systems are subject to a negative pledge to keep the pipelines free and clear of all liens and encumbrances. At March 31, 1996, the Company had $59,164 of available funds under this credit facility. In December 1995, the Company entered into a new financing agreement with a bank lender. The agreement provided for an initial $1,500,000 revolving line of credit with the amount of available credit being reduced by $17,860 per month (amended in May 1996. See Note 17). Upon maturity at January 15, 1999, the balance of principal plus accrued interest then remaining outstanding and unpaid is payable in full. The funds were used to repay $1,200,000 in debt owed to an affiliate for partially financing the Magnolia acquisition (see Note 5) and other working capital needs. In connection with this financing agreement, a $50,000 certificate of F-13 72 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) deposit and all of Magnolia's stock has been pledged as collateral. Also, Magnolia's pipeline system is subject to a negative pledge to keep the pipeline free and clear of all liens and encumbrances. At March 31, 1996, the Company had no available funds under this credit facility. In March 1996, $343,000 was extended by a bank to partially finance the construction of two pipelines in Tennessee. Under this agreement, the term loan is payable in 60 monthly installments of principal and accrued interest of $7,185 beginning August 15, 1996. In connection with this financing agreement, all proceeds from the transportation agreements with the industrial customers on the two pipelines to be constructed are pledged as collateral. All of the above referenced bank debt has been personally guaranteed by three stockholders who are also directors and officers of the Company. In December 1994, an affiliate owned by certain officers and directors of the Company provided a loan of $275,000 of which $75,000 was repaid during 1995. The loan, as amended, accrues interest at the prime rate plus 2.5% and matures on April 1, 1997. The proceeds of the loan were used for general corporate purposes including the repayment of other indebtedness. No collateral was required to obtain this loan. In May 1995, an affiliate owned by certain officers and directors of the Company provided a $173,822 loan to partially finance the acquisition of a 23% working interest in oil and gas production from two leases located in Starr County, Texas. The loan, as amended in March 1996, matures on April 1, 1997. No collateral was required to obtain this loan, although, as additional consideration for extending the loan, the affiliated company was assigned a one-half percent working interest in the oil and gas properties. In December 1995, an affiliate owned by an officer and director of the Company provided a loan of $660,000. The proceeds of the loan were used for general corporate purposes including the repayment of other indebtedness. No collateral was required to obtain this loan. In January 1996, the loan was repaid in full. In March 1996, an affiliate owned by an officer and director of the Company provided a loan commitment of $175,000. The Company drew $100,000 to fund its equity contribution in a new entity (Pan Grande) in which the Company has a 50% interest (see Note 5). The note, as amended, bears interest at the prime rate plus 2.5% and is payable in 59 monthly installments of $1,667 plus accrued interest and a final installment at March 15, 2001 in the amount of the remaining principal and accrued interest then outstanding and unpaid. The note is secured by the Company's interest in Pan Grande. The Company is in compliance with various normal covenants and certain financial ratios as required by its financing agreements. The aggregate maturities of long-term debt for the five years following December 31, 1995 are as follows:
FOR THE YEAR ENDING DECEMBER 31 (IN THOUSANDS) - ------------------- -------------- 1996.......................................... $ 541 1997.......................................... 1,972 1998.......................................... 1,036 1999.......................................... 953 2000.......................................... -- ------ Total............................... $4,502 ======
8. RELATED PARTY TRANSACTIONS: During 1994, an affiliate owned by certain officers and directors of the Company provided short-term loans to fund the Company's investment in Alaska (see Note 6) until long-term bank financing was obtained. Short-term loans of $316,250 were extended and subsequently repaid during 1994 including interest of $4,005 F-14 73 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) which was accrued at the prime rate plus 5%. In addition, a $275,000 loan was provided in 1994 which, as amended, bears interest at the Mercantile Bank, Corpus Christi prime rate plus 1.5%. Interest is payable monthly and principal and remaining accrued interest are due in full at maturity on April 1, 1997. The proceeds of the loan were used for general corporate purposes including the repayment of other indebtedness. Principal of $75,000 was repaid in November 1995 and cash payments of $30,057 were made for interest as of March 31, 1996. Affiliates owned by certain officers and directors of the Company extended the collateral to obtain the long-term bank financing for the Alaska investment. The collateral was outstanding for a period of approximately eight months at which point the Company replaced the loan with another commercial lender and the collateral requirement was extinguished. In consideration for extending the collateral on the initial loan, the Company assigned a five percent net revenue interest on the net income derived from the Company's investment in the oil and natural gas gathering pipelines near Cook Inlet, Alaska. However, the five percent net revenue interest applies only after all costs associated with the investment have been recouped by the Company. As a result, no amounts have yet been paid under the assignment of the net revenue interest. In May 1995, an affiliate owned by certain officers and directors of the Company provided a $173,822 loan to partially finance the acquisition of a 23% working interest in oil and gas production from two leases located in Starr County, Texas. The loan, as amended in March 1996, bears interest at the Mercantile Bank, Corpus Christi prime rate plus 1% and matures on April 1, 1997. Cash payments of interest amounting to $3,346 and $7,477 were made during the twelve months ended December 31, 1995 and three months ended March 31, 1996, respectively. No collateral was required to obtain this loan, although, as additional consideration for extending the loan, the affiliated company was assigned a one-half percent working interest in the oil and gas properties. An additional one-half percent working interest in the properties will be assigned to Texline if all principal and interest amounts due under the loan are not paid by August 1, 1996. The Five Flags acquisition discussed in Note 4 above was financed by an officer and director of the Company. A $1,872,450 promissory note was executed by the Company and called for monthly payments of interest beginning April 1, 1996 until December 31, 1996 at which time both principal and accrued interest would be due in full. Interest accrued at the prime rate plus 2%. However, the note plus accrued interest of approximately $10,500 was repaid in full on October 2, 1995 using the proceeds from the sale of the Five Flags investment. In addition to the $660,000 general corporate purposes loan provided in December 1995 and repaid in January 1996 (including accrued interest of $4,039) as discussed in Note 7 herein, $1,200,000 was borrowed from an affiliate owned by an officer and director of the Company on October 2, 1995. These funds were used in conjunction with the remainder of the sales proceeds of Five Flags to fully retire the $500,000 Debenture and $2,700,000 Note due the seller of Magnolia. The loan agreement called for interest to be accrued at the prime rate plus 5% and was due monthly beginning April 1, 1996. The loan was to mature on January 31, 1997, however, upon consummation of the new $1,500,000 bank credit facility in December 1995, the note plus accrued interest of $35,260 was repaid in full. As additional consideration for extending the $1,200,000 loan, Midcoast granted the affiliate a 5% net revenue interest in Magnolia's earnings before interest, income taxes and depreciation to be paid on a monthly basis. The net revenue interest, as amended in May 1996, applies only after Magnolia's acquisition cost has been recouped by the Company. At March 31, 1996, no amounts have yet been paid under the assignment of the net revenue interest. Midcoast has the right to repurchase this net revenue interest from the affiliate for a cash payment of $25,000. However, the repurchase amount is increased an additional $25,000 on November 1, 1995 and each following month up to a maximum of $500,000. In March 1996, the Company borrowed $100,000 from an affiliate owned by an officer and director of the Company for its equity contribution in Pan Grande (in which the Company owns a 50% interest, see Note 5) F-15 74 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) pursuant to a promissory note. The note, as amended, bears interest at the prime rate plus 2.5% and is payable in 59 monthly installments of $1,667 plus accrued interest and a final installment at March 15, 2001 in the amount of the remaining principal and accrued interest then outstanding and unpaid. The note is secured by the Company's interest in Pan Grande. The affiliate has committed to lend up to an additional $75,000 in the event an additional system is purchased by Pan Grande. In consideration for the financing of the equity contribution and the commitment for additional financing, the Company issued the affiliate 4,460 shares of the Company's common stock. 9. COMMITMENTS AND CONTINGENCIES: EMPLOYMENT CONTRACTS The Chief Executive Officer and President of the Company, has an employment agreement with the Company which terminates in December 1997 pursuant to which he receives a base annual salary of $125,000 adjusted for salary increases the Board may approve. In 1994 and 1995, two key employees of the Company entered into three and four year employment agreements, respectively. These agreements may be terminated by mutual consent or at the option of the Company for cause, death or disability. In the event termination is due to death, disability or defined changes in the ownership of the Company, the full amount of compensation remaining to be paid during the term of the agreement will be paid to the employee or their estate, after discounting at 12% to reflect the current value of unpaid amounts. CONSULTING AGREEMENT In February 1996, the Company executed an engagement letter with Triumph Resources Corporation for the purpose of assisting the Company with a contemplated sale transaction involving certain Magnolia assets. The agreement calls for a monthly retainer of $8,000 for a period of twelve months in addition to three year warrants to purchase 34,349 shares of the Company's common stock at $7.85 per share. LEASES In March 1996, Midcoast entered into a new noncancelable operating lease for its office space which expires on January 31, 1999. Previously, Midcoast had another noncancelable lease which expired in June 1995 and converted to a month-to-month arrangement until the new lease was executed. Rent expense of $45,400, $50,500, and $50,600 was incurred during the years ended 1993, 1994 and 1995, respectively under these operating leases. During the three months ended March 31, 1995 and 1996, $12,500 in rent expense was incurred in both periods. As of March 31, 1996, future minimum lease payments due under this lease are approximately $53,068 in 1996, $73,125 in 1997, $77,859 in 1998, and $6,488 in 1999. 10. CAPITAL STOCK: At March 31, 1996, the Company had authorized 6 million shares of common stock of which 1,470,141 shares were issued and outstanding. There are 79,403 shares issued and outstanding at March 31, 1996 which are subject to a vesting schedule in conjunction with employee shareholder agreements entered into during 1994 and 1995 (see Note 15). There were 1 million shares authorized and 200,000 shares outstanding of the Company's 5% cumulative preferred stock ("5% Preferred") at March 31, 1996. The 5% Preferred paid quarterly dividends based on an annual rate of 5% of the stated liquidation value and was redeemable in whole or in part at the Company's option at a price per share based on the liquidation value ($5.91 per share). The 5% Preferred voted as a separate class with respect to any change in the preferences or other rights attributable to the 5% Preferred. Upon the failure to declare or pay quarterly dividends for two consecutive quarterly periods, the holders of the 5% Preferred also had the right to elect one director until such time as all accrued dividends had been paid. F-16 75 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Subsequent to March 31, 1996, the Board approved increasing the authorized number of common shares to 10 million, authorizing an approximate 4.46 to 1 stock split, redeeming the 5% Preferred and amending the Company's Articles of Incorporation to reflect only one class of outstanding securities, the Company's common stock (see Note 17). 11. INCOME TAXES: The Company has a net operating loss ("NOL") carry forward of approximately $15.1 million expiring in various amounts from 1999 through 2008. In addition, the Company has an investment tax credit (ITC) carry forward of approximately $354,000 which expires primarily in 1997. These loss carryforwards were generated by the Company's predecessor. The ability of the Company to utilize the carry forwards is dependent upon the Company maintaining profitable operations and staying in compliance with certain Internal Revenue Service ("IRS") code provisions and regulations associated with a change in shareholder control. Failure to adhere to these IRS requirements could result in a significant limitation of the Company's ability to utilize its NOL and ITC carryforwards and could also result in a loss of utilization altogether. The tax effect of significant temporary differences representing deferred tax assets and liabilities at December 31, 1994 and 1995, are as follows (in thousands):
DECEMBER 31 ------------------- 1994 1995 ------- ------- Net operating and capital loss carry forwards.................... $ 5,183 $ 5,124 Investment tax credit carryforwards.............................. 354 354 Alternative minimum tax credit................................... -- 44 Financial basis of assets in excess of tax basis................. (644) (644) Valuation allowance.............................................. (4,893) (4,834) ------- ------- Net deferred tax assets.......................................... $ -- $ 44 ======= =======
A reconciliation of the 1993, 1994 and 1995 provision for income taxes to the statutory United States tax rate is as follows (in thousands):
1993 1994 1995 ----- ---- ----- Federal tax computed at statutory rate...................... $ 278 $ 50 $ 771 Utilization of net operating loss carryforwards............. (278) (50) (771) Federal alternative minimum tax............................. 16 -- -- Provision for state income taxes............................ 37 -- -- ----- ---- ----- Actual provision............................................ $ 53 $ -- $ -- ===== ==== =====
12. MAJOR CUSTOMERS: For the year ended December 31, 1993, the Company derived over 10% of its sale of natural gas and transportation fees from Mid-America Pipeline Company, Petro PSC, L.P. , and Seminole Pipeline Company. They accounted for 32%, 14%, and 12%, respectively. For the years ended December 31, 1994 and 1995, the Company derived over 10% of its sales of natural gas and transportation fees from Mid-America Pipeline Company and Westlake Petrochemicals Corporation. They accounted for 42% and 21% during 1994, and 40% and 14% during 1995, respectively. F-17 76 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 13. CONCENTRATION OF CREDIT RISK: The Company derives revenue from gas transmission and gathering services for commercial companies located in Alabama, Alaska, Kansas, Louisiana, New York, Oklahoma, and Texas. Two of Midcoast's largest customers account for 49% or approximately $1.13 million of the outstanding accounts receivable at December 31, 1995 (42% or approximately $895,000 at March 31, 1996). These accounts receivable were subsequently collected under normal credit terms and the Company believes that future accounts receivable with these companies will continue to be collected under normal credit terms based on previous experience which spans several years. The Company performs ongoing evaluations of its customers and generally does not require collateral. The Company assesses its credit risk and provides an allowance for doubtful accounts for any accounts which it deems doubtful of collection. At December 31, 1995 and March 31, 1996, no provision for doubtful accounts was provided. The Company maintains deposits in banks which may exceed the amount of federal deposit insurance available. Management periodically assesses the financial condition of the institutions and believes that any possible deposit loss is minimal. 14. FAIR VALUE OF FINANCIAL INSTRUMENTS: The Company's financial instruments consist of trade receivables and liabilities, notes payable to affiliates and various banks. The Company believes the carrying value of these financial instruments approximate their estimated fair value. 15. EMPLOYEE BENEFITS: The Company issued a total of 13,381, 36,132 and 63,343 common shares of the Company's common stock to certain key employees in 1993, 1994 and 1995, respectively. Of the shares issued in 1994 and 1995, 35,686 and 57,991 respectively were issued in connection with shareholder agreements with certain employees. The shares vest in equal amounts: the 35,686 shares over a five year period and the 57,991 shares over a four year period. The shares were valued at the estimated fair market value on the date of issuance. Compensation expense is being recognized rateably over the vesting period. In May 1996, the Board of the Company adopted the Midcoast Energy Resources, Inc. 1996 Incentive Stock Plan (the "Incentive Plan"). All employees, including officers (whether or not directors) of the Company and its subsidiaries are currently eligible to participate in the Incentive Plan. Persons who are not in an employment relationship with the Company or any of its subsidiaries, including non-employee directors, are not eligible to participate in the Incentive Plan. Under the Incentive Plan, the Compensation Committee may grant incentive awards (the "Incentive Awards") with respect to a number of shares of Common Stock that in the aggregate does not exceed 200,000 shares of Common Stock, subject to adjustment upon the occurrence of certain recapitalizations of the Company. The Incentive Plan provides for the grant of (i) options, both incentive stock options and non-qualified options, (ii) shares of restricted stock, (iii) performance awards payable in cash or Common Stock, (iv) shares of phantom stock, and (v) stock bonuses (collectively, the "Incentive Awards"). In addition, the Incentive Plan provides for the grant of cash bonuses payable when a participant is required to recognize income for federal income tax purposes in connection with the vesting of shares of restricted stock or the issuance of shares of Common Stock upon the grant of a performance award or a stock bonus, provided, that such cash bonus may not exceed the fair market value (as defined) of the shares of Common Stock received on the grant or exercise, as the case may be, of an Incentive Award. No Incentive Award may be granted under the Incentive Plan after ten (10) years from the Incentive Plan adoption date. F-18 77 MIDCOAST ENERGY RESOURCES, INC., AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 16. ABANDONMENT OF PIPELINES: In 1992, a complaint was filed before the Alabama Public Service Commission ("APSC") by a local distribution company alleging that Gas Utilities or its assignees were required to obtain a certificate of necessity and public convenience before the pipeline may be operated. As a result, an injunction was ordered by the Circuit Court of Hale County, Alabama, on October 8, 1992, against further construction on the pipeline until the matter was resolved before the APSC. Based upon the complaint filing, the APSC asserted jurisdiction, thereby requiring their certification of the pipeline, which would be extremely difficult and costly to obtain; therefore, the Company elected to write-off its investment in the pipeline ($210,687) during the third quarter of 1993. The Company pursued relief through the Alabama judicial system but did not prevail. The Company is currently considering other regulatory alternatives but no assurances can be made that the Company will recover its investment in the pipeline. Also in 1993, the Company disposed of most of the recoverable assets of an inactive gas gathering system and wrote-off the remaining net book value of $35,981. 17. SUBSEQUENT EVENTS: The Board and a majority of the existing shareholders have authorized increasing the number of authorized common shares from 6,000,000 shares to 10,000,000 shares. In addition, the Board authorized an approximate 4.46 for 1 stock split in anticipation of the Company registering with the United States Securities and Exchange Commission 1,150,000 shares (after consideration of the stock split) of its common stock, including the Company's grant of an option to the underwriters to purchase up to 150,000 shares to satisfy over-allotments in the sale of the Company's common stock. Under the terms of the underwriting agreement, the underwriters will also receive warrants to acquire 100,000 shares at 120% of the initial offering price per share. The securities underlying these warrants are subject to piggyback registration rights. In May 1996, the Board approved the redemption of the 5% Preferred for $118,367 held by directors and officers of the Company. The shares were redeemed for ten percent (10%) of the stated liquidation value ($1,183,665). Subsequently, no shares of the Company's preferred stock remain outstanding. Following redemption of the Company's 5% Preferred, a majority of the shareholders approved an amendment to the Articles of Incorporation to reflect only one class of outstanding securities, the Company's common stock. In May 1996, Magnolia acquired nine gathering pipeline systems and one transmission pipeline system from TSGGC. The systems were acquired pursuant to a purchase and sale agreement dated March 12, 1996 for a total purchase price of $390,000 less purchase price adjustments giving effect to operating income since the effective date of January 1, 1996. These systems total approximately 113 miles of 2 inch to 10 inch diameter pipeline with associated equipment. Five systems (Fayette, Happy Hill, Moores Bridge, Detroit and Sizemore) are located in Alabama, and five systems (Millbrook, Greenwood Springs, Heidelberg-TGP, Heidelberg-Koch and Baxterville) are located in Mississippi. The bulk of the systems are located within 100 miles of the Magnolia System and it is the Company's intention to integrate the operation of these systems with the Magnolia System. TSGGC had acquired these systems in 1994 as part of a larger acquisition package. The acquisition was financed by amending an existing credit facility with a bank as discussed below. In May 1996, the Company's $1,500,000 revolving line of credit with a bank was amended to increase the available credit by $350,000 and adjust the monthly reduction of availability from $17,860 to $23,000. This amendment was made to finance the TSGGC acquisition discussed in the preceding paragraph. F-19 78 - ------------------------------------------------------ - ------------------------------------------------------ NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF. ------------------------ TABLE OF CONTENTS
PAGE ---- Available Information.................. 2 Prospectus Summary..................... 3 Risk Factors........................... 7 Use of Proceeds........................ 11 Market for the Company's Common Stock and Dividend Policy.................. 13 Dilution............................... 14 Capitalization......................... 15 Selected Financial Data................ 16 Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 17 Business and Properties................ 23 Management............................. 43 Principal Stockholders................. 50 Shares Eligible for Future Sale........ 51 Description of Securities.............. 52 Underwriting........................... 54 Legal Matters.......................... 55 Experts................................ 55 Glossary............................... 56 Index to Financial Statements.......... F-1
- ------------------------------------------------------ - ------------------------------------------------------ - ------------------------------------------------------ - ------------------------------------------------------ 1,000,000 SHARES MIDCOAST ENERGY RESOURCES, INC. COMMON STOCK --------------------------- PROSPECTUS ---------------------- COLEMAN AND COMPANY SECURITIES, INC. NOLAN SECURITIES CORPORATION , 1996 - ------------------------------------------------------ - ------------------------------------------------------ 79 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS. The Company's Articles contain indemnification provisions which are consistent with those contained in the NGCL. Accordingly, the Company generally may indemnify its directors and officers against liabilities and expenses to which they may become subject or which they may incur as a result of being or having been a director, officer, employee or agent of the Company. Insofar as indemnification for liabilities arising under the Securities Act, may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act, and will be governed by the final adjudication of such issue. ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The estimated cash expenses to be incurred in connection with the registration and distribution of the securities covered by this Registration Statement are set forth below. SEC Registration Fee...................................................... $ 4,817 The Nasdaq National Market Application and Listing Fees................... 17,500 NASD Filing Fee........................................................... 1,897 Printing Expenses......................................................... 35,000 Legal Fees and Expenses................................................... 150,000 Blue Sky Fees and Expenses (including legal expenses)..................... 30,000 Accounting Fees and Expenses.............................................. 25,000 Transfer Agent and Registrar Fees and Expenses............................ 5,000 Miscellaneous Expenses.................................................... 20,786 --------- TOTAL........................................................... $290,000 =========
II-1 80 ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES. The following table reflects sales by the Company of unregistered securities within the past three years. Share amounts have been adjusted for the 4.460961 to 1 stock split effective prior to the date of this Prospectus. Except as otherwise disclosed, the issuances by the Company of the securities sold in the transactions referenced below were not registered under the Securities Act, pursuant to the exemption contemplated in Section 4(2) thereof, for transactions not involving a public offering. No underwriter was involved in the transactions and no commissions were paid. The consideration for which the shares of Common Stock were issued is indicated below:
DATE SHARES CONSIDERATION PURCHASER -------------------------- ------ ------------- -------------------------- August 17, 1993 892 Services Duane S. Herbst 1,338 Services I.J. Berthelot II 1,338 Services Richard A. Robert 446 Services Patricia R. Ashbrook 1,338 Services Bill G. Bray 446 Services Donna J. Haddock 446 Services Barbara A. Jordan 446 Services Kathy C. Smith April 30, 1993 6,691 Services I.J. Berthelot II April 30, 1994 6,691 Services Duane S. Herbst 11,152 Services I.J. Berthelot II 11,152 Services Richard A. Robert 6,691 Services Bill G. Bray 446 Services Mike Wissink April 17, 1995 44,609 Services I.J. Berthelot II April 30, 1995 446 Services I.J. Berthelot II 446 Services Richard A. Robert 446 Services Bill G. Bray August 1, 1995 446 Services Duane S. Herbst 446 Services Donna J. Haddock 446 Services Barbara A. Jordan 446 Services Kathy C. Smith September 20, 1995 13,382 Services I.J. Berthelot II December 1, 1995 446 Services Duane S. Herbst 446 Services I.J. Berthelot II 446 Services Richard A. Robert 446 Services Bill G. Bray 446 Services Ronald Harris March 29, 1996 4,460 Financing Rainbow April 8, 1996 892 Services Karen Callaway 334 Services Donna J. Haddock 446 Services Ronald Harris 2,676 Services Duane S. Herbst 446 Services Barbara A. Jordan 8,921 Services Richard A. Robert 557 Services Kathy C. Smith April 17, 1996 7,275 Services Bill G. Bray 4,460 Services Mark W. Fuqua
II-2 81 ITEM 27. EXHIBITS.
EXHIBITS DESCRIPTION - ---------- ---------------------------------------------------------------------------------- *1.1 -- Form of Underwriting Agreement by and among the Underwriters and Midcoast Energy Resources, Inc. **1.2 -- Agreement among Underwriters. **1.3 -- Selected dealer agreement. **3.1 -- Certificate of Incorporation of Midcoast Energy Resources, Inc., as amended. 3.2 -- By-Laws of Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1992). 4.1 -- Shareholder Agreement by and between Midcoast Energy Resources, Inc. and Bill G. Bray dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 4.2 -- Shareholder Agreement by and between Midcoast Energy Resources, Inc., and Duane S. Herbst dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 4.3 -- Shareholder Agreement by and between Midcoast Energy Resources, Inc., and Richard A. Robert dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 4.4 -- Shareholder Agreement by and between Midcoast Energy Resources, Inc., and Iris J. Berthelot, II dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). **4.5 -- Specimen Certificate for Shares of Common Stock, par value $.01 per share. **4.6 -- Representative's Warrants. *4.7 -- Termination Agreement dated May 13, 1996 to terminate the Shareholder Agreement by and between Magic Gas Corp. (f/k/a Midcoast Natural Gas, Inc.), Stevens G. Herbst and Kenneth B. Holmes, Jr. dated November 16, 1992. **5.1 -- Opinion of Porter & Hedges, L.L.P. respecting legality of securities being offered. 10.1 -- Employment Agreement by and between Midcoast Energy Resources, Inc., and Dan C. Tutcher dated January 1, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1992). 10.2 -- Amendment dated April 1, 1993 to the Employment Agreement by and between Midcoast Energy Resources, Inc., and Dan C. Tutcher dated January 1, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.3 -- Employment Agreement by and between Midcoast Energy Resources, Inc., and Richard A. Robert dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.4 -- Employment Agreement by and between Midcoast Energy Resources, Inc., and Bill G. Bray dated July 1, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.5 -- Revolving Loan and Credit Agreement dated December 8, 1992, by and between New First City, Texas -- Corpus Christi and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 8-K dated January 1, 1993). 10.6 -- First Amendment to Revolving Loan and Credit Agreement dated December 8, 1992 by and between New First City, Texas -- Corpus Christi, N.A. and Midcoast Energy Resources, Inc. dated January 6, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993).
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EXHIBITS DESCRIPTION - ---------- ---------------------------------------------------------------------------------- 10.7 -- Second Amendment to Revolving Loan and Credit Agreement dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated August 15, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.8 -- Third Amendment to Revolving Loan and Credit Agreement dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated September 1, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.9 -- Allonge and Amendment No. One to Promissory Note dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated April 29, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.10 -- Allonge and Amendment No. Two to Promissory Note dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated June 16, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.11 -- Allonge and Amendment No. Three to Promissory Note dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated August 15, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.12 -- Promissory Note dated July 1, 1993 by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc. including related Security Agreement and Continuing Unlimited Guaranty Agreements also dated July 1, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.13 -- First Amendment to Security Agreement dated July 1, 1993 by and between Midcoast Energy Resources, Inc. and Mercantile Bank, N.A. dated September 1, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.14 -- Promissory Note dated April 19, 1994 by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc., including related Security Agreements also dated April 19, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.15 -- Revolving Credit Promissory Note dated September 1, 1994 by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.16 -- Promissory Note dated December 1, 1994 by and between American National Bank including related Non-Standard Financing Agreement, Security Agreement and Commercial Guarantee Agreements also dated December 1, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.17 -- Promissory Note dated March 21, 1994 by and between Texline Gas Company and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.18 -- Promissory Note dated April 1, 1994 by and between Texline Gas Company and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.19 -- Promissory Note dated December 30, 1994 by and between Texline Gas Company and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994).
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EXHIBITS DESCRIPTION - ---------- ---------------------------------------------------------------------------------- 10.20 -- Assignment of Net Revenue Interest dated July 1, 1994 by and between Texline Gas Company and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.21 -- Assignment of Net Revenue Interest dated July 1, 1994 by and between Rainbow Investments Co. and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.22 -- Agreement for Purchase and Sale of Stock dated November 20, 1992, by and between Harbert Holdings No. One, Inc., and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 8-K dated January 1, 1993, as Exhibit 2.1). 10.23 -- Agreement for Purchase and Sale of Stock dated July 15, 1993 by and between Midcoast Holdings No. One, Inc. and Sunshine Interstate Pipeline Partners (Incorporated by reference from Midcoast Form 8-K dated September 2, 1993). 10.24 -- Agreement dated March 31, 1994 by and between Midcoast Energy Resources, Inc., and Stewart Petroleum Company (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.25 -- Agreement for Purchase and Sale of Stock dated September 6, 1995, by and between Midcoast Holdings No. One, Inc. and Koch Gateway Pipeline Company (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.26 -- First Amendment to Agreement for Purchase and Sale of Stock dated September 6, 1995, by and between Midcoast Holdings No. One, Inc. and Koch Gateway Pipeline Company dated October 2, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.27 -- Agreement for Purchase and Sale of Stock dated September 13, 1995, by and between Five Flags Holding Company and Midcoast Holdings No. One, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.28 -- Agreement for Purchase of Stock dated September 13, 1995, by and between Midcoast Holdings No. One, Inc. and Rainbow Investments Company (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.29 -- Agreement for Purchase and Sale of Stock dated July 27, 1995, by and between Williams Holdings of Delaware, Inc. and Midcoast Holdings No. One, Inc. (Incorporated by reference from Midcoast Form 8-K dated September 22, 1995). 10.30 -- Subordinated Debenture dated September 8, 1995 by and between Midcoast Energy Resources, Inc. and Williams Holdings of Delaware, Inc. (Incorporated by reference from Midcoast Form 8-K dated September 22, 1995). 10.31 -- Nonrecourse Promissory Note dated September 8, 1995 by and between Midcoast Holdings No. One, Inc. and Williams Holdings of Delaware, Inc. (Incorporated by reference from Midcoast Form 8-K dated September 22, 1995). 10.32 -- Allonge and Amendment No. One to Revolving Credit Promissory Note dated September 1, 1994, by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc. dated September 22, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.33 -- Allonge and Amendment No. Two to Revolving Credit Promissory Note dated September 1, 1994, by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc. dated November 1, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995).
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EXHIBITS DESCRIPTION - ---------- ---------------------------------------------------------------------------------- 10.34 -- Fourth Amendment to Revolving Loan and Credit Agreement dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated November 1, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.35 -- Revolving Credit Agreement dated October 31, 1995 by and between American National Bank and Midcoast Energy Resources, Inc. including related Revolving Credit Promissory Note, Security Agreement, Non-Standard Financing Statement and Commercial Guarantee Agreements also dated October 31, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.36 -- Loan Agreement dated October 3, 1995 by and between Midcoast Energy Resources, Inc. and Rainbow Investments Company including related Promissory Note, and Security Agreement also dated October 3, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.37 -- Assignment of Net Revenue Interest dated October 3, 1995, by and between Midcoast Energy Resources, Inc. and Rainbow Investments Company (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.38 -- Loan Agreement dated September 13, 1995, by and between Midcoast Energy Resources, Inc. and Stevens G. Herbst, including related Promissory Note, Security Agreements and Guaranty Agreement also dated September 13, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.39 -- Promissory Note dated May 30, 1995 by and between Midcoast Energy Resources, Inc. and Texline Gas Company (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.40 -- Employment Agreement by and between Midcoast Energy Resources, Inc. and I.J. Berthelot, II dated April 17, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.41 -- Amendment to Employment Agreement dated April 17, 1995 by and between Midcoast Energy Resources, Inc. and I.J. Berthelot, II, dated December 8, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.42 -- Credit Agreement dated December 20, 1995 by and between Compass Bank -- Houston and Magnolia Pipeline Corporation including related Financing Statement, Subordination Agreement, Security Agreements, Promissory Note and Guaranty Agreements (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.43 -- Operating Agreement of Pan Grande Pipeline, L.L.C. by and between Midcoast Holdings No. One, Inc. and Resource Energy Development, L.L.C. dated February 28, 1996 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.44 -- Amendment dated April 8, 1996 to the Employment Agreement by and between Midcoast Energy Resources, Inc. and Richard A. Robert dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.45 -- First Amendment dated March 1, 1996 to the Promissory Note by and between Texline Gas Company and Midcoast Energy Resources, Inc. dated December 30, 1994 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.46 -- Second Amendment dated May 1, 1996 to the Promissory Note by and between Texline Gas Company and Midcoast Energy Resources, Inc. dated December 30, 1994 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.47 -- First Amendment dated March 1, 1996 to the Promissory Note by and between Texline Gas Company and Midcoast Energy Resources, Inc. dated May 30, 1995 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996).
II-6 85
EXHIBITS DESCRIPTION - ---------- ---------------------------------------------------------------------------------- 10.48 -- Promissory Note dated March 1, 1996 by and between Rainbow Investments Company and Midcoast Energy Resources, Inc., including related Security Agreement (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.49 -- First Amendment dated May 1, 1996 to the Promissory Note by and between Rainbow Investments Company and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.50 -- Purchase and Sale Agreement dated March 12, 1996 by and between Texas Southeastern Gas Gathering Company and Magnolia Pipeline Corporation (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.51 -- Amendment dated May 8, 1996 to the Purchase and Sale Agreement by and between Texas Southeastern Gas Gathering Company and Magnolia Pipeline Corporation dated March 12, 1996 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.52 -- First Amendment and Supplement dated May 8, 1996 to the Credit Agreement by and between Compass Bank -- Houston and Magnolia Pipeline Corporation dated December 20, 1995 including related amendments to the Security Agreement, Promissory Note, and Guaranty Agreements. (Incorporated by reference from Midcoast Form 10-QSB for the three-month period ended March 31, 1996). *10.53 -- First Amendment to the Assignment of Net Revenue Interest dated October 3, 1995 by and between Midcoast Energy Resources, Inc. and Rainbow Investments Company dated May 15, 1996. *10.54 -- Allonge and Amendment No. One to Promissory Note dated November 1, 1995 by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc. dated May 14, 1996. **10.55 -- Warrant dated February 1, 1996 by and between Triumph Resources Corporation and Midcoast Energy Resources, Inc. **10.56 -- Midcoast Energy Resources, Inc. 1996 Incentive Stock Plan. 16.1 -- Letter dated March 22, 1994, from Arthur Andersen & Co. as to change in certifying accountant (Incorporated by reference from Midcoast Form 8-K dated March 17, 1994). 18.1 -- Preferability letter from Hein + Associates LLP, independent public accountants, regarding change in accounting principle (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). *21.1 -- Schedule listing subsidiaries of Midcoast Energy Resources, Inc. *23.1 -- Consent of Hein + Associates LLP. **23.2 -- Consent of Porter & Hedges, L.L.P. (included in its opinion filed as Exhibit 5.1 hereto). 24.1 -- Power of Attorney (included on signature page of this Registration Statement) 27.1 -- Financial Data Schedule for the three month period ended March 31, 1996 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996).
- --------------- * Filed herewith. ** To be filed by Amendment. II-7 86 ITEM 28. UNDERTAKINGS The undersigned Registrant hereby undertakes: (1) To file during any period in which it offers or sells securities, a post-effective amendment to this Registration Statement to: (i) Include any prospectus required by section 10(a)(3) of the Securities Act; (ii) Reflect in the prospectus any facts or events which, individually or together, represent a fundamental change in the information in the registration statement; and (iii) Include any additional or changed material information on the plan of distribution. (2) For determining liability under the Securities Act, treat each post-effective amendment as a new registration statement of the securities offered, and the offering of the securities at that time to be the initial bona fide offering. (3) File a post-effective amendment to remove from registration any of the securities that remain unsold at the end of the Offering. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the small business issuer pursuant to the foregoing provisions, or otherwise, the small business issuer has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the small business issuer of expenses incurred or paid by a director, officer or controlling person of the small business issuer in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the small business issuer will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. That: (i) for purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of the registration statement in reliance on Rule 430A and contained in the form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of the registration statement as of the time it was declared effective; and (ii) for the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-8 87 SIGNATURES In accordance with the requirements of the Securities Act of 1933, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements of filing a Registration Statement on Form SB-2 and authorized this Registration Statement to be signed on its behalf by the undersigned, in the City of Houston, State of Texas on this 28th day of May, 1996. MIDCOAST ENERGY RESOURCES, INC. By: /s/ DAN C. TUTCHER -------------------------------------- Dan C. Tutcher, Chairman of the Board, Chief Executive Officer and President (Principal Executive Officer) POWER OF ATTORNEY We, the undersigned directors and officers of Midcoast Energy Resources, Inc., do hereby constitute and appoint Dan C. Tutcher or Stevens G. Herbst or either of them, our true and lawful attorneys and agents, to do any and all acts and things in our name and on our behalf in our capacities as directors and officers, and to execute any and all instruments for us and in our names in the capacities indicated below, which such attorneys and agents may deem necessary or advisable to enable the corporation to comply with the Securities Act of 1933, as amended, and any rules, regulations and requirements of the Securities and Exchange Commission, in connection with the filing of this Registration Statement, including specifically without limitation power and authority to sign for us or any of us, in our names in the capacities indicated below, any and all amendments hereto; and we do hereby ratify and confirm all that such attorneys and agents shall do or cause to be done by virtue hereof. In accordance with the Requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on this 28th day of May, 1996.
SIGNATURE TITLE - --------------------------------------------- ---------------------------------------------- /s/ DAN C. TUTCHER Chairman of the Board, Chief Executive Officer - --------------------------------------------- and President (Principal Executive Officer) Dan C. Tutcher /s/ STEVENS G. HERBST Executive Vice President, Director - --------------------------------------------- Stevens G. Herbst /s/ RICHARD A. ROBERT Treasurer, Principal Financial Officer and - --------------------------------------------- Principal Accounting Officer Richard A. Robert /s/ KENNETH B. HOLMES, JR. Director - --------------------------------------------- Kenneth B. Holmes, Jr.
II-9 88 INDEX TO EXHIBITS
EXHIBITS DESCRIPTION - ---------- ---------------------------------------------------------------------------------- *1.1 -- Form of Underwriting Agreement by and among the Underwriters and Midcoast Energy Resources, Inc. **1.2 -- Agreement among Underwriters. **1.3 -- Selected dealer agreement. **3.1 -- Certificate of Incorporation of Midcoast Energy Resources, Inc., as amended. 3.2 -- By-Laws of Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1992). 4.1 -- Shareholder Agreement by and between Midcoast Energy Resources, Inc. and Bill G. Bray dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 4.2 -- Shareholder Agreement by and between Midcoast Energy Resources, Inc., and Duane S. Herbst dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 4.3 -- Shareholder Agreement by and between Midcoast Energy Resources, Inc., and Richard A. Robert dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 4.4 -- Shareholder Agreement by and between Midcoast Energy Resources, Inc., and Iris J. Berthelot, II dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). **4.5 -- Specimen Certificate for Shares of Common Stock, par value $.01 per share. **4.6 -- Representative's Warrants. *4.7 -- Termination Agreement dated May 13, 1996 to terminate the Shareholder Agreement by and between Magic Gas Corp. (f/k/a Midcoast Natural Gas, Inc.), Stevens G. Herbst and Kenneth B. Holmes, Jr. dated November 16, 1992. **5.1 -- Opinion of Porter & Hedges, L.L.P. respecting legality of securities being offered. 10.1 -- Employment Agreement by and between Midcoast Energy Resources, Inc., and Dan C. Tutcher dated January 1, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1992). 10.2 -- Amendment dated April 1, 1993 to the Employment Agreement by and between Midcoast Energy Resources, Inc., and Dan C. Tutcher dated January 1, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.3 -- Employment Agreement by and between Midcoast Energy Resources, Inc., and Richard A. Robert dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.4 -- Employment Agreement by and between Midcoast Energy Resources, Inc., and Bill G. Bray dated July 1, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.5 -- Revolving Loan and Credit Agreement dated December 8, 1992, by and between New First City, Texas -- Corpus Christi and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 8-K dated January 1, 1993). 10.6 -- First Amendment to Revolving Loan and Credit Agreement dated December 8, 1992 by and between New First City, Texas -- Corpus Christi, N.A. and Midcoast Energy Resources, Inc. dated January 6, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993).
89
EXHIBITS DESCRIPTION - ---------- ---------------------------------------------------------------------------------- 10.7 -- Second Amendment to Revolving Loan and Credit Agreement dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated August 15, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.8 -- Third Amendment to Revolving Loan and Credit Agreement dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated September 1, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.9 -- Allonge and Amendment No. One to Promissory Note dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated April 29, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.10 -- Allonge and Amendment No. Two to Promissory Note dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated June 16, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.11 -- Allonge and Amendment No. Three to Promissory Note dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated August 15, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.12 -- Promissory Note dated July 1, 1993 by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc. including related Security Agreement and Continuing Unlimited Guaranty Agreements also dated July 1, 1993 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.13 -- First Amendment to Security Agreement dated July 1, 1993 by and between Midcoast Energy Resources, Inc. and Mercantile Bank, N.A. dated September 1, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.14 -- Promissory Note dated April 19, 1994 by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc., including related Security Agreements also dated April 19, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.15 -- Revolving Credit Promissory Note dated September 1, 1994 by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.16 -- Promissory Note dated December 1, 1994 by and between American National Bank including related Non-Standard Financing Agreement, Security Agreement and Commercial Guarantee Agreements also dated December 1, 1994 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.17 -- Promissory Note dated March 21, 1994 by and between Texline Gas Company and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.18 -- Promissory Note dated April 1, 1994 by and between Texline Gas Company and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.19 -- Promissory Note dated December 30, 1994 by and between Texline Gas Company and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994).
90
EXHIBITS DESCRIPTION - ---------- ---------------------------------------------------------------------------------- 10.20 -- Assignment of Net Revenue Interest dated July 1, 1994 by and between Texline Gas Company and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.21 -- Assignment of Net Revenue Interest dated July 1, 1994 by and between Rainbow Investments Co. and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1994). 10.22 -- Agreement for Purchase and Sale of Stock dated November 20, 1992, by and between Harbert Holdings No. One, Inc., and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 8-K dated January 1, 1993, as Exhibit 2.1). 10.23 -- Agreement for Purchase and Sale of Stock dated July 15, 1993 by and between Midcoast Holdings No. One, Inc. and Sunshine Interstate Pipeline Partners (Incorporated by reference from Midcoast Form 8-K dated September 2, 1993). 10.24 -- Agreement dated March 31, 1994 by and between Midcoast Energy Resources, Inc., and Stewart Petroleum Company (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1993). 10.25 -- Agreement for Purchase and Sale of Stock dated September 6, 1995, by and between Midcoast Holdings No. One, Inc. and Koch Gateway Pipeline Company (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.26 -- First Amendment to Agreement for Purchase and Sale of Stock dated September 6, 1995, by and between Midcoast Holdings No. One, Inc. and Koch Gateway Pipeline Company dated October 2, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.27 -- Agreement for Purchase and Sale of Stock dated September 13, 1995, by and between Five Flags Holding Company and Midcoast Holdings No. One, Inc. (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.28 -- Agreement for Purchase of Stock dated September 13, 1995, by and between Midcoast Holdings No. One, Inc. and Rainbow Investments Company (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.29 -- Agreement for Purchase and Sale of Stock dated July 27, 1995, by and between Williams Holdings of Delaware, Inc. and Midcoast Holdings No. One, Inc. (Incorporated by reference from Midcoast Form 8-K dated September 22, 1995). 10.30 -- Subordinated Debenture dated September 8, 1995 by and between Midcoast Energy Resources, Inc. and Williams Holdings of Delaware, Inc. (Incorporated by reference from Midcoast Form 8-K dated September 22, 1995). 10.31 -- Nonrecourse Promissory Note dated September 8, 1995 by and between Midcoast Holdings No. One, Inc. and Williams Holdings of Delaware, Inc. (Incorporated by reference from Midcoast Form 8-K dated September 22, 1995). 10.32 -- Allonge and Amendment No. One to Revolving Credit Promissory Note dated September 1, 1994, by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc. dated September 22, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.33 -- Allonge and Amendment No. Two to Revolving Credit Promissory Note dated September 1, 1994, by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc. dated November 1, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995).
91
EXHIBITS DESCRIPTION - ---------- ---------------------------------------------------------------------------------- 10.34 -- Fourth Amendment to Revolving Loan and Credit Agreement dated December 8, 1992 by and between Mercantile Bank, N.A. (formerly known as New First City, Texas -- Corpus Christi, N.A.) and Midcoast Energy Resources, Inc. dated November 1, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.35 -- Revolving Credit Agreement dated October 31, 1995 by and between American National Bank and Midcoast Energy Resources, Inc. including related Revolving Credit Promissory Note, Security Agreement, Non-Standard Financing Statement and Commercial Guarantee Agreements also dated October 31, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.36 -- Loan Agreement dated October 3, 1995 by and between Midcoast Energy Resources, Inc. and Rainbow Investments Company including related Promissory Note, and Security Agreement also dated October 3, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.37 -- Assignment of Net Revenue Interest dated October 3, 1995, by and between Midcoast Energy Resources, Inc. and Rainbow Investments Company (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.38 -- Loan Agreement dated September 13, 1995, by and between Midcoast Energy Resources, Inc. and Stevens G. Herbst, including related Promissory Note, Security Agreements and Guaranty Agreement also dated September 13, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.39 -- Promissory Note dated May 30, 1995 by and between Midcoast Energy Resources, Inc. and Texline Gas Company (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.40 -- Employment Agreement by and between Midcoast Energy Resources, Inc. and I.J. Berthelot, II dated April 17, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.41 -- Amendment to Employment Agreement dated April 17, 1995 by and between Midcoast Energy Resources, Inc. and I.J. Berthelot, II, dated December 8, 1995 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.42 -- Credit Agreement dated December 20, 1995 by and between Compass Bank -- Houston and Magnolia Pipeline Corporation including related Financing Statement, Subordination Agreement, Security Agreements, Promissory Note and Guaranty Agreements (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.43 -- Operating Agreement of Pan Grande Pipeline, L.L.C. by and between Midcoast Holdings No. One, Inc. and Resource Energy Development, L.L.C. dated February 28, 1996 (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). 10.44 -- Amendment dated April 8, 1996 to the Employment Agreement by and between Midcoast Energy Resources, Inc. and Richard A. Robert dated April 30, 1994 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.45 -- First Amendment dated March 1, 1996 to the Promissory Note by and between Texline Gas Company and Midcoast Energy Resources, Inc. dated December 30, 1994 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.46 -- Second Amendment dated May 1, 1996 to the Promissory Note by and between Texline Gas Company and Midcoast Energy Resources, Inc. dated December 30, 1994 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.47 -- First Amendment dated March 1, 1996 to the Promissory Note by and between Texline Gas Company and Midcoast Energy Resources, Inc. dated May 30, 1995 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996).
92
EXHIBITS DESCRIPTION - ---------- ---------------------------------------------------------------------------------- 10.48 -- Promissory Note dated March 1, 1996 by and between Rainbow Investments Company and Midcoast Energy Resources, Inc., including related Security Agreement (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.49 -- First Amendment dated May 1, 1996 to the Promissory Note by and between Rainbow Investments Company and Midcoast Energy Resources, Inc. (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.50 -- Purchase and Sale Agreement dated March 12, 1996 by and between Texas Southeastern Gas Gathering Company and Magnolia Pipeline Corporation (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.51 -- Amendment dated May 8, 1996 to the Purchase and Sale Agreement by and between Texas Southeastern Gas Gathering Company and Magnolia Pipeline Corporation dated March 12, 1996 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996). 10.52 -- First Amendment and Supplement dated May 8, 1996 to the Credit Agreement by and between Compass Bank -- Houston and Magnolia Pipeline Corporation dated December 20, 1995 including related amendments to the Security Agreement, Promissory Note, and Guaranty Agreements. (Incorporated by reference from Midcoast Form 10-QSB for the three-month period ended March 31, 1996). *10.53 -- First Amendment to the Assignment of Net Revenue Interest dated October 3, 1995 by and between Midcoast Energy Resources, Inc. and Rainbow Investments Company dated May 15, 1996. *10.54 -- Allonge and Amendment No. One to Promissory Note dated November 1, 1995 by and between Mercantile Bank, N.A. and Midcoast Energy Resources, Inc. dated May 14, 1996. **10.55 -- Warrant dated February 1, 1996 by and between Triumph Resources Corporation and Midcoast Energy Resources, Inc. **10.56 -- Midcoast Energy Resources, Inc. 1996 Incentive Stock Plan. 16.1 -- Letter dated March 22, 1994, from Arthur Andersen & Co. as to change in certifying accountant (Incorporated by reference from Midcoast Form 8-K dated March 17, 1994). 18.1 -- Preferability letter from Hein + Associates LLP, independent public accountants, regarding change in accounting principle (Incorporated by reference from Midcoast Form 10-KSB for the fiscal year ended December 31, 1995). *21.1 -- Schedule listing subsidiaries of Midcoast Energy Resources, Inc. *23.1 -- Consent of Hein + Associates LLP. **23.2 -- Consent of Porter & Hedges, L.L.P. (included in its opinion filed as Exhibit 5.1 hereto). 24.1 -- Power of Attorney (included on signature page of this Registration Statement) 27.1 -- Financial Data Schedule for the three month period ended March 31, 1996 (Incorporated by reference from Midcoast Form 10-QSB for the three month period ended March 31, 1996).
- --------------- * Filed herewith. ** To be filed by Amendment. EX-1.1 2 FORM OF UNDERWRITING AGREEMENT 1 MIDCOAST ENERGY RESOURCES, INC. 1,000,000 Shares Common Stock (par value $.01 per share) UNDERWRITING AGREEMENT ___________, 1996 COLEMAN AND COMPANY SECURITIES, INC. As Representative of the several Underwriters named in Schedule A 666 Fifth Avenue New York, New York 10103 Dear Sirs or Madams: Midcoast Energy Resources, Inc., a Nevada corporation (the "Company"), hereby confirms its agreement with the several underwriters named in Schedule A hereto (the "Underwriters") for whom you have been authorized to act as representative (in such capacity, the "Representative"), as set forth below. The Company proposes to issue and sell to the several Underwriters an aggregate of 1,000,000 shares (the "Firm Securities") of the Company's common stock, par value $.01 per share ("Common Stock"). The Company proposes to grant to the several Underwriters an option to purchase up to an additional 150,000 shares of Common Stock if requested by the Representative as provided in section 2 of this agreement. Any and all shares of Common Stock to be purchased by the Underwriters pursuant to such option are referred to herein as the "Option Securities," and the Firm Securities and any Option Securities are collectively referred to herein as the "Securities." 1. Representations and Warranties of the Company. The Company represents and warrants to, and agrees with, each of the several Underwriters that: 2 (a) A registration statement on Form SB-2 (File No. 333-_____) with respect to the Securities and the Warrant Securities (as hereinafter defined), including a prospectus subject to completion, has been filed by the Company with the Securities and Exchange Commission (the "Commission") under the Securities Act of 1933 (the "Act"), and one or more amendments to that registration statement may have been so filed. Copies of such registration statement and of each amendment heretofore filed by the Company with the Commission have been delivered to you. After the execution of this agreement, the Company will file with the Commission either (i) if that registration statement, as it may have been amended, has been declared by the Commission to be effective under the Act, a prospectus in the form most recently included in an amendment to that registration statement (or, if no such amendment shall have been filed, in that registration statement), with such changes or insertions as are required by Rule 430A under the Act or permitted by Rule 424(b) under the Act and as have been provided to and approved by the Representative prior to the execution of this agreement, or (ii) if that registration statement, as it may have been amended, has not been declared by the Commission to be effective under the Act, an amendment to that registration statement, including a form of prospectus, a copy of which amendment has been furnished to and approved by the Representative prior to the execution of this agreement. As used in this agreement, the term "Registration Statement" means that registration statement, as amended at the time when it was or is declared effective, including all financial schedules and exhibits thereto and including any information omitted therefrom pursuant to Rule 430A under the Act and included in the Prospectus (as hereinafter defined); the term "Preliminary Prospectus" means each prospectus subject to completion filed with that registration statement or any amendment thereto (including the prospectus subject to completion, if any, included in the Registration Statement or any amendment thereto at the time it was or is declared effective); and the term "Prospectus" means the prospectus first filed with the Commission pursuant to Rule 424(b) under the Act or, if no prospectus is required to be filed pursuant to Rule 424(b), the prospectus included in the Registration Statement. The Company has caused to be delivered to you copies of each Preliminary Prospectus and has consented to the use of those copies for the purposes permitted by the Act. (b) The Commission has not issued any order preventing or suspending the use of any Preliminary Prospectus. When each Preliminary Prospectus and each amendment and each supplement thereto was filed with the Commission it (i) contained all statements and exhibits required therein in accordance with, and complied with the requirements of, the Act and the rules and regulations of the Commission thereunder and (ii) did not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. When the Registration Statement and each amendment thereto was or is declared effective, it (i) contained or will contain all statements required to be stated therein in accordance with, and complied or will comply with the requirements of, the Act and the rules and regulations of the Commission thereunder and (ii) did not or will not include any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. When the Prospectus and each -2- 3 amendment or supplement thereto is filed with the Commission pursuant to Rule 424(b) (or, if the Prospectus or such amendment or supplement is not required to be so filed, when the Registration Statement or the amendment thereto containing such Prospectus or amendment or supplement thereto was or is declared effective) and on the Firm Closing Date and any Option Closing Date (as each such term is hereinafter defined), the Prospectus, as amended or supplemented at any such time, (i) contained or will contain all statements required to be stated therein in accordance with, and complied or will comply with the requirements of, the Act and the rules and regulations of the Commission thereunder and (ii) did not or will not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. The foregoing provisions of this paragraph (b) do not apply to statements or omissions made in any Preliminary Prospectus, the Registration Statement or any amendment thereto or the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with written information furnished to the Company by any Underwriter through the Representative specifically for use therein. (c) The Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of the state of Nevada and is duly qualified to transact business as a foreign corporation and is in good standing in each jurisdiction where the ownership or leasing of its property or the conduct of its business requires such qualification. (d) The Company has full corporate power and authority to own or lease its property and conduct its business as now being conducted and as proposed to be conducted as described in the Registration Statement and the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus); and the Company has full corporate power and authority to enter into this agreement and to carry out all the terms and provisions hereof to be carried out by it. (e) The Company does not own, directly or indirectly, any capital stock of any corporation, any interest in any partnership or limited liability company or any other equity interest or participation in any other person, other than as described in Exhibit 21.1 to the Registration Statement (each of which, a "Subsidiary"). Each Subsidiary has been duly chartered and organized and is existing in good standing under the laws of its jurisdiction of incorporation or organization, as the case may be, and has full corporate power and authority to own or lease its property and conduct its business as now being conducted and as proposed to be conducted as described in the Registration Statement and the Prospectus (and, if the Prospectus is not in existence, the most recent Preliminary Prospectus). (f) The Company has an authorized, issued and outstanding capitalization as set forth in the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus). All of the issued shares of capital stock of the Company have been duly authorized and validly issued and are fully paid, nonassessable and free of preemptive rights. There are no outstanding options, warrants or other rights granted by the Company to -3- 4 purchase shares of its Common Stock or other securities other than as described in the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus). The Firm Securities and the Option Securities have been duly authorized by all necessary corporate action on the part of the Company and, when issued and delivered to and paid for by the Underwriters pursuant to this agreement, will be validly issued, fully paid, nonassessable and free of preemptive rights and will conform to the description thereof in the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus). No holders of outstanding shares of capital stock of the Company are entitled as such to any preemptive or other rights to subscribe for any of the Securities, and no person or entity is entitled to have securities registered by the Company under the Registration Statement or otherwise under the Act other than as described in the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus). The Company has reserved (a) 200,000 shares of Common Stock for issuance upon the exercise of qualified options that have been or may be granted to management and employees of the Company which options will be exercisable at a price that will be no lower than the price per share of the Firm Securities, (b) 34,439 shares of Common Stock issuable upon the exercise of outstanding warrants held by Triumph Resources Corporation and (c) a number of shares of Common Stock equal to 10% of the Firm Securities issuable upon exercise of the Representative's Warrants (as hereinafter defined). All repurchases by the Company of shares of Common Stock and Preferred Stock and options to purchase such shares were made in full compliance with all applicable laws, including federal, state or other securities laws, and there is no basis for any rescission or other claims, seeking damages or otherwise, of any kind by any party relating to any such repurchases. (g) The capital stock of the Company conforms to the description thereof contained in the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus). (h) All prior sales by the Company of the Company's securities have been made in compliance with or under an exemption from registration under the Act and applicable state securities laws and no shareholders of the Company have any recession rights with respect to Company securities other than those that have been effectively waived or satisfied. Since the inception of the Company, no compensation was paid to or on behalf of any member of the National Association of Securities Dealers, Inc. ("NASD"), or any affiliate or employee thereof, in connection with any private offering by the Company of the Company's securities. (i) The financial statements of the Company included in the Registration Statement and the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus) fairly present the financial position of the Company as of the dates indicated and the results of operations of the Company for the periods specified. Such financial statements have been prepared in accordance with generally accepted accounting principles, consistently applied. The selected financial data set forth under the caption "Selected Financial Data" in the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary -4- 5 Prospectus) fairly present, on the basis stated in the Prospectus (or such Preliminary Prospectus), the information included therein. (j) Hein + Associates LLP, who have certified certain financial statements of the Company and delivered their report with respect to the financial statements and schedules included in the Registration Statement and the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus), are independent public accountants with respect to the Company as required by the Act and the applicable rules and regulations thereunder. (k) Since the respective dates as of which information is given in the Registration Statement and the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus), (A) except as otherwise contemplated therein, there has been no material adverse change in the business, operations, condition (financial or otherwise), earnings or prospects of the Company or any Subsidiary, whether or not arising in the ordinary course of business, (B) except as otherwise stated therein, there have been no transactions entered into by the Company and no commitments made by the Company that, individually or in the aggregate, are material with respect to the Company, (C) there has not been any change in the capital stock or indebtedness of the Company, and (D) there has been no dividend or distribution of any kind declared, paid or made by the Company in respect of any class of its capital stock. (l) The Company has full corporate power and authority to enter into and perform its obligations under this agreement and the Representative's Warrant Agreement (as hereinafter defined). The execution and delivery of this agreement and the Representative's Warrant Agreement have been duly authorized by all necessary corporate action on the part of the Company and this agreement and the Representative's Warrant Agreement have each been duly executed and delivered by the Company and each is a valid and binding agreement of the Company, enforceable against the Company in accordance with its terms, except as the enforceability thereof may be limited by bankruptcy, insolvency, reorganization, fraudulent conveyance, moratorium and other similar laws affecting creditors' rights generally and to general principles of equity (regardless of whether enforcement is considered in a proceeding in equity or at law), and except as rights to indemnity and contribution under this agreement may be limited by applicable law. The issuance, offering and sale of the Securities to the Underwriters by the Company pursuant to this agreement or the Representative's Warrants to the Representative pursuant to the Representative's Warrant Agreement, the compliance by the Company with the other provisions of this agreement and the Representative's Warrant Agreement and with the provisions of the Securities and the consummation of the other transactions contemplated in this agreement and in the Representative's Warrant Agreement do not (i) require the consent, approval, authorization, registration or qualification of or with any court or governmental or regulatory authority, except such as have been obtained, such as may be required under state securities or blue sky laws and, if the registration statement filed with respect to the Securities (as amended) is not effective under the Act as of the time of execution hereof, such as may be required (and shall be obtained as provided in this agreement) under the Act, or (ii) conflict with -5- 6 or result in a breach or violation of, or constitute a default under, any contract, indenture, mortgage, deed of trust, loan agreement, note, lease or other agreement or instrument to which the Company or any Subsidiary is a party or by which the Company or any Subsidiary or any of its property is bound or subject, or the certificate of incorporation or by-laws of the Company or any Subsidiary, or any statute or any judgment, decree, order, rule or regulation of any court or other governmental or regulatory authority or any arbitrator applicable to the Company or any Subsidiary. (m) No legal or governmental proceedings are pending to which the Company or any Subsidiary is a party or to which the property of the Company or any Subsidiary is subject and no such proceedings have been threatened against the Company or any Subsidiary or with respect to any of its property, except such as are described in the Prospectus (and, if the Prospectus is not in existence, the most recent Preliminary Prospectus). No contract or other document is required to be described in the Registration Statement or the Prospectus or to be filed as an exhibit to the Registration Statement that is not described therein (or, if the Prospectus is not in existence, in the most recent Preliminary Prospectus) or filed as required. (n) Neither the Company nor any Subsidiary is (i) in violation of its certificate of incorporation or by-laws, (ii) in violation in any material respect of any law, statute, regulation, ordinance, rule, order, judgment or decree of any court or any governmental or regulatory authority applicable to the Company or any Subsidiary or (iii) in default in any material respect in the performance or observance of any obligation, agreement, covenant or condition contained in any contract, indenture, mortgage, deed of trust, loan agreement, note, lease or other agreement or instrument to which the Company or any Subsidiary is a party or by which it or any of its property may be bound or subject. (o) The Company and each Subsidiary currently owns or possesses the unrestricted right to use all intellectual property, including all U.S. and foreign patents, patent applications and all licenses, copyrights, inventions, know-how, trade secrets, proprietary technologies, including trademarks, service marks, trade names, processes and substances (including all unpatented and/or unpatentable proprietary or confidential information, systems or procedures) that are described in the Prospectus (or if the Prospectus is not in existence, the most recent Preliminary Prospectus), or other rights or interests in items of intellectual property as are necessary for the conduct of the business now conducted or proposed to be conducted by it and as are described in the Prospectus (or, such Preliminary Prospectus); and, except as disclosed in the Prospectus (or such Preliminary Prospectus), neither the Company nor any Subsidiary is aware of the granting of any patent rights to, or the filing of applications therefor by, others, nor is the Company nor any Subsidiary, except as disclosed in the Prospectus, aware of, nor has the Company nor any Subsidiary received notice of, infringement of or conflict with asserted rights of others with respect to any of the foregoing. All such patents, licenses (and the patents underlying those licenses as applicable), trademarks, service marks, trade names and copyrights are (i) valid and enforceable and (ii) to the best knowledge of the Company, not being infringed by any third parties. -6- 7 (p) The Company and each Subsidiary possesses all licenses, orders, authorizations, approvals, certificates or permits issued by the appropriate state, federal or foreign regulatory agencies or bodies necessary to conduct its business as described in the Registration Statement and the Prospectus (or if the Prospectus is not in existence, the most recent Preliminary Prospectus), and there are no pending or, to the best knowledge of the Company, threatened, proceedings relating to the revocation or modification of any such license, order, authorization, approval, certificate or permit. (q) The Company and each Subsidiary has good and marketable title to all of the properties and assets reflected in its financial statements or as described in the Registration Statement and the Prospectus (or if the Prospectus is not in existence, the most recent Preliminary Prospectus) subject to no lien, mortgage, pledge, charge or encumbrance of any kind, except those reflected in such financial statements or as described in the Registration Statement and the Prospectus (or such Preliminary Prospectus). The Company and each Subsidiary occupies its leased properties under valid and enforceable leases conforming to the description thereof set forth in the Registration Statement and the Prospectus (or such Preliminary Prospectus). The Company has no knowledge of any challenge to the underlying fee title of any lease, easement, right-of-way or license held by the Company or any Subsidiary or to the title of the Company or any Subsidiary to any lease, easement right-of-way, permit or lease and the Company believes that it and all its Subsidiaries have satisfactory title to all of their material leases, easements, rights-of-way and licenses. (r) The Company is not subject to registration as an "investment company" under the Investment Company Act of 1940. (s) The Company has obtained and delivered to the Representative, on behalf of the Underwriters, the agreements (the "Lock-up Agreements") of all of the Company's current officers, directors, affiliates and other stockholders (who in the aggregate represent 92% of the outstanding equity securities of the Company or securities convertible into equity securities of the Company) and holders of options or warrants issued by the Company, to the effect that, among other things, each such person or entity will not, commencing on the effective date of the Registration Statement and continuing for a period of 18 months after the effective date of the Registration Statement with respect to the Firm Securities, without your prior written consent, directly or indirectly, sell, offer or contract to sell or grant any option to purchase, transfer, assign or pledge, or otherwise encumber, or dispose of any shares of Common Stock or any securities convertible into or exercisable for Common Stock now or hereafter owned by such person or entity without the prior written consent of the Underwriters; provided, however, that each such person may transfer shares in a private transaction or grant a bona fide gift to any person without the Underwriter's consent, as long as such transferee or donee executes and delivers to you a Lock-up Agreement. The Company will use its best efforts to secure a Lock-up Agreement on an additional 2.5% of the outstanding equity securities of the Company, or securities convertible into equity securities of the Company, held by other persons or entities. -7- 8 (t) No labor dispute with the employees of the Company or any Subsidiary exists, is threatened or to the best of the Company's knowledge, is imminent that could result in a material adverse change in the condition (financial or otherwise), business prospects, net worth or results of operations of the Company or any Subsidiary, except as described in or contemplated by the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus). (u) The Company and each Subsidiary is insured by insurers of recognized financial responsibility against such losses and risks and in such amounts as are prudent and customary in the businesses in which it is engaged; neither the Company nor any Subsidiary has been refused any insurance coverage sought or applied for; and the Company has no reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business at a cost that would not materially and adversely affect the condition (financial or otherwise), business prospects, net worth or results of operations of the Company or any Subsidiary, except as described in or contemplated by the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus). (v) The Representative's Warrants will conform to the description thereof in the Registration Statement and in the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus) and, when sold to and paid for by the Representative in accordance with the Representative's Warrant Agreement, will have been duly authorized and validly issued and will constitute valid and binding obligations of the Company entitled to the benefits of the Representative's Warrant Agreement. The Warrant Shares (as hereinafter defined) have been duly authorized and reserved for issuance upon exercise of the Representative's Warrants by all necessary corporate action on the part of the Company and, when issued upon such exercise in accordance with the terms of the Representative's Warrant Agreement at the price therein provided, will be validly issued, fully paid, nonassessable and free of preemptive rights and will conform to the description thereof in the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus). (w) No person has acted as a finder in connection with the transactions contemplated herein and the Company will indemnify the several Underwriters with respect to any claim for finder's fees in connection herewith. Except as set forth in the Registration Statement and the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus), the Company has no management or financial consulting agreement with anyone. No promoter, officer, director or stockholder of the Company is, directly or indirectly, associated with an NASD member. (x) The Company has obtained and currently maintains "key-man" term insurance in the amount of $1,000,000 on the life of Dan C. Tutcher. -8- 9 2. Purchase, Sale and Delivery of the Securities and the Warrant Securities. (a) On the basis of the representations, warranties, agreements and covenants herein contained and subject to the terms and conditions herein set forth, the Company agrees to issue and sell to the Underwriters, and the Underwriters agree to purchase from the Company, in the amounts determined in the following sentence, 1,000,000 shares at a purchase price of $____ per share, net of an underwriting discount of 10%. The obligations of the Underwriters under this agreement are several and not joint. (b) One or more certificates in definitive form for the Firm Securities that the several Underwriters have agreed to purchase hereunder, and in such denomination or denominations and registered in such name or names as the Representative requests upon notice to the Company at least 48 hours prior to the Firm Closing Date, shall be delivered by or on behalf of the Company to the Representative for the respective accounts of the Underwriters, against payment by or on behalf of the Underwriters of the purchase price therefor by certified or official bank check or checks drawn upon or by a New York Clearing House bank and payable in next-day funds to the order of the Company, such payment to be made net of all amounts owed to the Representative under the terms of this Agreement upon such date of payment including, without limitation, the underwriting discount, net non-accountable expenses and the additional amounts owed under Section 5 of this Agreement. Such delivery of and payment for the Firm Securities shall be made at the offices of Coleman and Company Securities, Inc. ("Coleman"), 666 Fifth Avenue, New York, New York at 9:30 A.M., New York time, on ________ __, 1996, or at such other place, time or date as the Representative and the Company may agree upon or as the Representative may determine pursuant to section 8 hereof, if applicable, such time and date of delivery against payment being herein referred to as the "Firm Closing Date." The Company will make such certificate or certificates for the Firm Securities available for checking and packaging by the Representative, at the Representative's option, at the offices in New York, New York of the Company's transfer agent or registrar or Coleman's offices at least 24 hours prior to the Firm Closing Date. (c) For the purpose of covering any over-allotments in connection with the distribution and sale of the Firm Securities as contemplated by the Prospectus, the Company hereby grants to the several Underwriters an option to purchase, severally and not jointly, any or all of the Option Securities. The purchase price to be paid for any Option Securities shall be the same price per share as the price per share for the Firm Securities set forth above in paragraph (a) of this section 2 less a 1-3/4 non-accountable expense allowance and the applicable underwriting discount. The option granted hereby may be exercised as to all or any part of the Option Securities from time to time within 30 days after the date of the Prospectus. The Underwriters shall not be under any obligation to purchase any of the Option Securities prior to the exercise of such option. The Representative, on behalf of the Underwriters, may from time to time exercise the option granted hereby by giving notice in writing or by telephone (confirmed in writing) to the Company setting forth the aggregate number of Option Securities as to which -9- 10 the several Underwriters are then exercising the option and the date and time for delivery of and payment for such Option Securities. Any such date of delivery shall be determined by the Representative but shall not be earlier than two business days or later than seven business days after such exercise of the option and, in any event, shall not be earlier than the Firm Closing Date. The time and date set forth in such notice, or such other time on such other date as the Representative and the Company may agree upon or as the Representative may determine pursuant to section 7 hereof, is herein called the "Option Closing Date" with respect to such Option Securities. Upon exercise of the option as provided herein, the Company shall become obligated to sell to each of the several Underwriters, and, subject to the terms and conditions herein set forth, each of the Underwriters (severally and not jointly) shall become obligated to purchase from the Company, the same percentage of the total number of the Option Securities as to which the several Underwriters are then exercising the option as such Underwriter is obligated to purchase of the aggregate number of Firm Securities, as adjusted by the Representative in such manner as it deems advisable to avoid fractional shares. If the option is exercised as to all or any portion of the Option Securities, one or more certificates in definitive form for such Option Securities, and payment therefor, shall be delivered on the related Option Closing Date in the manner, and upon the terms and conditions, set forth in paragraph (b) of this section 2, except that reference therein to the Firm Securities and the Firm Closing Date shall be deemed, for purposes of this paragraph (c), to refer to such Option Securities and Option Closing Date, respectively. (d) It is understood that you, individually and not as the Representative, may (but shall not be obligated to) make payment on behalf of any Underwriter or Underwriters for any of the Securities to be purchased by such Underwriter or Underwriters. No such payment shall relieve such Underwriter or Underwriters from any of its or their obligations hereunder. (e) On the Firm Closing Date, the Company will further issue and sell to the Representative, and at the direction of the Representative, to any co-managing underwriter, or, at the direction of the Representative, to bona fide officers of the Representative, for a purchase price of $.001 per warrant, warrants to purchase Common Stock ("Representative's Warrants") entitling the holders thereof to purchase a number of shares of Common Stock equal to 10% of the Firm Securities for a period of three and one-half years, such period to commence 18 months after the effective date of the Registration Statement. The Representative's Warrants shall be exercisable at a price equal to 120% of the initial public offering price per share and shall contain terms and provisions more fully described herein below and as set forth more particularly in the warrant agreement relating to the Representative's Warrants executed by the Company on the date hereof (the "Representative's Warrant Agreement") including, but not limited to, the usual provisions protecting the holders against dilution. As provided in the Representative's Warrant Agreement, the Representative may designate that the Representative's Warrants be issued in varying amounts directly to bona fide officers of the Representative. As further provided, no sale, transfer, assignment, pledge or hypothecation of the Representative's Warrants shall be made for a period of 12 months from the -10- 11 effective date of the Registration Statement, except (i) by operation of law or reorganization of the Company, or (ii) to the Representative and bona fide officers of the Representative. The shares of Common Stock issuable upon exercise of the Representative's Warrants are referred to herein as the "Warrant Shares" and the Representative's Warrants and the Warrant Shares are collectively referred to herein as "Warrant Securities". 3. Offering by the Underwriters. Upon the Representative's authorization of the release of the Firm Securities, the several Underwriters propose to offer the Firm Securities for sale to the public upon the terms set forth in the Prospectus. 4. Covenants of the Company. The Company covenants and agrees with the Underwriters that: (a) The Company will use its best efforts to cause the Registration Statement, if not effective at the time of execution of this agreement, and any amendments thereto to become effective as promptly as possible. If required, the Company will file the Prospectus and any amendment or supplement thereto with the Commission in the manner and within the time period required by Rule 424(b) under the Act. During any time when a prospectus relating to the Securities is required to be delivered under the Act, the Company (i) will comply with all requirements imposed upon it by the Act and the rules and regulations of the Commission thereunder to the extent necessary to permit the continuance of sales of or dealings in the Securities in accordance with the provisions hereof and of the Prospectus, as then amended or supplemented, and (ii) will not file with the Commission the prospectus or any amendment referred to in the first sentence of section 1(a) hereof, any amendment or supplement to such prospectus or any amendment to the Registration Statement of which the Representative shall not previously have been advised and furnished with a copy for a reasonable period of time prior to the proposed filing and as to which filing the Representative shall not have given their consent. The Company will prepare and file with the Commission, in accordance with the rules and regulations of the Commission, promptly upon request by the Representative or counsel to the Underwriters, any amendments to the Registration Statement or amendments or supplements to the Prospectus that may be necessary or advisable in connection with the distribution of the Securities by the several Underwriters, and will use its best efforts to cause any such amendment to the Registration Statement to be declared effective by the Commission as promptly as possible. The Company will advise the Representative, promptly after receiving notice thereof, of the time when the Registration Statement or any amendment thereto has been filed or declared effective or the Prospectus or any amendment or supplement thereto has been filed and will provide evidence satisfactory to the Representative of each such filing or effectiveness. (b) The Company will advise the Representative, promptly after receiving notice or obtaining knowledge thereof, of (i) the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or any post-effective amendment thereto or any order preventing or suspending the use of any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, (ii) the suspension of the qualification -11- 12 of the Securities for offering or sale in any jurisdiction, (iii) the institution, threatening or contemplation of any proceeding for any such purpose or (iv) any request made by the Commission for amending the Registration Statement, for amending or supplementing the Prospectus or for additional information. The Company will use its best efforts to prevent the issuance of any such stop order and, if any such stop order is issued, to obtain the withdrawal thereof as promptly as possible. (c) The Company will, in cooperation with counsel to the Underwriters, arrange for the qualification of the Securities for offering and sale under the securities or blue sky laws of such jurisdictions as the Representative may designate and will continue such qualifications in effect for as long as may be necessary to complete the distribution of the Securities. (d) If, at any time when a prospectus relating to the Securities is required to be delivered under the Act, any event occurs as a result of which the Prospectus, as then amended or supplemented, would include any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if for any other reason it is necessary at any time to amend or supplement the Prospectus to comply with the Act or the rules or regulations of the Commission thereunder, the Company will promptly notify the Representative thereof and, subject to section 4(a) hereof, will prepare and file with the Commission, at the Company's expense, an amendment to the Registration Statement or an amendment or supplement to the Prospectus that corrects such statement or omission or effects such compliance. (e) The Company will, without charge, provide (i) to the Representative and to counsel to the Underwriters as many signed copies of the registration statement originally filed with respect to the Securities and each amendment thereto (in each case including exhibits thereto) as the Representative may reasonably request, (ii) to each Underwriter, as many conformed copies of such registration statement and each amendment thereto (in each case without exhibits thereto) as the Representative may reasonably request and (iii) so long as a prospectus relating to the Securities is required to be delivered under the Act, as many copies of each Preliminary Prospectus or the Prospectus or any amendment or supplement thereto as the Representative may reasonably request. The Company will timely file, and will provide or cause to be provided to the Representative and counsel to the Underwriters, and to each Underwriter that so requests in writing, a copy of the report on Form SR required to be filed by the Company pursuant to Rule 463 under the Act. (f) The Company, as soon as practicable, will make generally available to its security holders and to the Representative an earnings statement of the Company that satisfies the provisions of section 11(a) of the Act and Rule 158 thereunder. -12- 13 (g) The Company will apply the net proceeds from the sale of the Securities as set forth under "Use of Proceeds" in the Prospectus. (h) The Company will not, without the prior written consent of the Representative, covenant to restrict its ability to issue any new securities (other than debt securities) publicly or privately, which includes any security convertible into equity or conventional equity securities for a period of 18 months after the effective date of the Registration Statement. In addition, the Company will not, without the prior written consent of the Representative, directly or indirectly offer, sell, grant any option to purchase or otherwise dispose (or announce any offer, sale, grant of any option to purchase or other disposition) of any shares of Common Stock or any securities convertible into, or exchangeable or exercisable for, shares of Common Stock for a period of 18 months after the effective date of the Registration Statement, except (i) shares of Common Stock issued pursuant to this agreement, (ii) shares of Common Stock issued upon the exercise of the Representative's Warrants, (iii) shares of Common Stock issued upon the exercise of options and warrants referred to on Schedule 4(h) hereto, and (iv) shares of Common Stock issued as consideration for the acquisition of assets, provided, however, that such shares shall be restricted shares which shall bear legends to such effect in a form that is acceptable to the Representative. (i) If, at the time that the Registration Statement becomes effective, any information shall have been omitted therefrom in reliance upon Rule 430A under the Act, then immediately following the execution of this agreement, the Company will prepare, and file or transmit for filing with the Commission in accordance with such Rule 430A and Rule 424(b) under the Act, copies of the Prospectus including the information omitted in reliance on Rule 430A, or, if required by such Rule 430A, a post-effective amendment to the Registration Statement (including an amended Prospectus), containing all information so omitted. (j) The Company will file with The Nasdaq Stock Market Inc. ("Nasdaq") all documents and notices that are required by Nasdaq, respectively, of companies with securities that are traded on the Nasdaq National Market System. The Company will cause the Securities to be included in the Nasdaq National Market System on the effective date of the Registration Statement and to maintain such listing thereafter. (k) During the period of five years from the Firm Closing Date, the Company will, as promptly as possible, (i) not to exceed 90 days, after each annual fiscal period render and distribute reports to its stockholders which will include audited statements of its operations and changes of financial position during such period and its audited balance sheet as of the end of such period, as to which statements the Company's independent certified public accountants shall have rendered an opinion and (ii) not to exceed 45 days, after each of the first three quarterly fiscal periods render and distribute reports to its stockholders which will include unaudited statements of its operations and changes in financial position during such period and its unaudited balance sheet as of the end of such period. -13- 14 (l) During a period of three years commencing with the Firm Closing Date, the Company will furnish to the Representative, at the Company's expense, copies of all periodic and special reports furnished to stockholders of the Company, all information, documents and reports filed with the Commission and, within a reasonable amount of time prior to its release, any press release. (m) Prior to the Firm Closing Date, the Company will deliver to the Representative a reasonably detailed budget covering the period from the Firm Closing Date to the end of the Company's first fiscal year following the Firm Closing Date. In addition, during the next succeeding two fiscal years, the Company will supply the Representative, not less than 30 days after the beginning of each fiscal year, with a budget for such fiscal year. For each period covered by a budget to be supplied to the Representative, the Company will also supply financial statements prepared in sufficient detail so as to allow comparison to the budgets. (n) For a period of three years after the effective date of the Registration Statement, the Company will continue to retain Hein + Associates LLP, or other independent certified public accountants reasonably satisfactory to the Representative. (o) The Company has appointed Key Corp Shareholders Services, Inc. as transfer agent for the Common Stock. The Company will not change or terminate such appointment for a period of three years from the Firm Closing Date without first obtaining the written consent of the Representative. For a period of five years after the Firm Closing Date, the Company shall cause the transfer agent to delivery promptly to the Representative a duplicate copy of the daily transfer sheets relating to trading of the Shares. (p) The Company has registered the class of equity securities which constitutes the Common Stock by filing with the Securities and Exchange Commission under the Securities Exchange Act of 1934. (q) During the period of 180 days after the date of this agreement, the Company will not at any time, directly or indirectly, take any action designed to or that will constitute, or that might reasonably be expected to cause or result in, the stabilization of the price of the Common Stock to facilitate the sale or resale of any of the Securities. (r) For a period of three years following the Firm Closing Date, the Company will permit a representative of Coleman and Company Securities, Inc. ("Coleman") (which Coleman hereby designates as Stanley L. Bartels) to observe the meetings of the Company's board of directors and shall provide to such representative, at the same time provided to such board member, all notices, documents, information and other materials generally provided to other board members. The Company will reimburse that advisor directly for all expenses incurred in attending board meetings, including but not limited to food, transportation and lodging, and shall pay that advisor $2,000.00 per meeting attended. During that three-year period, the Company will hold no less than four formal and "in person" meetings of its board of -14- 15 directors each year at which meetings, and all other meetings of the board of directors during such time period, the advisor will be invited to attend and minutes shall be taken, a copy of which shall be furnished to the advisor. (s) The Company will not take any action to facilitate the sale of any shares of Common Stock pursuant to Rule 144 under the Act if any such sale would violate any of the terms of the Lock-up Agreements executed by the officers, directors, affiliates and stockholders of the Company. (t) For a period of three years from the Firm Closing Date, the Company will maintain "key-man" term life insurance on the life of Dan C. Tutcher in an amount of not less than $1 million. (u) Prior to the 90th day after the Firm Closing Date, the Company will provide the Representative and its designees with five sets of bound volumes of the transaction documents relating to the Registration Statement and the closing(s) hereunder, in form and substance reasonably satisfactory to the Representative. (v) The Company will declare an initial dividend of $0.08 per share, payable 90 days after the effective date of the Registration Statement. The Company agrees that future dividends will be paid each quarter, dependent on the earnings of the Company and available cash, and subject to compliance with applicable law. The Company agrees that it will be its stated policy to pay a quarterly dividend and the Company will accommodate its growth program to allow for a return to all shareholders of the Company. (w) Commencing upon the Firm Closing Date, the Company will retain the Representative in an investment banking advisory capacity and the Company agrees to pay the Representative as consideration for such advisory services a monthly fee of $3,000, plus pre-approved disbursements, for a period of 24 months commencing upon the Firm Closing Date. (x) For a period of 3 years commencing upon the Firm Closing Date, the Company agrees to retain the Representative, in a non-exclusive capacity, for mergers and acquisitions introduced or arranged by the Representative. Upon the consummation of any such transactions, the Representative shall be compensated on the basis of the "Lehman Formula." 5. Expenses. (a) The Company shall pay all costs and expenses incident to the performance of its obligations under this agreement, whether or not the transactions contemplated hereby are consummated or this agreement is terminated pursuant to section 10 hereof, including all costs and expenses incident to (i) the preparation, printing and filing or other production of documents with respect to the transactions, including any costs of printing the registration statement originally filed with respect to the Securities and any amendment thereto, any -15- 16 Preliminary Prospectus and the Prospectus and any amendment or supplement thereto, this agreement, the master agreement among underwriters, the selected dealer agreement and the other agreements and documents governing the underwriting arrangements and any blue sky memoranda, (ii) all reasonable and necessary arrangements relating to the delivery to the Underwriters of copies of the foregoing documents, (iii) the fees and disbursements of the counsel, the accountants, a consultant to the Representative (not to exceed $15,000), and any other experts or advisors retained by the Company, (iv) the preparation, issuance and delivery to the Underwriters of any certificates evidencing the Securities, including transfer agent's and registrar's fees or any transfer or other taxes payable thereon, (v) the qualification of the Securities under state securities and blue sky laws, including filing fees and fees and disbursements of counsel for the Underwriters relating thereto (such counsel fees not to exceed $30,000, $10,000 of which was paid prior to the execution of this agreement) and any fees and disbursements of local counsel, if any, retained for such purpose, (vi) the filing fees of the Commission and the NASD relating to the Securities, (vii) the inclusion of the Securities on the Nasdaq National Market System (including fees and disbursements of counsel for the Underwriters, which the Company has authorized to provide certain services in this regard, relating thereto subject to the maximum amount set forth above) and, if requested by the Representative, in the Standard and Poor's Corporation Descriptions Manual, (viii) all "road show" expenses, including travel and lodging expenses, of the Representative and its designees and (ix) the placing of "tombstone advertisements" in publications selected by the Representative and the manufacture of prospectus memorabilia. In addition to the foregoing, the Company shall reimburse the Representative for its expenses on the basis of a non- accountable expense allowance in the amount of 1-3/4% of the gross offering proceeds to be received by the Company, $35,000 of which has been paid by the Company to the Representative. The Representative hereby acknowledges receipt of such $35,000, which shall be credited against the non-accountable expense allowance to be paid by the Company. The unpaid portion of the expense allowance, based on the gross proceeds from the sale of the Firm Securities, shall be deducted from the funds to be paid by the Representative in payment for the Firm Securities, pursuant to section 2 of this agreement, on the Firm Closing Date. To the extent any Option Securities are sold, the non-accountable expense allowance based on the gross proceeds from the sale of the Option Securities shall be deducted from the funds to be paid by the Representative in payment for the Option Securities, pursuant to section 2 of this agreement, on the Option Closing Date. The Company warrants, represents and agrees that all such payments and reimbursements will be promptly and fully made. (b) Notwithstanding any other provision of this agreement, if the Company determines not to proceed with the offering of the Securities contemplated hereby for any reason, or the Representative elects to terminate this agreement pursuant to section 10 hereof, the Company agrees that, in addition to the Company paying its own expenses as described in subparagraph (a) above, (i) the Company shall reimburse the Representative for all of its out-of-pocket legal expenses (in addition to blue sky legal fees and expenses referred to in subparagraph (a) above), and (ii) the Representative shall be entitled to retain the non-accountable expense allowance paid by the Company pursuant to subparagraph (a) above; provided, however, that the amount retained pursuant to this clause (ii) shall not exceed the Representative's expenses on an -16- 17 accountable basis to the date of such cancellation. Such expenses shall include, but are not to be limited to, fees for the services and time of Underwriters' counsel to the extent not covered by clause (i) above, plus any additional expenses and fees, including, but not limited to, travel expenses, postage expenses, duplication expenses, long-distance telephone expenses, and other expenses incurred by the Representative in connection with the proposed offering. If the Company shall fail to pay any portion of the expense allowance set forth herein within five (5) days of receipt of a written request therefor, the Company shall be liable to the Representative for attorneys' fees and costs incurred in the collection of said amount. 6. Conditions of the Underwriters' Obligations. The obligations of the several Underwriters to purchase and pay for the Firm Securities shall be subject to the accuracy of the representations and warranties of the Company contained herein as of the date hereof and as of the Firm Closing Date as if made on and as of the Firm Closing Date, to the accuracy of the statements of the Company's officers made pursuant to the provisions hereof, to the performance by the Company of its covenants and agreements hereunder and to the following additional conditions: (a) If the Registration Statement or any amendment thereto filed prior to the Firm Closing Date has not been declared effective as of the time of execution hereof, the Registration Statement or such amendment shall have been declared effective not later than 11 A.M., New York time, on the date on which the amendment to the registration statement originally filed with respect to the Securities or to the Registration Statement, as the case may be, containing information regarding the initial public offering price of the Securities has been filed with the Commission, or such later time and date as shall have been consented to by the Representative; if required, the Prospectus and any amendment or supplement thereto shall have been filed with the Commission in the manner and within the time period required by Rule 424(b) under the Act; no stop order suspending the effectiveness of the Registration Statement or any amendment thereto shall have been issued, and no proceedings for that purpose shall have been instituted or threatened or, to the knowledge of the Company or the Representative, shall be contemplated by the Commission; and the Company shall have complied with any request of the Commission for additional information (to be included in the Registration Statement or the Prospectus or otherwise). (b) The Underwriters shall have received an opinion, dated the Firm Closing Date, of Porter & Hedges, L.L.P., counsel to the Company, to the effect that: (1) the Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of the state of Nevada and is duly qualified to transact business as a foreign corporation and is in good standing under the laws of each other jurisdiction in which its ownership or leasing of any properties or the conduct of its business requires such qualification, and each Subsidiary has been duly incorporated or organized, as the case may be, and is validly existing and in good standing under the laws of its jurisdiction of incorporation or organization, as the case may be, and is in good standing under the laws of each -17- 18 jurisdiction in which its ownership or leasing of any properties or the conduct of its business requires such qualification. (2) the Company and each Subsidiary has full corporate power and authority to own or lease its property and conduct its business as now being conducted and as proposed to be conducted, in each case as described in the Registration Statement and the Prospectus, and the Company has full corporate power and authority to enter into this agreement and the Representative's Warrant Agreement and to carry out all the terms and provisions hereof and thereof to be carried out by it; (3) there are no outstanding options, warrants or other rights granted by the Company to purchase shares of its Common Stock or other securities other than as described in the Prospectus; the Securities have been duly authorized by all necessary corporate action on the part of the Company and, when issued and delivered to and paid for by the Underwriters pursuant to this agreement, will be validly issued, fully paid, nonassessable and free of preemptive rights and will conform to the description thereof in the Prospectus; and, no person or entity is entitled to have securities registered by the Company under the Registration Statement or otherwise under the Act other than as described in the Prospectus; the outstanding shares of Common Stock of the Company have not been issued in violation of the preemptive rights of any shareholder and the Shareholders of the Company do not have any preemptive rights or other rights to subscribe for or to purchase other than those that have been effectively waived or satisfied, nor are there any restrictions upon the voting or transfer of any of the Common Stock except as disclosed in the Prospectus; all prior sales by the Company of the Company's securities have been made in compliance with or under an exemption from registration under the Act and applicable state securities laws and no shareholders of the Company have any rescission rights with respect to Company securities other than those that have been effectively waived or satisfied. (4) the Securities have been approved for inclusion in the Nasdaq National Market System; (5) the execution and delivery of this agreement and the Representative's Warrant Agreement have been duly authorized by all necessary corporate action on the part of the Company and this agreement and the Representative's Warrant Agreement each have been duly executed and delivered by the Company, and each is a valid and binding agreement of the Company, enforceable against the Company in accordance with its respective terms, except as enforceability may be limited by bankruptcy, insolvency, reorganization, fraudulent conveyance, moratorium and other similar laws affecting creditors' rights generally and to general principles of equity (regardless of whether enforcement is considered in a proceeding in equity or at law) and except as rights to indemnity and contribution under this agreement and the Representative's Warrant Agreement may be limited by applicable law; (6) the Representative's Warrants conform to the description thereof in the Registration Statement and in the Prospectus and are duly authorized and validly -18- 19 issued and constitute valid and binding obligations of the Company entitled to the benefits of the Representative's Warrant Agreement; the Warrant Shares have been duly and validly authorized and reserved for issuance upon exercise of the Representative's Warrants and, when issued upon exercise in accordance with the terms of, and for the consideration set forth in, the Representative's Warrant Agreement, will be duly and validly issued, fully paid and nonassessable and free of preemptive rights; (7) the statements set forth under the heading "Description of Securities" in the Prospectus, insofar as those statements purport to summarize the terms of the capital stock and warrants of the Company, provide a fair summary of such terms; the statements set forth under the headings "Prospectus Summary," "Risk Factors," "Dividend Policy," "Business," "Management" and "Shares Eligible for Future Sale" in the Prospectus, insofar as those statements constitute matters of law or legal conclusions, or summaries of the contracts and agreements referred to therein, constitute a fair summary of those matters, or contracts and agreements and include all material terms thereof, as applicable; (8) none of (A) the execution and delivery of this agreement and the Representative's Warrant Agreement, (B) the issuance, offering and sale by the Company of the Securities to the Underwriters pursuant to this agreement and the Representative's Warrants to the Representative pursuant to the Representative's Warrant Agreement, nor (C) the compliance by the Company with the other provisions of this agreement and the Representative's Warrant Agreement and the consummation of the other transactions contemplated hereby and thereby, (1) requires the consent, approval, authorization, registration or qualification of or with any court or governmental authority, except such as have been obtained and such as may be required under state securities or blue sky laws, or (2) conflicts with or results in a breach or violation of, or constitutes a default under any contract, indenture, mortgage, deed of trust, loan agreement, note, lease or other agreement or instrument to which the Company or any Subsidiary is a party or by which the Company or any Subsidiary or any of its property is bound or subject of which such counsel is aware after reasonable inquiry, or the certificate of incorporation or by-laws of the Company, or any material statute or any judgment, decree, order, rule or regulation of any court or other governmental or regulatory authority applicable to the Company or any Subsidiary; (9) No legal or governmental proceedings are pending to (A) which the Company is a party or to which the property of the Company is subject other than as disclosed in the Prospectus and (B) no contract or other document is required to be described in the Registration Statement or the Prospectus or to be filed as an exhibit to the Registration Statement that is not described therein or filed as required; (10) The Company and each Subsidiary possesses adequate licenses, orders, authorizations, approvals, certificates or permits issued by the appropriate federal, state or foreign regulatory agencies or bodies necessary to conduct its business as described in the Registration Statement and the Prospectus, and, to the best of such counsel's knowledge after due inquiry, there are no pending or threatened proceedings relating to the -19- 20 revocation or modification of any such license, order, authorization, approval, certificate or permit, except as disclosed in the Registration Statement and the Prospectus. (11) the Registration Statement is effective under the Act; any required filing of the Prospectus pursuant to Rule 424(b) has been made in the manner and within the time period required by Rule 424(b); and no stop order suspending the effectiveness of the Registration Statement or any amendment thereto has been issued, and no proceedings for that purpose have been instituted or threatened or, to the best knowledge of such counsel after due inquiry, are contemplated by the Commission; (12) the Registration Statement originally filed with respect to the Securities and each amendment thereto and the Prospectus (in each case, other than all references to the financial statements and other financial and statistical information contained therein, as to which such counsel need express no opinion) comply as to form in all material respects with the applicable requirements of the Act and the rules and regulations of the Commission thereunder; and (13) the Company is not subject to registration as an "investment company" under the Investment Company Act of 1940. (14) The Company and each Subsidiary possesses all licenses, orders, authorizations, approvals, certificates or permits issued by the appropriate state, federal or foreign regulatory agencies or bodies necessary to conduct its business as described in the Registration Statement and the Prospectus (or if the Prospectus is not in existence, the most recent Preliminary Prospectus), and there are no pending or, to the best knowledge of the Company, threatened, proceedings relating to the revocation or modification of any such license, order, authorization, approval, certificate or permit. (15) The Company and each subsidiary has good and marketable title to all of the properties and assets reflected in its financial statements or as described in the Registration Statement and the Prospectus (or if the Prospectus is not in existence, the most recent Preliminary Prospectus) subject to no lien, mortgage, pledge, charge or encumbrance of any kind, except those reflected in such financial statements or as described in the Registration Statement and the Prospectus (or such Preliminary Prospectus). The Company occupies its leased properties under valid and enforceable leases conforming to the description thereof set forth in the Registration Statement and the Prospectus (or such Preliminary Prospectus). Such Counsel has no knowledge of any challenge to the underlying fee title of any lease, easement, right-of-way or license held by the Company or any Subsidiary or to the title of the Company or any Subsidiary to any lease, easement right-of-way, permit or lease. Such counsel shall also state that nothing has come to such counsel's attention that has caused them to believe that the Registration Statement, at the time it became effective (including the information deemed to be a part of the Registration Statement at the time of -20- 21 effectiveness pursuant to Rule 430A(b), if applicable), contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading or that the Prospectus, as of its date or as of the Firm Closing Date, contained an untrue statement of material fact or omitted to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. In rendering any such opinion, such counsel may rely, as to matters of fact, to the extent such counsel deems proper, on certificates of responsible officers of the Company and public officials, copies of which certificates will be provided to counsel to the Underwriters. Any such opinion shall expressly permit the reliance thereon by Parker Chapin Flattau & Klimpl, LLP counsel to the Underwriters, in rendering its opinions pursuant to section 6(i). References to the Registration Statement and the Prospectus in this paragraph (b) shall include any amendment or supplement thereto at the date of such opinion. (c) The Underwriters shall have received from Hein Associates LLP, a letter dated the date the Registration Statement is declared effective and the Firm Closing Date, in form and substance satisfactory to the Representative, to the effect that (i) they are independent public accountants with respect to the Company within the meaning of the Act and the applicable rules and regulations thereunder; (ii) in their opinion, the financial statements examined by them and included in the Registration Statement and the Prospectus comply as to form in all material respects with the applicable accounting requirements of the Act and the applicable rules and regulations thereunder; (iii) based upon procedures set forth in detail in such letter, nothing has come to their attention which causes them to believe that (A) the financial information set forth under "Selected Financial Data" in the Prospectus was not determined on a basis substantially consistent with that used in determining the corresponding amounts in the financial statements included in the Registration Statement or (B) at a specified date not more than five days prior to the date of this agreement, there has been any change in the capital stock of the Company or any increase in the long- term debt of the Company or any decrease in working capital or net assets as compared with the amounts shown in the ____ __, 199_ balance sheet included in the Registration Statement or, during the period from ____ __, 199_ to a specified date not more than five days prior to the date of this agreement, there were any decreases, as compared with the corresponding period in the preceding quarter, in revenues, or any increase in certain specified expense items of the Company, except in all instances for changes, increases or decreases which the Registration Statement and the Prospectus disclose have occurred or may occur; and (iv) in addition to the examination referred to in their opinions and the limited procedures referred to in clause (iii) above, they have carried out certain specified procedures, not constituting an audit, with respect to certain amounts, percentages and financial information which are included in the Registration Statement and Prospectus and which are specified by the Underwriters, and have found such amounts, percentages and financial information to be in agreement with the relevant accounting, financial and other records of the Company identified in such letter. -21- 22 References to the Registration Statement and the Prospectus in this paragraph (c) with respect to the letter referred to above shall include any amendment or supplement thereto at the date of such letter. (d) The representations and warranties of the Company contained in this agreement shall be true and correct as if made on and as of the Firm Closing Date; the Registration Statement, as amended as of the Firm Closing Date, shall not include any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein not misleading, and the Prospectus, as amended or supplemented as of the Firm Closing Date, shall not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; and the Company shall have performed all covenants and agreements and satisfied all conditions on its part to be performed or satisfied at or prior to the Firm Closing Date. (e) No stop order suspending the effectiveness of the Registration Statement or any amendment thereto shall have been issued, and no proceedings for that purpose shall have been instituted or threatened or contemplated by the Commission. (f) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, there shall not have been any material adverse change, or any development involving a prospective material adverse change, in the business, operations, condition (financial or otherwise), earnings or prospects of the Company, except in each case as described in or contemplated by the Prospectus (exclusive of any amendment or supplement thereto). (g) The Representative shall have received a certificate, dated the Firm Closing Date, of the Chief Executive Officer and Secretary of the Company to the effect set forth in subparagraphs (d) through (f) above. (h) The Common Stock shall be qualified in such states as the Representative may reasonably request pursuant to section 4(c), and each such qualification shall be in effect and not subject to any stop order or other proceeding on the Firm Closing Date. (i) The Company shall have executed and delivered to the Representative the Representative's Warrant Agreement and a certificate or certificates evidencing the Representative's Warrants, in each case in a form deemed acceptable by the Representative. (j) On or before the Firm Closing Date, the Underwriters and counsel for the Underwriters shall have received such further certificates, documents or other information as they may have reasonably requested from the Company. -22- 23 (k) all relevant terms, conditions and circumstances relating to the proposed pubic offering shall be reasonably satisfactory to the Representative. All opinions, certificates, letters and documents delivered pursuant to this agreement will comply with the provisions hereof only if they are reasonably satisfactory in all material respects to the Representative and counsel for the Underwriters. The Company shall furnish to the Representative such conformed copies of such opinions, certificates, letters and documents in such quantities as the Representative and counsel for the Underwriters shall reasonably request. The respective obligations of the several Underwriters to purchase and pay for any Option Securities shall be subject, in their discretion, to each of the foregoing conditions to purchase the Firm Securities, except that all references to the Firm Securities and the Firm Closing Date shall be deemed to refer to such Option Securities and the related Option Closing Date, respectively. 7. Indemnification and Contribution. (a) The Company agrees to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of section 15 of the Act or section 20 of the Securities Exchange Act of 1934 (the "Exchange Act"), against any losses, claims, damages, amounts paid in settlement or liabilities, joint or several, to which such Underwriter or such controlling person may become subject under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon: (1) any breach of any representation or warranty of the Company contained in section 1 of this agreement, (2) any untrue statement or alleged untrue statement of any material fact contained in (A) the registration statement originally filed with respect to the Securities or any amendment thereto, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto or (B) any application or other document, or any amendment or supplement thereto, executed by the Company or based upon written information furnished by or on behalf of the Company filed in any jurisdiction in order to qualify the Securities under the securities or blue sky laws thereof or filed with the Commission or any securities association or securities exchange (each an "Application"), or (3) the omission or alleged omission to state in such registration statement or any amendment thereto, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, or any Application a material fact required to be stated therein or necessary to make the statements therein not misleading, -23- 24 and will reimburse, as incurred, each Underwriter and each such controlling person for any legal or other expenses reasonably incurred by such Underwriter or such controlling person in connection with investigating, defending against or appearing as a third-party witness in connection with any loss, claim, damage, liability, action, investigation, litigation or proceeding; provided, however, that the Company will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in such registration statement or any amendment thereto, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto or any Application in reliance upon and in conformity with written information furnished to the Company by any Underwriter through the Representative specifically for use therein. This indemnity agreement will be in addition to any liability which the Company may otherwise have. The Company will not, without the prior written consent of the Representative, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action, suit or proceeding in respect of which indemnification may be sought hereunder (whether or not any Underwriter or any person who controls any Underwriter within the meaning of section 15 of the Act or section 20 of the Exchange Act is a party to such claim, action, suit or proceeding), unless such settlement, compromise or consent includes an unconditional release of each Underwriter and each such controlling person from all liability arising out of such claim, action, suit or proceeding. (b) Each Underwriter will indemnify and hold harmless the Company, each of its directors, each of its officers who signed the Registration Statement and each person, if any, who controls the Company within the meaning of section 15 of the Act or section 20 of the Exchange Act against, any losses, claims, damages or liabilities to which the Company or any such director, officer or controlling person may become subject under the Act or otherwise, but only insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement or any amendment thereto, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, or any Application, or (ii) the omission or the alleged omission to state therein a material fact required to be stated in the Registration Statement or any amendment thereto, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, or any Application, or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company by any Underwriter through the Representative specifically for use therein; and, subject to the limitation set forth immediately preceding this clause, will reimburse, as incurred, any legal or other expenses reasonably incurred by the Company or any such director, officer or controlling person in connection with investigating or defending any such loss, claim, damage, liability or any action in respect thereof. This indemnity agreement will be in addition to any liability which such Underwriter may otherwise have. -24- 25 (c) Promptly after receipt by an indemnified party under this section 7 of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this section 7, notify the indemnifying party of the commencement thereof; but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party otherwise than under this section 7. In case any such action is brought against any indemnified party, and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party; provided, however, that if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be one or more legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, the indemnifying party shall not have the right to direct the defense of such action on behalf of such indemnified party or parties and such indemnified party or parties shall have the right to select separate counsel to defend such action on behalf of such indemnified party or parties. After notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof and approval by such indemnified party of counsel appointed to defend such action, the indemnifying party will not be liable to such indemnified party under this section 7 for any legal or other expenses, other than reasonable costs of investigation, subsequently incurred by such indemnified party in connection with the defense thereof, unless (i) the indemnified party shall have employed separate counsel in accordance with the proviso to the next preceding sentence or (ii) the indemnifying party has authorized the employment of counsel for the indemnified party at the expense of the indemnifying party. After such notice from the indemnifying party to such indemnified party, the indemnifying party will not be liable for the costs and expenses of any settlement of such action effected by such indemnified party without the consent of the indemnifying party. (d) In circumstances in which the indemnity agreement provided for in the preceding paragraphs of this section 7 is unavailable or insufficient to hold harmless an indemnified party in respect of any losses, claims, damages or liabilities (or actions in respect thereof), each indemnifying party, in order to provide for just and equitable contribution, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect (i) the relative benefits received by the indemnifying party or parties on the one hand and the indemnified party on the other from the offering of the Securities or (ii) if the allocation provided by the foregoing clause (i) is not permitted by applicable law, not only such relative benefits but also the relative fault of the indemnifying party or parties on the one hand and the indemnified party on the other in connection with the statements or omissions or alleged statements or omissions that resulted in such losses, claims, damages or liabilities (or actions in respect thereof). The relative benefits received by the Company on the one hand and the Underwriters on the other shall be deemed to be in the same proportion as the total proceeds from the offering (before deducting expenses) received by the Company bear to the total underwriting -25- 26 discounts and commissions received by the Underwriters. The relative fault of the parties shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information, supplied by the Company or the Underwriters, the parties' relative intents, knowledge, access to information and opportunity to correct or prevent such statement or omission, and the other equitable considerations appropriate in the circumstances. The Company and the Underwriters agree that it would not be equitable if the amount of such contribution were determined by pro rata or per capita allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation that does not take into account the equitable considerations referred to in the first sentence of this paragraph (e). Notwithstanding any other provision of this paragraph (e), no Underwriter shall be obligated to make contributions hereunder that in the aggregate exceed the total public offering price of the Securities purchased by such Underwriter under this agreement, less the aggregate amount of any damages that such Underwriter has otherwise been required to pay in respect of the same or any substantially similar claim, and no person guilty of fraudulent misrepresentation (within the meaning of section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations to contribute hereunder are several in proportion to their respective underwriting obligations and not joint, and contributions among Underwriters shall be governed by the provisions of the agreement among underwriters. For purposes of this paragraph (e), each person, if any, who controls an Underwriter within the meaning of section 15 of the Act or section 20 of the Exchange Act shall have the same rights to contribution as such Underwriter, and each director of the Company, each officer of the Company who signed the Registration Statement and each person, if any, who controls the Company within the meaning of section 15 of the Act or section 20 of the Exchange Act, shall have the same rights to contribution as the Company. 8. Default of Underwriters. If one or more Underwriters or selected dealers default in their obligations to purchase Firm Securities or Option Securities hereunder and the aggregate number of such Securities that such defaulting Underwriter, or Underwriters or selected dealers agreed but failed to purchase is ten percent or less of the aggregate number of Firm Securities or Option Securities to be purchased by all of the Underwriters at such time hereunder, the other Underwriters may make arrangements satisfactory to the Representative for the purchase of such Securities by other persons (who may include one or more of the non-defaulting Underwriters, including the Representative), but if no such arrangements are made by the Firm Closing Date or the related Option Closing Date, as the case may be, the other Underwriters shall be obligated severally in proportion to their respective commitments hereunder to purchase the Firm Securities or Option Securities that such defaulting Underwriter or Underwriters or selected dealer agreed but failed to purchase. If one or more Underwriters so default with respect to an aggregate number of Firm Securities or Option Securities that is more than ten percent of the aggregate number of Firm Securities or Option Securities, as the case may be, to be purchased by all of the Underwriters at such time hereunder, the non- defaulting Underwriters shall use all reasonable efforts to procure other underwriters to purchase the Securities the defaulting underwriters or selected dealer agreed but failed to purchase, and if -26- 27 arrangements satisfactory to the Representative are not made within 24 hours, the Company shall have an additional 48 hours to make such arrangements, and if arrangements satisfactory to the Representative are not made within 72 hours after such default for the purchase by other persons (who may include one or more of the non-defaulting Underwriters, including the Representative) of the Securities with respect to which such default occurs, this agreement will terminate without liability on the part of any non-defaulting Underwriter or the Company other than as provided in section 11 hereof. In the event of any default by one or more Underwriters or selected dealers as described in this section 8, the Representative shall have the right to postpone the Firm Closing Date or the Option Closing Date, as the case may be, established as provided in section 2 hereof for not more than seven business days in order that any necessary changes may be made in the arrangements or documents for the purchase and delivery of the Firm Securities or Option Securities, as the case may be. As used in this agreement, the term "Underwriter" includes any person substituted for an Underwriter under this section 8. Nothing herein shall relieve any defaulting Underwriter from liability for its default. 9. Survival. The respective representations, warranties, agreements, covenants, indemnities and other statements of the Company, any of its officers or directors and the several Underwriters set forth in this agreement or made by or on behalf of them, respectively, pursuant to this agreement shall remain in full force and effect, regardless of (i) any investigation made by or on behalf of the Company, any of its officers or directors, any Underwriter or any controlling person referred to in section 7 hereof and (ii) delivery of and payment for the Securities. The respective agreements, covenants, indemnities and other statements set forth in sections 5 and 7 hereof shall remain in full force and effect, regardless of any termination or cancellation of this agreement. 10. Termination. (a) This agreement may be terminated with respect to the Firm Securities or any Option Securities in the sole discretion of the Representative by notice to the Company given prior to the Firm Closing Date or the related Option Closing Date, respectively, in the event that the Company shall have failed, refused or been unable to perform all obligations and satisfy all conditions on its part to be performed or satisfied hereunder at or prior thereto or if at or prior to the Firm Closing Date or such Option Closing Date, respectively, (1) the Company sustains a loss by reason of explosion, fire, flood, accident or other calamity, which, in the reasonable opinion of the Representative, substantially affects the value of the properties of the Company or which materially interferes with the operation of the business of the Company regardless of whether such loss shall have been insured; there shall have been any material adverse change, or any development involving a prospective material adverse change (including, without limitation, a change in management or control of the Company), in the business, operations, condition (financial or otherwise), earnings or prospects of the Company, except in each case as described in or contemplated by the Prospectus (exclusive of any amendment or supplement thereto); or Mr. Dan C. Tutcher shall -27- 28 have suffered any injury or disability of a nature that could materially adversely affect his ability to function as President of the Company for more than six months; (2) any material action, suit or proceeding shall be threatened, instituted or pending, at law or in equity, against the Company or any of its directors or executive officers, by any person or by any federal, state or other governmental or regulatory commission, board or agency; (3) trading in the Common Stock shall have been suspended by the Commission or the NASD or trading in securities generally on the New York Stock Exchange shall have been suspended or minimum or maximum prices shall have been established on either such exchange or quotation system; (4) a banking moratorium shall have been declared by New York or United States authorities; or (5) there shall have been (A) an outbreak of hostilities between the United States and any foreign power (or, in the case of any ongoing hostilities, a material escalation thereof), (B) an outbreak of any other insurrection or armed conflict involving the United States or (C) any other calamity or crisis or material change in financial, political or economic conditions, having an effect on the financial markets that, in any case referred to in this clause (5), any of which of the above events or other market-related events, in the sole judgment of the Representative makes it impracticable or inadvisable to proceed with the public offering or the delivery of the Securities as contemplated by the Registration Statement, as amended as of the date hereof. (b) Termination of this agreement pursuant to this section 10 shall be without liability of any party to any other party except as provided in section 5(b) and section 9 hereof. 11. Information Supplied by Underwriters. The statements set forth in the last paragraph on the front cover page and in paragraphs 1, 2 and 3 under the heading "Underwriting" in any Preliminary Prospectus or the Prospectus (to the extent such statements relate to the Underwriters) constitute the only information furnished by any Underwriter through the Representative to the Company for the purposes of sections 1(b) and 7(b) hereof. The Underwriters confirm that such statements (to such extent) are correct. 12. Notices. All communications hereunder shall be in writing and, if sent to any of the Underwriters, shall be mailed or delivered or telegraphed or faxed to Coleman and Company Securities, Inc., 666 Fifth Avenue, New York, New York 10103, Attention: Corporate Finance Department; and if sent to the Company, shall be mailed, delivered or telegraphed or faxed to the Company at Midcoast Energy Resources, Inc., 1100 Louisiana, Suite 2950, Houston, Texas 77002, Attention: Mr. Dan C. Tutcher. -28- 29 13. Successors. This agreement shall inure to the benefit of and shall be binding upon the several Underwriters, the Company and their respective successors and legal representatives, and nothing expressed or mentioned in this agreement is intended or shall be construed to give any other person any legal or equitable right, remedy or claim under or in respect of this agreement, or any provisions herein contained, this agreement and all conditions and provisions hereof being intended to be and being for the sole and exclusive benefit of such persons and for the benefit of no other person except that (i) the indemnities of the Company contained in section 7 of this agreement shall also be for the benefit of any person or persons who control any Underwriter within the meaning of section 15 of the Act or section 20 of the Exchange Act and (ii) the indemnities of the Underwriters contained in section 7 of this agreement shall also be for the benefit of the directors of the Company, the officers of the Company who have signed the Registration Statement and any person or persons who control the Company within the meaning of section 15 of the Act or section 20 of the Exchange Act. No purchaser of Securities from any Underwriter shall be deemed a successor because of such purchase. 14. Applicable Law. The validity and interpretation of this agreement, and the terms and conditions set forth herein, shall be governed by and construed in accordance with the laws of the state of New York, without giving effect to any provisions relating to conflicts of laws. 15. Counterparts. This agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. If the foregoing correctly sets forth our understanding, please indicate your acceptance thereof in the space provided below for that purpose, whereupon this letter shall constitute an agreement binding the Company and each of the several Underwriters. Very truly yours, MIDCOAST ENERGY RESOURCES, INC. By:_____________________________________ Name: Dan C. Tutcher Title: President -29- 30 The foregoing agreement is hereby confirmed and accepted as of the date first above written. COLEMAN AND COMPANY SECURITIES, INC. As Representative of several underwriters By:___________________________ Name: Stanley L. Bartels Title: Executive Vice-President -30- 31 SCHEDULE A UNDERWRITERS Number of Underwriter Shares ----------- --------- Coleman and Company Securities, Inc. Nolan Securities Corporation --------- TOTAL 1,000,000 --------- -1- 32 SCHEDULE 4(h) OPTIONS AND WARRANTS -2- EX-4.7 3 TERMINATION AGREEMENT DATED 05/13/96 1 EXHIBIT 4.7 TERMINATION AGREEMENT THIS TERMINATION AGREEMENT is entered into on this 13th day of May 1996 by, between and among Midcoast Energy Resources, Inc., a Nevada corporation (the "Company"), and Magic Gas Corp., a Texas corporation, (f/k/a Midcoast Natural Gas, Inc.), Stevens G. Herbst and Kenneth B. Holmes, Jr. (collectively the "Shareholders" and individually, a "Shareholder"), together with all spouses of individual Shareholders designated on signature pages hereto. WITNESSETH: WHEREAS, the Shareholders and the Company are parties to that certain Shareholder Agreement, dated November 16, 1992 between the Shareholders and the Company (the "Shareholder Agreement"); WHEREAS, pursuant to Section VII of the Shareholder Agreement, the Shareholder Agreement shall terminate upon an executed written agreement among the Company and the Shareholders which terminates the Shareholder Agreement; and WHEREAS, the parties hereto desire to terminate the Shareholder Agreement upon the effective date of the public offering of one million shares of the Company's common stock, $.01 par value (the "Offering"). NOW, THEREFORE, for and in consideration of the premises, and the mutual and dependent promises contained herein, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto, intending to be legally bound, hereby agree as follows: The Shareholder Agreement be, and it hereby is, in all respects terminated on the date hereof without further action hereby from the Company or the Shareholders, and the Company and the Shareholders acknowledge and agree that they have no further rights or remedies thereunder. 2 IN WITNESS WHEREOF, this Termination Agreement is executed and delivered on and as of the day first above written. MIDCOAST ENERGY RESOURCES, INC. By: /s/ DAN C. TUTCHER -------------------------------- Dan C. Tutcher, President MAGIC GAS CORP. (f/k/a Midcoast Natural Gas, Inc.) By: /s/ DAN C. TUTCHER -------------------------------- Dan C. Tutcher, President /s/ STEVENS G. HERBST ------------------------------------ Stevens G. Herbst /s/ JUNE HERBST ------------------------------------ June Herbst, Spouse Address: 5018 Cascade Drive Corpus Christi, Texas 78413 /s/ KENNETH B. HOLMES, JR. ------------------------------------ Kenneth B. Holmes, Jr. /s/ DOROTHY C. HOLMES ------------------------------------ Dorothy C. Holmes, Spouse Address: Address: 5201 N.W. Trail Corpus Christi, Texas 78401 /s/ DAN C. TUTCHER ------------------------------------ Dan C. Tutcher /s/ KIMBERLY TUTCHER ------------------------------------ Kimberly Tutcher, Spouse Address: 2207 Twin Oaks Kemah, Texas 77565 2 EX-10.53 4 1ST AMEND. TO THE ASSIGNMENT OF NET REVENUE INT. 1 EXHIBIT 10.53 Amendment #1 to Assignment of Net Revenue Interest This amendment is to modify the terms of the Assignment of Net Revenue Interest in Magnolia Pipeline Corporation ("Magnolia") to Rainbow Investments Company ("Rainbow") dated October 3, 1995 by Midcoast Energy Resources, Inc. ("Midcoast"). It is hereafter mutually agreed that the net revenue interest assigned to Rainbow shall apply only after payout of the purchase price paid by Midcoast for Magnolia. Payout shall be defined as such time as the sum of net revenues derived from the earnings of Magnolia, before deduction of interest, taxes, depreciation, amortization and general and administrative charges, equals $3,200,000. For the purposes of calculating payout, net revenue shall include the gross proceeds from the sale of any and all assets, regardless if said assets are subsequently leased back to Magnolia. Dated this the 15th of May, 1996 RAINBOW INVESTMENTS COMPANY By:/s/ STEVENS G. HERBST, PRESIDENT ------------------------------------ Stevens G. Herbst, President MIDCOAST ENERGY RESOURCES, INC. By:/s/ DAN C. TUTCHER ------------------------------------ Dan C. Tutcher EX-10.54 5 ALLONGE & AMEND #1 TO PROMISSORY NOTE - 05/14/96 1 EXHIBIT 10.54 ALLONGE AND AMENDMENT NO. ONE TO PROMISSORY NOTE MAKER: Midcoast Energy Resources, Inc. ORIGINAL PRINCIPAL: $750,000.00 DATE OF NOTE: November 1, 1995 PAYEE: MERCANTILE BANK, N.A. This is an amendment and allonge to the Promissory Note described above. The said Promissory Note is hereby amended as follows. The maturity date on the above mentioned note will be extended from 06-01-96 to 08-01-96. All other terms of the note will continue in full force as originally contracted. THIS WRITTEN LOAN AGREEMENT REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. EXECUTED effective the 14th day of May, 1996. HOLDER: MAKER: MERCANTILE BANK, N.A. Midcoast Energy Resources, Inc. /S/ EDWARD J. BACAK, II /s/ DAN C. TUTCHER - ------------------------------ -------------------------------- BY: Edward J. Bacak, II Executive Vice Pres. GUARANTORS: /s/ STEVENS G. HERBST -------------------------------- Stevens G. Herbst /s/ KENNETH B. HOLMES, JR. -------------------------------- Kenneth B. Holmes, Jr. /s/ DAN C. TUTCHER -------------------------------- Dan C. Tutcher EX-21.1 6 SCHEDULE LISTING SUBSIDIARIES 1 EXHIBIT 21.1 SUBSIDIARIES OF MIDCOAST ENERGY RESOURCES, INC.
STATE OF YEAR OF SUBSIDIARIES INCORPORATION INCORPORATION OWNERSHIP INTEREST - --------------------------------- ---------- ------------- ------------------ H & W Pipeline Corporation* Alabama 1976 100% Midcoast Holdings No. One, Inc. Delaware 1993 100% Midcoast Marketing, Inc.* Texas 1991 100% Nugget Drilling Corporation* Minnesota 1982 100% Magnolia Pipeline Corporation Alabama 1989 100%
- --------------- * Presently Inactive EX-23.1 7 CONSENT OF HEIN + ASSOCIATES LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We consent to the use of our report dated February 12, 1996 included herein, and to the reference to our Firm under the heading "Experts" in the Prospectus and the Registration Statement on Form SB-2. HEIN + ASSOCIATES LLP Certified Public Accountants Houston, Texas May 28, 1996 -----END PRIVACY-ENHANCED MESSAGE-----