-----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, WlZ6FE7q8ga9U62pVnpCorkIDqDwNE3OE/maGypDiISjqKCns8jsc2L1Xo1gBrVn +KbTIf48j6oKEH3VO8VlcA== 0000914233-98-000032.txt : 19980407 0000914233-98-000032.hdr.sgml : 19980407 ACCESSION NUMBER: 0000914233-98-000032 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980406 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: FORELAND CORP CENTRAL INDEX KEY: 0000773326 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 870422812 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-14096 FILM NUMBER: 98587759 BUSINESS ADDRESS: STREET 1: 12596 W BAYAUD AVE STE 300 STREET 2: UNION TERRACE OFFICE BLDG CITY: LAKEWOOD STATE: CO ZIP: 80228-2019 BUSINESS PHONE: 3039883122 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 Commission File Number 0-14096 Foreland Corporation (Exact name of registrant as specified in its charter) Nevada 87-0422812 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 12596 West Bayaud, Suite 300 Lakewood, Colorado 80228-2019 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code (303) 988-3122 Securities registered pursuant to section 12(b) of the Act: Title of each class Name of each exchange on which registered None None Securities registered pursuant to section 12(g) of the Act: Common Stock, Par Value $0.001 Preferred Stock Purchase Rights (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes[x] No[ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.[ ] The aggregate market value of the registrant's voting stock held by nonaffiliates computed at the average closing bid and asked prices in the over- the-counter market as quoted on the National Association of Securities Dealers National Quotation system ("NASDAQ") on March 27, 1998, was approximately $37,475,000. As of March 27, 1998, the Company had outstanding 8,481,036 shares of its common stock, par value $0.001. Documents Incorporated by Reference. List hereunder the following documents if incorporated by reference and the part of the form 10-K (e.g., part I, part II, etc.) into which the document is incorporated: (1) any annual report to security holders; (2) any proxy or information statement; and (3) any prospectus filed pursuant to rule 424(b) or (c) under the Securities Act of 1933: The Company's definitive proxy statement related to the 1998 annual meeting of stockholders is incorporated herein by reference in response to Part III of this annual report. PREFACE Caution Respecting Forward-Looking Information This annual report contains certain forward-looking statements and information relating to the Company that are based on the beliefs of the Company or management as well as assumptions made by and information currently available to the Company or management. When used in this document, the words "anticipate," "believe," "estimate," "expect," and "intend" and similar expressions, as they relate to the Company or its management, are intended to identify forward-looking statements. Such statements reflect the current view of the Company respecting future events and are subject to certain risks, uncertainties, and assumptions, including the risks and uncertainties noted. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected, or intended. In each instance, forward-looking information should be considered in light of the accompanying meaningful cautionary statements herein. Neither the Company nor any other person undertakes any obligation to revise these forward- looking statements to reflect events or circumstances hereof or to reflect the occurrence of unanticipated events All defined terms under Rule 4-10(a) of Regulation S-X shall have their statutorily prescribed meanings when used in this report. PART I. ITEM 1. BUSINESS General Since its organization in June 1985, the Company has been engaged principally in oil exploration in the Great Basin and Range of Nevada ("Great Basin"), an area that management believes is one of the most promising unexplored onshore domestic areas with potential for the discovery of major oil reserves. In continuing to advance this exploration, the Company's strategy is to generate exploration prospects with the most recent generally available scientific techniques, expand and improve the Company's strategic land position, and establish arrangements with other oil exploration firms active in Nevada to obtain additional scientific data, leases, and funding. Until 1994, the Company had only limited revenue, consisting of modest amounts of interest income earned on net proceeds from the sale of securities and revenue from producing properties. In order to supplement its own exploration efforts, between 1993 and 1994, the Company acquired certain leases and properties in Railroad Valley, Nevada, including the Eagle Springs field. Since acquiring the Eagle Springs field, the Company has reworked and returned to production eleven acquired wells, drilled a new water injection well, drilled and placed into production eight additional wells, replaced and improved surface equipment to handle increased production and to lower long-term operating costs, and conducted a 3-D seismic evaluation program. Much of this development work was conducted under an agreement with an industry partner, Barrett Resources Corporation (successor-in-interest to Plains Petroleum Operating Company) ("Barrett"). Effective August 1, 1996, the Company acquired all of Barrett's interest in the Eagle Springs field. In June 1997, the Company acquired leases to 3,200 acres in and adjacent to the southern and western portions of the Eagle Springs field. In November 1997, the Company initiated an enhanced oil recovery ("EOR") pilot program in the Eagle Springs field using high-pressure air injection. During 1998, the Company intends to continue this program and drill new wells in the Eagle Springs field to place into production undeveloped reserves and to test horizons that are productive in existing wells. During 1996, the Company discovered the Ghost Ranch field on the Eagle Springs leases approximately one-half mile south of the Eagle Springs field in a different formation and geological structure. The discovery of the Ghost Ranch field confirmed that 3-D seismic is a successful tool in the exploration for oil in Nevada. The first Ghost Ranch discovery well was completed in late July 1996 and resulted in significant production and increases in the Company's oil reserves. The Company plugged a second Ghost Ranch well in November 1996, after determining it was not economic to produce. During 1997, the Company completed two additional Ghost Ranch wells for production. The drilling in the Ghost Ranch field was conducted by the Company as operator, with Barrett holding a 40% working interest pursuant to the agreement discussed above. In January 1998, effective December 31, 1997, the Company acquired all of Barrett's interest in the Ghost Ranch field. In connection with the implementation of the EOR program in Eagle Springs, the Company has initiated steps to identify and acquire interests in properties within the Rocky Mountain region that meet the necessary parameters for implementation of high-pressure air injection enhance recovery. The Company continues to increase and improve its geological and geophysical expertise respecting the Great Basin of Nevada through its own efforts and by obtaining data from third parties as part of joint exploration, property acquisition, or data sharing arrangements and from drilling and other field work in which the Company participates. In addition, all information is continually reanalyzed as additional drilling data is gathered and as new computer modeling and other analytical tools become available to the industry. This has enabled the Company to increase substantially its understanding of the geology, location, potential, and other characteristics of exploration prospects in Nevada. The Company has benefited from capital provided by oil industry participants for drilling and other exploration of certain oil prospects through joint arrangements typical in the oil industry. Through 1996, the Company funded its exploration program principally from the sale of its equity securities. In November 1996, the Company established a bank credit facility to provide debt financing for certain proposed activities. In early 1998, the Company completed a $16.9 million debt financing with Energy Income Fund, L.P. ("Energy Income Fund"). Funds available through this arrangement will be used to implement the EOR program and development drilling in the Eagle Springs field, 3-D seismic acquisition, the drilling of 3-D defined exploration targets, the acquisition of producing properties and retirement of existing debt. On December 31, 1997, the Company entered into an option to purchase a refinery and related oil trucking facilities. The exercise of this option would enable the Company to integrate its oil production with downstream asphalt manufacturing and marketing to stabilize the price the Company receives for its crude oil and achieve increased revenue through the sale of finished products from the Company's and other's crude oil. Nevada Exploration During the early 1980s, the Great Basin emerged as a possible new frontier area for oil exploration. Conventional wisdom in the oil industry at the time held that certain geological indicators pointed to north and central Nevada as a possible repository of large (by continental United States standards) petroleum deposits. Between 1980 and 1983, Gulf Oil Corporation ("Gulf") conducted a detailed study of the hydrocarbon potential of north and central Nevada and other frontier exploration areas. The study, conducted by Gulf personnel and by outside consultants, generated a mass of raw data pertaining to the age and depositional history of potential oil-bearing formations. In 1983, Gulf was acquired by Chevron USA, Inc. ("Chevron"). In connection with that acquisition, a number of Gulf's exploration projects were delayed, including the study of Nevada, and a number of Gulf's employees voluntarily retired. One such retiree was Dr. Grant Steele, who had been manager of geology for Gulf's central exploration group and oversaw, coordinated, controlled, and managed Gulf's study of the Great Basin of Nevada. Personal and professional interest in the potential of the Great Basin of Nevada continued after his early retirement from Gulf in 1983. In 1985, Dr. Steele organized the Company. Following its organization, the Company acquired rights to Gulf's data base, conducted additional geological survey work, acquired oil and gas lease holdings in north and central Nevada, and began detailed exploration of the area. Business Strategy The Company has assembled a management and technical team of persons with specialized technical training and experience concentrated on Nevada oil exploration. In all, the Company's technical team has over 80 years of combined Nevada oil exploration experience, much of it with major oil companies. The Company believes that the working experience of its executives and employees in Nevada is a significant factor in the Company's exploration progress to date and in its ability to act as operator under exploration arrangements with other exploration firms such as Enserch Exploration, Inc. ("Enserch"), Berry Petroleum Company ("Berry"), Parker and Parsley Petroleum Company (successor-in-interest to Santa Fe Energy Resources, Inc.) ("P&P"), and Barrett. The Company's management and technical team employs the following strategies in guiding the Company's Nevada exploration: . Take full advantage of the most advanced generally available scientific exploration tools and techniques such as 3-D and reprocessed seismic data to generate drilling prospects and select specific drilling locations. . Generate promising exploration prospects in areas in which the Company holds or believes that it can acquire a preemptive lease position and upgrade lease holdings based on further prospect evaluation. . Seek joint exploration agreements with other exploration firms active in Nevada to diversify the risk and to obtain additional scientific data and expertise, land, and funding. . Increase revenues in the Eagle Springs field through development and EOR techniques. . Continually generate drilling prospects for long-term exploration of the Great Basin. . Stabilize prices received for oil produced and reduce dependence on a shrinking number of crude oil purchasers by establishing selected downstream processing and marketing to increase revenue through the sale of finished products. Science The Company seeks to utilize the most advanced available scientific tools and techniques to evaluate the risk and exploration potential of specific prospects. The Company's oil exploration model for the Great Basin of Nevada continually evolves from a large data base collected, originally by Gulf and, since 1985, by the Company. As a result of the Company's own work as well as information sharing arrangements with others, the Company now has access to over 1,400 line miles of 2-D seismic data, much of it reprocessed with new analytical computer programs, newly acquired high resolution 3-D seismic surveys, and gravity data gathered by the Company as well as by Exxon, P&P, Mobil, Chevron, Enserch, and Berry. Data from 3-D seismic, gravity, reprocessed seismic surveys, and subsurface data from drilling are integrated as a guide to further exploration. The Company believes that it benefits from the experience of the Company's personnel in Nevada oil exploration and operations, which enhances the Company's ability for exploration success and to interest industry partners in joint ventures. The Company also seeks to utilize the most advanced technology to improve and enhance recovery from its drilling activities. In 1997, the Company implemented an EOR program in the Eagle Springs field using high-pressure air injection techniques. Management believes that the early results of this program are very encouraging and could significantly increase the Company's oil reserves and resulting cash flows. In connection with the advancement of such recovery techniques, in January 1998, the Company formed the Foreland EOR Group, headed by the Company's senior engineer, in alliance with Mr. Alexander Erickson, an industry expert on high-pressure air injection EOR programs, to identify and acquire interests in properties within the Rocky Mountain region that the Company believes would benefit from the implementation of EOR programs to increase revenues and reserves. The Company will continue to evaluate other properties that warrant enhanced oil recovery. Prospect Generation and Leasing The Company's leasing program is coordinated with prospect generation and exploration results. As areas of interest are identified, the Company attempts to acquire leases or other exploration rights on what preliminarily appears to be the most promising prospect areas in order to establish a preemptive lease position prior to generating a specific drilling prospect. As specific prospect evaluation advances, the Company may seek leases on additional areas or relinquish leases on areas that appear less promising, thereby reducing lease holding costs. As a result, the Company has substantially increased the size of its gross acreage while, in management's opinion, improving the exploration potential of its leaseholdings. Joint Exploration The Company regularly considers joint exploration arrangements with other oil exploration firms active or interested in Nevada. Joint exploration arrangements are sought with firms that have significant lease positions in the prospect area and that will bear a portion of the costs of specified further exploration. The Company also utilizes joint exploration arrangements to spread the risks of specific exploration, attempting to retain a larger interest by bearing an equal ratio of the related costs in those prospect areas in which management believes that the risks and reserve potential warrant such action. In situations in which management perceives a higher degree of risk or a smaller potential for the prospect, it seeks to retain a smaller interest and bear a smaller share of related costs. Industry interest in oil exploration in Nevada fluctuates significantly, and there can be no assurance that the Company can continue to identify oil exploration firms to undertake joint exploration of Nevada prospects. With the acquisition of Barrett's 40% interest in the Eagle Springs field and Ghost Ranch field, the Company assumed the cost and associated risk of 100% of operations in both fields. Management believes these acquisitions are consistent with its policies, given the established reserves of both fields, and will allow the Company to operate each field as the Company deems warranted. Drilling Near Existing Production Further development drilling is required to delineate the extent of productive horizons in individual fields. In the Eagle Springs and Ghost Ranch fields, the Company's geophysical and geological evaluation is ongoing to identify additional drilling locations. In both fields, the Company has surface facilities capable of handling additional production. The Company also intends to drill 3-D defined exploration wells in areas of existing production, primarily in the Pine and Railroad Valleys. These prospects involve somewhat lower risk than exploration testing in areas with relatively less drilling history or no exploration success to date. Long-Term Exploration Management anticipates that it will take several years to explore fully the target areas that have been identified by the Company in the Great Basin of Nevada, as is the case in many frontier areas of exploration. In such a long term exploration effort, the results of early exploration serve as a guide for identifying new prospects so it is important, in management's view, to continually identify new prospect concepts and areas for possible future exploration while advancing existing prospects to the drilling stage. Between 1993 and 1996, the Company focused its activities on drilling in the Eagle Springs to exploit proved undeveloped reserves and to drill additional exploratory prospects in the Pine and Railroad Valleys and Toano Draw of Nevada. In 1996, the Company's exploration effort led to the discovery of the Ghost Ranch field, which confirmed the effectiveness of 3-D seismic by the Company in successfully identifying exploration prospects in Nevada. During 1997, the Company completed two wells for production in the Ghost Ranch field and initiated its EOR program on the Eagle Springs field. Additionally, during 1997, the Company acquired additional acreage contiguous to the Eagle Springs and Ghost Ranch fields that warrant additional exploration. Through 1998, the Company will continue its exploration and development activities in this area. In addition, the Company will continue its acquisition of 3-D seismic data and reanalysis of existing 2D seismic data. The Company will also continue its evaluation of data to identify additional exploration targets, expand its leaseholdings where warranted, and may seek additional exploration arrangements with other industry participants. Ghost Ranch Field Based on results of its Eagle Springs 3-D seismic program, in 1996 the Company identified the Ghost Ranch prospect located just south of the Eagle Springs field. The Ghost Ranch no. 48-35 discovery well was Nevada's first 3-D defined exploration success and resulted significant production and increases to the Company's oil reserves. The Ghost Ranch no. 58-35 exploratory well, the second well drilled in the Ghost Ranch area, was intended to test a different horizon than the discovery well but was plugged by the Company because the water cut was too high to produce the well economically. In 1997, the Company completed the Ghost Ranch no. 38-35 and 47-35 well for production. The wells in the Ghost Ranch field are now producing at a rate of approximately 250 barrels of oil per day. The Company believes that discovery of the Ghost Ranch field confirms the effectiveness of 3-D seismic as a valuable exploration tool in Nevada. The drilling activities in the Ghost Ranch field were conducted jointly with Barrett, which held a 40% working interest in the field. In January 1998, effective December 31, 1997, the Company acquired Barrett's 40% interest in the Ghost Ranch field for $476,000, utilizing funds drawn under the Company's recently established debt financing with Energy Income Fund. As a result of the acquisition of Barrett's interest, the Company began to receive 100% of the revenue and assume 100% of the cost and associated risk of operations in the Ghost Ranch field. No additional development is currently indicated for the Ghost Ranch field. During 1997 production from one Ghost Ranch well was adversely affected by water handling problems that have now been addressed. Eagle Springs In 1993 and 1994, to supplement the Company's own exploration efforts, it acquired approximately 3,040 gross acres in Railroad Valley, Nevada, with eleven shut-in wells in the Eagle Springs field. In connection with the acquisition, the Company implemented certain in-field environmental remediation measures and resolved issues raised by various regulatory agencies and the claims of entities which asserted an ownership interest or had advanced funds or services to the field. Since acquisition of the Eagle Springs properties, the Company has returned eleven acquired wells to production, drilled a water injection well, drilled and placed into production eight additional wells, replaced and improved surface equipment to handle increased production and to lower long term operating costs, and acquired a seven square mile 3-D seismic program in the area. Much of this work in the Eagle Springs field was completed with Barrett pursuant to a 1994 agreement under which Barrett provided $1,920,000 in specified well costs to earn a 40% interest in the Company's Eagle Springs producing properties. In November 1996, the Company acquired Barrett's 40% interest in the Eagle Springs field, effective August 1, 1996, for $2.4 million. Pursuant to the 1994 agreement, Barrett continued to have a Ghost Ranch field interest until it was acquired effective December 31, 1997, by the Company. As a result of the acquisition of Barrett's interest in November 1996, effective August 1, 1996, the Company assumed 100% of the cost and associated risk of operations in the Eagle Springs field. Additional development work was delayed in the Eagle Springs field during the first half of 1997 while the Company pursued leases on adjacent acreage. Following the acquisition of the additional acreage in June, in September 1997, the Company initiated an air injection EOR pilot program as a low-risk method to add significant reserves, increase production, and enhance cash flow at a low cost to the Company. This required a temporary interruption of production from some wells as the program was implemented. The pilot program was completed in January 1998 utilizing funds drawn under the Company's recently established debt financing with Energy Income Fund. Early results from the pilot test phase have demonstrated the occurrence of spontaneous ignition, oxygen consumption, and beginning reservoir repressurization in affected areas, leading to the expectation that increased production will result. The Company is now reviewing the impact of the pilot EOR program on various wells throughout the field to estimate the location of one or more additional injection wells and up to four additional production wells to determine the specifications of permanent EOR equipment required for the entire field. The Company expects that several months will be required to appraise the level of success of this program in each affected area. Management believes that the program could significantly increase recoverable reserves from the Eagle Springs field at a capital cost of less than $1 per barrel with daily production of 1800 bpd. Kate Springs In June 1997, the Company acquired federal leases on approximately 3,200 acres located in and adjacent to the southern and western portions of the Eagle Springs field. These leases in Railroad Valley contain one well, the Kate Springs well, currently in production, and a number of exploration prospects that will be evaluated with 3-D seismic studies and other data for future exploration drilling. Exploration Activities Toano Draw In accordance with an agreement with P&P, the Company identified an exploration target in the Deadman Creek area of Toana Draw, Elko County, Nevada, based on the Company's review of available data regarding the Deadman Creek no. 44-13 test drilled by another operator in the mid 1980s that encountered favorable oil shows but was not completed for production. The Company reentered and completed the well, which initially tested at rates of 20 to 40 barrels per day. Based on the test results, the Company intends to acquire the surface equipment to place this well into production. The Company originally intended to complete the well in 1997 but was unable to acquire the necessary equipment on terms economically favorable to the Company. There can be no assurance that the Company will be successful in 1998 in acquiring such equipment. On completion of the well for production, the Company will earn a 100% working interest in 5,013 gross acres (4,261 net acres), subject to P&P's 15% working interest in each well after the Company has recouped costs incurred. The Company may drill additional wells in this area. Pine Valley During 1997, the Company and its partners completed a 16.75 square mile 3-D seismic acquisition program. This seismic program was designed to identify updip drilling locations from the numerous shows in the Company's Pine Creek no. 1-7 exploratory well. The Pine Creek no. 1-7 was drilled during the fourth quarter of 1996, and recovered a high gravity, low pour point oil, but the water cut was too high to warrant completion for production. In addition, the 3-D survey will also be used to identify other exploratory drilling targets in the 16.75 square mile 3-D seismic program. Additional 3D seismic acquisition is scheduled for completion during 1998. Dixie Flats Prospect The Company identified the Dixie Flats prospect in Huntington Valley during 1997 based on 2-D seismic data. Industry participation is now being sought to complete a 3-D seismic survey, if warranted, and drill an exploratory well. North Humboldt Prospect The Company identified the North Humboldt prospect based on data available pursuant to its agreements with P&P and subsequently obtained a lease from P&P respecting this prospect. Based on its evaluation of existing seismic date of the area. The Company is seeking to form an industry group to fund exploration drilling of this prospect. Little Smoky and Antelope Valley The Company has participated in four test wells in these two valleys in previous years. Although all of these tests were plugged and abandoned, they added significantly to the Company's information in these two sparsely drilled yet promising prospect valleys. The Company will continue to evaluate the exploration potential of these two valleys. Newark Valley The Company is conducting ongoing geological evaluation of prospects in Newark Valley. Joint Exploration Arrangements Enserch/Berry Pursuant to a March 1993 agreement with Enserch/Berry, the Company drilled five tests with Enserch Berry, all of which were plugged and abandoned. In 1996, the parties determined not to drill a planned sixth well and the Company acquired all of Enserch/Berry's interest in 46,600 gross acres in Pine, Little Smoky, and Antelope Valleys, all of Enserch/Berry's rights to over 57 line miles of jointly acquired seismic data in those valleys, an access license to over 61 miles of Enserch/Berry proprietary seismic, and an option to acquire an additional 100 miles of seismic data in Pine Valley, Nevada. P&P Pursuant to a December 1992 agreement with P&P's predecessor in interest, the Company identified the Deadman Creek, North Humboldt, and Pine Creek prospects, and acquired leases to approximately 36,400 gross acres. The Company has agreed to grant P&P an overriding royalty in these leaseholds and to provide to P&P copies of any seismic and geological data acquired in the prospects. The Company released the remaining acres subject to the P&P agreement when it expired in December 1996. Exploration Arrangements The Company intends to continue to negotiate with interested parties to fund further drilling on defined prospects in a number of locations in the Great Basin of Nevada. The ultimate goal of the Company is to arrange for the exploration and, if oil reservoirs are discovered, development of its holdings, using the Company's own limited financing, established credit facility, and other sources, to the extent available. In some instances, the Company may reach an agreement with other firms in which all participants contribute acreage and available scientific data and bear a portion of the costs of agreed drilling or other exploration, thereby earning a shared ownership in the contributed acreage and production, if any. The nature and extent of the Company's participation, share of costs, and interest retained in various arrangements will be dependent on the acreage it has under lease in the target area, the amount of scientific information it has available as compared to the other participants, the relative financial strength of the participants, the risks and rewards perceived by the various participants, and other factors. These arrangements are very project specific and will likely vary from drilling prospect to drilling prospect. Joint exploration agreements with industry participants to obtain leases, scientific data, and funds for drilling and other exploration typically set forth obligations that the participants must perform timely in order to earn specified property interests, permit funding participants to terminate their participation at specified points during the exploration program, and condition continuation of joint efforts on obtaining satisfactory results. If such a participant elects not to continue with respect to any well, the Company would be required to fund all of the costs of such well if it is drilled, in which case it would be dependent on proceeds from the sale of securities and production revenue, which could delay or limit planned drilling. Concentration of Activities in Frontier Area Exploration for oil is a highly speculative business. There is no way to know in advance of drilling and testing whether any prospect will yield oil in sufficient quantities to be economically feasible. The completion of a well for production or the initiation of production in paying quantities does not necessarily mean that the well will be economic because it may not produce sufficient revenues to recover related costs and generate a financial return to the Company. Management of the Company has focused its efforts on acquiring lease positions, developing data, and exploring and drilling in the Great Basin area of Nevada, a largely unproved and unexplored geological province. While the Company holds exploration rights to a significant number of acres, its holdings are insignificant when compared to the size of the potential geological area. Other than in the Eagle Springs field and Ghost Ranch field, no significant ongoing commercial production of oil has been established on the Company's properties. In addition, the areas targeted by the Company, other than the Eagle Springs field and Ghost Ranch field, have geological and geophysical complexities which may hinder the development or establishment of significant production or reserves. There is no assurance that these problems can be overcome or that the Company's drilling program will be commercially successful. Despite the expertise of management, the significant amount of data that the Company has collected with respect to Nevada, and the expenditure of several million dollars in property acquisition, data collection, and exploration since 1985, the Company has established only limited reserves and developed limited ongoing production as a result of its exploratory drilling program. The Ghost Ranch discovery well, which was placed into production in late 1996, is the first exploration test by the Company that has resulted in significant ongoing production and reserves. The oil production from the Eagle Springs field was acquired by the Company in 1993 and did not result from the Company's exploration activities, although the Company increased production by reworking the acquired shut-in wells, completing eight development wells, and implementing an EOR program in the field. Although the Company is continuing to receive oil production revenue from the Eagle Springs field and Ghost Ranch field, the Company's success will continue to depend on the results of drilling, evaluation, and testing of its various prospects. North Willow Creek and Tomera Ranch Discoveries The Company continues to receive limited production from two North Willow Creek wells drilled in previous years, but production continues to decline. Management has concluded that the wells are not producing to the potential indicated by initial tests and engineering and geologic evaluations. The Company's sole remaining Tomera Ranch well continues to have only limited sustained production. The Company continues to evaluate the productive potential of the area. Both the North Willow Creek and Tomera Ranch wells hold acreage over productive zones that the Company believes can be produced at higher rates with additional evaluation. The Company plans to acquire 3-D seismic over these areas and continue drilling operations, as warranted. Competition Competition in the oil and gas industry is intense. The acquisition and exploration of oil and gas prospects are highly competitive. The Company competes with numerous other firms and individuals in its activities. The Company's current and potential competitors include major oil companies and other independent operators, many of which have greater financial resources, broader exploration programs, a greater number of managerial and technical personnel, and facilities substantially larger than those of the Company. There can be no assurance that the Company will be able to compete effectively in the exploration for oil in Nevada. The Company faces intense competition in obtaining risk capital for test drilling within the Great Basin province. Management believes that competition for drilling funds from such sources is principally dependent on an analysis by the potential industry or financing participant of the costs of drilling and related activities, the likelihood of discovering oil or other hydrocarbons in commercial quantities, and the potential size of oil reserves which geologic and engineering analyses indicate may eventually be established. The Company believes that an important consideration in obtaining risk capital for drilling, new exploration rights, and joint exploration and development arrangements with other industry participants is the amount and quality of the Company's scientific data and exploration experience in Nevada. The Company also believes that it benefits from its use of 3-D seismic and reprocessed 2D seismic data and its experience in correlating that data with the results of actual drilling. In its efforts to obtain oil leases within the Great Basin, the Company encounters competition from lease speculators, independent oil firms, and major oil companies. The ability to acquire leases is generally determined by the amount of cash paid to acquire the lease, the royalty or other interest retained by the transferor, and the nature of any commitment to drill on the lease acreage. The Company seeks to acquire leases in those areas that have been identified through geological and geophysical data as having potential to produce oil in sufficient quantities to be economic. The availability of a ready market for production and the prices obtained for production of oil depend on a number of factors beyond the Company's control, the effects of which cannot be predicted accurately. Such factors include the extent of domestic production and imports of oil; the competitive position of oil as a source of energy as compared to gas, coal, nuclear energy, hydroelectric power, and other energy forms; the refining capacity of prospective purchasers; transportation costs; the availability and capacity of pipelines and other means of transportation; and the effect of federal and state regulation on production, transportation, and sale of oil. Marketing General During 1997 the Company sold the crude oil produced from its Ghost Ranch field to Petro Source for processing into asphalt and ancillary products at its Eagle Springs, Nevada refinery and the oil produced from its Eagle Springs and Kate Springs fields to Crysen Refinery in Salt Lake City, Utah. See "Item 2. Properties: Production and Sale of Oil." As a result of the sale of the Crysen Refinery during 1997, the Company concluded that it faced increased risks that the Crysen Refinery may not be a reliable market for the Company's Eagle Springs and Kate Springs crude oil because of planned refinery renovations that might preclude processing of Nevada crude. Accordingly, the Company initiated steps to reduce its dependence on third party crude oil purchasers and to seek arrangements that would enable the Company to market finished products for a higher return than crude oil. Petro Source Refinery Option As a result of the circumstances described above, on December 31, 1997, the Company entered into an Option and Purchase Agreement with Petro Source Corporation, an independent crude oil processing, transportation, and trading firm based in Houston, Texas, pursuant to which the Company obtained an option to acquire at any time prior to December 31, 1998, certain of the businesses and business assets of Petro Source Refining Corporation and Petro Source Transportation. The optioned assets include the Eagle Springs Nevada refinery, which manufactures asphalt and ancillary products from crude oil produced by the Company and other Nevada operators, a processing facility in Tonopah, Nevada, and rolling stock utilized by Petro Source Transportation to gather crude oil and distribute products. The Company's management believes that the acquisition of the Petro Source assets would enable the Company to integrate production, processing, and marketing to obtain price protection, establish new profit centers, and increase revenues. The Company agreed to pay $520,000 for the option, payable in four equal quarterly installments of $130,000 each in either Common Stock or, if the Company so elects, in cash. Upon exercise of the option by the Company, the purchase price for the assets refinery and transportation assets to be acquired is $5.0 million or four times the annual income of the businesses to be purchased, with certain adjustments. The terms of the option were the result of arm's length negotiations. In connection with entering into the option with Petro Source, the Company agreed to sell all of its crude oil production in Nevada to Petro Source at a price equal to Chevron's posting for Southwest Wyoming Sweet crude oil, adjusted for actual API gravity, less $4.15 in the Ghost Ranch field and $4.65 in Pine Valley and the Eagle Springs field. Under such agreements, the average weighted unit price to Petro Source from the Company's production was $12.80 per barrel. Government Regulation The exploration for and production of oil in the United States are subject to extensive regulation by both federal and state authorities. The following discussion concerning regulation of the oil and gas industry is necessarily brief and is not intended to constitute a complete discussion of the various statutes, rules, regulations, and governmental orders to which operations of the Company may be subject. Environmental Regulations Operations of the Company are subject to comprehensive federal, state, and local laws and regulations governing the storage, use, and discharge of materials into the environment, the remediation of environmental impacts, and other matters relating to environmental protection, all of which may adversely affect the Company's operations and costs of doing business. It is probable that state and federal environmental laws and regulations or their interpretations will become more stringent in the future. There can be no assurance that measures to further regulate the disposal of oil waste may not be adopted. Environmental laws and regulations are frequently changed so the Company is unable to predict the ultimate cost of compliance. The Company does not believe that it will be required in the near future to expend material amounts due to current environmental laws and regulations. Present, as well as future, legislation and regulations could cause additional expenditures, restrictions, and delays in the Company's business, the extent of which cannot be predicted and which may require the Company to limit substantially, delay or cease operations in some circumstances or subject the Company to various governmental controls. From time to time, regulatory agencies have proposed or imposed price controls and limitations on production by restricting the rate of flow of oil and gas wells below actual production capacity in order to conserve supplies of oil and gas. Because federal energy and taxation policies are subject to constant revisions, no prediction can be made as to the ultimate effect of such governmental policies and controls on the Company. In connection with the acquisition of the Eagle Springs property, the Company performed limited environmental inquiries and agreed to undertake certain work to remediate a contaminated drilling pit at a former water injection well site. That work was completed at a cost of $111,000 in coordination with federal and state supervising agencies in early 1994, for which the Company received the Bureau of Land Management's "Health of the Land" award. The Company does not believe that it has any material continuing financial obligation respecting remediation of environmental matters involving the Eagle Springs field. However, there can be no assurance that new remediation issues will not arise in the future due to existing undiscovered conditions or future legislation. As a negotiated term of the acquisition of the Eagle Springs lease, the Company agreed to indemnify the secured creditor from which the Company acquired a portion of its property interests against claims for environmental liability. The Company does not believe that it has any material financial obligation under such agreement. State and Local Regulation of Drilling and Production State regulatory authorities have established rules and regulations requiring permits for drilling, drilling bonds, and reports concerning drilling and producing activities. Such regulations also cover the location of wells, the method of drilling and casing wells, the surface use and restoration of well locations, and the plugging and abandoning of wells, the density of well spacing within a given area, and other matters. Nevada also has statutes and regulations governing a number of environmental and conservation matters, including the unitization and pooling of oil properties and establishment of maximum rates of production from oil wells. The Company believes it is currently in full compliance with all material provisions of such regulations. Federal Leases The Company conducts significant portions of its activities under federal oil and gas leases. These operations must be conducted in accordance with detailed federal regulations and orders which regulate, among other matters, drilling and operations on these leases and calculation and disbursement of delay rentals and royalty payments to the federal government. Safety and Health Regulations The Company must also conduct its operations in accordance with various laws and regulations concerning occupational safety and health. Currently, the Company does not foresee expending additional material amounts to comply with these occupational safety and health laws and regulations. However, since such laws and regulations are frequently changed, the Company is unable to predict the future effect of these laws and regulations. Operational Hazards and Insurance The Company's operations are subject to the usual hazards incident to the drilling for and the production of oil. These hazards include, but are not limited to, pipe failure, blowouts, cratering, explosions, uncontrollable flows of oil, natural gas, or well fluids, fires, pollution, releases of toxic gas, and other environmental hazards and risks. These hazards can cause personal injury and loss of life, severe damage to and destruction of property and equipment, pollution or environmental damage, and suspension of operations and could result in the Company incurring substantial losses and liabilities to third parties.. In order to lessen the effects of these hazards, the Company maintains insurance of various types to cover its operations. As is customary in exploration arrangements with other energy companies under which specified drilling is to be conducted, the operator is required to purchase and pay for insurance against risks customarily insured against in the oil and gas industry by others conducting similar activities. The Company has general liability insurance of $1 million per occurrence, with a $2 million aggregate limitation, including coverage for certain oil industry activities. Management believes that the Company's current insurance coverage is adequate; however, the Company may not be insured against all losses or liabilities which may arise from all hazards because such insurance is unavailable at economic rates, because of limitations on the insurance policy, or other factors. The Company's insurance does not cover every potential risk associated with the exploration, drilling, and production of oil. In particular, coverage is not available for certain types of environmental hazards. The occurrence of a significant adverse event, the risks of which are not fully covered by insurance, could have a materially adverse effect on the Company. Moreover, no assurance can be given that adequate insurance will be available at reasonable rates or that the Company or the operators of wells in which the Company owns an interest will elect to maintain certain types or amounts of insurance. The Company's activities are subject to periodic interruptions due to weather conditions, which may be quite severe at various times of the year. Periods of heavy precipitation make travel to exploration or drilling locations difficult and/or impossible, while extremely cold temperatures limit or interrupt drilling, pumping, and/or production activities or increase operating costs. Employees The Company has 17 employees, including three executive officers (all of whom are also directors), four technical employees in addition to the executive officers, four field operations employees, and four administrative employees. None of the Company's employees is represented by a collective bargaining organization, and the Company considers its relationship with its employees to be satisfactory. ITEM 2. PROPERTIES The Company's principal oil and gas properties are located in Nevada. In the oil and gas industry and as used herein, the word "gross" well or acre is a well or acre in which a working interest is owned; the number of gross wells is the total number of wells in which a working interest is owned. A "net" well or acre is deemed to exist when the sum of fractional ownership working interests in gross wells or acres equals one. The number of net wells or acres is the sum of the fractional working interests owned in gross wells or acres. Proved Reserves The following table sets forth the estimated oil reserves, net to the Company's interest, of oil and gas properties as of December 31, 1997. The reserve information is based on the independent appraisal prepared by Malkewicz Hueni Associates, Inc., Golden, Colorado, and was calculated in accordance with the rules and regulations of the Securities and Exchange Commission. In accordance with such rules and regulations, the estimates of future net revenues from the Company's proved reserves are made using a sales price of $10.00 through March 1, 1998 and $12.80 thereafter, based on the price provisions of existing contracts, and are held constant throughout the life of the properties. See "Item 1. Business." Present Value of Estimated Future Net Estimated Revenues, Estimated Proved Reserves Oil Discounted at 10% (1) (MBbl) (In thousands) Proved Developed Producing Eagle Springs Field..... 1,101.4 $3,073.1 Ghost Ranch Field....... 335.9 1,199.0 Kate Springs Field...... 12.6 18.7 --------- ---------- Subtotal............ 1,449.9 4,290.8 Proved Developed Nonproducing Eagle Springs Field..... 847.4 2,421.2 --------- ---------- Subtotal ........... 2,297.3 6,712.0 ========= ========== Purchase of Proved Developed Producing: Ghost Ranch Field (2)... 223.9 799.4 --------- ---------- Subtotal............. 2,521.2 $7,511.4 ========= ========== (1) The initial price used in the evaluation was the year-end values at the wellhead. The crude oil from the Eagle Springs field was then being sold to Crysen Refinery in Salt Lake City at a floor price of $10.00 per barrel. Beginning March 1, 1998, the Eagle Springs oil is being sold to Petro Source's Eagle Springs refinery at a contract price the equal to $12.80 per barrel. Accordingly, the oil price was revised to $12.80 per barrel for production subsequent to March 1, 1998 for the economic evaluation. See "Item 1. Business: Marketing." Operating costs have not been escalated. The operating costs, based on information provided by the Company, are computed by estimating expenditures to be incurred in developing and producing the proved oil reserves, based on year-end costs and assuming the continuation of existing economic conditions. See "Item 8. Financial Statements and Supplementary Data." The discounted amounts have been reduced by the Company's share of estimated development costs in the amount of approximately $2,240,000. The foregoing estimates include costs of $300,000 for the Company's recently implemented enhanced recovery program in Eagle Springs but do not give effect to any potential increases in reserves or cash flow, as the program has been recently implemented. There can be no assurance that the program will be successful in increasing reserves or improving cash flow. (2) Gives effect to the purchase of Barrett's interest in the Ghost Ranch field in January 1998, effective December 31, 1997. The oil reserves assigned to the properties in this evaluation were determined by analyzing current test data, extrapolating historical production data, and comparing field data with the production history of similar wells in the area. The current volatility of oil prices provides an element of uncertainty. If prices should vary significantly from those projected in the appraisal, the resulting values would change substantially. The reserve estimates contained in the engineering report are based on accepted engineering and evaluation principles. The present value of estimated future net revenues, discounted at 10%, does not necessarily represent an estimate of a fair market value for the evaluated properties. There no longer appears to be significant competition for the purchase of crude oil from Nevada, which may effecting future prices for oil. Additionally, Petro Source may terminate its contract to purchase the Company's crude oil if it concludes that processing of the crude oil purchased is uneconomic. The Company has acquired an option to purchase the Petro Source refinery in an effort to integrate production, processing, and marketing to obtain price protection, establish a new profit center, and increase revenues. See "Item 1. Business: Marketing." There are numerous uncertainties inherent in estimating quantities of proved oil reserves. The estimates in the appraisal are based on various assumptions relating to rates of future production, timing and amount of development expenditures, oil prices, and the results of planned development work. Actual future production rates and volumes, revenues, taxes, operating expenses, development expenditures, and quantities of recoverable oil reserves may vary substantially from those assumed in the estimates. Any significant change in these assumptions, including changes that result from variances between projected and actual results, could materially and adversely affect future reserve estimates. In addition, such reserves may be subject to downward or upward revision based upon production history, results of future development, prevailing oil prices, and other factors. The borrowing base under the Company's recently established credit facility is based on the estimate of the Company's reserves. Therefore, any downward revision of this estimate could have an adverse effect on the Company's borrowing capability under the credit facility. The actual amount of the Company's proved reserves are also dependent on the prevailing price for oil, which is beyond the Company's control or influence. World oil prices generally declined during 1997 from the previous year, and have declined further during early 1998. There can be no assurance that oil prices will not substantially decline in the future. Oil and gas prices have been and are likely to continue to be volatile and subject to wide fluctuations in response to any of the following factors: relatively minor changes in the supply of and demand for oil and gas; market uncertainty; political conditions in international oil producing regions; the extent of domestic production and importation of oil; the level of consumer demand; weather conditions; the competitive position of oil or gas as a source of energy as compared with coal, nuclear energy, hydroelectric power, and other energy sources; the refining capacity of prospective oil purchasers; the effect of federal and state regulation on the production, transportation and sale of oil; and other factors, all of which are beyond the control or influence of the Company. In an effort to limit the adverse effects of extreme declines in oil prices, the Company has entered into agreements with Petro Source, Houston, Texas, to sell oil from its currently producing fields through December 31, 1998 at minimum fixed prices. See "Production and Sale of Oil" below. Notwithstanding these agreements, adverse changes in the market or regulatory environment would likely have an adverse effect on the Company's ability to obtain additional funding from lending institutions, industry participants, the sale of additional securities, and other sources. During 1997, Crysen and Petro-Source accounted for 91.1% and 8.9%, respectively, of the Company's oil sales revenues. Wells and Acreage Shown below is a tabulation of the productive wells owned by the Company in Nevada as of December 31, 1997. Productive Oil Wells -------------------- Gross Net (1) ------- --------- 24.0 22.1 (1) Does not give effect to the purchase of Barrett's 40% interest in the Ghost Ranch field in January 1998, effective December 31, 1997. Set forth below is information respecting the developed and undeveloped acreage owned by the Company in Nevada as of December 31, 1997. Developed Acreage Undeveloped Acreage ----------------- --------------------- Gross Net Gross Net (1) ----- ------ ------- -------- 4,200 4,104 156,528 152,581 (1) Does not give effect to the purchase of Barrett's 40% interest in the Ghost Ranch field in January 1998, effective December 31, 1997. The Company's leases in Eagle Springs (2,960 gross and net acres, Ghost Ranch (80 gross and net acres), Tomera Ranch (680 gross and net acres), North Willow Creek (400 gross and net acres), Kate Springs (80 gross and 16 net acres) are held by production. The Company's undeveloped leases have various primary terms ranging from one to ten years. Management believes that the expiration of any individual or group of related undeveloped leasehold interests would not have a material adverse effect on the Company. Annual rentals on all undeveloped leases aggregate approximately $195,000. Drilling Activities Set forth below is a tabulation of wells drilled and completed in which the Company has participated and the results thereof for each of the periods indicated. Year Ended December 31, -------------------------------------- 1995 1996 1997 ----------- ----------- ------------ Gross Net Gross Net Gross Net ----- ---- ----- ----- ------ ----- Exploratory: Dry.................... 2.0 0.84 2.0 1.16 -- -- Oil.................... -- -- 2.0 1.60 -- -- Gas.................... -- -- -- -- -- -- ---- ---- ---- ---- ---- ---- Totals............. 2.0 0.84 4.0 2.76 -- -- ==== ==== ==== ==== ==== ==== Development: Dry.................... -- -- -- -- -- -- Oil.................... 5.0 3.0 -- -- 2.0 1.2 Gas.................... -- -- -- -- -- -- ---- ---- ---- ---- ---- ---- Totals............. 5.0 3.0 -- -- 2.0 1.2 ==== ==== ==== ==== ==== ==== Production and Sale of Oil The following table summarizes certain information relating to the Company's net oil produced and sold from the Company's Nevada properties, after royalties, during the periods indicated. Year Ended December 31, ------------------------------- 1995(1) 1996 1997 ----------- --------- -------- Average net daily production of oil (Bbl) 240 325 492 Average sales price of oil ($ per Bbl) $11.61 $15.87 $12.46 Average production cost ($ per Bbl)(2) $4.84 $4.01 $5.03 (1) Represents production from North Willow Creek, Tomera Ranch and Eagle Springs. (2) Includes lifting costs (electricity, fuel, water disposal, repairs, maintenance, pumper, and similar items), and production taxes. Production from Eagle Springs started in January 1994, and currently accounts for about 70% of the Company's oil production. Production from the Eagle Springs field consists of oil produced and sold net to the Company's interest from the eleven wells the Company acquired, reworked, and returned to production plus the eight development wells drilled since the field was acquired, net of production royalties. As part of routine field maintenance wells are shut-in from time to time, subject to the availability of appropriate rig and equipment in the area and the availability of funds. The oil from the Eagle Springs, Nevada, wells was sold to Crysen Refining, Inc., Salt Lake City, Utah, an unrelated purchaser, during 1997 at a price equal to Amoco Oil Company's Wyoming per barrel sour crude oil posted price, adjusted for gravity and oil quality, less transportation of $3.05 or $2.90 per barrel, depending on the producing field, but in no case less than $10.00 per barrel after deduction of all charges. For example, during the month of December 1997, the Company received a net price of $10.00 per barrel, after deducting transportation charges. The sale of oil is subject to price adjustments, production curtailments, and similar provisions common in oil purchase contracts. The oil from the Ghost Ranch field is sold to Petro Source's Eagle Springs, Nevada, refinery. During February 1997, the Company received a net price per barrel of $10.00. In December 1997, the Company entered into a new agreement, effective March 1, 1998, for the sale of all of its Nevada crude oil to Petro Source at its Eagle Springs refinery that the Company has the option to purchase. See "Item 1. Business: Marketing." The Company's oil exploration and production activities are dependent on the prevailing price for oil, which is beyond the Company's control or influence, and there is no assurance that the Company's wells can be produced at levels in excess of related production costs. World oil prices declined significantly during late 1997 below the significantly higher prices during 1996. Early 1998 price rebounds have not overcome the declines of the preceding several months. There can be no assurance that oil prices will not continue to decline or decline substantially in the future. Oil and gas prices have been and are likely to continue to be volatile and subject to wide fluctuations in response to any of the following factors: relatively minor changes in the supply of and demand for oil and gas; market uncertainty; political conditions in international oil producing regions; the extent of domestic production and importation of oil; the level of consumer demand; weather conditions; the competitive position of oil or gas as a source of energy as compared with coal, nuclear energy, hydroelectric power, and other energy sources; the refining capacity of prospective oil purchasers; the effect of federal and state regulation on the production, transportation and sale of oil; and other factors, all of which are beyond the control or influence of the Company. In addition to its direct impact on the prices at which oil or gas may be sold, adverse changes in the market or regulatory environment would likely have an adverse effect on the Company's ability to obtain funding from lending institutions, industry participants, the sale of additional securities, and other sources. Overall operating costs are a combination of costs associated with each well and costs associated with operation of the entire field. As additional wells are added to the production system, the field operating costs will be spread among additional wells, lowering the impact of such costs on each well and per barrel produced. In addition, the Company has implemented measures to utilize cost effective energy sources for continuing production in a further effort to control costs. This consists principally of a large capacity boiler that is fueled principally by natural gas from the wells, which requires only supplementary propane and, because its large capacity heats the oil to higher temperatures, will reduce costs for well treatment chemicals and increases production efficiencies. Because of the foregoing, the Company expects that production costs per barrel will continue to decrease as additional wells are drilled and placed into production to obtain economics of scale and dilute the impact of fixed operating costs. In addition, operating costs may continue to vary materially due to the costs of ongoing treatment or reworking of existing wells and the impact of the other factors discussed above. The Company has only minor gas production which is used in operations to reduce energy costs. Title to Properties Substantially all of the Company's working interests are held pursuant to leases from third parties. The Company performs only a minimal title investigation before acquiring undeveloped properties, and a title opinion is typically obtained only prior to the commencement of drilling operations. The Company has obtained other documentary confirmation of title on its principal producing properties and believes that it has satisfactory title to such properties. The Company's properties are subject to customary royalty interests, liens for current taxes, and other common burdens which the Company believes do not materially interfere with the use of such properties and whose economic effect has been appropriately reflected in the Company's acquisition costs of such properties. Offices The Company's principal executive offices located at 12596 West Bayaud, Suite 300, Lakewood, Colorado 80228-2019, are rented from an unrelated party under a lease expiring September 1, 1998, and requiring monthly payments of $4,696, including certain common area charges. The Company also maintains a field operations office at 2561 South 560 West, Suite 200, Woods Cross, Utah 84087 requiring monthly payment of $1,063 on a month-to-month basis. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceeding, and none has been threatened by or, to the best of the Company's knowledge, against the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the shareholders during the fourth quarter of 1997. PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Reverse Stock Split Effective June 15, 1996, the Company effected a three-to-one reverse stock split of its issued and outstanding common stock ("Common Stock"). All share and per-share amounts in this report have been adjusted to give effect to such stock split. Price Range of Common Stock The Company's Common Stock is traded in the over-the-counter market and is quoted on Nasdaq under the symbol "FORL." The following table sets forth the high and low closing bid quotations for the Company's Common Stock as quoted by Nasdaq for the periods indicated, based on interdealer bid quotations, without markup, markdown, commissions, or adjustments (which may not reflect actual transactions). Common Stock High Low 1996 First Quarter............ $5.25 $3.65625 Second Quarter........... 4.875 3.1875 Third Quarter............ 7.0625 3.4375 Fourth Quarter........... 7.00 4.75 1997 First Quarter............ 5.6875 4.3125 Second Quarter........... 4.375 2.6875 Third Quarter ........... 3.50 2.0625 Fourth Quarter........... 5.00 3.375 On March 27, 1998, the closing bid price of the Company's Common Stock on Nasdaq was approximately $4.625. The Company has approximately 2,000 Common Stock shareholders of record. The market price for the Common Stock has been volatile in the past and could fluctuate significantly in response to the results of specific exploration drilling tests, variations in quarterly operating results, and changes in recommendations by securities analysts. Further, the trading volume of the Common Stock is relatively small, and the market for the Common Stock may not be able to efficiently accommodate significant trades on any given day. Consequently, sizable sales or purchases of the Common Stock have in the past, and may in the future, cause volatility in the market price of the Common Stock to a greater extent than in other more actively traded securities. Until more trading volume develops, larger transactions may not be able to be closed at the then current market price for the Common Stock. In addition, the securities markets regularly experience significant price and volume fluctuations that are often unrelated or disproportionate to the results of operations of particular companies. These broad fluctuations may adversely affect the market price of the Common Stock. The Company has granted to employees, officers, and directors vested options to purchase up to approximately 1.2 million shares of Common Stock with exercise prices ranging from $2.50 to $9.00 per share. Options to purchase a total of 94,000 shares contain a provision that, on exercise, the holder is granted a new option covering the number of shares for which the prior option was exercised, with the exercise price of the new option fixed at the then fair market value of the Common Stock. The Company also has outstanding options and warrants held by unrelated third parties to purchase over approximately 1.7 million shares of Common Stock at prices ranging from $3.75 per share to $12.00 per share. In addition, the Company has shares of outstanding preferred stock that are convertible into Common Stock and has agreed to grant warrants to purchase common stock on conversion of certain of such preferred stock. The existence of such options, warrants, and preferred stock may prove to be a hindrance to future financing by the Company, and the exercise of options and warrants and conversion of preferred stock may further dilute the interests of the stockholders. The possible future issuances of Common Stock on the exercise of options and warrants or the conversion of preferred stock could adversely affect the prevailing market price of the Company's Common Stock. Further, the holders of options and warrants may exercise them at a time when the Company would otherwise be able to obtain additional equity capital on terms more favorable to the Company. Dividend Policy The Company has never paid cash dividends on its Common Stock and does not anticipate that it will pay dividends in the foreseeable future. The Company intends to continue using any cash from operations to expand its business operations. The November 1996 line of credit agreement with the unaffiliated bank prohibited the payment of dividends. The line of credit was paid in full and closed January 1998. New debt financing with Energy Income Fund was established in 1998. Its terms also prohibit the payment of dividends on Common Stock. Unregistered Sales of Securities During 1997, the year covered by this report, the Company sold securities without registration under the Securities Act of 1933 (the "Securities Act") in the following transactions: 1 Individuals converted 56,666 shares of 1995 Preferred Stock into 18,888 shares of Common Stock, 12.5 shares of 1996 Preferred Stock into 6,202 shares of Common Stock and 255 shares of 1996-4 Preferred Stock into 1,101,782 shares of Common Stock. The shares of Common Stock issued in such conversions were issued without registration in reliance on the exemption from registration requirements of the Securities Act provided in Section 3(a)(9) thereof. 2 During 1997, the Company issued 71,759 shares of Common Stock as accrued dividends on the 1996 and 1996-4 Preferred Stock converted into Common Stock. 3 During the first quarter of 1997, the Company issued to Keith Mazer, an individual who participated in assisting the Company in selling its equity securities during 1996, an aggregate of 44,750 shares of Common Stock. 4 In January 1997, the Company issued 1,500 shares of Common Stock, to Barrow Street Research in connection with the preparation of reports for technical publications for use by investment brokerage houses and investment bankers. In December 1997, the board of directors of the Company approved the issuance of an additional 1,500 shares of Common Stock to Barrow Street Research. 5 During 1997, the Company issued an aggregate of 6,040 shares of Common Stock, together with cash payments of $25,000, to Tosca Sullivan & Dominek Pieretti in connection with the acquisition of oil and gas properties valued at approximately $50,000. Except as otherwise noted, the securities issued in the transactions described above were issued in reliance on the exemption from the registration and prospectus delivery requirements of the Securities Act provided in Section 4(2) thereof. Each purchaser was provided with business and financial information respecting the Company and was provided with the opportunity to obtain additional information in order to verify the information provided or to further inform themselves respecting the Company. Each of the persons acquiring such securities acknowledged in writing that such person was obtaining "restricted securities" as defined in rule 144 under the Securities Act; that such shares could not be transferred without registration or an available exemption therefrom; that such person must bear the economic risk of the investment for an indefinite period; and that the Company would restrict the transfer of the securities in accordance with such representations. Such persons also agreed that any certificates representing such shares would be stamped with a restrictive legend covering the transfer of such shares. The certificates representing the foregoing shares bear an appropriate restrictive legend conspicuously on their face, and stop transfer instructions are noted on the Company's stock transfer records. ITEM 6. SELECTED FINANCIAL DATA The following selected financial data of the Company for each of the past five years, including the period ended December 31, 1997, are derived from the audited financial statements and notes thereto of the Company. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements of the Company and related notes thereto included with this report. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 8. Financial Statements and Supplementary Data." The Company effected a three-to-one reverse stock split on June 15, 1996. All share and per share amounts herein have been retroactively adjusted to give effect to such reverse split.
Year Ended December 31, 1993 1994 1995 1996 1997 Statement of Operations Data: Revenues......................... $ 98,244 $542,991 $ 1,115,876 $2,018,816 $2,300,774 Net Loss......................... (3,578,254) (4,453,718) (2,275,565) (3,385,287) (3,129,900) Net Loss Applicable to Common Stockholders.................... (3,578,254) (4,453,718) (2,275,565) (5,715,489) (3,509,929) Net Loss Per Share............... (1.03) (1.03) (0.48) (0.99) (0.46) Weighted Average Number of Common Shares Outstanding.............. 3,468,000 4,330,000 4,757,000 5,752,000 7,656,400
December 31, 1993 1994 1995 1996 1997 Balance Sheet Data: Working Capital (Deficit) $677,980 $ 47,629 $(2,005,407) $2,340,858 $(495,155) Total Assets.................... 6,596,443 5,197,414 5,601,098 10,760,457 7,955,072 Long-Term Debt.................. - 400,000 23,091 1,018,247 642,951 Current Portion of Long-Term Debt - -- 404,237 4,844 25,301 Stockholders' Equity............. 5,521,402 3,708,472 3,012,872 8,884,365 6,456,288
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION Overview Since its organization in June 1985, the Company has been engaged principally in oil exploration in the Great Basin and Range of Nevada, an area that management believes is one of the most promising unexplored onshore domestic areas with potential for the discovery of major oil reserves. In continuing to advance this exploration, the Company's strategy is to generate exploration prospects with the most recent generally available scientific techniques, expand and improve the Company's strategic land position, and establish arrangements with other oil exploration firms active in Nevada to obtain additional scientific data, leases, and funding. Until 1994, the Company had only limited revenue, consisting of modest amounts of interest income earned on net proceeds from the sale of securities and revenue from producing properties. In order to supplement its own exploration efforts, between 1993 and 1995, the Company acquired certain leases and properties in Railroad Valley, Nevada, including the Eagle Springs field. Since acquiring the Eagle Springs field, the Company has reworked and returned to production eleven acquired wells, drilled a new water injection well, drilled and placed into production eight additional wells, replaced and improved surface equipment to handle increased production and to lower long-term operating costs, completed a 3-D seismic evaluation program, and implemented an EOR program. These efforts were funded in part between August 1994 and November 1996, by Barrett, which then held a 40% working interest in the field. In November 1996, the Company utilized proceeds from the sale of securities and its bank credit facility to purchase Barrett's 40% working interest in the Eagle Springs field for $2.4 million, effective August 1, 1996. The Eagle Springs field has been the Company's principal producing property since 1994. During 1997, the Company acquired leases to 3,200 additional acres in and adjacent to the Eagle Springs field and on which the Kate Springs well is located. During 1996, the Company's production and reserves increased substantially as a result of its discovery of the Ghost Ranch field. During 1997, the Company drilled and placed into production two additional wells in the Ghost Ranch field. These drilling activities were funded in part by Barrett, which held a 40% interest in the Ghost Ranch field. In January 1998, the Company utilized funds drawn from a recently established credit facility to purchase Barrett's 40% working interest in the Ghost Ranch field for $470,000, including adjustment for oil inventory and accrued expenses, effective December 31, 1997. During 1997, the Company utilized existing capital resources to drill additional wells in the Ghost Ranch and Eagle Springs field, develop a pilot study on an EOR program for the Eagle Springs field, and initiate the EOR pilot program. The auditor's report on the financial statements of the Company as of December 31, 1997, contains an explanatory paragraph as to the ability of the Company to continue as a going concern because of its continuing losses from operations. The Company had a working capital deficit as of December 31, 1997, of $(495,200). The initial cash drawn of $5,280,000 under the financing arrangement was allocated for certain accrued EOR and exploration costs and further 1998 specified development, 3D seismic data acquisition, and exploration drilling. The Company believes that the projected cash from operations, including the additional revenues expected to be received from development work to be completed during the year, will be sufficient to meet its anticipated cash requirements for 1998, while funds from the initial draw-down under its debt financing as well as further advances will fund significant exploration during the year. Results of Operations 1997 and 1996 Oil sales increased $255,000, or 13.0%, to $2,213,300 in 1997 as compared to 1996, consisting principally of an increase of $449,700 in Ghost Ranch field revenue offset by a $169,200 decrease in Eagle Springs field revenue and a $25,500 decrease in the revenue from the from the Company's other properties. The increase in total oil revenue was the result of an increase of 51.6% in barrels of oil sold and a decrease of 21.5% in the average price per barrel of oil sold. Operating and well service revenue increased $19,800, or 37.5%, to $72,800 in 1997 as compared to 1996, due to the drilling of two additional Ghost Ranch wells and production overhead charges on the three Ghost Ranch wells during 1997 Oil and gas production cost for 1997 increased $374,000, or 70.1%, reflecting the general increase in production during 1997. Per barrel production expense increased $1.02 per barrel, or 25.4%, to $5.03 in 1997, as compared to $4.01 per barrel in 1996. The Eagle Springs field contributed $173,100 of the increase, partially due to workover cost on the water injection well. Additionally the Ghost Ranch field contributed $142,600 of the increase due to two additional wells beginning operations in 1997, and the Company's remaining wells contributed $58,300 to the increased oil and gas production cost. Oil and gas exploration cost increased $418,400, or 50.2%, to $1,252,800 in 1997 as compared to a year earlier as a result of the Company's increased exploration activity. Primary contributors were exploration personnel cost increase of $208,600, while 3-D seismic cost increased $129,500 when compared to the prior year's activity, and cost associated with lease rentals in 1997 increased $30,600 when compared to 1996. During 1997, dry hole, abandonment and impairment costs decreased $906,900, or 61.0 %, to $578,900 as compared to 1996. The 1997 expenses includes $411,000 in impairment expense related to a well in progress at the end of 1996 that was determined to be uneconomic. The Company also expensed $154,400 in capitalized leasehold cost associated with leases that expired at the end of their primary term. General and administrative expenses increased $356,900, or 62.8% to $925,300 for 1997 as compared to 1996. Administrative personnel cost increased $175,400 and a non-cash compensation charge of $147,000 associated with the overriding royalty interest conveyed as part of an employee termination agreement was recognized in 1997. Shareholder/investor services decreased $865,500 during 1997 to $192,700 as compared to 1996. This decrease relates to a reduction in the number of investor relations advisors. During 1996 the company incurred a non-cash expense of $418,000 resulting from the application of SFAS 123, Accounting for Stock Based Compensation. (See Note 8 to Notes to Consolidated Financial Statements.) The Company did not have any such investor related expenses in 1997. During 1997 compensation for below market options increased $25,800, or 16.2% when compared to 1996. These were primarily for options associated with debt retirement for four officers and directors. Depreciation, depletion and amortization increased $577,200, or 81.1%, in 1997 to $1,288,800 as compared to the previous year. The 1997 increase was due principally to a significant increase in production combined with a decrease in reserves. The December 31, 1997, oil prices adversely affect the reserve quantity of the Company's reserves. Lower reserves and increased oil sales for 1997 increased the percentage used to calculate the depletion for 1997. During 1997, net loss applicable to common stockholders was increased by dividends of $164,000 incurred on preferred stock converted during the year and imputed dividends of $216,000, as a result of convertibility of its outstanding preferred stock into common stock at below-market prices. These amounts are for earnings per share calculations only and are not recorded in the Company's financial statements. 1996 and 1995 Oil sales increased $941,000, or 92.5%, to $1,958,000 in 1996 as compared to 1995, consisting principally of a $875,800 increase in Eagle Springs field revenue, including $261,700 from the purchase of Barrett's 40% working interest in the field on November 15, 1996 and $259,800 in revenue from the newly discovered Ghost Ranch well. The increase in total oil revenue was the result of an increase of 34.1% in barrels produced and 36.0% in the average sales price of oil. Subsequent to December 31, 1996, oil prices have declined, but total barrels produced continued to increase as an additional Ghost Ranch well began production. Operating and well service revenue decreased $19,000, or 26.2%, to $53,000 in 1996 as compared to 1995, due to the purchase of Barrett's 40% interest in the Eagle Springs field. Other income during 1996 decreased $19,000, or 72.0%, to $8,000 as compared to 1995, because of reduced equipment rental and reduced sales of equipment inventory. Oil and gas production costs for 1996 increased $109,000, or 25.7%, reflecting the general increase in production during 1996. However, per barrel production expense declined $0.83 per barrel, or 17.1%, to $4.01 in 1996, as compared to $4.84 per barrel in 1995, as a result of the spread of fixed production costs over an increased number of barrels produced, utilizing previous excess field operations capacity. Oil and gas exploration costs increased $216,000, or 34.8%, to $834,000 in 1996 as compared to a year earlier as a result of the Company's increased exploration activity, particularly during the latter half of 1996. During 1996, dry hole, abandonment, and impairment costs increased $760,000, or 104.8%, to $1,486,000, as compared to 1995, again reflecting the Company's increased exploration activity during 1996. This item includes $940,900 in expenses during 1996 for test wells that were plugged and abandoned as well as an impairment charge of $529,900, $429,900 of which was a result of the adoption of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets. (See Note 1 to Notes to Consolidated Financial Statements.) General and administrative expenses were approximately equal for 1996 and 1995, During early 1996, the Company implemented certain cost containment measures due to temporary shortages of working capital and in the last part of 1996 increased its general and administrative resources to manage increased activities following the receipt of proceeds from the sales of securities during the year. Shareholder/investor services increased $852,000, or over four fold, during 1996 to $1,058,000 as compared to 1995. This increase relates to repositioning the Company in the investment community in connection with the three-to-one reverse stock split effected June 15, 1996, the engagement of investor relations advisors, and the preparation and publication of Company information. Of such amount, $418,000 is a non-cash expense resulting from the promulgation of SFAS 123, Accounting for Stock Based Compensation. (See Note 8 to Notes to Consolidated Financial Statements.) The Company does not expect that such expenditures in similar amounts will continue. During 1996, for the first time in any of the three most recent fiscal years, the Company recognized expenses for the issuance of options with an exercise price below market as of the date of grant for a total of $159,500. Depreciation, depletion and amortization decreased $151,000, or 17.5% in 1996, to $712,000 as compared to the previous year. The 1996 decrease was due principally to unusually high depletion recognized in 1995 which related to a marginal property with relatively high costs and increased reserves in 1996, which were the result of the discovery of the Ghost Ranch field and generally higher oil prices during 1996. During 1996, net loss was increased by dividends of $85,000 related to preferred stock outstanding during the year. These dividends were paid or are payable in Common Stock. The Company incurred no such dividends in either of the preceding years. A portion of the shares of preferred stock on which dividends were incurred during 1996 remain outstanding, so additional dividends will be incurred in 1997. During 1996, net loss applicable to common stockholders increased by dividends of $85,200 incurred on preferred stock outstanding during the year and imputed dividends of $2.2 million, as a result of convertibility of its outstanding preferred stock into common stock at below- market prices. These amounts are for earnings per share calculations and are not recorded in the Company's financial statements. Accounting Treatment of Certain Capitalized Costs The Company follows the "successful efforts" method of accounting for oil and gas producing activities. Costs to acquire mineral interests in oil and gas properties, to drill and equip exploratory wells that find proved reserves, and to drill and equip development wells are capitalized. Costs to drill exploratory wells that do not find proved reserves, geological and geophysical costs, and costs of carrying and retaining unproved properties are expensed. Included in oil and gas properties on the Company's balance sheets are costs of wells in progress. As of December 31, 1997, the Company had net capitalized costs of approximately $420,000 related to a well in progress. Such costs are capitalized until a decision is made to plug and abandon or, if the well is still being evaluated, until one year after reaching total depth, at which time such costs are charged to expense, even though the well may subsequently be placed into production. During 1996 the Company was required to adopt a new accounting policy that requires it to assess the carrying cost of long-lived assets whenever events or changes of circumstances indicate that the carrying value of long lived assets may not be recoverable. When an assessment for impairment of oil and gas properties is performed, the Company is required to compare the net carrying value of proved oil and gas properties on a lease by lease basis (the lowest level at which cash flows can be determined on a consistent basis) to the related estimates of undiscounted future net cash flows for such properties. If the carrying value exceeds the net cash flows, then impairment is recognized to reduce the carrying value to the estimated fair value. As a result of the adoption of this new accounting policy, at December 31, 1996, the Company recognized an impairment charge of $429,900 during the first quarter of 1996, and an impairment charge of $411,000 in the fourth quarter of 1997. The Company expects that from time to time capitalized costs will be charged to expense based on management's evaluation of specific wells or properties or the disposition, through sales or conveyances of fractional interests in connection with industry sharing arrangements, of property interests. As part of the Company's evaluation of its oil and gas reserves in connection with the preparation of the Company's annual financial statements, the Company completes an engineering evaluation of its properties based on current engineering information, oil and gas prices, and production costs, which may result in material changes in the total undiscounted net present value of the Company's oil and gas reserves and may, therefore, result in an impairment allowance as discussed above. See "Item 2. Properties." Certain costs The costs of exploring, drilling, producing, and transporting are higher in the geological province targeted by management than they would be in a more fully developed oil producing area. Access roads to drilling targets over relatively long distances frequently have to be completed, drilling equipment and services typically must be brought in from considerable distances, and there is no collection pipeline so that any oil that is produced must be trucked to a refinery, the nearest of which is in Salt Lake City, Utah, a distance of several hundred miles. Liquidity and Capital Resources Previous Periods Historically the Company has obtained cash required for its operating and investing requirements from financing activities, principally the sale of equity securities. The Company's operations used net cash of $495,200 in 1997 when the Company reported a net loss of $3,129,900. The 1997 loss included non-cash expenses of $579,000 for abandonment's and impairments (including a $411,000 impairment of a well in progress at the end of 1996 that was determined to be uneconomic (see Accounting Treatment of Certain Capitalized Cost), $1,288,800 for depreciation, depletion and amortization, and $185,400 for below market options. Components of working capital requiring cash expenditures included $102,200 used to reduce accounts payable and accrued expenses, and $30,600 for prepaid expenses and other miscellaneous assets. Components of working capital providing cash are a reduction of accounts receivable of $522,700, use of existing inventory of $19,500 and an increase of officers and other salaries payable of $78,600. This is compared to the Company's operations that used net cash of $1,648,000 in 1996 when the Company reported a net loss of $3,385,000. The 1996 loss included non- cash expenses of $1,486,000 for abandonment's and impairments (including a $429,000 impairment resulting from the adoption of a new accounting policy), $712,000 for depreciation, depletion, and amortization, $418,000 for the issuance of stock options for services, and $160,000 for below market stock options. Components of working capital requiring cash expenditures included $568,000 used to reduce accounts payable and accrued expenses, $337,000 for increases in accounts receivable, and $107,000 for payments of officers' salaries payable. Investing activities required cash of $1,477,300 in 1997, including approximately $1.4 million for additions to oil and gas properties, conversion cost for an air injection well for the pilot EOR program in the Eagle Spring field and the completion of two Ghost Ranch wells. Additionally the Company used $71,900 to purchase other property and equipment. Investing activities in 1996 required cash of $5,356,200, including approximately $2.4 million for the purchase of Barrett's 40% working interest in the Eagle Springs field and approximately $2.9 million for additions to oil and gas properties, principally the successful drilling in the Ghost Ranch field. As noted above, cash required for both operating and investing activities was provided from financing activities during each of the fiscal years ending December 31, 1995 and 1996. Financing activities for 1997 used $353,200, primarily for the payment of debt associated with the credit facility with Colorado National Bank. During 1996 financing activities provided cash of $9,299,000, including net cash of $8,270,000 from the issuance of equity securities and $625,000 in net proceeds from borrowings after $404,000 was repaid to retire previous indebtedness and $1,000,000 drawn from the Company's newly established bank credit facility. In November 1996, the Company established a $10,000,000 credit facility with a commercial bank, collateralized by the Company's Eagle Springs and Ghost Ranch producing properties and related assets. In January 1998 the Company paid in full the monies owed under this revolving credit agreement with proceeds from its new larger debt financing, discussed below. In addition to the above, the Company's oil and gas exploration and production activities were also advanced by approximately $2,345,000, $698,000, and $868,000 provided during 1995, 1996, and 1997, respectively, by others under industry sharing arrangements related to specific drilling or other exploration. Debt Financing In January 1998, the Company completed a $16.9 million debt financing with Energy Income Fund. The funds will be used in the enhanced oil recovery program and development drilling in the Eagle Springs field, 3D seismic acquisition, the drilling of 3D defined exploration targets, the acquisition of producing properties, and to retire existing debt. In January 1998, the Company borrowed $3,585,000 of its new available debt financing to fund the implementation of a high pressure air injection program, including compressors and buildings in the Company's Eagle Springs field, a 3D seismic program on the Company's Pine Creek property, the retirement of existing debt and the payment of closing costs. An additional $1,846,000 was placed into an escrow account to fund the drilling and completion of two development wells and one exploratory well. Pursuant to the terms of the financing arrangement, the Company is required to make payments of interest only through November 1998, after which payments of principal and interest are required to amortize the indebtedness generally over a 48-month period; provided, however, that the final payment of all accrued but unpaid interest and the remaining principal balance is due on January 1, 2002. The Company also agreed to transfer to Energy Income Fund a 3% overriding royalty interest in the Company's interest in the Company's proved oil and gas properties and a 1% overriding royalty interest in certain unproved properties. Amounts due under the financing arrangement are collateralized by oil and gas properties and the Company is required to maintain certain financial ratios and comply with other terms and conditions while any balance of indebtedness remains outstanding. The Company has issued to Energy Income Fund five-year warrants to purchase 750,000 shares of common stock at $6.00 per share and 250,000 shares at $10.00 per share. The Company granted Energy Income Fund the right to designate a representative for appointment to the Board of Directors of the Company. Current Position/Future Requirements The Company had a working capital deficit as of December 31, 1997, of $495,200. In January 1998 the Company entered in an agreement with Energy Income Fund-Associated Energy Managers for a $16.9 million debt financing, which is available for certain projects. The initial cash drawn of $5,280,000 under the financing arrangement was allocated for certain accrued EOR and exploration costs and further 1998 specified development, 3D seismic data acquisition, and exploration drilling. The Company believes that the projected cash from operations, including the additional revenues expected to be received from development work to be completed during the year, will be sufficient to meet its anticipated cash requirements for 1998, while funds from the initial draw-down under its debt financing as well as further advances will fund significant exploration during the year. Based on current oil prices, the Company's net production revenue alone is not currently sufficient to meet all of its cash requirements for oil and gas production costs, general and administrative expenses, ongoing shareholder/investor relations, property maintenance expenditures, and payments of indebtedness. The EOR program started in the Eagle Springs field is proceeding as planned and based on initial results, the Company believes this this program will lead to increased oil production from this field. The Company believes that the increase in production should provide the Company sufficient funds to meet its cash requirements for its oil production cost, general and administrative expenses, ongoing shareholder/investor relations, property maintenance expenditures and payment of indebtedness. Of course, there can be no assurance that production quantities or oil prices will not decline further, which may contribute to operating cash shortages. The Company has formed an industry exploration group and conducted a 3D seismic study in Pine Valley, Nevada, to define additional targets for drilling during 1998. The exploration staff is currently evaluating the data provided by the 3D seismic study to determine future drilling sites. The reserve engineer's report indicates that there are four drilling sites in the Eagle Springs field; however the Company believes that that there are additional locations that would be step-out drilling locations that would enlarge the Eagle Springs field. The Company spudded the Eagle Springs 44-35 well on one of the step-out locations and is currently waiting for the well to be completed. The Company estimates that on the reserve engineer's four locations in the Eagle Springs field, drilling and completion costs are approximately $2,200,000 for the year if all wells are drilled. The Company is exploring the possible purchase of additional production to increase the Company's financial security and stability as it continues its exploration. As part of this effort, in January 1998, the Company acquired the 40% minority interest of Barrett in the Ghost Ranch field for $500,000, with an effective date of December 31, 1997. The Company is pursuing opportunities to purchase other properties that will require additional debt and equity financing. One such property is the Petro Source refinery. There can be no assurance that the Company can negotiate the acquisition of any properties or that the Company will be able to obtain funds that may be required or that such funds can be obtained on terms favorable to the Company. The nature, extent, and cost of exploring prospects in the Great Basin province over several years cannot be predicted, but the total cost could amount to tens of millions of dollars. Because of the size of the total exploration possibilities and the Company's limited resources, it is likely that the interest of the Company's shareholders in the Company and the interest of the Company in its drilling prospects will continue to be diluted substantially as the Company continues to obtain funding through the sale of additional securities or through sharing arrangements with industry participants. There can be no assurance that exploration funds will be available to the Company when required or, if available, that such funds can be obtained on terms acceptable or favorable to the Company. The Company may also utilize funds available under its new credit facility, cash now budgeted for exploration and development, as well as proceeds from the sale of additional equity securities or new borrowings to complete strategic corporate acquisitions. No acquisition has been targeted, and there can be no assurance that any acquisition will be completed at all or on terms favorable to the Company. Inflation The Company's activities have not been, and in the near-term are not expected to be, materially affected by inflation or changing prices in general. The Company's oil exploration and production activities are generally affected by prevailing sales prices for oil, however, and material price declines may make wells with low rates of production uneconomical to operate. Because of the size of potential discoveries in Nevada, the Company does not expect that short term declines in oil prices would materially affect its exploration activities. Impact of the Year 2000 Issue Many existing computer programs use only two digits, rather than four, to define a year within the date field in order to conserve memory resources. Such programs were designed and developed without considering the potential impact of the upcoming change of the century. The Company uses computers principally for processing and analyzing geophysical and geophysical data, map-making, and administrative functions, including word-processing, accounting, and other applications. After December 31, 1999, any of the computer programs used by the Company that contain date-sensitive computer codes that are not "year 2000 compliant," may recognize a date using "00" as the year 1900 rather than the year 2000. If not corrected, such computer applications could fail or create erroneous results. The Company has contacted its vendors who have represented that the systems and software used by the Company are year 2000 compliant. The Company will require future vendors to make such representation. There can be no assurance that such programs are actually year 2000 compliant. The Company also interacts with the computer systems of others. There can be no assurance that such computer systems are year 2000 compliant. The Company believes that it will not incur material expenditures in connection with this issue, but there can be no assurance that the Company has anticipated every circumstance where the Company's operations may be impacted. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The table of contents of the financial statements and supplementary data included in this report is contained in "ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K." ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT The information from the definitive proxy statement for the 1998 annual meeting of stockholders under the caption "1. ELECTION OF DIRECTORS: Directors and Executive Officers" is incorporated herein by reference. The business of the Company is dependent on its management and technical team and their substantial Nevada exploration experience, the loss of any one of whom could adversely affect the Company's proposed activities. The Company does not have and does not intend to acquire key man life insurance on any of its executives. ITEM 11. EXECUTIVE COMPENSATION The information from the definitive proxy statement for the 1998 annual meeting of stockholders under the caption "1. ELECTION OF DIRECTORS: Executive Compensation" is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information from the definitive proxy statement for the 1998 annual meeting of stockholders under the caption "1. ELECTION OF DIRECTORS: Certain Beneficial Owners and Management" is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information from the definitive proxy statement for the 1998 annual meeting of stockholders under the caption "1. ELECTION OF DIRECTORS: Certain relationships and Related Transactions" is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) Financial Statements. The following financial statements are included in this report: Title of Document Page Table of Contents F-1 Report of Hein + Associates LLP, Certified Public Accountants F-2 Consolidated Balance Sheets - As of at December 31, 1996 and 1997 F-3 Consolidated Statements of Operations - For the Years Ended December 31, 1995, 1996, and 1997 F-5 Consolidated Statements of Stockholders' Equity - For the Years Ended December 31, 1995 1996, and 1997 F-6 Consolidated Statements of Cash Flows - For the Years Ended December 31, 1995, 1996, and 1997 F-8 Notes to Consolidated Financial Statements F-10 (a)(2) Financial Statement Schedules. Schedules are omitted because of the absence of conditions under which they are required or because the information is shown in the financial statements. (a)(3) Exhibits. The following exhibits are included as part of this report Exhibits SEC Exhibit Reference No. No. Title of Document Location Item 3. Articles of Incorporation and Bylaws 3.01 3 Articles of Incorporation Incorporated by Reference(15) 3.02 3 Bylaws Incorporated by Reference(2) Instruments Defining the Rights of Security Holders, Including Indentures Item 4. 4.01 4 Specimen Common Stock Certificate Incorporated by Reference(1) 4.02 4 Designation of Rights, Privileges, and Incorporated Preferences of 1991 Series Preferred by Stock Reference(1) 4.03 4 Designation of Rights, Privileges and Incorporated Preferences of 1994 Series Convertible by Preferred Stock Reference(3) 4.04 4 Designation of Rights, Privileges and Incorporated Preferences of 1995 Series Convertible by Preferred Stock Reference(7) 4.05 4 Designation of Rights, Privileges and Incorporated Preferences of 1996 by Series 6% Convertible Preferred Stock Reference(8) 4.06 4 Designation of Rights, Privileges and Incorporated Preferences of 1996-2 Series 6% by Convertible Preferred Stock Reference(9) 4.07 4 Designation of Rights, Privileges and Incorporated Preferences of 1996-3 Series 8% by Convertible Preferred Stock Reference(9) 4.08 4 Certificate of Designation of 1996-4 Incorporated Series Preferred Stock by Reference(10) 4.09 4 Form of Underwriter's Warrant to Purchase Incorporated Units by Reference(5) 4.10 4 Form of Warrant Agreement between the Incorporated Company and Atlas Stock Transfer by Corporation relating to M Warrants Reference(7) 4.11 4 Form of Warrants to Kevin L. Spencer and Incorporated Jay W. Enyart by Reference(9) 4.12 4 Warrant to First Geneva Holdings, Inc., Incorporated relating to offering of 1996 Preferred by Stock Reference(9) 4.17 4 Form of Warrant to placement agent and Incorporated assigns relating to offer of 1996-4 by Series Preferred Stock, with related Reference(10) schedule 4.18 4 Form of First Amendment to the Incorporated Designation of Rights, Privileges, and by Preferences of 1996-2 Series 6% Reference(13) Convertible Preferred Stock 4.19 4 Designation of Rights, Privileges and Incorporated Preferences of Series A Preferred Stock by Reference(14) 4.20 4 Form of Rights Agreement dated effective Incorporated April 12, 1997, between the Company and by Atlas Stock Transfer Corporation Reference(14) 4.21 4 Warrant of Energy Income Fund, L.P., Incorporated dated January by 6, 1998, to purchase 750,000 shares of Reference(16) common stock at $6.00 per share 4.22 4 Warrant of Energy Income Fund, L.P., Incorporated dated January by 6, 1998, to purchase 250,000 shares of Reference(16) common stock at $10.00 per share Item 10. Material Contracts 10.01 10 Option Agreement between N. Thomas Steele Incorporated and Foreland Corporation, dated June 24, by 1985** Reference(6) 10.02 10 Option Agreement between Kenneth L. Incorporated Ransom and Foreland Corporation, dated by June 24, 1985** Reference(6) 10.03 10 Option Agreement between Grant Steele and Incorporated Foreland Corporation, dated June 24, by 1985** Reference(6) 10.04 10 Form of Options to directors dated April Incorporated 30, 1991 with respect to options by previously granted 1986** Reference(1) 10.05 10 Form of Stock Appreciation Rights Incorporated Agreement between the Company and by officers, with related schedule** Reference(4) 10.06 10 Form of Nonqualified Stock Option between Incorporated the Company and unrelated third parties, by with related schedule Reference(4) 10.07 10 Form of Promissory Notes relating to Incorporated certain options exercised by officers, by with related schedule Reference(5) 10.08 10 Form of Option granted pursuant to reload Incorporated provisions of previously granted options by with related schedule* Reference(5) 10.09 10 Form of Registration Agreement relating Incorporated to Units consisting of 1995 Series by Preferred Stock and M Warrants Reference(7) 10.10 10 Crysen Refining, Inc., document Incorporated respecting extension of Crude Oil by Purchase Agreement Reference(7) 10.11 10 Form of Registration Agreement relating Incorporated to 1996 Series Convertible Preferred by Stock Reference(9) 10.12 10 Form of Revised Executive Employment Incorporated Agreement between the Company and by executive officers, with related Reference(10) schedule** 10.13 10 Form of Nonqualified Stock Options Incorporated granted to executive officers dated July by 18, 1996, with related schedule** Reference(10) 10.14 10 Form of Nonqualified Stock Options Incorporated granted to executive officers in by connection with employment agreements, Reference(10) with related schedule** 10.15 10 Form of Nonqualified Stock Options Incorporated granted to employees in connection with by employment agreements, with related Reference(10) schedule 10.16 10 Form of Registration Rights Agreement Incorporated relating to offer of 1996-4 Series by Preferred Stock, with related schedule Reference(10) 10.17 10 Purchase and Sale Agreement dated Incorporated November 14, 1996, between Plains by Petroleum Operating Company and Eagle Reference(11) Springs Production Limited Liability Company, respecting the purchase of Plains' interest in the Eagle Springs field, with related Assignment, Conveyance, and Bill of Sale 10.18 10 Purchase Contract Confirmation dated Incorporated September 1, 1996, between Foreland by Corporation and Petro Source Refining Reference(12) Partners 10.19 10 Revolving Credit Agreement dated November Incorporated 13, 1996, by and among Foreland by Corporation, Eagle Springs Production Reference(13) Limited Liability Company, and Colorado National Bank 10.20 10 Promissory Note dated November 13, 1996 Incorporated by Foreland Corporation and Eagle Spring by Production Limited Liability Company Reference(13) 10.21 10 Financing Agreement dated as of January Incorporated 6, 1998, by and among the Company, Eagle by Springs Production Limited Liability Reference(16) Company and Energy Income Fund, L.P. 10.22 10 Refinancing Note dated as of January 6, Incorporated 1998, by the Company and Eagle Springs by Production Limited Liability Company Reference(16) 10.23 10 Development Note dated as of January 6, Incorporated 1998, by the Company and Eagle Springs by Production Limited Liability Company Reference(16) 10.24 10 Acquisition Note dated as of January 6, Incorporated 1998, by the Company and Eagle Springs by Production Limited Liability Company Reference(16) 10.25 10 Deed of Trust, Security Agreement, Incorporated Assignment of Production and Proceeds, by Financing Statement and Fixture Filing Reference(16) dated as of January 6, 1998, by and among the Company, Eagle Springs Production Limited Liability Company, First American Title Company of Nevada, and Energy Income Fund, L.P. 10.26 10 Assignment of Overriding Royalty Interest Incorporated dated effective as of January 1, 1998, of by a 3% net revenue interest from the Reference(16) Company and Eagle Springs Production Limited Liability Company to Energy Income Fund, L.P. 10.27 10 Assignment of Overriding Royalty Interest Incorporated dated effective as of January 1, 1998, of by a 1% net revenue interest from the Reference(16) Company and Eagle Springs Production Limited Liability Company to Energy Income Fund, L.P. 10.28 10 Option and Purchase Agreement between This Filing* Foreland Corporation and Petro Source Corporation re the purchase of Petro Source Transportation dated effective December 31, 1997 10.29 10 Purchase and Sale Agreement dated This Filing* effective December 31, 1998, between Foreland Corporation and Plains Petroleum Operating Company 10.30 10 Purchase Contract Confirmation dated This Filing* effective December 15, 1997, between Foreland Corporation and Petro Source Refining Partners Item 23. Consents of Experts and Counsel 23.01 23 Consent of Hein + Associates LLP, This Filing* certified public accountants 23.02 23 Consent of Malkewicz Hueni Associates, This Filing* Inc. Item 27. Financial Data Schedule 27.01 Financial Data Schedule This Filing* (1) Incorporated by reference from the Company's registration statement on form S-2, SEC file number 33-42828. (2) Incorporated by reference from the Company's registration statement on form S-1, SEC file number 33-19014. (3) Incorporated by reference from the Company's registration statement on form S-1, SEC file number 33-81538. (4) Incorporated by reference from the Company's registration statement on form S-2, SEC file number 33-64756. (5) Incorporated by reference from the Company's registration statement on form S-2, , SEC file number 33-86076. (6) Incorporated by reference from the Company's annual report on form 10-K for the fiscal year ended December 31, 1985. (7) Incorporated by reference from the Company's annual report on form 10-K for the fiscal year ended December 31, 1994. (8) Incorporated by reference from the Company's annual report on form 10-K for the fiscal year ended December 31, 1995. (9) Incorporated by reference from the Company's registration statement on form S-3, SEC file number 333-3779. (10) Incorporated by reference from the Company's quarterly report on form 10-Q for the period ending September 30, 1996. (11) Incorporated by reference from the Company's interim report on form 8-K dated November 15, 1996. (12) Incorporated by reference from the Company's registration statement on form S-3, SEC file number 333-19063. (13) Incorporated by reference from the Company's annual report on form 10-K for the fiscal year ended December 31, 1996. (14) Incorporated by reference from the Company's interim report on form 8-K dated May 12, 1997. (15) Incorporated by reference from the Company's registration statement on form S-3, SEC file number 333-37793. (16) Incorporated by reference from the Company's interim report on form 8-K dated January 6, 1998. * Filed as an exhibit to this annual report on Form 10-K. ** Identifies each management contract or compensatory plan or arrangement required to be filed as an exhibit. (b) Reports on Form 8-K. During the last quarter of the fiscal year ended December 31, 1997, the Company filed reports on form 8-K as follows: Date of Event Reported Item Reported October 21, 1997 Item 5. Other Events SIGNATURES Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FORELAND CORPORATION Dated: March 31, 1998 By /s/ N. Thomas Steele, President Pursuant to the requirements of the Securities Exchange of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Dated: March 31, 1998 /s/ N. Thomas Steele, President and Director (Principal Executive and Financial Officer) ted: March 31, 1998 /s/ Grant Steele, Director Dated: March , 1998 Bruce C. Decker, Director Dated: March 31, 1998 /s/ Don W. Treece, Controller (Principal Accounting Officer) Dated: March , 1998 Robert D. Gershen, Director Dated: March 31, 1998 /s/ Lee Brian Van Ramshorst, Director INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE Independent Auditor's Report................................................F-2 Consolidated Balance Sheets - As of December 31, 1996 and 1997..............F-3 Consolidated Statements of Operations - For the Years Ended December 31, 1995, 1996, and 1997.........................................................F-5 Consolidated Statements of Stockholders' Equity - For the Years Ended December 31, 1995, 1996, and 1997......................................F-6 Consolidated Statements of Cash Flows - For the Years Ended December 31, 1995, 1996, and 1997.........................................................F-8 Notes to Consolidated Financial Statements.................................F-10 INDEPENDENT AUDITOR'S REPORT Board of Directors Foreland Corporation Lakewood, Colorado We have audited the accompanying consolidated balance sheets of Foreland Corporation and subsidiaries as of December 31, 1996 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit 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 Foreland Corporation and subsidiaries as of December 31, 1996 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the real- ization of assets and liquidation of liabilities in the normal course of business. As discussed in Note 2 to the financial statements, the Company has suffered losses from inception. This condition raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also discussed in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. As discussed in Note 1, the Company changed its method of accounting for impairment of long-lived assets during 1996. HEIN + ASSOCIATES LLP Denver, Colorado March 21, 1998 FORELAND CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, -------------------------- 1996 1997 ------------ ------------ ASSETS CURRENT ASSETS: Cash and equivalents $ 2,325,079 $ 40,631 Accounts receivable 775,039 245,041 Inventory 80,568 61,108 Prepaid expenses and other 18,017 11,998 ------------ ------------ Total current assets 3,198,703 358,778 PROPERTY AND EQUIPMENT, at cost: Oil and gas properties, under the successful efforts method 10,575,655 11,878,336 Furniture, equipment, and vehicles 340,476 362,171 ------------ ------------ 10,916,131 12,240,507 Less accumulated depreciation, depletion and amortization (3,504,719) (5,346,333) ------------ ------------ 7,411,412 6,894,174 OTHER ASSETS: Option to acquire Petro Source Refining Corporation - 520,000 Deposits and other 150,342 180,220 ------------ ------------ Total other assets 150,342 700,220 ------------ ------------ TOTAL ASSETS $10,760,457 $ 7,953,172 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of long-term debt $ 4,844 $ 25,301 Accounts payable and accrued expenses 479,105 424,769 Officers' salaries payable 285,721 364,276 Oil and gas sales payable 88,175 39,587 ------------ ------------ Total current liabilities 857,845 853,933 LONG-TERM DEBT, less current maturities 1,018,247 642,951 COMMITMENTS (Notes 2, 3, and 7) STOCKHOLDERS' EQUITY: Preferred stock, $.001 par value, 5,000,000 shares authorized: 1991 Convertible Preferred Stock, 40,000 shares issued and outstanding, liquidation preference of $50,000 40 40 1994 Convertible Redeemable Preferred Stock, 165,140 shares issued and outstanding, liquidation preference of $330,280 165 165 1995 Convertible Redeemable Preferred Stock, 613,334 and 556,667 shares issued and outstanding, liquidation preference of $920,000 and $835,000 613 557 1996 Series 6% Convertible Preferred Stock, issued and outstanding 12.5 shares in 1996, liquidation preference of $13,090 in 1996 - - 1996-4 Preferred Stock, issued and outstanding 255 shares in 1996, liquidation preference of $2,573,474 in 1996 - - Common stock, $.001 par value, 50,000,000 shares authorized; 7,238,177 and 8,467,703 shares issued and outstanding, respectively 7,238 8,468 Additional paid-in capital 32,568,175 32,486,345 Less stock subscriptions receivable (1,094,237) (311,758) Accumulated deficit (22,597,629) (25,727,529) ------------ ------------ Total stockholders' equity 8,884,365 6,456,288 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $10,760,457 $ 7,953,172 ============ ============ See accompanying notes to these consolidated financial statements. FORELAND CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, ------------------------------------- 1995 1996 1997 ----------- ----------- ------------ REVENUE: Oil sales $ 1,017,401 $1,958,348 2,213,336 Operator and well service revenue 71,722 52,945 72,782 Other income, net 26,753 7,523 14,626 ----------- ----------- ------------ Total revenue 1,115,876 2,018,816 2,300,744 EXPENSES: Oil production 424,445 533,339 907,332 Oil exploration 618,895 834,407 1,252,838 Dry hole, abandonment, and impairment costs 725,648 1,485,820 578,888 General and administrative 568,974 568,348 925,287 Shareholder/investor services: Fair value of options under FAS 123 - 418,000 - Other 206,326 640,145 192,664 Below market stock options - 159,500 185,371 Bad debt expense - - 36,241 Depreciation, depletion, and amortization 862,563 711,608 1,288,780 ----------- ----------- ------------ Total expenses 3,406,851 5,351,167 5,367,401 ----------- ----------- ------------ OPERATING LOSS (2,290,975) (3,332,351) (3,066,657) OTHER INCOME (EXPENSE): Interest income 140,688 107,234 113,407 Interest expense (125,278) (160,170) (169,176) Loss on sale of oil and gas properties - - (7,474) ----------- ----------- ------------ NET LOSS (2,275,565) (3,385,287) (3,129,900) PREFERRED STOCK DIVIDENDS: Converted to common stock - (61,138) (164,029) Accrued - (24,064) - Imputed - (2,245,000) (216,000) ----------- ----------- ------------ NET LOSS APPLICABLE TO COMMON STOCKHOLDERS (2,275,565) $(5,715,489) $(3,509,929) =========== =========== ============ NET LOSS PER COMMON SHARE $ (.48) $ (.99) $ (.46) =========== =========== ============ WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 4,757,000 5,752,000 7,656,400 =========== =========== ============ See accompanying notes to these consolidated financial statements.
FORELAND CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1996, AND 1997 NOTES FOR PREFERRED STOCK COMMON STOCK ADDITIONAL STOCK TOTAL ---------------- ----------------- PAID-IN ACCUMULATED SUBSCRIPTION STOCKHOLDERS' SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT RECEIVABLE EQUITY --------- ------ --------- ------- ------------- ------------- ------------ ------------- BALANCES, January 1, 1995 1,282,210 $1,282 4,529,284 $4,529 $21,896,688 $(16,936,777) $(1,257,250) $3,708,472 Preferred stock offering 1,015,334 1,015 - - 1,521,985 - - 1,523,000 Offering costs - - - - (146,282) - - (146,282) Preferred stock exchanged for common (808,524) (808) 269,508 269 539 - - - Warrants issued below market - - - - 13,000 - - 13,000 Exercise of warrants for cash - - 42,611 43 191,706 - - 191,749 Note receivable for exercise of warrants - - 30,556 31 137,469 - (137,500) - Collection of principal on notes - - - - - - 34,900 34,900 Services rendered for common stock - - 15,000 15 82,173 - - 82,188 Accrued interest on notes - - - - - - (118,590) (118,590) Common stock returned by officers in payment of subscriptions receivable and accrued interest - - (57,159) (57) (385,761) - 385,818 - Net-loss - - - - - (2,275,565) - (2,275,565) --------- ------ --------- ------- ------------- ------------- ------------ ------------- BALANCES, December 31, 1995 1,489,020 1,489 4,829,800 4,830 23,311,517 (19,212,342) (1,092,622) 3,012,872 Preferred stock offerings 5,255 5 - - 7,549,995 - - 7,550,000 Offering costs - - - - (820,861) - - (820,861) Preferred stock exchanged for common (675,533) (676) 1,932,212 1,932 (1,256) - - - Accrued preferred stock dividends converted to common stock - - 15,957 16 (16) - - - Exercise of warrants for common stock - - 455,050 455 1,937,822 - - 1,938,277 Fair value of options granted to consultants for services - - - - 418,000 - - 418,000 Options granted to employees at below market exercise prices - - - - 159,500 - - 159,500 Acquisition of oil and gas property for common stock - - 8,276 8 34,907 - - 34,915 Collection of principal on notes - - - - - - 28,850 28,850 Accrued interest on notes - - - - - - (51,901) (51,901) Common stock returned by former officer in payment of subscriptions receivable and accrued interest - - (3,118) (3) (21,433) - 21,436 - Net loss - - - - - (3,385,287) - (3,385,287) --------- ------ --------- -------- ------------- ------------- ------------ ------------- BALANCES, December 31, 1996 818,742 818 7,238,177 7,238 32,568,175 (22,597,629) (1,094,237) 8,884,365 Preferred stock exchanged for common (56,935) (56) 1,126,872 1,127 (1,071) - - - Accrued preferred stock dividends converted to common stock - - 71,759 71 (71) - - - Fair value of options granted to 7,033 consultants for services - - 46,250 46 6,987 - - Options granted to employees at below market exercise price - - - - 67,488 - - 67,488 Acquisition of oil and gas property for common stock - - 6,040 6 27,552 - - 27,558 Collection of principal on notes - - - - - - 2,323 2,323 Accrued interest on notes - - - - - - (66,544) (66,544) Stock options returned by officers in payment of subscriptions receivable and accrued interest - - - - - - 117,883 117,883 Common stock returned in payment of subscriptions receivable and accrued interest - - (151,395) (151) (702,584) - 728,817 26,082 Issuance of common stock for option to acquire Petro Source - - 130,000 131 519,869 - - 520,000 Net-loss - - - - - (3,129,900) - (3,129,900) --------- ------ ---------- -------- ------------- ------------- ------------ ------------- BALANCES, December 31, 1997 761,807 $ 762 8,467,703 $8,468 $32,486,345 $(25,727,529) $ (311,758) $6,456,288 ========= ====== ========== ======== ============= ============= ============ =============
See accompanying notes to these consolidated financial statements. FORELAND CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS , FOR THE YEARS ENDED DECEMBER 31 --------------------------------------- 1995 1996 1997 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(2,275,565) $(3,385,287) $(3,129,900) Adjustments to reconcile net loss to net cash from operating activities: Depreciation, depletion and amortization 862,563 711,608 1,288,780 Bad debt expense - - 36,241 Abandonments and impairments 725,648 1,485,820 578,888 Issuance of stock and options for services 82,188 418,000 7,033 Accrued note receivable interest (118,590) (51,901) (66,544) Amortization of loan origination fee 46,750 - 3,912 Below market stock options - 159,500 67,488 Stock options surrendered for stock subscriptions receivable - - 117,883 Loss on sale of assets - - 7,474 Oil and royalty interest conveyed under severance agreement - - 147,000 Other - 33,362 - Changes in operating assets and liabilities: (Increase) decrease in: Accounts receivable 426,720 (336,981) 522,698 Inventory (10,178) 814 19,460 Prepaid expenses and other (3,523) (8,219) (30,627) Increase (decrease) in: Accounts payable and accrued expenses 417,095 (568,345) (102,230) Officers' salaries payable 37,500 (106,741) 78,555 ------------ ------------ ------------ Net cash provided by (used in) operating activities 190,608 (1,648,370) (453,889) CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of assets 41,607 - 2,050 Additions to oil and gas properties (1,883,496) (5,314,837) (1,407,481) Purchase of other property and equipment (7,264) (41,314) (71,917) Proceeds from note receivable 34,900 - - ------------ ------------ ------------ Net cash used in investing activities (1,814,253) (5,356,151) (1,477,348) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from sale of stock 1,523,000 7,550,000 - Proceeds from exercise of warrants and options 191,749 1,938,277 - Payment of offering and registration costs (153,363) (813,780) - Payment of long-term debt and promissory notes (966) (404,237) (355,533) Collection of principal on notes - 28,850 2,322 Proceeds from long-term debt - 1,000,000 - ------------ ------------ ------------ Net cash provided by financing activities 1,560,420 9,299,110 (353,211) ------------ ------------ ------------ INCREASE (DECREASE) IN CASH AND EQUIVALENTS (63,225) 2,294,589 (2,284,448) CASH AND EQUIVALENTS, beginning of year 93,715 30,490 2,325,079 ------------ ------------ ------------ CASH AND EQUIVALENTS, end of year $ 30,490 $2,325,079 $ 40,631 ============ ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION - Cash paid for interest $ 41,327 $ 175,508 $ 169,175 ============ ============ ============ Exercise of stock options and warrants in exchange for notes receivable $ 137,500 $ - $ - ============ ============ ============ Below market warrants issued as loan origination fee $ 13,000 $ - $ - ============ ============ ============ Issuance of common stock for acquisition of oil and gas properties $ - $ 34,915 $ 27,558 ============ ============ ============ Debt incurred for purchase of equipment $ 28,294 $ - $ - ============ ============ ============ Return of common stock by officers for subscription receivable $ 385,818 $ 21,436 $ 728,817 ============ ============ ============ Accrued preferred stock dividends converted to common stock $ - $ 61,138 $ 164,032 ============ ============ ============ Issuance of common stock for option to acquire Petro Source $ - $ - $ 520,000 ============ ============ ============ See accompanying notes to these consolidated financial statements. FORELAND CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Nature of Operations - Foreland Corporation (Foreland) was incorporated in Nevada in 1985 to engage in oil exploration, development, and production. Activities to date have focused primarily in north-central Nevada. Principles of Consolidation - The consolidated financial statements include the accounts of Foreland and its wholly-owned subsidiaries, Krutex Energy Corporation (Krutex), and Eagle Springs LLC (Eagle Springs), collectively referred to as the Company. All significant intercompany transactions and balances have been eliminated in consolidation. Cash Equivalents - The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Oil and Gas Properties - The Company follows the "successful efforts" method of accounting for oil and gas producing activities. Costs to acquire mineral interests in oil and gas properties, to drill and equip exploratory wells that find proved reserves, and to drill and equip development wells are capitalized. Costs to drill exploratory wells that do not find proved reserves, geological and geophysical costs, and costs of carrying and retaining unproved properties are expensed. Management estimates that the salvage value of lease and well equipment will approximately offset the future liability for plugging and abandonment of the related wells. Capitalized costs of producing oil and gas properties are depreciated and depleted by the unit-of-production method. Costs of exploratory wells in progress are capitalized and excluded from depletion until such time as proved reserves are established or impairment is determined, generally not longer than one year from completion of drilling. Depreciation and depletion expense related to oil and gas properties amounted to $821,691, $663,160, and $1,243,485 for the years ended December 31, 1995, 1996, and 1997, respectively. Upon the sale of an entire interest in an unproved property for cash, gain or loss on the sale is recognized, taking into consideration the amount of any recorded impairment if the property had been assessed individually. If a partial interest in an unproved property is sold, the amount received is treated as a reduction of the cost of the interest retained. Other Property and Equipment - Furniture, equipment, and vehicles are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives (ranging from 3 to 10 years) of the respective assets. The cost of normal maintenance and repairs is charged to operating expenses as incurred. Material expenditures which increase the life of an asset are capitalized and depreciated over the estimated remaining useful life of the asset. The cost of properties sold, or otherwise disposed of, and the related accumulated depreciation or amortization are removed from the accounts, and any gains or losses are reflected in current operations. Depreciation expense related to other property and equipment amounted to $40,872, $48,448, and $45,295 for the years ended December 31, 1995, 1996, and 1997, respectively. Impairment of Long-Lived Assets - Prior to 1996, the Company assessed impairment of proved oil and gas properties by comparing the net carrying value of all of the Company's proved properties to the undiscounted future net revenues for such properties. Impairment was recognized to the extent that the carrying value exceeded the undiscounted future net revenues. In March 1995, the Financial Accounting Standards Board issued statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets." SFAS No. 121 changes the Company's method of determining impairment for all long-lived assets, including proved oil and gas properties. During 1996, the Company adopted SFAS No. 121, which requires the Company to assess impairment whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. When an assessment for impairment of oil and gas properties is performed, the Company is required to compare the net carrying value of proved oil and gas properties on a lease-by-lease basis (the lowest level at which cash flows can be determined on a consistent basis) to the related estimates of undiscounted future net cash flows for such properties. If the net carrying value exceeds the net cash flows, then impairment is recognized to reduce the carrying value to the estimated fair value. As a result of this change in accounting, the Company recognized an impairment charge of $429,900 during the first quarter of 1996. Management believes this impairment charge primarily results from the change in accounting rather than a change in the economic and operating conditions related to the properties. During 1997, the Company recognized an impairment charge of $411,038. The allowance for impairment is included in accumulated depreciation and depletion in the accompanying balance sheets. Unproved oil and gas properties are periodically assessed for impairment of value, and a loss is recognized at the time of impairment by providing an impairment allowance. Inventory - Inventory consists primarily of oil and gas production equipment and crude oil. Inventory is carried at the lower of cost or market, cost being determined generally under the average cost method of accounting, or where possible, by specific identification. The Company has classified $50,000 of used oil field equipment inventory as long-term (included with other assets), because based on current inventory usage and the type of equipment, it is not expected to be sold or placed in service within the next year. Income Taxes - The Company accounts for income taxes on the liability method, whereby deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates. Revenue Recognition - The Company recognizes oil sales upon delivery to the purchaser. Revenues from operator and well service fees are recognized as the services are performed. Net Loss Per Common Share - Net loss per common share is presented in accordance with the provisions of Statement of Financial Accounting Standards No. 128, Earnings Per Share (FAS 128). FAS 128 replaces the presentation of primary and fully diluted earnings per share (EPS), with a presentation of basic EPS and diluted EPS. Under FAS 128, basic EPS is computed by dividing income or loss applicable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur in securities or other contracts to issue common stock were exercised or converted into common stock and resulted in the issuance of common stock. Basic and diluted EPS are the same in 1995, 1996, and 1997 as all potential common shares were antidilutive. For the years ended December 31, 1996 and 1997, the Company recognized imputed preferred dividends of $2,245,000 and $216,000, respectively, in arriving at the net loss applicable to common stockholders. This charge relates to preferred stock that is convertible to common stock at a discount. Stock-Based Compensation - The Company accounts for stock-based compensation issued to employees using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation cost for stock options granted to employees is measured as the excess, if any, of the quoted market price of the Company's common stock at the measurement date (generally, the date of grant) over the amount an employee must pay to acquire the stock. In October 1995, the Financial Accounting Standards Board issued a new statement titled Accounting for Stock-Based Compensation (FAS 123). FAS 123 requires that options, warrants, and similar instruments which are granted to non-employees for goods and services be recorded at fair value on the grant date. Fair value is generally determined under an option pricing model using the criteria set forth in FAS 123. The Company did not adopt FAS 123 to account for stock-based compensation for employees but is subject to the pro forma disclosure requirements. Accounting Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. The actual results could differ from those estimates. The Company's financial statements are based on a number of significant estimates including the allowance for doubtful accounts, realizability of notes for common stock subscriptions receivable, assumptions affecting the fair value of options and warrants, impairment of unproved oil and gas properties, and oil reserve quantities which are the basis for the calculation of depreciation, depletion, and impairment of proved oil and gas properties. The Company's reserve estimates were determined by an independent petroleum engineering firm. However, management emphasizes that reserve estimates are inherently imprecise and that estimates of more recent discoveries are more imprecise than those for properties with long production histories. Accordingly, the Company's estimates are expected to change as future information becomes available. As discussed above, the reserve estimates are also the basis for assessment of impairment of proved oil and gas properties. In addition to the uncertainties inherent in the reserve estimation process, this amount is affected by historical and projected prices for oil which have typically been volatile. It is reasonably possible that the Company's oil reserve estimates will change in the forthcoming year. Stock Split - On June 15, 1996, the Company effected a three for one stock split. Accordingly, all share and per share amounts in the accompanying financial statements have been retroactively restated to give effect to the stock split. Financial Instruments - Statement of Financial Accounting Standards No. 107 requires all entities to disclose the fair value of certain financial instruments in their financial statements. Accordingly, at December 31, 1997, management's best estimate is that the carrying amount of all financial instruments approximates fair value. Reclassifications - Certain reclassifications have been made to the 1995 and 1996 financial statements to conform to the presentation in 1997. The reclassifications had no effect on the 1995 or 1996 net loss. 2.BASIS OF PRESENTATION: The accompanying consolidated financial statements have been prepared on the going concern basis, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The Company has incurred cumulative losses of approximately $25.7 million since inception, and the ability of the Company to continue as a going concern is dependent on its ability to successfully develop its oil and gas properties and ultimately achieve profitable operations. Management's plans in this regard are set forth below. As discussed in Note 12, the Company completed a debt financing arrangement in January 1998 which may provide up to $16.9 million in capital to fund future exploration, development and acquisitions. The initial cash drawn of $5,280,000 under the financing arrangement was allocated for certain accrued EOR and exploration costs and further 1998 specified development, 3D seismic data acquisition, and exploration drilling. The Company believes that the projected cash from operations, including the additional revenues expected to be received from development work to be completed during the year, will be sufficient to meet its anticipated cash requirements for 1998, while funds from the initial draw-down under its debt financing as well as further advances will fund significant exploration during the year. Based on current oil prices, the Company's net production revenue alone is not currently sufficient to meet all of its cash requirements for oil and gas production costs, general and administrative expenses, ongoing shareholder/investor relations, property maintenance expenditures, and payments of indebtedness.In the event that the Company determines to accelerate or expand its exploration effort, additional funds may be sought from cash proceeds from the exercise of options and warrants currently outstanding or the sale of other equity securities for cash. The Company may also attempt to reduce its funding requirements for exploration by entering into joint operations with other exploration firms. There can be no assurance that the Company would be successful in obtaining any additional funding or reaching joint exploration arrangements with other firms on terms acceptable or favorable to the Company. 3.STOCKHOLDERS' EQUITY: 1991 Convertible Preferred Stock - At December 31, 1997, the Company has 40,000 shares of 1991 Convertible Preferred Stock issued and outstanding. These shares are convertible to an aggregate of 13,333 shares of common stock at the election of the holders. 1994 Convertible Redeemable Preferred Stock - In 1994, the Company issued 1,316,210 shares of 1994 Convertible Redeemable Preferred Stock for net proceeds of $2,341,370. The Company issued to the placement agent in this offering warrants to purchase 65,811 shares of preferred stock which are exercisable before July 8, 1999, at an exercise price of $4.40 per share. At December 31, 1997, the Company has 165,140 shares of 1994 convertible redeemable Preferred Stock issued and outstanding. These shares are convertible to 55,047 shares of common stock. At the election of the holder, three shares of preferred stock may be converted into one share of common stock. The 1994 preferred stock is redeemable at $4.00 per share at the Company's option, and has a liquidation preference of $2.00 per share. 1995 Convertible Redeemable Preferred Stock - In 1995, the Company completed the sale of 507,667 non-transferable units (the "Units") for $3.00 per unit. Each Unit consisted of two shares of preferred stock and one M warrant. At December 31, 1997, the Company has 556,667 shares of 1995 Convertible Redeemable Preferred Stock issued and outstanding. These shares are convertible to 185,556 shares of common stock. At the election of the holder, three shares of 1995 Preferred Stock may be converted into one share of common stock. The 1995 Preferred Stock has a liquidation preference of $1.50 per share. Each three M warrants entitles the holder to purchase, at any time through December 31, 1998, for $12.00 one share of Common Stock. M Warrants not exercised by December 31, 1998 will expire. The M Warrants may be redeemed by the Company under certain circumstances. 1996 Series 6% Convertible Preferred Stock - In March 1996, the Company issued 500 shares of 6% Convertible Preferred Stock for gross proceeds of $500,000 and an additional 25 shares were issued to the placement agent. Each share was convertible into 3,333 shares of common stock, subject to adjustment in certain circumstances based on the market price of the common stock on the date of conversion. By December 31, 1997, all of the outstanding shares of 6% Convertible Preferred Stock had been converted into shares of Common Stock. 1996-2 Preferred Stock - The Company issued 1,700 shares of 1996-2 Preferred Stock in an offering completed in May 1996 for which the Company received gross proceeds of $1,700,000. By December 31, 1997, all of the shares of 1996-2 Preferred Stock had been converted into shares of Common Stock. 1996-3 Preferred Stock - The Company issued 2,775 shares of 1996-3 Preferred Stock in an offering completed in July 1996 for which the Company received gross proceeds of $2,775,000. By December 31, 1997, all of the shares of 1996-3 Preferred Stock had been converted into shares of Common Stock. 1996-4 Preferred Stock - The Company issued 255 shares of 1996-4 Preferred Stock in an offering completed in November 1996 for which the Company received gross proceeds of $2,550,000. The 1996-4 Preferred Stock became convertible 15% on March 20, 1997, and 15% each month thereafter. Each share of 1996-4 Preferred Stock is convertible into 1,333 shares of Common Stock, plus an accretion at 8% per annum, subject to adjustment in certain circumstances based on the market price of the Common Stock at the time of conversion. By December 31, 1997, all shares of 1996-4 Preferred Stock had been converted into shares of Common Stock. Preferred Stock Warrants - The Company has outstanding warrants exercisable at prices ranging from $6.60 to $8.25 to purchase preferred stock convertible into an aggregate of 90,541 shares of common stock. Imputed Preferred Stock Dividends - Under the terms of each Series of 1996 Preferred Stock, the holder was provided the opportunity to convert shares of Preferred Stock to common stock pursuant to a formula that provides a minimum discount of 10% to 35% of the market price of the Company's common stock. In substance, this discount represents a dividend to the preferred holders. This dividend is recognized in the accompanying statement of operations over the period from the issuance date to the earliest date when each series of Preferred Stock is convertible. For the years ended December 31, 1996 and 1997, the aggregate amount of imputed dividends amount to $2,245,000 and $216,000, respectively. 4.INCOME TAXES: Deferred tax assets (liabilities) are comprised of the following at December 31, 1996 and 1997: 1996 1997 -------------- -------------- Long-term deferred tax assets (liabilities): Net operating loss carryforward $ 10,735,000 $11,645,000 Property and equipment basis (680,000) (430,000) differences Below-market stock options 200,000 200,000 -------------- -------------- Net deferred tax assets 10,255,000 11,415,000 Less valuation allowance (10,255,000) (11,415,000) -------------- -------------- Net deferred tax assets $ - $ - ============== ============== The Company has a net operating loss carryforward of approximately $31.5 million for income tax purposes. This carryforward expires in varying amounts from 1999 through 2012. A portion of this net operating loss carryforward may be subject to reduction or limitation of use as a result of change in ownership or certain consolidated return filing regulations. 5.SIGNIFICANT CONCENTRATIONS: Substantially all of the Company's accounts receivable result from crude oil sales and joint interest billings to companies in the oil and gas industry. This concentration of customers and joint interest owners may impact the Company's overall credit risk, either positively or negatively, since these entities may be similarly affected by changes in economic or other conditions. In determining whether or not to require collateral from a customer or joint interest owner, the Company generally analyzes the entity's net worth, cash flows, earnings, and/or credit ratings. Receivables are generally not collateralized; however, receivables from joint interest owners are subject to collection under operating agreements which generally provide lien rights. Historical credit losses incurred on trade receivables by the Company have been insignificant. The Company's oil and gas properties are located in north-central Nevada where the net price realized for the Company's oil production is typically discounted due to gravity adjustments and transportation costs. Accordingly, in comparison to the net price received by oil producers in many other areas of the United States, the Company often realizes a lower net sales price. Due to the remote location, the Company may be vulnerable to delays and shortages of equipment due to a relatively limited number of suppliers for certain goods and services. Two purchasers account for all of the Company's oil sales. As discussed in Note 9, the Company has an option exercisable through 1998 to acquire ownership of one of the purchasers. 6.LONG-TERM DEBT: Long-term debt at December 31, 1996 and 1997, consists of the following: 1996 1997 ------------ ------------ Note payable pursuant to revolving credit agreement. Interest at variable rate (11% at December 31, 1997), collateralized by oil and gas properties. $ 1,000,000 $ 650,000 Other installment notes. Interest at 13.4%, monthly principal and interest payments of approximately $639 through October 1999 when the remaining balance is due. The notes are collateralized by vehicles. 23,091 18,252 ------------ ------------ Total long-term debt 1,023,091 668,252 Less current maturities (4,844) (25,301) ------------ ------------ Total long-term debt, less current maturities $ 1,018,247 $ 642,951 ============ ============ The revolving credit agreement contains certain covenants, including those that limit or prohibit the Company from paying dividends, selling assets and incurring additional indebtedness, as well as maintaining certain financial covenants. During 1997, the Company had violated certain covenants in the credit agreement and the bank had the right to accelerate the due date of the loan. As discussed in Note 12, the Company repaid borrowings under the credit agreement in January 1998 and refinanced the balance under a long-term arrangement. At December 31, 1997, the aggregate maturities of long-term debt were determined based on the principal payments required under the new credit agreement for the refinanced borrowings, and are summarized as follows: Year Ending December 31, ------------ 1998 $ 25,301 1999 139,915 2000 143,339 2001 161,518 2002 198,179 ----------- $ 668,252 =========== 7. COMMITMENTS AND CONTINGENCIES: Operating Leases - The Company currently rents administrative office space and equipment under noncancelable leases. Total rental expenses incurred under operating leases amounted to $67,382, $69,879, and $60,125 for the years ended December 31, 1995, 1996, and 1997, respectively. The total minimum rental commitment under the Company's office lease is approximately $30,000. Delay Rentals - At December 31, 1997, the Company has an investment in undeveloped oil and gas leases with a carrying value of $471,537. In order to retain these leases, management estimates that delay rental payments of approximately $195,000 will be required in 1998. Delay rental expense amounted to $214,019 for the year ended December 31, 1997 and is included in oil exploration expense in the statement of operations. Employment Agreements - In September 1997, the Company entered into employment agreements with four officers, directors, and employees of the Company. The agreements automatically renew each month for a period of 3 years and provide for aggregate annual salaries of $388,000. The agreements also provide for an increase in the aggregate annual salaries to $484,000 when the Company sustains net oil production at an average of at least 1,000 barrels of oil per day for any calendar month. Director and Employee Royalties - During 1996, the Company agreed to transfer a 1% overriding royalty interest in substantially all of the Company's wells to a limited liability company to be formed to hold this interest. The proceeds from this royalty interest are required to be distributed to employees as additional compensation. During October 1997, in connection with a director's severance arrangements, the Company agreed to transfer a 1% overriding royalty in properties which comprise substantially all of the Company's proved reserves. The estimated fair value of this royalty interest of approximately $147,000 is included in general and administrative expenses in the 1997 statement of operations. Environmental - The Company is subject to extensive Federal, state, and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are recorded when environmental assessment and/or remediation is probable, and the costs can be reasonably estimated. Contingencies - The Company may from time to time be involved in various claims, lawsuits, disputes with third parties, actions involving allegations of discrimination, or breach of contract incidental to the operations of its business. The Company is not currently involved in any such incidental litigation which it believes could have a materially adverse effect on its financial conditions or results of operations. 8. STOCK-BASED COMPENSATION: Employee Stock Options - The Company's Board of Directors has granted non- qualified stock options to officers, directors, and employees of the Company. The following is a summary of activity under these stock option plans for the years ended December 31, 1995, 1996, and 1997:
Outstanding, beginning of year 425,667 $ 5.97 434,000 $ 6.01 1,098,667 5.25 Granted 8,333 8.17 804,667 4.80 1,519,667 3.45 Surrendered for notes receivable - - - - (408,334) 5.70 Expired - - (23,333) 8.13 (16,333) 6.13 Repriced - - (116,667) 4.39 (140,667) 4.41 ---------- ---------- ------------ Outstanding, end of year 434,000 6.01 1,098,667 5.25 1,653,000 3.89 ========== ========== ============
At December 31, 1997, outstanding options vest as follows: Number Weighted Average Vested at December 31, of Shares Exercise Price - ---------------------- ----------- ----------------- 1997 788,000 $4.46 1998 345,000 3.38 1999 295,000 3.53 2000 225,000 3.17 ----------- 1,653,000 3.89 =========== If not previously exercised, options outstanding at December 31, 1997, will expire as follows: Number Weighted Average Year Ending December 31, of Shares Exercise Price - ---------------------- ----------- ----------------- 1998 16,667 $5.70 1999 36,666 8.40 2002 116,667 4.39 2003 - 2006 583,000 5.76 2007 487,500 3.58 2008 - 2010 412,500 2.50 ----------- 1,653,000 3.89 =========== Options Subject to Shareholder Approval - In July 1996, the board of directors granted options to officers and directors for an aggregate of 400,000 shares of common stock, subject to approval by the Company's shareholders. The options will be submitted for consideration at the 1998 annual meeting. These options will be exercisable at $4.00 per share for a term of five years. Due to the contingency of shareholder approval, these options are not considered to be granted for accounting purposes at December 31, 1997. Accordingly, they have been excluded from the disclosures above and compensation cost, if any, will be measured on the date that shareholders approve the grants. Warrants and Non-Qualified Stock Options - The Company has also granted warrants and non-qualified common stock purchase options to non-employees which are summarized as follows for the years ended December 31, 1995, 1996, and 1997:
1995 1996 1997 ----------------------- ------------------------ ------------------------- Weighted Weighted Weighted Average Average Average Number Exercise Number Exercise Number Exercise of Shares Price of Shares Price of Shares Price ---------- ----------- ---------- ----------- ----------- ----------- Outstanding, beginning of year 1,002,537 $ 15.51 1,006,224 $ 15.58 326,025 $ 9.38 Granted for goods and services 133,334 5.25 433,333 5.20 - - Granted in equity offerings 388,590 7.77 90,920 5.39 - - Granted to previous holders of L warrants - - - - 414,000 12.00 Reload grants - - 175,200 9.23 - - Anti-dilution adjustments 10,000 2.52 41,600 2.52 - - Expired (169,035) 5.42 (956,202) 15.74 - - Exercised (73,167) 4.50 (455,050) 4.26 - - Repriced (286,035) 8.30 (10,000) 9.00 - - ---------- ---------- ----------- Outstanding, end of year 1,006,224 15.58 326,025 9.38 740,025 10.84 ========== ========== ===========
All outstanding warrants and non-qualified options granted to non-employees were exercisable at December 31, 1997. If not previously exercised, these instruments will expire as follows: Number Weighted Average Year Ending December 31, of Shares Exercise Price - ------------------------ ------------ ----------------- 1998 583,222 $ 12.00 1999 110,000 6.61 2000 8,333 4.50 2001 38,470 6.79 ------------ Total 740,025 10.84 ============ For 433,333 options granted to non-employees for goods and services in 1996, the estimated fair value of these warrants was determined using the Black- Scholes option pricing model. Significant assumptions included a risk-free interest rate of 6.5%, expected volatility of 70%, and that no dividends would be declared during the expected term of the options. The weighted average contractual term of the options was approximately 1.4 years compared to a weighted average expected term of 1.0 year. The estimated fair value of these warrants amounted to $418,000, which was charged to operations during the year ended December 31, 1996. Reload Options - At December 31, 1997, options and warrants with a reload feature are outstanding for a total of 140,667 shares of common stock. Upon exercise of all or part of these options, additional options will be granted with an exercise price equal to the market price of the Company's common stock at the date of exercise and an exercise period of 5 years. Stock Subscriptions Receivable - During 1994, officers and directors exercised stock options to acquire an aggregate of 216,667 shares of common stock at a weighted average exercise price of $4.67 per share. Pursuant to the terms of the options exercised, each optionee paid the purchase price of the options by the delivery of a promissory note payable in three equal, consecutive installments of principal plus interest on the unpaid balance at 7% per annum, payable annually commencing on the first anniversary of the exercise. The note installments are payable in cash or the delivery of Common Stock or other options valued at the trading price at the time of payment. Also pursuant to the terms of the options exercised, the Company automatically granted new five year options to purchase 216,667 shares of Common Stock at $6.38 per share. In connection with the issuance of shares on the exercise of such options, in 1994 the optionees returned an aggregate of 24,118 shares of Common Stock to satisfy withholding obligations of the Company, as provided for in the terms of the options exercised. The first payment for the above referenced notes became due in September 1995, when the officers returned an aggregate of 57,159 shares of Common Stock in satisfaction of the first installment of principal and interest on their notes. In connection with employment agreements executed in 1996, the due dates for the September 1996 and 1997 installments were deferred for one year. The remaining balance due under these notes of $735,523 was satisfied in 1997 through the delivery of an aggregate of 151,395 shares of common stock owned by the directors. The fair value of these shares amounted to $617,640 and the directors also agreed to surrender stock options for an aggregate of 208,334 shares of common stock with an exercise price of $6.38 per share as additional consideration for the repayment of the notes receivable. The Company recognized a charge of $117,883 related to the exchange of the stock options for the remaining obligations under the notes receivable. Stock Appreciation Rights - At December 31, 1997, a total of 60,000 Stock Appreciation Rights (SARS) are outstanding. The SARS entitle the officers to receive cash, stock or a combination of both in an amount equal to the amount by which the fair market value of the Company's common stock on the date the SARS are exercised exceeds $13.68 per share. These SARS expire in May 1998. In 1994, the Company granted 15,000 SARS to an executive officer and director who resigned in May 1996. The SARS entitled the officer to receive cash, stock, or a combination of both in an amount equal to the amount by which the fair market value of the Company's common stock on the date the SARS are exercised exceeds $7.50 per share. These SARS expired in July 1996 due to termination of employment. Pro Forma Stock-Based Compensation Disclosures - The Company applies APB Opinion 25 and related interpretations in accounting for stock options and warrants which are granted to employees. Accordingly, the Company recognizes compensation cost for options granted to employees to the extent that the market price of the Company's common stock exceeds the exercise price on the date of grant. If compensation cost had been recognized using the fair value method prescribed by FAS 123 rather than the intrinsic value method under APB 25,the Company's net loss applicable to common shareholders and loss per share would have been changed to the pro forma amounts indicated below. Year Ended December 31, ---------------------------------------- 1995 1996 1997 ------------ ------------ ------------ Net loss applicable to common stockholders: As reported $(2,275,565) $(5,715,489) $(3,509,929) Pro forma (2,293,000) (6,648,000) (5,068,313) Net loss per common share: As reported $ .48 $ (.99) $ (.46) Pro forma .48 (1.19) (.66) Since options granted to employees typically vest over several years and the Company typically makes grants each year, the pro forma disclosures during the initial phase-in period for FAS 123 may not be representative of the impact expected in future years. The weighted average fair value of options granted to employees amounted to $2.12, $3.03, and $1.54 for the years ended December 31, 1995, 1996, and 1997, respectively. The fair value of each employee option and warrant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: Year Ended December 31, ---------------------------------------- 1995 1996 1997 ------------ ------------ ------------ Expected volatility 65.0% 70.0% 70.0% Risk-free interest rate 6.8% 6.5% 6.4% Expected dividends - - - Expected terms (in years) 3.0 4.7 6.7 9. OPTION AGREEMENT: On December 31, 1997, the Company entered into an Option and Purchase Agreement with Petro Source Corporation, a closely-held corporation, pursuant to which the Company obtained an option to acquire at any time prior to December 31, 1998, certain of the businesses and business assets of Petro Source Refining Corporation and Petro Source Transportation. The optioned assets include a refinery which processes crude oil produced by the Company and other Nevada operators, a processing facility, and rolling stock utilized by Petro Source Transportation to gather crude oil and distribute products. The price for the option was $520,000 and the Company agreed to deliver 130,000 shares of Common Stcok for the option consideration. The Company may be required to deliver additional shares or cash to the extent that the value realized upon the sale of the shares by Petro Source is less than $520,000. The purchase price for the optioned assets is $5 million or four times the annual income of the businesses to be purchased, with certain adjustments. 10. FOURTH QUARTER ADJUSTMENTS AND TRANSACTIONS: During the fourth quarter of 1997, the Company recognized impairment expense of $411,000 related to a well in progress that was determined to be uneconomic. Other transactions recognized in the fourth quarter which impacted the Company's operations included a stock-based compensation charge of $117,883 related to the surrender of options by employees for notes receivable. 11. DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES: All oil and gas operations of the Company and its subsidiaries are conducted in the United States. Capitalized costs relating to oil and gas producing activities are as follows: DECEMBER 31, -------------------------- 1996 1997 ------------ ------------ Proved oil and gas producing properties $9,678,986 $11,406,799 Wells in progress 421,167 - Unproved properties, net of allowance for impairment of $100,000 in 1996 and $169,000 in 1997 475,502 471,537 ------------ ------------ 10,575,655 11,878,336 Accumulated depreciation, depletion and amortization (3,276,444) (5,114,382) ------------ ------------ $7,299,211 $ 6,763,954 ============ ============ Costs incurred in oil and gas producing activities, whether capitalized or expensed, during the three years ended December 31, 1995, 1996, and 1997 are as follows: 1995 1996 1997 ---------- ---------- ---------- Acquisition costs $ 46,597 $2,908,254 $ 358,403 ========== ========== ========== Exploration costs $1,024,008 $2,205,883 $1,252,838 ========== ========== ========== Development costs $2,414,265 $ 477,210 $1,076,636 ========== ========== ========== Estimated Quantities of Proved Oil and Gas Reserves (Unaudited) - Proved oil and gas reserves are the estimated quantities of crude oil, which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed oil and gas reserves are those expected to be recovered through existing wells with existing equipment and operating methods. However, reserve information should not be construed as the current market value of the Company's oil and gas reserves or the costs that would be incurred to obtain equivalent reserves. Reserve calculations involve the estimation of future net recoverable reserves of oil and gas and the timing and amount of future net revenues to be received therefrom. These estimates are based on numerous factors, many of which are variable and uncertain. Accordingly, it is common for the actual production and revenues to vary from earlier estimates. At December 31, 1997, approximately 37% of the Company's reserves are attributable to undeveloped properties which are scheduled to be drilled over the next two years at an estimated cost of approximately $2,240,000. Reserve estimates for recently drilled wells and undeveloped properties are subject to substantial upward or downward revisions after drilling is completed and a production history obtained. Hence, reserve estimates and estimates of future net revenues from production may be subject to substantial revision from year to year. Reserve information presented herein is based on reports prepared by independent petroleum engineers. Set forth below is the unaudited summary of the changes in the net quantities of the Company's proved oil reserves (in barrels) as of December 31, 1995, 1996, and 1997: 1995 1996 1997 ---------- ---------- ---------- Proved reserves, beginning of year 1,848,000 2,006,000 3,723,000 Production (88,000) (118,000) (180,000) Purchase of reserves in place - 1,321,000 16,000 Transfer of royalty interests to - (50,000) (28,000) employees Discoveries, extensions and other 724,000 646,000 - additions Revisions of previous estimates (478,000) (82,000) (1,234,000) ----------- ---------- ----------- Proved reserves, end of year 2,006,000 3,723,000 2,297,000 =========== ========== =========== Proved developed reserves, beginning of year 992,000 1,175,000 1,900,000 =========== ========== =========== Proved developed reserves, end of year 1,175,000 1,900,000 1,449,880 =========== ========== =========== Standardized Measure of Discounted Future Net Cash Flows (Unaudited) - Statement of Financial Accounting Standards No. 69 prescribes guidelines for computing a standardized measure of future net cash flows and changes therein relating to estimated proved reserves. The Company has followed these guidelines which are briefly discussed below. Future cash inflows and future production and development costs are determined by applying year-end prices and costs to the estimated quantities of oil and gas to be produced. Estimated future income taxes are computed using current statutory income tax rates including consideration for estimated future statutory depletion and tax credits. The resulting future net cash flows are reduced to present value amounts by applying a 10% annual discount factor. The Company's year-end reserve report was prepared based upon the December 31, 1997 oil price averaging approximately $12.43 per barrel. In February 1998, the Company was receiving approximately $10.00 per barrel of oil sold. The assumptions used to compute the standardized measure are those prescribed by the Financial Accounting Standards Board and, as such, do not necessarily reflect the Company's expectations for actual revenues to be derived from those reserves nor their present worth. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the standardized measure computations since these estimates are the basis for the valuation process. DECEMBER 31, ----------------------------------------- 1995 1996 1997 ------------ ------------ -------------- Future cash inflows $ 25,926,000 $67,226,000 $28,838,000 Future production costs (11,092,000) (19,216,000) (14,502,000) Future development costs (2,754,000) (5,182,000) (2,240,000) Future income tax expense - (3,630,000) - ------------- ------------ -------------- Future net cash flows 12,080,000 39,198,000 12,096,000 10% annual discount for estimated timing of cash flows (5,880,000) (18,218,000) (5,384,000) ------------- ------------ -------------- Standardized measure of discounted future net cash flows $ 6,200,000 $20,980,000 $ 6,712,000 ============= ============ ============== The following are the principal sources of change in the standardized measure of discounted future net cash flows for the years ended December 31, 1995, 1996, and 1997: DECEMBER 31, ----------------------------------------- 1995 1996 1997 ------------ ------------ -------------- Standardized measure, beginning of year $5,111,000 $6,200,000 $20,980,000 Sales of oil and gas, net of production costs (593,000) (1,425,000) (1,306,000) Extensions, discoveries and other, net 4,122,000 6,977,000 - Purchase of reserves in place - 8,964,000 37,000 Transfer of royalty interests to employees - (290,000) (213,000) Net change due to revisions in quantity estimates (2,565,000) (1,913,000) (5,728,000) Net change due to changes in prices and production costs (2,000) 5,719,000 (13,530,000) Net change in future development costs (384,000) (1,930,000) 2,432,000 Net change in income taxes - (1,942,000) 1,942,000 Accretion of discount 511,000 620,000 2,098,000 ------------- ------------ -------------- Standardized measure, end of year $6,200,000 $20,980,000 $6,712,000 ============= ============ ============== 12.SUBSEQUENT EVENTS: Debt Financing - In January 1998, the Company completed a $16.9 million debt financing with Energy Income Fund, L.P. (EIF). The funds will be used in the enhanced oil recovery program and development drilling in the Eagle Springs field, 3D seismic acquisition, the drilling of 3D defined exploration targets, the acquisition of producing properties, and to retire existing debt. In January 1998, the Company borrowed $3,585,000 of its new available debt financing to fund the implementation of a high pressure air injection program, including compressors and buildings in the Company's Eagle Springs field, a 3D seismic program on the Company's Pine Creek property, the retirement of existing debt and the payment of closing costs. An additional $1,846,000 was placed into an escrow account to fund the drilling and completion of two development wells and one exploratory well. Pursuant to the terms of the financing arrangement, the Company is required to make payments of interest only through November 1998, after which payments of principal and interest are required to amortize the indebtedness generally over a 48-month period; provided, however, that the final payment of all accrued but unpaid interest and the remaining principal balance is due on January 1, 2002. The Company also agreed to transfer to EIF a 3% overriding royalty interest in the Company's interest in the Company's proved oil and gas properties and a 1% overriding royalty interest in certain unproved properties. Amounts due under the financing arrangement are collateralized by oil and gas properties and the Company is required to maintain certain financial ratios and comply with other terms and conditions while any balance of indebtedness remains outstanding. The Company has issued to EIF five-year warrants to purchase 750,000 shares of common stock at $6.00 per share and 250,000 shares at $10.00 per share. The Company granted EIF the right to designate a representative for appointment to the Board of Directors of the Company. Acquisition of Oil and Gas Properties - In January 1998, the Company entered into an agreement to acquire the remaining 40% working interest in the Ghost Ranch field. The net purchase price was $470,000 and the Company now owns a 100% working interest in substantially all of the Company's proved oil and EX-10 2 OPTION AND PURCHASE AGREEMENT THIS OPTION AND PURCHASE AGREEMENT (hereinafter referred to as this "Agreement") is entered into effective as of the 31st day of December, 1997, by and between FORELAND CORPORATION, a Nevada corporation (hereinafter "Foreland") on the one hand, and PETRO SOURCE CORPORATION, a Utah corporation, PETRO SOURCE REFINING CORPORATION, a Utah corporation, and PETROSOURCE TRANSPORTATION, a Utah corporation, on the other (collectively, "PSC"), based on the following: PREMISES A. Among other things, PSC is engaged in the business of refining, processing, and transporting crude and refined hydrocarbons and associated products and desires to grant an option for the sale of and, if exercised, to sell, as a going concern, substantially all of its assets and operations associated with a crude oil refinery/asphalt manufacturing plant located in Nevada, known as the Eagle Springs Refinery; a crude oil and/or transmix refinery facility producing primarily diesel fuel, residual fuel oil, and/or gasoline located in Tonopah, Nevada; a common carrier trucking operation conducted under the name "Petrosource Transportation," consisting of truck tractors and specialized combination trailers for hauling crude oil and refinery products; and a roofing asphalt blower and associated equipment currently located at Fredonia, Arizona, all as more particularly described in this Agreement. B. Foreland desires to obtain an option to purchase and, if it elects to exercise such option, to acquire through a wholly owned subsidiary to be organized for such purpose, Foreland Refining Corporation, the assets of PSC described above for the agreed consideration and on the terms and conditions set forth in this Agreement, and to continue to operate the businesses acquired. AGREEMENT NOW, THEREFORE, based on the stated premises, which are incorporated herein by reference, and for and in consideration of the mutual covenants and agreements hereinafter set forth and the mutual benefit to the parties to be derived herefrom, it is hereby agreed as follows: ARTICLE I DEFINITIONS In this Agreement, the following terms have the meanings specified or referred to in this Article I. Such definitions shall be equally applicable to both the singular and plural forms. Any agreement referred to below shall mean such agreement as amended, supplemented and modified from time to time to the extent permitted by the applicable provisions thereof and by this Agreement. "Assumed Obligations" means the obligations under the contracts, leases, and agreements which are assumed by Foreland, all as more particularly described in Section 3.03. "Business" means the business, operations, and the Business Assets and Assumed Obligations, including the tangible and intangible real and personal property owned or leased by PSC and used in connection with the Business Assets, excluding, however, the Excluded Assets, all as more particularly described in Section 3.01. "Business Assets" means the tangible and intangible real and personal assets of the Business as more particularly described in Section 3.01. "Business Executive" means management and executive level salaried employees of PSC engaged for all or substantially all of their working time in the management and operation of the Business. "Closing" has the meaning set forth in Section 3.07. "Closing Date" has the meaning set forth in Section 3.07. "Closing Exhibits" means the updated PSC Exhibits delivered by PSC at or prior to the Closing. "Closing Schedules" means the updated PSC Schedules delivered by PSC at or prior to the Closing. "Due Diligence Period" means the 30 days after the date of delivery of the PSC Exhibits and PSC Schedules during which Foreland may inspect such PSC Exhibits and PSC Schedules. "EBITDA" means earnings before interest, taxes, depreciation, and amortization, as determined in accordance with GAAP, applied consistently with the financial statements of the Business included in the PSC Schedules, all as determined in accordance with the calculation methodology contained in Appendix "A," initialed by the parties for identification, attached hereto, and incorporated herein by reference. "Effective Time" has the meaning set forth in Section 3.08. "Environmental Laws" means the federal, state, and local laws and regulations governing the generation, marketing, refining, recycling, treatment, handling, use, storage, transportation, disposal, and cleanup of hazardous, radioactive, reactive, flammable, infectious, toxic, or dangerous materials or the protection of public health or the environment including, without limitation, the Comprehensive Environmental Response, Compensation, and Liability Act of 1980; the Resource Conservation and Recovery Act of 1976; the Toxic Substances Control Act; the Clean Air Act, the Federal Water Pollution Control Act; the Safe Drinking Water Act; the Hazardous Material Transportation Act; the Federal Insecticide, Fungicide, Rodentcide Act; the Occupational Safety and Health Act; and any similar state or local law, regulation, or ordinance and all permits and regulatory approvals issued thereunder. "ES Production" means Eagle Springs Production Limited Liability Company, a Nevada limited liability company and a wholly owned subsidiary of Foreland. "Exchange Act" means the Securities Exchange Act of 1934, as amended, and the regulations promulgated thereunder. "Exercise Date" means the date of exercise of the Option granted pursuant to this Agreement as set forth in Section 2.04. "Exercise Period" has the meaning set forth in Section 2.03. "Exercise Period Quarter" means the successive calendar quarters ending on March 15, June 15, September 15, and December 15, 1998. "Foreland Stock" means shares of common stock of Foreland, par value $0.001 per share. "GAAP" means generally accepted accounting principles, consistently applied. "Option Consideration" has the meaning set forth in Section 2.02. "Option Period" means the period starting with the date of this Agreement and ending at 11:59 p.m., Mountain Time, December 31, 1998, or at the end of any Exercise Period Quarter with respect to which Foreland has not fulfilled its obligations as set forth in Article II. "Option Shares" has the meaning set forth in Section 2.02. "PSC Exhibits" means the documents describing in detail the items more generally described in Article III. "PSC Schedules" means the disclosures as set forth in Section 2.07. "Purchase Price" has the meaning set forth in Section 3.05. "Refining" means Foreland Refining Corporation, a corporation to be organized by, and as a subsidiary of, Foreland for the purpose of purchasing the Business and Business Assets. "Registration Statement" means a registration statement filed under the provisions of the Securities Act as provided in Section 2.02. "SEC" means the Securities and Exchange Commission. "Securities Act" means the Securities Act of 1933, as amended, and the regulations promulgated thereunder. "Shares" means either or both the Option Shares or Purchase Shares, as the case may be. ARTICLE II OPTION TO PURCHASE Section 2.01 Grant of Option. For and in consideration of the Crude Oil Purchase Agreement entered into this date by and between PSC and Foreland, the Option Consideration as set forth in Section 2.02, and the benefits to the parties arising under this Agreement, PSC hereby grants to Foreland the irrevocable right and option (the "Option"), exercisable at any time during the Exercise Period set forth in Section 2.03, to purchase the Business and Business Assets for the Purchase Price set forth in Section 3.05. Section 2.02 Option Consideration. In consideration of the Option granted by PSC pursuant to this Agreement, Foreland agrees to pay to PSC an aggregate of $520,000 (the "Option Consideration") as follows: (a) On or before January 15, 1998, Foreland shall deliver to Petro Source Refining Corporation ("PSRC"), an aggregate of 130,000 shares (the "Option Shares") of Foreland Stock, which shall be registered in the name of PSRC, but held and disposed of in accordance with the terms and conditions hereof. (b) At the earliest practicable date, Foreland shall file, at its sole cost, and utilize its best efforts to obtain the effectiveness of, by acceleration, the Registration Statement on such form as Foreland may select under the Securities Act covering the resale of the Option Shares by and for the account of PSRC, which shall be named as a selling shareholder in the Registration Statement, all as more particularly set forth in Article IX hereof. Foreland shall utilize its best efforts to obtain the effectiveness of the Registration Statement at the earliest practicable date and to maintain its effectiveness throughout the Exercise Period. (c) On or before the expiration of each Exercise Period Quarter, Foreland may pay the $130,000 Option Consideration installment for such quarter in immediately available funds by wire transfer to PSC at the following account: Bank of America NT&SA, Concord, CA ABA no. 121000358 Petro Source Refining Corporation Account Account no. 12331-15325 Reference Co. 80 (d) If Foreland elects not to pay the $130,000 in cash in accordance with the provisions of paragraph (c) above on or before the end of any Exercise Period Quarter, and the Registration Statement is then effective, PSC may cause to be sold, at any time and from time-to-time and in accordance with the Registration Statement, that number of Option Shares that yields proceeds, net of brokerage and other usual and customary transaction costs, the amount of $130,000 as payment in full of the Option Consideration installment for such Exercise Period Quarter. (e) If (i) the Registration Statement is not effective on or before the date on which PSC would be able to cause Option Shares to be sold thereunder but for its lack of effectiveness, or (ii) insufficient Option Shares are held by PSRC such that the net proceeds therefrom would not equal $130,000, PSRC may demand that Foreland pay in cash the $130,000 Option Consideration installment for that quarter, in which case Foreland shall pay such amount in cash in immediately available funds within five days after such demand, and the Option Shares attributable to such quarter shall be returned to Foreland. (f) If at the end of the Option Period any Option Shares remain unsold, such shares shall be returned to Foreland for cancellation. If Option Shares have been sold for net proceeds in excess of the Option Consideration due to PSC under the terms of this Agreement, such excess proceeds shall also be delivered to Foreland. Section 2.03 Exercise Period. The Option may be exercised at any time on or before December 31, 1998, provided that as of the date of exercise all Option Consideration required to have been paid as of such date in accordance with the requirements of Section 2.02 has been paid in full. Section 2.04 Manner of Exercise. The Option shall be exercised by notice thereof from Foreland to PSC in the manner for giving notices as hereinafter provided. The Exercise Date shall be the date such notice shall be deemed to be given in accordance with Section 13.02. Section 2.05 Effect of Exercise. On the timely exercise of the Option by Foreland, this Agreement shall become a binding, bilateral agreement between PSC and Foreland or, at Foreland's election, Refining, for the sale and purchase of the Business and Business Assets on the terms and conditions hereinafter set forth. Section 2.06 Access and Information; Noncompetition. During the Option Period: (a) PSC shall (i) afford Foreland and its respective officers, directors, partners, managers, members, employees, accountants, consultants, legal counsel, agents, and other representatives (collectively, the "Foreland Representatives") reasonable access at reasonable times, upon reasonable prior notice, to the Business and Business Assets and the officers, directors, employees, agents, offices and facilities of PSC and to the books and records relating to such Business and Business Assets; and (ii) furnish promptly to Foreland and the Foreland Representatives such information concerning the business, properties, contracts, records, and personnel of the Business and Business Assets and PSC insofar as related to the Business and Business Assets (including financial, operating and other data and information) as may be reasonably requested, from time to time, by any Foreland or such Foreland Representatives. (b) PSC grants to Foreland and the Foreland Representatives a non- exclusive license to enter into and upon the Real Property (as defined below) for the purpose of completing an environmental site assessment, all as more particularly set forth in Section 4.07(d). (c) Notwithstanding the foregoing provisions of this Section 2.06, PSC shall not be required to grant access or furnish information to Foreland or the Foreland Representatives to the extent that such access to or the furnishing of such information is prohibited by law or a valid order by a court of competent jurisdiction. No investigation by Foreland hereto made heretofore or hereafter shall affect the representations and warranties of PSC which are herein contained, and each such representation and warranty shall survive such investigation. (d) The information received pursuant to this section shall be deemed to be "Confidential Information." Foreland agrees that it will treat in confidence all documents, materials and other Confidential Information which it shall have obtained regarding the Business, Business Assets, or PSC during the course of the negotiations leading to the consummation of the transactions contemplated hereby (whether obtained before or after the date of this Agreement), the investigation provided for herein, and the preparation of this Agreement and other related documents. Such documents, materials and other Confidential Information shall not be communicated to any third person (other than to counsel, accountants, financial advisors or lenders who have agreed to treat the information as Confidential Information) and shall not be used for any purpose to the detriment of PSC. Foreland shall not use any Confidential Information in any manner whatsoever except solely for the purpose of evaluating the possible business relationship with PSC. Neither Foreland nor any Foreland Representative will, during the term of this Agreement or at any time during the two years thereafter, irrespective of the time, manner, or cause of termination of this Agreement, use, disclose, copy, or assist any other person or firm in the use, disclosure, or copying of any documents, materials or other Confidential Information of PSC. This provision is not intended to supercede the Confidentiality Agreement between PSC and Foreland dated August 25, 1997, and, in addition to the covenants hereof, information received pursuant to this section shall be deemed to be "Confidential Information" under that agreement. Section 2.07 PSC Schedules and Exhibits. (a) On or before January 15, 1998, PSC shall prepare and deliver to Foreland a revised set of exhibits and schedules updating the exhibits provided under the terms of Article III (the "PSC Exhibits") and the schedules limiting the representations of PSC set forth in Article IV or otherwise required by the terms of this Agreement (the "PSC Schedules"). (b) Foreland shall have until 30 days after the date of delivery of the revised PSC Exhibits and PSC Schedules (the "Due Diligence Period") in which to inspect such PSC Exhibits and PSC Schedules. If, within the Due Diligence Period, Foreland reasonably determines and advises PSC in writing of respects in which the revised PSC Exhibits or PSC Schedules are materially and adversely different from the PSC Exhibits and Schedules attached hereto ("Objections"), PSC shall have the right to attempt to cure all valid Objections within 30 days after the expiration of such Due Diligence Period; Foreland shall have no obligation to cure such Objections. If PSC does undertake to cure such Objections, such curative measures shall be set forth in writing and shall be specifically enforceable by Foreland. If valid Objections are not reasonably resolved within such 30 day cure period, Foreland may void this Agreement by written notice thereof to PSC within seven days after the expiration of such cure period. If this Agreement is voided, (i) all amounts previously paid or delivered by the parties under the terms of this Agreement shall be returned within ten days; and (ii) the Purchase Contract Confirmation of even date herewith shall be null and void and the existing crude oil purchase agreement shall be reinstated effective as of December 15, 1997, and any overpayments shall be paid within ten days. If Foreland does not so void this Agreement, it shall be deemed to have accepted such revised PSC Exhibits and PSC Schedules. If, at the end of the Due Diligence Period, Foreland has not delivered written objection to the revised PSC Exhibits or PSC Schedules pursuant to this subsection, Foreland will be deemed to have accepted the revised PSC Exhibits and PSC Schedules as submitted by PSC. The revised PSC Exhibits and PSC Schedules accepted or deemed to have been accepted by Foreland shall be attached to and become part of this Agreement and shall be the effective PSC Exhibits and Schedules under the provisions of Article IV and other relevant sections of this Agreement. Section 2.08 Affirmative Covenants of PSC. PSC hereby covenants and agrees that during the Option Period and, if this Option is timely exercised, then until the Effective Time, unless otherwise expressly contemplated by this Agreement or consented to in writing by Foreland, PSC will, insofar as it relates to the Business or Business Assets: (a) continue to operate the Business in the ordinary course consistent with past practices, subject to such changes in operations as are necessary or advisable, and consistent with prudent business practices; (b) use all reasonable efforts to preserve substantially intact its business organization, maintain its material rights, permits, and franchises, retain the services of its executives, senior managers, and employees, and maintain its relationships with its material customers and suppliers to the extent that a prudent business person would do so; (c) maintain and keep its material properties and the Business Assets in as good of repair and working condition as at present, ordinary wear and tear excepted, and maintain supplies and inventories of products based on its customary business practice; (d) continue to operate the Business and Business Assets in compliance with all laws and regulations applicable thereto, including all Environmental Laws; (e) pay all obligations, taxes, and liens with respect to the Business and Business Assets as they come due; (f) keep adequate records and books of account with complete entries sufficient for the preparation and auditing of financial statements in accordance with the requirements of GAAP; (g) timely pay its accounts payable associated with the Business and Business Assets in the ordinary course, consistent with prior practices; (h) use reasonable efforts to timely collect its accounts receivable in the ordinary course, consistent with past practices; and (i) use all reasonable efforts to keep in full force and effect insurance and bonds comparable in amount and scope of coverage to that currently maintained. Section 2.09 Negative Covenants of PSC. Except as expressly contemplated by this Agreement or as otherwise consented to in writing by Foreland (which consent will not be unreasonably withheld), during the Option Period and, if the Option is timely exercised, then until the Effective Time, PSC will not: (a) sell, lease, exchange, mortgage, pledge, transfer or otherwise dispose of, or encumber, or agree to do any of the foregoing with respect to the Business or Business Assets, except for the sale of inventory or similar dispositions in the ordinary course, consistent with prior practice; (b) knowingly take, or agree to commit to take, any action that would make any representation or warranty of PSC contained herein or in the PSC Disclosure Schedules inaccurate in any material respect at the Closing Date, or as of any time during the Option Period and, if the Option is timely exercised, then until the Effective Time; (c) except in the ordinary course of business, enter into any agreement or arrangement to extend the time covered by an agreement to purchase crude oil, hydrocarbons, or other feedstock or supplies for the Business and Business Assets, which agreement has a term in excess of one year, or to increase the price paid to a supplier of such items; (d) enter into any agreement or arrangement that is not cancelable on 30 days' notice with respect to Petrosource Transportation, except for the replacement of obsolete or worn equipment and the purchase of equipment on the termination of leases, all in accordance with past practice and prudent business; (e) permit the presence, use, disposal, storage, or release of hazardous materials on, in, or under the Business Assets except in the ordinary course and in accordance with conditions that are generally recognized as safe and appropriate and that are in strict compliance with all Environmental Laws; (f) except as provided above, make any capital expenditures to increase or improve the Business Assets in excess of $100,000; (g) increase the wages or salary of any employee associated with the Business other than in the ordinary course, consistent with past practice or enter into any collective or individual employment bargaining process or employee agreements; or (h) agree in writing or otherwise to do any of the foregoing items 2.09 (a) - (g). Section 2.10 PSC Employees. (a) During the Option Period and with prior notice to PSC, Foreland may discuss with management and executive level salaried employees of PSC engaged for all or substantially all of their working time in the management and operation of the Business (the "Business Executives") the possible terms under which such Business Executives may be offered employment by Foreland or Refining after the Effective Time. If this Option is not exercised and the purchase of the Business is not Closed as contemplated hereby, for a period of two years subsequent to the termination of the Option Period neither Foreland nor any affiliated entity will offer any employment or consulting position to any Business Executive or induce or attempt to induce or persuade any such Business Executive to terminate his or her employment relationship with PSC or assist any other person or entity in doing the foregoing, except that Foreland shall not be precluded from considering and accepting unsolicited applications from such Business Executives or applications from such Business Executives in response to a general solicitation of employment not specifically directed to employees of PSC. Prior to the exercise of the Option, Foreland will not offer employment or discuss the existence of the Option with employees who are not Business Executives without PSC's prior written consent, which shall not be unreasonable withheld. (b) If Foreland does exercise its Option to purchase the Business, Foreland will offer employment to (i) each of the Business Executives employed by PSC at the Effective Time, and (ii) each PSC employee who devotes substantially all of his or her working time to the Business. Such offers will provide for (iii) a salary or hourly rate equivalent to the salary or hourly rate in effect as of the date hereof or such higher rate approved by Foreland, (iv) employee benefits equal to the standard employee benefit package provided by Foreland to its other employees, and (v) past service credit under the Foreland employee benefit plans for the time that such employee was employed by PSC. Foreland shall not be responsible for any accrued and unused vacation or sick leave or for any pension, retirement, or employee benefit obligation of PSC arising prior to the Effective Time. 2.11 Non-Circumvention of Option. During the Option Period and, if the Option is timely exercised, then until the Effective Time, PSC shall not, directly or indirectly: (a) Enter into any transaction or enter into or continue negotiations with any party other than Foreland relative to any disposition by PSC of the Business or Business Assets; (b) Solicit or encourage submission of inquiries, proposals, or offers from any other party relative to any disposition by PSC of the Business or Business Assets; (c) Provide further information to any party other than Foreland relating to any possible disposition by PSC of its interest in the Business or Business Assets; (d) Disclose to any third party, other than its attorney or other professional advisors, or bankers or other lenders on a confidential basis, PSC's willingness to sell the Business or Business Assets or discuss the existence or substance of this Agreement with any such third party; or (e) Take any action, the reasonable and foreseeable consequence of which would be to materially frustrate the purpose, intent, or financial benefit to Foreland of this Agreement and the transactions contemplated hereby. If, during the Option Period, PSC receives an offer or proposal relating to the possible acquisition of the Business or Business Assets or any part thereof, it will immediately notify Foreland of said offer or proposal, the identity of the party making the offer or proposal, and the specific terms of such offer or proposal. ARTICLE III PURCHASE OF ASSETS Section 3.01 The Purchase. Foreland shall have the right to exercise the Option at any time during the Option Period as set forth in Article II of this Agreement. On such timely exercise, PSC shall be obligated to sell, and Foreland shall be obligated to purchase the Business and Business Assets as set forth in this Article III. Except as set forth in section 3.02 of this Agreement, and on the terms and conditions contained in this Agreement, PSC shall sell, assign, transfer, convey, set over, and deliver to Foreland, and Foreland shall purchase from PSC, the Business and the Business Assets, consisting of the following: (a) (i) all tangible personal property owned by PSC and located at, or used in connection with, the operation of the Eagle Springs Refinery, the Tonopah Refinery (including the emulsifier), or Petrosource Transportation, (ii) the asphalt blower equipment located at the Fredonia Terminal (provided Foreland, at its own expense, removes such equipment from PSC's property within 24 months after the Closing Date, otherwise the ownership of such equipment shall revert to PSC), and (iii) the rights of PSC as lessee of all tangible personal property leased, including the equipment, tools, vehicles, furniture and fixtures, and supplies described in Exhibit "A" (the "Tangible Personal Property"); (b) all of PSC's rights as lessee to the real property and all buildings and improvements thereon on which the Eagle Springs Refinery and the Tonopah Refinery are located, as more particularly described in Exhibit "B" (the "Real Property"); (c) all inventory of PSC existing as of the Effective Time which was purchased in furtherance of the Business, as described in Exhibit "C" (the "Inventory"); (d) all of the notes and trade and other accounts receivable associated with the Eagle Springs Refinery, the Tonopah Refinery, or Petrosource Transportation existing as of the Effective Time, and all cash and cash equivalents in payment thereof received after the Effective Time, as described in Exhibit "D" (the "Accounts Receivable"); (e) all of PSC's rights under (i) those crude oil and transmix purchase contracts and agreements described in Exhibit "E" which were entered into by PSC in the ordinary course of business and are executory, and (ii) all contracts and agreements intended to facilitate the sale of asphalt or other refinery products manufactured at the Eagle Springs or Tonopah refineries, together (the "Contract Rights"); (f) lists of current and past (within the preceding two years) customers and lists of prospective customers (i.e., persons with whom PSC has discussed potential sales and from whom PSC has received what PSC believes to be serious expressions of interest) of the Business compiled by PSC including, to the extent the same is in the possession of PSC, the name, address, contact person, and telephone number of each such customer or prospective customer (the "Customer Lists"), set forth on Exhibit "F"; (g) all lists of current and past (within the preceding two years) suppliers and all files, records, and data used in connection with the Business; (h) those prepaid expenses, fees, deposits, letters of credit, or bonds with respect to the Business or Business Assets, including those set forth on Exhibit "G," (the "Prepaid Expenses"); (i) all federal, state, or local licenses, permits, or approvals granted or used in connection with the operation of the Business or the Business Assets; (j) all of PSC's rights under warranties covering the Tangible Personal Property being transferred hereunder to the fullest extent permitted by such warranties; (k) all intellectual property of PSC necessary to the operation of the Business, including the proprietary scheduling software used in connection with Petrosource Transportation and the right to use any trade secrets, confidential or proprietary information, or general processes used by PSC in the conduct of the Business, together with a non-exclusive right to use the process and name "Melt PacTM," to sell asphalt manufactured at either the Eagle Springs Refinery or the Tonopah Refinery in the states of Arizona, California, Colorado, Nevada, New Mexico and Utah only, provided Foreland pays PSC a royalty equal to $2.00 per ton of roofing asphalt sold in Melt PacTM bags., all as described in Exhibit "H" (the "Intellectual Property"); (l) the current telephone number(s) used in connection with the Business at its locations in Eagle Springs and Tonopah, Nevada, and telephone and other directory listings used by PSC in the operation of the Business other than the Salt Lake City numbers; (m) to the extent permitted by the carrier, all contracts of insurance relating to the Business or Business Assets and all claims, casualties, or other occurrences prior to the Closing Date and prepaid premiums or deposits related thereto, which policies are specific to and separately maintained for the Business Assets, as described in Exhibit "I" (the "Insurance Policies"); (n) originals or copies of all accounting, operating, management, and other business records in documentary or electronic form relating to the Business (provided, however, PSC may maintain a record copy of any such items); (o) the rights of PSC under all confidentiality, non-competition, or similar agreements with present or former employees, consultants, and others associated with PSC insofar as related to the Business; (p) the goodwill of PSC associated with the Business; and (q) all other assets of PSC used to carry out the Business or Business Assets not included in any specific provision of the foregoing subsections existing as of the Effective Time which are not excluded in section 3.02. Section 3.02 Excluded Assets. Notwithstanding the provisions of Section 3.01, the assets conveyed hereunder shall not include the following: (a) the two asphalt spreader trucks currently in the name of Petrosource Transportation or Petro Source Refining Partners; (b) the bank accounts maintained by PSC on behalf of the Business; (c) all corporate books and records not relating to the Business or the Business Assets purchased hereunder, including the minute books and stock transfer books and the corporate seal of PSC; (d) PSC's employee benefit agreements, plans, or similar arrangements; (e) The office furniture and equipment used by any PSC employee who works on Business matters, but is not hired by Foreland; (f) Software which is not used by PSC exclusively for the Business such as PSC's general ledger and accounting, and revenue distribution systems; and (g) The items listed in Exhibit J. Section 3.03 Assumed Obligations. On the Closing Date, Foreland shall assume and agree to discharge the following obligations and liabilities of PSC with respect to the Business Assets, in accordance with their respective terms and subject to the respective conditions thereof: (a) all obligations of PSC under the leases set forth on Exhibit K-1 relating to the Tangible Personal Property or the Real Property; (b) all current trade accounts payable and other current liabilities as of the Effective Time, that arose in the ordinary course of the Business, all to be set forth in Exhibit K-2 of the Closing Exhibits; (c) all liabilities and obligations of PSC to be paid or performed after the Effective Time under the contracts and other agreements set forth on Exhibit K-3 relating to the Business and Business Assets being conveyed hereunder; (d) all liabilities in respect of any taxes for the period beginning on the Effective Time, and any other accrued, but unpaid, as of the Effective Time and set forth in the Closing Schedule. Real and personal property taxes shall be prorated between the parties as of the Effective Time; and (d) other obligations listed on Exhibit K-4. Section 3.04 Excluded Liabilities. Except to the extent that such liabilities operate to reduce the purchase price pursuant to Section 3.05, neither Foreland nor Refining shall assume or be obligated to pay, perform or otherwise discharge the following: (a) any liability or obligation of PSC, direct or indirect, known or unknown, absolute or contingent, not expressly assumed by Foreland pursuant to section 3.03 or otherwise pursuant to this Agreement; (b) any liability for accrued bonuses, vacation, personal leave, or other amounts for the benefit of employees of the Business (the "Employee Benefits"); (c) taxes for any period prior to the Effective Time; and (d) the accounts payable listed on Schedule 3.04. Section 3.05 Amount of Purchase Price. The consideration payable by Foreland for the purchase (the "Purchase Price") of the Business and Business Assets shall be the greater of either: (a) Five million dollars ($5,000,000); or (b) Four times the annualized Adjusted EBIDTA of the Business, as set forth below, based on the six months preceding the month in which the Option is exercised, as calculated in accordance with the following formula: (Adjusted EBIDTA for preceding six months) x 2 x 4 = Purchase Price For purposes of the foregoing formula: "Adjusted EBIDTA" means the earnings of the Business before interest, taxes, depreciation, and amortization, as determined in accordance with GAAP, based on the six months prior to the Exercise Date, adjusted (1) to credit the Business with an amount equal to the difference between Amoco's Southwest Wyoming Sweet Crude Oil posted price less $6.15 per barrel and the amount paid per barrel for oil purchased from Foreland that is produced from the Ghost Ranch number 48-35 currently producing well during such period by PSC under the Crude Oil Purchase Agreement entered contemporaneous with the execution of this Agreement as compared to the amount that would have been paid per barrel of oil purchased under the immediately preceding agreement, and (2) to substitute for actual general and administrative expenses incurred in the operation of the Business an amount equal to $800,000 per month. plus, in the case of either (a) or (b) above, the total of (u) the sum of capital expenditures incurred by PSC to improve or add to the Business Assets between the date hereof and the Effective Time; (v) a negative amount equal to the sum of proceeds from the sale of any property, plant and/or equipment which is a component of the Business Assets to a third party by PSC between the date hereof and the Effective Time; (w) the sum of the current assets, as determined in accordance with GAAP (except that finished goods inventory will be valued at market), assigned to Foreland hereunder; (x) a negative amount equal to the sum of the current liabilities, as determined in accordance with GAAP, assumed by Foreland hereunder, excluding, however, the current portion of long term liabilities or liabilities under operating leases assumed by Foreland hereunder that is not properly attributable to the period prior to the Effective Date in accordance with GAAP; (y) any unpaid portion of the Option Consideration; and (z) 100,000 shares of Foreland Stock, the resale of which by PSC shall be covered by an effective Registration Statement in accordance with Article IX. Section 3.06 Payment of Purchase Price. In consideration of the purchase of the Business Assets, at the Closing Foreland shall or shall cause Refining to: (a) pay to PSC the cash portion of the Purchase Price in immediately available funds by wire transfer in accordance with Section 2.02(c); and (b) deliver to PSC one or more stock certificate(s) registered in the name of PSC or its designee for the 100,000 shares of Foreland Stock constituting a portion of the Purchase Price. That amount of the Purchase Price consisting of the unpaid portion of the Option consideration shall be paid in accordance with Section 2.02. Section 3.07 Closing; Closing Date. Subject to timely exercise by Foreland of the Option, the consummation of the sale and purchase of the Business and Business Assets as contemplated hereby (the "Closing") shall take place at the offices of Kruse, Landa & Maycock, L.L.C., at 50 West Broadway, Eighth Floor, Bank One Tower, Salt Lake City, Utah 84101, or such other place as is mutually acceptable to the parties hereto as soon as practicable within 20 days after the Effective Time, but in any event on or before December 31, 1998. The date on which the Closing takes place shall be the "Closing Date." Section 3.08 Effective Time. The Closing shall be effective (the "Effective Time") as of midnight, Nevada time, on the last day of the month during which Petro Source receives Foreland's notice of Option Exercise. Section 3.09 Closing Events. At the Closing, each of the respective parties hereto shall execute, acknowledge, and deliver (or shall cause to be executed, acknowledged, and delivered) (i) the deeds, bills of sale, assignments, and other documents and instruments of conveyance and transfer, all in form and substance reasonably satisfactory to Foreland and its counsel, necessary to vest, subject to any scheduled condition subsequent, marketable title in Foreland to all the rights, interests, assets, and properties to be acquired by Foreland pursuant to this Agreement; (ii) originals or copies of all of PSC's agreements, contracts, and commitments assumed by Foreland hereunder; (iii) a list of all of the customers and suppliers of PSC relevant to the Business, including addresses and telephone numbers; (iv) all certificates, opinions, schedules, agreements, resolutions, or other instruments required by this Agreement to be so delivered at or prior to the Closing; and (v) such other items as may be reasonably requested by the parties hereto and their respective legal counsel in order to effectuate or evidence the transactions contemplated hereby. In addition, at the Closing, Foreland shall deliver to PSC the Purchase Price in accordance with Section 3.06. Section 3.10 Allocation of Purchase Price. The Purchase Price shall be allocated among the Business Assets according to the Schedule 3.11. PSC and Foreland agree to prepare all financial reports of the transactions contemplated herein, including all federal and state tax returns, in accordance with the allocation of the Purchase Price set forth in such Schedule and hereby indemnify each other against any loss which such other party may incur by reason of the Indemnifying Party's failure to comply with this section. Upon request, each party agrees to provide to the other photocopies of any forms filed with any taxing authority in which the results of this transaction are reported. Section 3.11 Further Assurances. At the Closing or at any time thereafter, each party shall execute and deliver to the other such opinions, certificates, consents, and other documents required herein and execute and deliver such other documents, and take such other actions, as may be reasonably requested to carry out the terms of this Agreement, all as the other party hereto may reasonably require. Section 3.12 Registration of Purchase Price Shares. Foreland will, at its sole cost, in any registration statement filed with the SEC for the sale of Foreland Shares after the Closing, include the Shares issued to PSC as part of the purchase price ("Purchase Shares") and cover the resale of such Shares by and for the account of PSRC, which shall be named as a selling shareholder in such registration statement, all as more particularly set forth in Article IX hereof, and shall use its best efforts to maintain its effectiveness throughout for at least three months. If Foreland has not filed such a registration statement within one year of the date of Closing, Foreland shall file, at its sole cost, and utilize its best efforts to obtain the effectiveness of, by acceleration, a registration on such form as Foreland may select under the Securities Act covering the resale of the Purchase Shares by and for the account of PSRC, which shall be named as a selling shareholder in such registration statement, all as more particularly set forth in Article IX hereof. Foreland shall utilize its best efforts to obtain the effectiveness of such Registration Statement at the earliest practicable date and to maintain its effectiveness for a period of at least three months. Section 3.13 Covenants Not to Compete. At the time of Closing, the parties shall enter into one or more agreements providing that: (i) PSC and its affiliates will not compete with Foreland for (x) the refining of Nevada crude hydrocarbons or (y) the processing of transmix in the states of California, Utah, Arizona, or Nevada for a period of three years after the Closing Date; and (ii) Foreland and its affiliates will not manufacture or sell emulsions in the state of Nevada for a period of two years after the Closing Date. ARTICLE IV REPRESENTATIONS, COVENANTS, AND WARRANTIES OF PSC PSC hereby represents, covenants, and warrants to Foreland, such representations, covenants, and warranties to be made as of the date hereof and at and as of the Closing Date and to survive the Closing and continue in accordance with the terms hereof (except as otherwise expressly set forth in Article VII hereof), as follows: Section 4.01 Organization. Petro Source Corporation, Petro Source Refining Corporation and Petrosource Transportation are each corporations duly organized, validly existing, and in good standing under the laws of the state of Utah and have the corporate power and are duly authorized, qualified, franchised, and licensed under all applicable laws, regulations, ordinances, and orders of public authorities to own all of their properties and assets and to carry on their business in all material respects as it is now being conducted. There is no jurisdiction in which any of such companies is not so qualified in which the character and location of the assets owned by it or the nature of the business transacted by it requires qualification, except where failure to do so would not have a material adverse effect on the business or properties of such company. The execution and delivery of this Agreement does not, and the consummation of the transactions contemplated by this Agreement in accordance with the terms hereof will not, violate any provision of such companies' articles of incorporation or bylaws. Each of such companies has taken all action required by law, its articles of incorporation, its bylaws, or otherwise to authorize the execution and delivery of this Agreement and the consummation of the transactions herein contemplated. Section 4.02 Approval of Agreement. The board of directors and shareholders of each of Petro Source Corporation, Petro Source Refining Corporation and Petrosource Transportation have authorized the execution and delivery of this Agreement and have approved the consummation of the transactions contemplated hereby. This Agreement is the legal, valid, and binding agreement of PSC enforceable between the parties in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, or other laws affecting the enforcement of creditors' rights generally and by general principles of equity. Section 4.03 Financial Statements. (a) Included in Schedule 2.03 to this Agreement are the audited balance sheets of Petro Source Refining Partners ("PSRP") as of December 31, 1995 and 1996, and the related statements of operations, stockholders' equity, and cash flows for the years ended December 31, 1995 and 1996, respectively, including the notes thereto and the reports of Deloitte & Touche. Such schedule also includes the unaudited balance sheet of PSRP as of October 31, 1997 ("PSRP's Current Balance Sheet"), and the related statements of operations, cash flows, and partners' equity for the ten months ended October 31, 1997, which present fairly the results of operations and financial position of PSC for the periods and as of the dates indicated in all material respects. All such financial statements have been prepared in accordance with GAAP consistently applied throughout the periods involved as explained in the notes to such financial statements, except that PSRP's Current Balance Sheet does not contain all of the footnote disclosures required by GAAP. (b) Such financial statements, as of their respective dates, fairly reflect in all material respects the financial position of the Business as of such date and the results of operations for the periods presented. Except as reflected on the most recent balance sheet, the Business did not have any liability or obligation (absolute or contingent) which should be reflected in a balance sheet or the notes thereto prepared in accordance with GAAP. All assets reflected on PSRP's Current Balance Sheet are properly reported and present fairly in all material respects the assets of the Business in accordance with GAAP, except that PSRP's Current Balance Sheet does not contain all of the footnote disclosures required by GAAP. (c) The books and records, financial and otherwise, with respect to the Business are in all material respects complete and correct and have been maintained in such a fashion as to permit the preparation and audit of financial statements (at Foreland's expense) for at least two full years in accordance with GAAP. (d) Except as set forth on the most recent Balance Sheet or in the Notes thereto, or Schedule 4.03, PSC has: (i) good and marketable title to its receivables, free of any security interests or liens and free of any material defenses, counterclaims, and set-offs, and all of such receivables are actual and bona fide receivables representing obligations for the total dollar amount thereof shown on its books; and (ii) has no material contingent liability, direct or indirect, matured or unmatured. The receivables set forth on the most recent Balance Sheet arose in the ordinary course of business and are collectable in all material respects upon the continuation of reasonable collection efforts by employees of the Business, without resorting to litigation. (e) PSC represents that the financial statements of PSRP are of limited applicability because they pertain to a partnership that was terminated as of the end of October 1997 when PSRC acquired all of the partnership interest of the only other partner in PSRP, and PSRP owned assets in addition to the Business Assets, including, but not limited to, the Fredonia terminal and the Melt PacTM patents and licenses. Section 4.04 Absence of Certain Changes or Events. Except as set forth in Schedule 4.04 to this Agreement, since the date of PSRP's Current Balance Sheet described in Section 4.03, there has not been (i) any material adverse change in the business, operations, properties, level of inventory, assets, or condition of the Business or (ii) any damage, destruction, or loss to Business Assets (whether or not covered by insurance) materially and adversely affecting the business, operations, properties, assets, or conditions of the Business, including any: (a) material adverse change in the liabilities or assets of PSC relating to the Business or Business Assets; (b) change in the manner in which PSC carries on its business or preserves its business organization and existing business relations, which might affect the Business or the Business Assets in any material way; (c) transaction by PSC relating to the Business or Business Assets, except in the ordinary course of business as conducted on the date of PSRP's Current Balance Sheet; (d) failure to maintain in full force and effect substantially the same level and types of insurance coverage as in effect on the date of PSRP's Current Balance Sheet or any destruction, damage to, or loss of any of the Business Assets (whether or not covered by insurance) materially and adversely affecting the business or prospects of PSC relating to the Business or the Business Assets; (e) sale, assignment, transfer of any tangible or intangible assets of PSC associated with the Business, including any rights to intellectual property, except in the ordinary course of business; (f) mortgage, pledge, or other encumbrance of any tangible or intangible assets of PSC relating to the Business; or (g) written or oral agreement by PSC to take any of the actions described above. Section 4.05 Governmental Authorizations. PSC has all licenses, franchises, permits, and other governmental authorizations that are legally required to enable it to conduct its businesses in all material respects as conducted on the date of this Agreement. No authorization, approval, consent, or order of, or registration, declaration, or filing with, any court or other governmental body is required in connection with the execution and delivery by PSC of this Agreement and the consummation by PSC of the transactions contemplated hereby. Schedule 4.05 sets forth a list of all franchises, grants, authorizations, licenses, permits, easements, variances, exemptions, consents, certificates, approvals and orders necessary or convenient to own, lease and operate its properties and to carry on the Business (collectively, the "Business Permits"), and there is no action, proceeding or investigation pending or threatened of which PSC has received actual notice regarding suspension or cancellation of any of the Business Permits, except where the failure to possess, or the suspension or cancellation of, such Business Permits would not have a material adverse effect on the Business or Business Assets. PSC is not in conflict with, or in default or violation of any law applicable to the Business or Business Assets. During the three-year period prior to the date of this Agreement, PSC has not received from any governmental entity any written notification with respect to possible conflicts, defaults or violations of Laws, except as set forth in Schedule 4.05 of the PSC Disclosure Schedule and except for written notices relating to possible conflicts, defaults or violations that would not have a material adverse effect on the Business or Business Assets. Section 4.06 Accounts Receivable; Inventories. All of the Accounts Receivable of PSC included in the Business Assets have arisen from bona fide transactions by PSC in the ordinary course of its business and are good and collectible in the ordinary course of business at the aggregate recorded amounts thereof. The Inventory of PSC (including raw materials, supplies, work-in- process, finished goods and other materials), a description of which is included in an exhibit to this Agreement as provided above, is in good, merchantable, resalable, and usable condition. Section 4.07 Real Property. (a) PSC will obtain, pay for, and deliver to Foreland, within 30 days after execution of this Agreement, a commitment for a policy of title insurance respecting the leasehold interests in the Real Property issued by a title insurance company reasonably acceptable to Foreland, accompanied by a copy of all documents listed as exceptions to good and clear marketable title in such commitment (the "Title Report"). PSC shall pay any title commitment cancellation charge incurred in connection with the Title Report. PSC shall also deliver to Foreland (i) a copy of all leases affecting such Real Property not expiring before the Closing Date, (ii) a copy of a survey of the Real Property, if PSC has one, and (iii) a copy of each environmental assessment or survey of any of the Real Property in the care, custody, or control of PSC. The Title Report and the other documents and information described above, which shall be included in Schedule 2.07 to this Agreement, are hereinafter referred to as the "Real Property Disclosures." (b) PSC warrants marketable title to the Real Property, save and except for only the exceptions to title set forth in the Title Report that are acceptable to Foreland as not impairing good and clear marketable title together with the printed exceptions and exclusions referred to in such Title Report; private, public, and utility easements; roads and highways, if any; the special taxes or assessments for improvements not yet completed; installments not yet due at the date hereof or any special tax or assessment for improvements heretofore completed; rights-of-way for drainage ditches, feeders and laterals; zoning laws and ordinances; all matters, including but not limited to encroachments which would be disclosed by an accurate survey and/or inspection of the Real Property; and all acts or omissions of Foreland and all governmental authorities and those acting by, through, or under such parties. (c) Foreland shall have until 30 calendar days after the date of delivery of the Real Property Disclosures (the "Real Property Due Diligence Period") in which to inspect the Real Property and the Real Property Disclosures. If, within the Real Property Due Diligence Period, Foreland advises PSC in writing of reasonable objections to the status of title to or that the condition of the Real Property is in violation of laws, ordinances, rules or regulations, PSC shall have the right to attempt to cure such objections within 30 calendar days after the expiration of such Real Property Due Diligence Period; Foreland shall have no obligation to cure such objections. If PSC does undertake to cure such objections of Foreland, such curative measures shall be set forth in writing and shall be specifically enforceable by Foreland. If Foreland's objections are not resolved to its reasonable satisfaction within such 30 calendar day cure period, Foreland may void this Agreement by written notice thereof to PSC within seven calendar days after expiration of such 30 day cure period, provided, however, to the extent that the objection is in respect to (i) title defects, or (ii) the Business Assets' conformity to environmental laws or regulations, but such objectional condition is of a nature that an ordinary purchaser of refining facilities would accept such condition in light of an indemnity from a seller similar to PSC, PSC may cure the objection by indemnifying Foreland against any loss, cost or expense incurred by Foreland with respect to such condition in excess of $100,000. During the Real Property Due Diligence Period, Foreland shall have the right to terminate this Agreement if Foreland reasonably determines PSC's representations and warranties are false in any respect material to the transaction, taken as a whole. If, at the end of the Real Property Due Diligence Period, this Agreement is not terminated by Foreland in the manner provided above, or Foreland has not delivered written objection to the PSC pursuant to this subsection, at the Closing, if any, Foreland will be deemed to have accepted the Real Property in "as is, where is" condition in accordance with the provisions set forth herein. (d) For the purposes set forth in this section, PSC hereby grants Foreland a limited license to inspect the Real Property at reasonable times agreeable to PSC, so long as such inspection does not damage the improvements and other property located on the Real Property or interfere with the ordinary conduct of PSC's business. Foreland agrees to indemnify, defend, and hold PSC harmless from any cost, expense, damage, liability, or claim arising out of or in connection with the exercise by the Foreland of the rights conferred under the provisions of this section. Notwithstanding the above or anything else herein, if Foreland desires to have the Real Property inspected for the presence of hazardous materials beyond a standard Phase I Environmental Assessment or have the surface penetrated in any manner for any purpose (such as soils tests), it shall first inform PSC in writing of such desires. Thereafter, PSC and Foreland shall meet to discuss how and when such inspection(s) shall be undertaken, it being understood and agreed that PSC is concerned about the confidentiality of any such inspection and resulting reports, if any, and potential damage to or interference with the Real Property. (e) The Real Property, a description of which is included in an exhibit to this Agreement as provided above, constitutes all interests in any real property, options to acquire any such interest, or easements, rights of way, or similar rights with respect to real property owned by PSC and used in or relating to the operation of the Business. There are no leases, subleases, tenancies or other rights of occupancy affecting such Real Property. The Real Property and improvements owned by PSC and used in or relating to the Business are in good operating condition and repair, are suitable for the purposes for which they are being used, and no such improvement, or any appurtenance thereto or equipment therein, violates any restrictive covenant or any provisions of any federal, state or local law, ordinance or zoning regulation, or encroaches on any property owned by others. PSC has the right, power, and authority to transfer good and clear marketable title in its leasehold interests in the real property comprising the Real Property to Foreland, without the consent of any other person or entity, as contemplated by this Agreement. (f) At the Closing, PSC shall deliver possession of the Real Property broom clean and free of debris and personal property not to be conveyed pursuant hereto. Section 4.08 Tangible Personal Property. The list of Tangible Personal Property, a description of which is included in an exhibit to this Agreement as provided above, is a complete and accurate list of all machinery, equipment, vehicles, furniture and other tangible property owned or leased by PSC and used in or relating to the Business. Except as disclosed in Schedule 4.08, the Tangible Personal Property (a) is in good operating condition and repair and is suitable for the purposes for which it is being used. The Tangle Personal Property includes all of the assets and property necessary and convenient to operate the Business in the ordinary course in the fashion in which it has been operated by PSC. Unless otherwise stated in such exhibit, all of such Tangible Personal Property is located on the Real Property. All leases for tangible property are in full force and effect, have an unexpired term as set forth in the lease agreements, and there is no outstanding default or event that with the passage of time or notice would constitute a default, on behalf of PSC or any other party to the lease agreements. The remaining obligations of PSC under the terms of each lease for Tangible Personal Property do not exceed the current fair market value of the personal property subject to such lease. PSC has the right, power, and authority to transfer all of the tangible and intangible property comprising the Business Assets to Foreland, without the consent of any other person or entity, as contemplated by this Agreement. At the Closing, PSC will deliver possession of the Tangible Personal Property to Foreland with all equipment and vehicles in working order. Section 4.09 Intellectual Property. The list of Intellectual Property, a description of which is included in an exhibit to this Agreement as provided above, is a complete and accurate list of all of the trade secrets, technology, know-how, tradenames, trademarks, servicemarks, and other proprietary information owned by or used in connection with the business of PSC, including all copyrights, patents, patent applications, registrations, and applications with respect. Except as set forth in the above referenced exhibit, PSC owns the entire right, title, and interest in and to such Intellectual Property, and such Intellectual Property is not subject to the payment of royalties or any other obligation to any other person or entity. Except as set forth in the above referenced exhibit, none of the employees of PSC owns, directly or indirectly, any right, title, or interest in or to the Intellectual Property. To the best knowledge of PSC, none of the Intellectual Property is subject to any order, decree, judgment, stipulation, settlement, encumbrance, or attachment. There are no pending or threatened proceedings, litigation, or other adverse claims of which PSC is aware affecting or with respect to the Intellectual Property. The Intellectual Property does not infringe on the copyright, patent, trade secret, know-how, or other proprietary right of any other person or entity and comprises all such rights necessary to permit the operation of the business of PSC as now being conducted. Section 4.10 Employees and Related Agreements; ERISA. (a) Schedule 4.10 contains a description of each "employee pension benefit plan" (as such term is defined in Section 3(2) of Employee Retirement Income Security Act of 1974, as amended ("ERISA")) or "welfare benefit plan" (as such term is defined in Section 3(1) of ERISA), maintained by PSC, or with respect to which PSC is required to contribute, on behalf of any employees of PSC. Each of the plans described in such schedule which is intended to qualify under Section 401(a) of the Internal Revenue Code (the "Code"), other than any "multiemployer plan" (as such term is defined in Section 3(37) of ERISA) has received a favorable determination letter from the IRS, and no event has occurred which would cause any such plan to cease being so qualified. Each of the plans described on such schedule (other than any multiemployer plans) complies in form in all material respects in accordance with the requirements of ERISA and, where applicable, the Code. To the best knowledge of PSC, each multiemployer plan is qualified under Section 401(a) of the Code and complies in form in all material respects and has been administered in all material respects in accordance with the requirements of ERISA and, where applicable, the Code. (b) None of PSC's employee plans subject to Title IV of ERISA has terminated; no proceeding has been initiated to terminate any such plan; and there has been no "reportable event" (within the meaning of Section 4043(b) of ERISA). PSC has not incurred any liability on account of a "partial withdrawal" or a "complete withdrawal" (within the meaning of Sections 4203 and 4205, respectively, of ERISA) from any multiemployer plan, and PSC is not aware of any events which could result in any such partial or complete withdrawal. None of PSC's employee plans which is a defined benefit plan has incurred any "accumulated funding deficiency" (within the meaning of Section 412 of the Code), whether or not waived. Assuming that each of PSC's employee plans which is subject to Title IV of ERISA (other than multiemployer plans) were terminated as of the Closing Date, PSC would not have any liability under Title IV of ERISA as a result of such termination. The PSC has no obligations under any of PSC's employee plans or otherwise to provide health benefits to former employees of PSC, except as specifically required by law. (c) Except as to multiemployer plans (as to which this representation and warranty is made to the best knowledge of PSC), neither PSC nor, to the best knowledge of PSC, any other "disqualified person" (within the meaning of Section 4975 of the Code) or "party in interest" (within the meaning of Section 3(14) of ERISA) has engaged in any "prohibited transaction" (within the meaning of Section 4975 of the Code or Section 406 of ERISA) with respect to any of PSC's employee plans which could subject any such plan (or its related trust) or PSC, or any officer, director or employee of PSC to the penalty or tax under Section 402(i) of ERISA or Section 4975 of the Code. (d) There is no pending or, to the best knowledge of PSC, threatened claim which alleges any violation of ERISA or any other law (i) by or on behalf of any of PSC's plans or (ii) by any employee of PSC or any plan participant or beneficiary against any such plan. Section 4.11 Employee Relations. The PSC has complied in respect of the Business in all material respects with all applicable laws, rules and regulations that relate to prices, wages, hours, harassment, disabled access, and discrimination in employment and collective bargaining and to the operation of its business and is not liable for any arrears of wages or any taxes or penalties for failure to comply with any of the foregoing. PSC believes that its relations with the employees of PSC are satisfactory. Section 4.12 Litigation and Proceedings. Except as set forth on Schedule 4.12, there are no actions, suits, or proceedings pending or, to the knowledge of PSC, threatened by or against, or affecting the Business or Business Assets, at law or in equity, before any court or other governmental agency or instrumentality, domestic or foreign, or before any arbitrator of any kind; PSC does not have any knowledge of any default on its part with respect to any judgment, order, writ, injunction, decree, award, rule, or regulation of any court, arbitrator, or governmental agency or instrumentality. Section 4.13 Material Contract Defaults. PSC is not in default in any respect under the terms of any outstanding contract, agreement, lease, or other commitment which is material to the business, operations, properties, assets, or condition of PSC, and there is no event of default or other event which, with notice or lapse of time or both, would constitute a default in any material respect under any such contract, agreement, lease, or other commitment in respect of which PSC has not taken adequate steps to prevent such a default from occurring. Section 4.14 Taxes. All federal, state, local, and foreign tax returns and tax reports required to be filed by or on behalf of PSC have been filed with the appropriate governmental agency and all jurisdictions in which such reports are required to be filed and all taxes which have become due pursuant to such tax returns or to any assessment which has become payable have been paid. Proper and accurate amounts of taxes have been withheld by or on behalf of PSC with respect to all compensation paid to employees of PSC for all periods ending on or before the date hereof, and all deposits required with respect to compensation paid to such employees have been made, in complete compliance with the provisions of all applicable federal, state, and local tax and other laws. Section 4.15 Third-Party Consents. Except as set forth in Schedule Section 4.15, no contract, agreement, lease, or other commitment, written or oral, to which PSC is a party or to which any of its properties or assets are subject require the consent of the other party in order to consummate the transactions herein contemplated, except where the failure to obtain such consent would not have a material adverse effect on the Business Assets. In the event a supply or sales contracts may not be assigned without the consent of the other party to the agreement, which consent cannot be obtained before Closing, PSC will remain the party to the contract, and purchase products from Foreland with respect to sales contracts, and sell products to Foreland with respect to purchase contracts, in either case at PSC's cost so as to maintain the economic value of the contract. PSC will remain a party to such contracts as nominee for the account of Foreland, and Foreland will otherwise fulfill all obligations with respect to such contracts and will hold PSC harmless from any loss, cost or expense with respect thereto. The failure to obtain a consent in such a case will not be considered a material adverse event, or otherwise give Foreland the right to terminate this Agreement. Section 4.16 No Conflict With Other Instruments. The execution of this Agreement and the consummation of the transactions contemplated by this Agreement will not result in the breach of any term or provision of, or constitute an event of default under, any material indenture, mortgage, deed of trust, or other material contract, agreement, or instrument to which PSC is a party or to which any of its properties or operations are subject, except where such breach or default would not have a material adverse effect on the assets transferred pursuant hereto. Section 4.17 Compliance With Laws and Regulations. PSC has complied with all applicable statutes and regulations of any federal, state, or other governmental entity or agency thereof, except to the extent that noncompliance would not materially and adversely affect the business, operations, properties, assets, or condition of PSC or except to the extent that noncompliance would not result in the incurrence of any material liability for PSC. Section 4.18 Hazardous Substances. (a) The following words and phrases shall have the meanings indicated: (i) "Current Actual Knowledge" shall mean that no information that would give PSC current actual knowledge of the inaccuracy of any statements has come to the attention of PSC's officers and directors; however, no special or independent investigation has been undertaken to determine the accuracy of such statements. (ii) "Environment" shall mean soil, surface waters, groundwaters, land, stream sediments, surface or subsurface strata, ambient air, and any environmental medium. (iii) "Environmental Law" shall mean any environmental related law, regulation, rule, ordinance, or bylaw at the federal, state, or local level, existing as of the date hereof. (iv) "Hazardous Material" shall mean any pollutant, toxic substance, hazardous waste, hazardous material, hazardous substance, or oil as currently defined in the Resource Conservation and Recovery Act, as amended; the Comprehensive Environmental Response, Compensation, and Liability Act, as amended; the Federal Clean Water Act, as amended; or any other federal, state, or local environmental law, regulation, ordinance, rule, or bylaw, existing as of the date hereof. (v) "Permit" shall mean environmental permit, license, approval, consent, or authorization issued by a federal, state, or local governmental entity. (vi) "Premises" shall mean the real property owned or leased by PSC on which it currently conducts the business of PSC. (vii) "Release" shall mean any releasing, spilling, leaking, pumping, pouring, emitting, emptying, discharging, injecting, escaping, leaching, disposing, or dumping into the Environment. (viii) "Threat of Release" shall mean a substantial likelihood of a Release which requires action to prevent or mitigate damage to the Environment which may result from such Release. (b) Except as set forth on Schedule 4.18, to PSC's Current Actual Knowledge, (i)PSC has no liability under any Environmental Law applicable to the Premises and the facilities and operations thereon, and (ii) there are not currently any violations of Environmental Laws existing on the Premises or with respect to any facilities or operations thereon. (c) Except as set forth on Schedule 4.18, to PSC's Current Actual Knowledge, PSC has not violated and is in compliance with all Environmental Laws applicable to the Premises and the facilities and operations thereon and has not generated, manufactured, refined, transported, treated, stored, handled, disposed, transferred, produced, processed, or Released any Hazardous Material on the Premises, except in compliance with such Environmental Laws, and has no Current Actual Knowledge of the Release or Threat of Release of any Hazardous Material on the Premises in violations of such Environmental Laws. (d) Except as set forth on Schedule 4.18, within the last three years, PSC has not: (i) Entered into or been subject to any consent decree, compliance, order, or administrative order with respect to the Premises or any facilities or operations thereon; (ii) Received notice under the citizen suit provision of any violation of any Environmental Law in connection with the Premises or any facilities or operations thereon; (iii) Received any request for information, notice, demand letter, administrative inquiry, or claim with respect to a violation of any Environmental Law relating to the Premises or any facilities or operations thereon; (iv) Been subject to or threatened with any governmental or citizen enforcement action with respect to a violation of any Environmental Law on the Premises or at any facilities or operations thereon; or (v) Received notice of any civil action with respect to any damages claimed to result from a Release of any Hazardous Material on the Premises. Section 4.19 Insurance. The list of Insurance Policies, a description of which is included as an exhibit to this Agreement as provided above, is a complete and accurate description (including nature of coverage, limits, deductibles, premiums and the loss experience for the most recent five years with respect to each type of coverage) of all policies of insurance maintained, owned or held by PSC on the date hereof with respect to the Business Assets or the business of PSC. All of the insurable properties of PSC are insured for the benefit of PSC in the amount of their full replacement value (subject to reasonable deductibles) against losses due to fire and other casualty, with extended coverage, and other risks customarily insured against by persons operating similar properties in the localities where such properties are located and under valid and enforceable policies issued by insurers of recognized responsibility. Such policy or policies containing substantially equivalent coverage will be outstanding and in full force at the Closing Date, as hereinafter defined. PSC makes no representation, warranty, or covenant as to whether any of the Insurance Policies or the benefits thereof may be conveyed to Foreland. In the event any such insurance policy cannot be assigned, either by the express terms of such policy or the governing practices or policies of the issuer thereof, PSC shall convey to Foreland any premium or deposit refund received as a result of the termination or cancellation of such policy. Section 4.20 Customers and Suppliers. There exists no actual or threatened termination, cancellation or limitation of, or any modification or change in, the business relationship of PSC with any customer or group of customers of PSC, or whose purchases individually or in the aggregate are material to the operations of the business of PSC, or with any supplier or group of suppliers of PSC, or whose sales individually or in the aggregate are material to the operations of the business of PSC, and there exists no present or future condition or state of facts or circumstances involving customers, suppliers or sales representatives which PSC can now reasonably foresee would materially adversely affect the business of PSC or prevent the conduct of such business after the consummation of the transactions contemplated by this Agreement in essentially the same manner in which it has heretofore been conducted. Section 4.21 Broker's Fees. The PSC has not engaged or entered into any agreement with any broker or finder in connection with any of the transactions contemplated by this Agreement requiring the payment of any fee or compensation. Section 4.22 PSC Schedules. PSC has delivered to Foreland the following disclosure schedules, which are collectively referred to as the "PSC Schedules": (a) A schedule required by Section 4.03 with respect to balance sheet; (b) A schedule required by Section 4.04 with respect to material changes; (c) A schedule required by Section 4.05 with respect to governmental authorizations; (d) A schedule required by Section 4.10 with respect to employee plans; (e) A schedule required by Section 4.12 with respect to litigation; and (f) A schedule required by Section 4.15 with respect to real property. PSC shall cause the exhibits to this Agreement, the PSC's Schedules, and the other documents, instruments, and data delivered to Foreland hereunder to be updated after the date hereof and prior to the Closing Date. ARTICLE V REPRESENTATIONS, COVENANTS, AND WARRANTIES OF FORELAND Foreland hereby represents, warrants, and covenants to PSC, as follows: Section 5.01 Organization, Standing and Power of Foreland. Foreland is a corporation duly organized, validly existing, and in good standing under the laws of the state of Utah and has the power and is duly authorized, qualified, franchised, and licensed under all applicable laws, regulations, ordinances, and orders of public authorities to own all of its properties and assets and to carry on its business in all material respects as it is now being conducted and is proposed to be conducted immediately following the Closing. Section 5.02 Reports; Financial Statements. (a) Since March 31, 1991, Foreland and its subsidiaries have filed all forms, reports, statements and other documents required to be filed with (A) the Securities and Exchange Commission (the "SEC") including (1) all Annual Reports on Form 10-K, (2) all Quarterly Reports on Form 10-Q, (3) all proxy statements relating to meetings of stockholders (whether annual or special), (4) all Current Reports on Form 8-K and (5) all other reports, schedules, registration statements or other documents and (B) any applicable state securities authorities and all forms, reports, statements and other documents required to be filed with any other applicable federal or state regulatory authorities, except where the failure to file any such forms, reports, statements or other documents would not have a material adverse effect (all such forms, reports, statements and other documents in clauses (i) and (ii) of this Section 5.02(a) being referred to herein, collectively, as the "Foreland Reports"). The Foreland Reports, including all Surgical Reports filed after the date of this Agreement and prior to the Effective Time, (x) were or will be prepared in accordance with the requirements of applicable Law (including the Securities Act and the Exchange Act, as the case may be, and the rules and regulations of the SEC thereunder applicable to such Foreland Reports) and (y) did not at the time they were filed, or will not at the time they are filed, contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading. (b) Each of the consolidated financial statements (including, in each case, any related notes thereto) contained in Foreland Reports filed prior to the Effective Time, have been or will be prepared in accordance with the published rules and regulations of the SEC and generally accepted accounting principles applied on a consistent basis throughout the periods involved (except (a) to the extent required by changes in generally accepted accounting principles; (b) with respect to Foreland Reports filed prior to the date of this Agreement, as may be indicated in the notes thereto; and (c) with respect to interim financial statements as may be permitted by Article 10 of Regulation S-X) and fairly present or will fairly present the consolidated financial position of Surgical and its subsidiaries as of the respective dates thereof and the consolidated results of operations and cash flows for the periods indicated (including reasonable estimates of normal and recurring year-end adjustments), except that (x) any unaudited interim financial statements were or will be subject to normal and recurring year-end adjustments and (y) any pro forma financial statements contained in such consolidated financial statements are not necessarily indicative of the consolidated financial position of Surgical and its subsidiaries as of the respective dates thereof and the consolidated results of operations and cash flows for the periods indicated. [The foregoing are intended as factual disclosures in connection with the issuance of securities. The obligations under this Agreement are Foreland's, with the assets conveyed to Refining for operating purposes.] Section 5.03 Authority. The execution, delivery, and performance of this Agreement has been duly and validly authorized and approved by Foreland's board of directors and shareholder(s). The execution of and delivery of this Agreement do not, and the consummation of the transactions described herein will not, result in or constitute a default, breach or violation of Foreland's articles of incorporation or bylaws or any other agreement to which Foreland is a party. Section 5.04 Broker's Fees. Foreland has not engaged or entered into any agreement with any broker or finder in connection with any of the transactions contemplated by this Agreement requiring the payment of any fee or compensation. Section 5.05 Material Misstatements or Omissions. To the best of Foreland's knowledge and belief, no representation, warranty, or statement of Foreland in this Agreement or in any document, certificate, or exhibit furnished under this Agreement or in connection with the transactions contemplated hereby, contains any untrue statement of a material fact, or omits to state a material fact necessary to make the statements or facts contained therein not misleading. ARTICLE VI CONDITIONS PRECEDENT TO THE OBLIGATIONS OF FORELAND The obligation of Foreland to purchase the Business Assets and assume the Obligations is subject to the satisfaction, at or before Closing, of each of the conditions set out below except for any condition which has been waived in a writing signed by Foreland at or prior to the Closing. Section 6.01 Performance by PSC. PSC shall have substantially performed all conditions of this Agreement unless the requirement has been waived in writing by Foreland. Section 6.02 Corporate Approval. The board of directors and shareholders of PSC shall have approved the transactions described in this Agreement and resolutions setting forth those approvals shall have been certified to Foreland by an officer of PSC. Section 6.03 Satisfaction of Condition of Title to Real Property. Foreland shall not have timely terminated this Agreement pursuant to the provisions of Section 4.07. Section 6.04 No Material Adverse Change Through the Closing Date. There shall not have been any material adverse change in the financial condition or in the results of operations of the Business, and there shall not have been any material loss or damage to the Business Assets or Business, whether or not insured, materially affecting PSC's ability to conduct a material part of the Business. Section 6.05 Absence of Litigation. No action, suit, or proceeding before any court or any governmental body or authority pertaining to the acquisition of the Business Assets or Business by Foreland or materially affecting the Business Assets or Business shall have been instituted or threatened on or before the Closing. Section 6.06 Closing Date Review and Deliveries. On and as of the Closing Date, PSC shall, together with one or more representatives of Foreland, undertake a Closing Date review of PSC's books, records, and physical inventory. The PSC shall have provided Foreland with a true, correct, and complete list and amount, as of Closing Date, of: (a) the Inventory; (b) the Tangible Personal Property; (c) PSC's Accounts Receivable with respect to the Business and a list of all shipped but unbilled shipments as of the Closing Date, including an aging thereof; (d) PSC's trade accounts payable, accrued current liabilities, and the Assumed Obligations with respect to the Business; (e) all unfilled customer orders with respect to the Business; and (f) all shipments made with respect to the Business during the period from the date of this Agreement to the Closing Date; none of which information shall, in Foreland's sole reasonable discretion, be materially different from the information supplied by PSC in the Exhibits and Schedules delivered to Foreland on or before January 15, 1998. Section 6.07 Closing Date Prorations. Foreland and PSC shall prorate, as of the Closing Date, all charges and items of expense (including those charges and items of expense that were prepaid and are unamortized) with respect to the Business Assets that Foreland has either expressly assumed or is otherwise obligated to pay in accordance with the terms of this Agreement, with PSC bearing the proportionate expense attributable to the period prior to the Closing Date in accordance with the terms of this Agreement. Within 30 days after the Closing Date, Foreland and PSC shall jointly prepare or cause to be prepared a schedule of prorations in accordance with this Agreement showing the net amount due to Foreland or PSC, as the case may be. The net amount shown on such schedule shall be paid to the party entitled thereto within 60 days after the Closing Date. Any amounts subject to proration determined more than 30 days after the Closing Date shall be prorated, as set forth above, by the end of each calendar month and paid within 15 days thereafter. Section 6.08 Third Party Consents. Subject to the provisions of Section 4.15, PSC shall have obtained consents of all third parties whose consent is required to the transfer of any Business Assets or Business described herein, including any consents reasonably requested by Foreland. ARTICLE VII CONDITIONS PRECEDENT TO THE OBLIGATIONS OF PSC The obligation of PSC to sell the Business Assets is subject to Foreland's satisfaction, at the time of Closing, of the conditions set out below, except for any condition which has been waived in writing by PSC at or prior to the Closing. Section 7.01 Performance by Foreland. Foreland shall have substantially performed all the conditions of this Agreement, unless the requirement has been waived in writing by PSC. Section 7.02 Corporate Approval. The board of directors and shareholder(s) of Foreland shall have approved the transactions described in this Agreement and resolutions setting forth those approvals shall have been certified to PSC by an officer of Foreland. ARTICLE VIII SURVIVAL OF REPRESENTATIONS AND WARRANTIES All representations and warranties made in Articles IV and V shall be continuing and shall survive the Closing, but shall expire 24 months after the Closing Date; provided, however, that if a claim for indemnification has been asserted pursuant to Article VII prior to or as of the expiration date of such 24-month period, such representations and warranties shall remain in full force and effect until full and complete resolution of such claim. Notwithstanding the foregoing, however, the time for making a claim based upon such representation or warranty shall expire 24 months after the Closing Date. ARTICLE IX REGISTRATION OF SHARES Section 9.01 Obligations of Foreland. Whenever, in accordance with the terms of this Agreement, Foreland is required to file a Registration Statement, it shall proceed diligently and in good faith to: (a) Prepare and file with the SEC a Registration Statement with respect to such securities and use commercially reasonable best efforts to cause such Registration Statement to become effective, and keep such Registration Statement effective until all Option Consideration has been received by PSC from the sale of Shares or until the sale of such securities is no longer required to be registered by reason of rule 144(k) adopted under the Securities Act. (b) Use commercially reasonable best efforts to prepare and file with the SEC such amendments and supplements to such Registration Statement and the prospectus used in connection with such Registration Statement as may be necessary to comply with the provisions of the Securities Act with respect to the disposition of all Shares during the period that Foreland is obligated to keep the Registration Statement effective. (c) Furnish to the Holders such numbers of copies of a prospectus, including a preliminary prospectus, in conformity with the requirements of the Securities Act, and such other documents as they may reasonably request in order to facilitate the disposition of Shares on their behalf. (d) Use commercially reasonable best efforts to register and qualify the securities covered by such Registration Statement under such other securities or blue sky laws of such jurisdictions as shall be reasonably requested by the Holders; provided that, Foreland is not required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions. (e) Notify PSC at any time when a prospectus relating to the resale of the Shares is required to be delivered under the Securities Act, of the happening of any event that limits PSC's ability to rely on such Registration Statement, including any event that results in the prospectus included in such Registration Statement, as then in effect, containing an untrue statement of a material fact or omitting to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing; any stop order issued by the SEC or any state securities agency; or the suspension or limitation of any preemption or exemption from state registration or other qualification on which Foreland and PSC are relying. In any such event, Foreland shall use commercially reasonable best efforts to file an amendment to update the Registration Statement to the extent necessary or to take other remedial action. (f) Cause all such Shares registered hereunder to be listed on each securities exchange on which similar securities issued by Foreland are then listed. Section 9.02 Cooperation by PSC. (a) PSC shall furnish to Foreland in writing such information and affidavits as Foreland may reasonably require from PSC in connection with any registration, qualification, or compliance with respect to such Shares. It shall be a condition precedent to the obligations of Foreland to take any action pursuant to this Agreement with respect to the Shares of any selling Holder that PSC shall furnish to Foreland such information regarding PSC, the Shares and other securities in Foreland held, and the intended method of disposition of such securities as shall be required to effect the registration of PSC's Shares. (b) PSC, upon receipt of any notice from Foreland of the happening of any event of the kind described in paragraph (f) of section 3, will forthwith discontinue disposition of the Shares until PSC's receipt of the copies of the supplemented or amended prospectus contemplated by paragraph (f) of section 3 or until it is advised in writing by Foreland that the use of such prospectus may be resumed, and has received copies of any additional or supplemental filings that are incorporated by reference in such prospectus, and if so directed by Foreland, PSC will, or will request the managing underwriter or underwriters, if any, to, deliver to Foreland all copies, other than permanent file copies then in PSC's possession, of the prospectus covering such Shares current at the time of receipt of such notice. (c) At the end of any periods during which Foreland is obligated to keep any Registration Statement current and effective as provided herein, PSC shall discontinue sales of securities pursuant to such Registration Statement upon receipt of notice from Foreland of its intention to remove from registration the securities covered by such Registration Statement which remain unsold, and PSC shall notify Foreland of the number of securities registered which remain unsold promptly after receipt of such notice from Foreland. (d) PSC acknowledges that the registration of the sale of the Shares or the availability of an exemption from registration in certain states may impose certain limitations and conditions on the manner and nature of such sales. Foreland shall advise PSC in writing of such registration or exemption and the related limitations and conditions from time to time. PSC shall be solely responsible for PSC's own compliance with such limitations and conditions. Section 9.03 Expenses of Registration. All expenses, other than underwriting discounts and commissions, incurred in connection with registrations, filings or qualifications, including (without limitation) all registration, filing and qualification fees, printer's and accounting fees, and fees and disbursements of counsel for Foreland, shall be borne by Foreland. Section 9.04 Delay of Registration. PSC shall not have any right to obtain or seek an injunction restraining or otherwise delaying any such registration as the result of any controversy that might arise with respect to the interpretation or implementation of this Agreement. Section 9.05 Indemnification. In the event any Shares are included in a Registration Statement in which PSC is included as a Selling Shareholder is filed: (a) To the extent permitted by law, Foreland will indemnify and hold harmless PSC, whose Shares are included in a Registration Statement, any underwriter (as defined in the Securities Act) for PSC, and each person, if any, who controls PSC or underwriter within the meaning of the Securities Act or the Exchange Act, against any losses, claims, damages, or liabilities to which they may become subject under the Securities Act, insofar as such losses, claims, damages, or liabilities arise out of or are based upon any of the following statements, omissions or violations (collectively, a "Violation"): (i) any untrue statement or alleged untrue statement of a material fact contained in such Registration Statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto, (ii) the omission or alleged omission to state therein a material fact required to be stated therein, or necessary to make the statements therein not misleading, or (iii) any Violation or alleged violation by Foreland of the Securities Act or any rule or regulation promulgated under the Securities Act; and Foreland will pay to each PSC, underwriter or controlling person, any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement shall not apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of Foreland (which consent shall not be unreasonably withheld), nor shall Foreland be liable in any such case for any such loss, claim, damage, liability, or action to the extent that it arises out of or is based upon a Violation which occurs in reliance upon and in conformity with written information furnished expressly for use in connection with such registration by any PSC, underwriter, or controlling person. (b) To the extent permitted by law, PSC will indemnify and hold harmless Foreland, each of its directors, each of its officers who has signed the Registration Statement, each person, if any, who controls Foreland within the meaning of the Securities Act, any underwriter, any other Selling Shareholder selling securities in such Registration Statement and any controlling person of any such underwriter or other Selling Shareholder, against any losses, claims, damages, or liabilities to which any of the foregoing persons may become subject under the Securities Act or the Exchange Act, insofar as such losses, claims, damages, or liabilities (or actions in respect thereto) arise out of or are based upon any Violation, in each case to the extent (and only to the extent) that such Violation occurs in reliance upon and in conformity with written information furnished by PSC expressly for use in connection with such registration; and PSC will pay any legal or other expenses reasonably incurred by any person intended to be indemnified in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement shall not apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of PSC, which consent shall not be unreasonably withheld. Notwithstanding the foregoing provision, PSC's indemnification obligation under this subparagraph shall not exceed the amount received by PSC on the sale of securities pursuant to the Registration Statement. (c) Promptly after receipt by an indemnified party of notice of the commencement of any action (including any governmental action), such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this paragraph, deliver to the indemnifying party a written notice of the commencement thereof, and the indemnifying party shall have the right to participate in, and to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly noticed, to assume the defense thereof with counsel mutually satisfactory to the parties; provided, however, that an indemnified party (together with all other indemnified parties which may be represented without conflict by one counsel) shall have the right to retain one separate counsel, with the fees and expenses to be paid by the indemnifying party, if representation of such indemnified party by the counsel retained by the indemnifying party would be inappropriate due to actual or potential differing interest between such indemnified party and any other party represented by such counsel in such proceeding. The failure to deliver written notice to the indemnifying party within a reasonable time of the commencement of any such action, if prejudicial to its ability to defend such action, shall relieve such indemnifying party of any liability to the indemnified party under this paragraph, but the omission so to deliver written notice to the indemnifying party will not relieve it of any liability that it may have to any indemnified party otherwise than under this paragraph. (d) If the indemnification provided for in this section is held by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any loss, liability, claim, damage, or expense referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party hereunder, shall contribute to the amount paid or payable by such indemnified party as a result of such loss, liability, claim, damage, or expense in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and of the indemnified party on the other in connection with the statements or omissions that resulted in such loss, liability, claim, damage, or expense as well as any other relevant equitable considerations. The relative fault of the indemnifying party and of the indemnified party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party and the parties' relative intent, knowledge, access to information, and opportunity to correct or prevent such statement or omission. Notwithstanding the foregoing provision, the contribution obligation of PSC shall not exceed the amount received by PSC from the sale of securities pursuant to the Registration Statement. (e) The obligations of Foreland and PSC under this paragraph shall survive the completion of any offering of Shares pursuant to a Registration Statement. ARTICLE X INDEMNIFICATION Section 10.01 By Foreland and PSC. Foreland, on the one hand, and PSC on the other hand, each hereby agrees to indemnify and hold harmless the other party against all claims, damages, losses, liabilities, costs, and expenses (including settlement costs and any legal, accounting, or other expenses for investigating or defending any actions or threatened actions) reasonably incurred by the indemnified party in connection with each and all of the following: (a) any breach by the indemnifying party of any representation or warranty in this Agreement; (b) any breach of any covenant, agreement, or obligation of the indemnifying party contained in this Agreement or any other agreement, instrument, or document contemplated by this Agreement; and (c) any misrepresentation contained in any statement, exhibit, certificate, or schedule furnished by the indemnifying party pursuant to this Agreement or in connection with the transactions contemplated by this Agreement. Section 10.02 By PSC. The PSC agrees to indemnify and hold harmless Foreland from any and all claims, damages, liabilities, costs, and expenses (including settlement costs and any legal, accounting, or other expenses for investigating or defending any actions or threatened actions) reasonably incurred by the indemnified party in connection with each and all of the following: (a) any claims against, or liabilities or obligations of, PSC or against the Business or Business Assets not specifically assumed by Foreland pursuant to this Agreement which, in the aggregate, exceed $100,000; and (b) any and all claims, damages, losses, liabilities, costs, and expenses including settlement costs and any legal, accounting, or other expenses for investigating or defending any actions or threatened actions) reasonably incurred by Foreland in connection with any warranty claim or product liability claim relating to (i) products manufactured or sold by PSC prior to the Closing Date, or (ii) PSC's business or operations prior to the Closing Date. Section 10.03 Claims for Indemnification. Whenever any claim shall arise for indemnification hereunder, the party seeking indemnification (the "Indemnified Party"), shall promptly notify, in writing, the party from whom indemnification is sought (the "Indemnifying Party") of the claim and, when known, the facts constituting the basis for such claim. In the event of any such claim for indemnification hereunder resulting from or in connection with any claim or legal proceedings by any party, the notice to the Indemnifying Party shall specify, if known, the amount or an estimate of the amount of the liability arising therefrom. The Indemnified Party shall not settle or compromise any claim by a third party for which it is entitled to indemnification hereunder without the prior written consent of the Indemnifying Party, when shall not be unreasonably withheld, unless suit shall have been instituted against it and the Indemnifying Party shall not have taken control of such suit after notification thereof as provided in section 10.04 hereof. Section 10.04 Defense by Indemnifying Party. In connection with any claim giving rise to indemnity hereunder resulting from or arising out any claim or legal proceeding by a person who is not a party to this Agreement, the Indemnifying Party, at its sole cost and expense may, upon written notice to the Indemnified Party, assume the defense of any such claim or legal proceeding if it acknowledges to the Indemnified Party in writing its obligations to indemnify the Indemnified Party with respect to all elements of such claim. The Indemnified Party shall be entitled to participate (but not control) the defense of any such action, with its counsel and at its own expense. If the Indemnifying Party does not assume the defense of any such claim or litigation resulting therefrom within 30 days after the date such claim is made: (a) the Indemnified Party may defend against such claim or litigation in such manner as it may deem appropriate, including, but not limited to, settling such claim or litigation, after giving notice of the same to the Indemnifying Party, on such terms as the Indemnified Party may deem appropriate; and (b) the Indemnifying Party shall be entitled to participate in (but not control) the defense of such action, with its counsel and at its own expense. If the Indemnifying Party thereafter seeks to question the manner in which the Indemnified Party defended such third party claim or the amount or nature of any such settlement, the Indemnifying Party shall have the burden to prove by a preponderance of the evidence that the Indemnified Party did not defend or settle such third party claim in a reasonably prudent manner. ARTICLE XI SPECIAL COVENANTS Section 11.01 Obligations After Closing. For a period of 18 months following the Closing Date, Foreland shall have access to and the right to copy all business records necessary to permit the preparation and audit of the financial statements required by the Securities Act and/or the Exchange Act with respect to the Business. The officers, directors, and employees will cooperate, to the extent necessary, to assist in the preparation and audit of such financial statements. In addition, PSC and Foreland shall have access to and the right to copy all of the records of each other relative to the Business as maybe necessary for preparation of employee or corporate tax returns, employee tax reports, and customary accounting functions. Additionally, PSC and Foreland shall agree to make available to the other, at reasonable times and upon reasonable advance notice, relevant records and personnel in connection with the preparation of a defense or the participation in a defense, participation in the prosecution of claim or litigation, and negotiation of a settlement relating to any pending, future, or threatened litigation, or government agency proceeding (including a tax audit) involving the conduct of the Business before or after the Closing, as the case may be, or in the perfection, registration, or transferring of any copyright, trademark right, or other proprietary information or right acquired by Foreland hereunder. Section 11.02 Waiver of Bulk Sale. Foreland hereby waives compliance by PSC with the provisions of the Nevada Commercial Code applicable to bulk transfers. Section 11.03 Financial Statements Respecting the Business. PSC shall utilize its best efforts to make available to Foreland PSC's financial statements, related information, and access to PSC's accountants and auditors, at Foreland's expense, to the extent reasonably required for Foreland to meet the requirements under applicable securities laws for providing financial statements on acquired businesses. ARTICLE XII SPECIFIC PERFORMANCE The parties hereto agree the failure of any party to perform any obligation or duty which each has agreed to perform shall cause irreparable harm to the parties willing to perform the obligations and duties herein, which harm cannot be adequately compensated for by money damages. It is further agreed by the parties hereto an order of specific performance against a party in default under the terms of this Agreement would be equitable and would not work a hardship on the defaulting party. Accordingly, in the event of default by any party hereto, the non-defaulting party, in addition to whatever other remedies are available at law or in equity, shall have the right to compel specific performance by the defaulting party of any obligation or duty herein. ARTICLE XIII MISCELLANEOUS PROVISIONS Section 13.01 Costs. Foreland and PSC shall each pay all of their own costs and expenses incurred or to be incurred by each in negotiating and preparing this Agreement and in closing and carrying out the transactions contemplated by this Agreement. Section 13.02 Notices. Any notice, demand, request, or other communication under this Agreement shall be in writing and shall be deemed to have been given on the date of service if personally served or by facsimile transmission (if receipt is confirmed by the facsimile operator of the recipient), or delivered by overnight courier service or on the third day after mailing if mailed by certified mail, return receipt requested, addressed as follows: If to PSC, to: A. Howard McCollum President and CEO Petro Source Refining Corporation 9801 Westheimer, Suite 900 Houston, Texas 77042 Telecopy: (713) 972-2035 With copies to: Harvey H. Cody III Vice-President, General Counsel and Secretary Petro Source Refining Corporation 9801 Westheimer, Suite 900 Houston, Texas 77042 Telecopy: (713) 972-2035 If to Foreland, to: Foreland Corporation Attn: N. Thomas Steele, President 12596 West Bayaud, Suite 300 Lakewood, Colorado 80226 Telecopy: (303) 988-3234 With copies to: James R. Kruse, Esq. Kruse, Landa & Maycock, L.L.C. Eighth Floor, Bank One Tower 50 West Broadway Salt Lake City, Utah 84101 Telecopy: (801) 531-7091 or such other addresses and facsimile numbers as shall be furnished in writing by any party in the manner for giving notices hereunder, and any such notice, demand, request, or other communication shall be deemed to have been given as of the date so delivered or sent by facsimile transmission (if receipt is confirmed by the facsimile operator of the recipient), three days after the date so mailed, or one day after the date so sent by overnight delivery. Section 13.03 Governing Law. This Agreement shall be governed by, enforced and construed under and in accordance with the laws of the United States of America and, with respect to matters of state law, with the laws of the state of Utah. Venue for all actions regarding this Agreement shall be in Salt Lake County, Utah. The parties hereby submit to the personal jurisdiction of such court for the purpose of resolving any dispute arising under this Agreement. Section 13.04 Attorneys' Fees. In the event that any party institutes any action or suit to enforce this Agreement or to secure relief from any default hereunder or breach hereof, the breaching party or parties shall reimburse the nonbreaching party or parties for all costs, including reasonable attorneys' fees, incurred in connection therewith and in enforcing or collecting any judgment rendered therein. Section 13.05 Schedules and Exhibits; Knowledge. Whenever in any section of this Agreement reference is made to information set forth in the exhibits or the PSC Schedules, such reference is to information specifically set forth in such exhibits or schedules and clearly marked to identify the section of this Agreement to which the information relates. Whenever any representation is made to the "knowledge" of any party, it shall be deemed to be a representation that no officer or director of such party, after reasonable investigation, has any knowledge of such matters. Section 13.06 Entire Agreement. This Agreement, together with the documents to be delivered pursuant hereto, represent the entire agreement between the parties relating to the subject matter hereof. There are no other courses of dealing, understanding, agreements, representations, or warranties, written or oral, except as set forth herein. Section 13.07 Survival; Termination. The representations, warranties, and covenants of the respective parties shall survive the Closing. Section 13.08 Form of Execution; Counterparts. A valid and binding signature hereto or any notice or demand hereunder may be in the form of a manual execution or a true copy made by photographic, xerographic, or other electronic process that provides similar copy accuracy of a document that has been executed. This Agreement may be executed in multiple counterparts, each of which shall be deemed an original and all of which taken together shall be but a single instrument. Section 13.09 Amendment or Waiver. Every right and remedy provided herein shall be cumulative with every other right and remedy, whether conferred herein, at law, or in equity, and may be enforced concurrently herewith, and no waiver by any party of the performance of any obligation by the other shall be construed as a waiver of the same or any other default then, theretofore, or thereafter occurring or existing. At any time prior to the Closing Date, this Agreement may be amended by a writing signed by all parties hereto, with respect to any of the terms contained herein, and any term or condition of this Agreement may be waived or the time for performance thereof may be extended by a writing signed by the party or parties for whose benefit the provision is intended. Section 13.10 Waiver of Jury Trial. Each party hereby (a) knowingly, voluntarily, intentionally, and irrevocably waives, to the maximum extent not prohibited by law, any right it may have to a trial by jury in respect of any litigation based hereon, or directly or indirectly at any time arising out of, under, or in connection with this Agreement or any transaction contemplated hereby or associated herewith; and (b) acknowledges that it has been induced to enter into this Agreement and the transactions contemplated hereby by, among other things, the mutual waivers and certifications contained in this section. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first above written. FORELAND CORPORATION By /s/ N. Thomas Steele, President PETRO SOURCE CORPORATION By /s/ Harvey H. Cody III, Vice-President PETRO SOURCE REFINING CORPORATION By /s/ Harvey H. Cody III, Vice-President PETROSOURCE TRANSPORTATION By /s/ Harvey H. Cody III, Vice-President EX-10 3 PURCHASE AND SALE AGREEMENT THIS PURCHASE AND SALE AGREEMENT (the "Agreement"), made and entered into this 2nd day of February, 1998 by and between Plains Petroleum Operating Company, whose address is 1515 Arapahoe Street, Tower 3, Suite 1000, Denver, Colorado 80202 (hereinafter referred to as "Seller"), and Eagle Springs Production Limited Liability Company, whose address is 2561 South 1560 West, Suite 200, Woods Cross, Utah 84087 (hereinafter referred to as "Buyer"). I. PURCHASE AND SALE 1.01 Purchase and Sale. In consideration of the mutual promises contained herein, the benefits to be derived by each party hereunder and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and subject to the terms of this Agreement, Seller agrees to sell the Interests to Buyer and Buyer agrees to purchase the Interests from Seller. 1.02 Interests. The term "Interests" shall have the same meaning assigned to it in the Assignment, Conveyance and Bill of Sale dated February 2, 1998, from Seller to Buyer ("Assignment") attached hereto as Exhibit 1. 1.03 Effective Date. The purchase and sale of Interests shall be effective for all purposes on December 31, 1997, at 7:00 a.m. local time at the location of the Leases (the "Effective Date"). II. PURCHASE PRICE 2.01 Purchase Price. The purchase price for the Interests is Five Hundred Thousand Dollars ($500,000.00) subject to adjustment set forth in Section 2.02 and Section 4.01 (the "Purchase Price"). 2.02 Adjustments to Purchase Price. The Purchase Price shall be adjusted as provided in Section 2.02 and the resulting amount shall be referred to as the "Adjusted Purchase Price." Not less than three (3) business days prior to the Closing Date, Buyer shall deliver to Seller a closing statement containing these adjustments to the Purchase Price using the best information then available and prepared in accordance with customary accounting principles used in the oil and gas industry (the "Closing Statement"). (a) The Purchase Price shall be increased by the following: (l) An amount equal to the quantity of merchantable oil produced from the Leasehold Interests (as defined in the Assignment) in storage at the Effective Date, and not sold or disposed of prior to Closing, multiplied by the posted price for such oil at the Effective Date, net of all taxes and gravity adjustments and transportation expenses necessary to market such production; (2) The amount of all operating and capital expenditures, together with any lease operating expenses charged under the applicable operating agreement and general and administrative costs charged as overhead charges under applicable operating agreement, that are (i) attributable to the Interests during the period between the Effective Date and Closing, and (ii) incurred by Seller, including without limitation capital expenditures; (3) Taxes paid by Seller for assessments based on ownership of the Interests after the Effective Date, the production of hydrocarbons therefrom, or the receipt of proceeds attributable thereto (excluding income taxes) after the Effective Date; (4) An amount equal to all prepaid expenses attributable to the Interests paid by Seller and attributable to the period from and after the Effective Date, including without limitation prepaid ad valorem, property, production and other taxes and payments for insurance coverage accruing to the benefit of Buyer subsequent to the Effective Date. (b) The Purchase Price shall be decreased by the following: (1) The amount of net proceeds or other value received by Seller for the sale or disposition of oil, gas, associated hydrocarbons, by-products of oil and gas production, including water, net proceeds, from the sale of liquids and other constituents removed in gas plants or other processing facilities for production occurring after the Effective Date; (2) The amount of proceeds or other value received by Seller for the sale or disposition after the Effective Date of any portion of the Interests; (3) The amount of all unpaid taxes and assessments based on the ownership of property, the production of hydrocarbons or the receipt of proceeds, excluding income taxes, accruing to the Interests prior to the Effective Date and for the payment of which Buyer assumes liability subsequent to Closing. If possible, this adjustment shall be computed using the tax rate and values for the tax period in question. If this is not possible, the adjustment shall be based on the taxes assessed for the immediately preceding tax period. If taxes assessed for the preceding tax period are determined to be more or less than the actual taxes, the difference shall be a Post-Closing Adjustment or Subsequent Adjustment under Section 4.01 and 4.02. III. CLOSING 3.01 Closing Date. Subject to the terms of this Agreement, the consummation of the transactions contemplated by this Agreement ("Closing"), shall occur at Seller's office listed above (or at such other place and time as the Parties may agree) on or before January 31, 1998. The date on which Closing actually occurs is referred to herein as the "Closing Date" 3.02 Closing Obligations. At Closing, the following shall occur, each being a condition precedent to the others and each being deemed to have occurred simultaneously: (a) Upon confirmation of receipt of the Adjust Purchase Price, Seller shall execute and deliver to Buyer an assignment conveying the Interests to Buyer in the form attached to this Agreement at Exhibit 1. Seller shall also execute and deliver such other assignment on appropriate forms as may be required by governmental authority, subject to the terms of the assignment attached as Exhibit 1. The assignment(s) shall provide for warranty of title by, through and under Seller, but not otherwise. (b) Seller and Buyer shall execute and deliver to each other the Closing Statement. (c) Buyer shall deliver the Adjusted Purchase Price to Seller by direct bank or wire transfer, as directed by Seller. (d) Upon confirmation of receipt of the Adjusted Purchase Price, Seller shall deliver to Buyer possession of the Interests. (e) Seller shall execute transfer orders to letters-in-lieu on forms prepared by Seller and reasonably satisfactory to Buyer directing purchasers of production to make payment to Buyer as contemplated by this Agreement. IV. OBLIGATIONS AFTER CLOSING 4.01 Post-Closing Adjustments. Seller and Buyer acknowledge that the amount of all adjustments under Section 2.02 may not be available prior to Closing. Within sixty (60) days, Buyer shall prepare and submit to Seller a statement containing adjustments contemplated by Section 2.02 that were not finally determined as of Closing ("Final Settlement Statement"). Seller shall promptly notify Buyer of any changes Seller proposes and the parties shall negotiate in good faith to agree on these adjustments within ninety (90) days after the Closing Date. Payment to the appropriate party shall be made within five (5) business days after agreement is reached ("Final Settlement Date"). 4.02 Subsequent Adjustments. Seller and Buyer recognize that either party may receive funds or pay expenses after the Final Settlement Date which are properly the property or obligation of the other party. Upon receipt of net proceeds or net expenses due to or payable by the other party, whichever occurs first, such party shall submit a statement showing the items of income and expense. Payment by the appropriate party shall be made within ten (10) business days of receipt of the statement. 4.03 Reservation of Claims. Except as provided in this Agreement, Seller is entitled to all claims related to the Interests prior to the Effective Date regardless of when payment is made. Except as provided in this Agreement, Buyer is entitled to all claims related to the Interests which arise after the Effective Date. 4.04 Sales and Use Taxes and Recording Fees. Buyer shall pay all applicable transfer, sales and use taxes occasioned by the sale of the Interests. Buyer shall also pay all documentary, filing and recording fees required in connection with the filing and recording of all instruments contemplated by this Agreement. V. MISCELLANEOUS 5.01 Notices. All notices required or permitted under this Agreement shall be effective upon receipt if personally delivered, if mailed by registered or certified mail, postage prepaid, or if delivered by telegram or facsimile if directed to the parties as follows: TO BUYER: Eagle Springs Production Limited Liability Company 2561 South 1560 West, Suite 200 Woods Cross, Utah 84087 Telephone: (801) 298-9866 Fax: (801) 298-9889 Attn: Bruce Decker TO SELLER: Plains Petroleum Operating Company 1515 Arapahoe Street, Tower 3, Suite 1000 Denver, Colorado 80202 Telephone: (303) 606-4052 Fax: (303) 629-8281 Attn: Joseph P. Barrett Any party may give written notice of a change in the address or individual to whom delivery shall be made.5.02 Expenses. Except as otherwise specifically provided in this Agreement, all fees, costs and expenses incurred by the parties in negotiating this Agreement or in consummating the transactions contemplated by this Agreement shall be paid by the party incurring the item. 5.03 Amendment. This Agreement may not be altered or amended, nor any rights waived, except by a written instrument executed by the party to be charged with the amendment or waiver. No waiver of any provision of this Agreement shall be construed as a continuing waiver of the provision. 5.04 Conditions. The inclusion in this Agreement of conditions to Seller's and Buyer's obligations at Closing shall not, in and of itself, be a covenant of either party to satisfy the conditions to the other party's obligations at Closing. 5.05 Headings. The headings are for convenience only and do not limit or otherwise affect the provisions of this Agreement. 5 06 Counterparts. This Agreement may be executed in counterparts, each of which shall be an original and which, taken together, shall constitute the same instrument. 5.07 References. References, including use of a pronoun, shall include, where applicable, masculine, feminine, singular or plural individuals or legal entities. 5 08 Governing Law. This Agreement and the transactions contemplated by this Agreement shall be governed and construed in accordance with the internal laws of the State of Colorado without giving effect to any principles of conflicts of law. 5.09 Announcements. Except as required by law, prior to Closing, neither Seller nor Buyer shall announce or otherwise publicize this Agreement or the transactions contemplated by this Agreement without the prior written consent of the other party. 5.10 Entire Agreement. This Agreement is the entire understanding between Seller and Buyer concerning the subject matter of this Agreement. This Agreement supersedes all negotiations, discussions, representations, prior agreements and understandings, whether oral or written. 5.11 Parties in Interest. This Agreement is binding upon and shall inure to the benefit of Seller and Buyer and, except where prohibited their heirs, successors, representatives and assigns. No other party is intended to have any benefits, rights or remedies under this Agreement. There are no third-party beneficiaries. 5.12 Buyer's Responsibility. Buyer acknowledges that it is the operator of the Interests. As such it has superior knowledge as to the Interests and has made its analyses and decisions as to proceeding with this transaction based upon such knowledge and not upon any information it might have received from Seller. 5.13 Exhibits. All exhibits attached to this Agreement are incorporated into this Agreement for all purposes. 5.14 Severance. If any provision of this Agreement is found to be illegal or unenforceable, the other terms of this Agreement shall remain in effect and this Agreement shall be construed as if the illegal or unenforceable provision had not been included. SELLER: Plains Petroleum Operating Company By: /s/ Joseph P. Barrett Joseph P. Barrett Vice President - Land BUYER:Eagle Springs Production Limited Liability Company By:/s/ N. Thomas Steele Name: N. Thomas Steele Title: Manager Exhibit I To that certain Purchase and Sale Agreement dated February 2, 1998, by and between Plains Petroleum Operating Company and Eagle Springs Limited Liability Company.ASSIGNMENT, CONVEYANCE AND BILL OF SALE THIS ASSIGNMENT, CONVEYANCE AND BILL OF SALE (herein called "Assignment") is made between PLAINS PETROLEUM OPERATING COMPANY, hereinafter called "ASSIGNOR", having an address of 1515 Arapahoe, Tower 3, Suite 1000, Denver, Colorado 80202 and EAGLE SPRINGS PRODUCTION LIMITED-LIABILITY COMPANY, a Nevada limited liability company, hereinafter called "ASSIGNEE", having an address of 2561 South 1560 West, Suite 200, Woods Cross, UT 84087. In consideration of Ten Dollars ($10.00), other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and of the covenants and agreements set forth herein, ASSIGNOR hereby grants, sells' assigns, transfers and conveys to ASSIGNEE, its successors and assigns, all of Assignor's right, title and interest in and to the following (all of which are herein called the "Interests"): 1. Federal Oil and Gas Leases NVN-012321 and NVN-42341 in Nye County, Nevada (the "Leasehold Interests") insofar and only insofar as the Leasehold Interests cover the lands described in Exhibit "A" (herein collectively called the "Lands"), together with all of the property and rights incident thereto; 2. All permits, franchises, licenses, servitudes, easements, surface leases, rights-of-way and any other rights associated with the exploration, development, operation, marketing, maintenance and production of oil, gas and associated hydrocarbons from the Lands or relating to the Leasehold Interests; 3. All contracts and agreements affecting the Lands and Leasehold Interests including, but not limited to, rights and interests in or derived from crude oil purchasing agreements, unit agreements, communization agreements, joint operating agreements, pooling agreements, farmout/farmin agreements, enhanced recovery and injection agreements, boundary line or well agreements, assignments of operating rights, working interests and subleases; 4. All of the personal property, fixtures and improvements now or as of the Effective Date located on or in the vicinity of the Lands and used in connection with operations of the Lands, or with the production, treatment, sale or disposal of hydrocarbons or water produced therefrom or attributable thereto, including, without limitation, the personal property described on Exhibit "B" attached hereto and made part of this Agreement by incorporation and reference, and all other machinery, equipment, fixtures, tank batteries, pipelines, water disposal systems and product processing plants located on or in the vicinity of the Lands or used or obtained in connection with operation of the Lands (herein called the "Personal Property"); 5. All of the wells and boreholes (herein called the "Wells") on the Lands including without limitation those described in Exhibit "B"; and 6. The oil, gas, and associated hydrocarbon production from or relating to the Lands and the Leasehold Interest, if any, from the Effective Date. This ASSIGNMENT shall be subject to the following terms, conditions or exceptions: A. This ASSIGNMENT shall be effective as of 7:00 a.m. PDT, December 31, 1997 ("Effective Date"). B. All production from the Lands and the Leasehold Interests, all oil in storage above the pipeline connection, and all proceeds from the sale of such production, which are produced from the Lands and the Leasehold Interests or accrue prior to the Effective Date shall be the property of ASSIGNOR. All such production which is produced after the Effective Date, and all proceeds for such production, shall be the property of the ASSIGNEE, except as otherwise provided herein. C. ASSIGNOR shall be responsible for payment of its proportionate share of all expenses and taxes and incurred against operation of the interests prior to the Effective Date, regardless of when those expenses are billed. ASSIGNEE shall be responsible for payment of all expenses and taxes incurred against operation of the Interests after the Effective Date. Property and ad valorem taxes for the year 1997 shall be prorated between ASSIGNOR and ASSIGNEE as of the Effective Date. The party making payment of such 1997 taxes shall be entitled to reimbursement for such payment of the other party's prorated share. D. ASSIGNEE hereby agrees that it has inspected the Personal Property assigned and conveyed herein and that it accepts same in their present condition. ASSIGNEE hereby understands and agrees that ALL WELLS, FIXTURES, FACILITIES, EQUIPMENT, LINES AND MATERIALS ARE INTENDED TO BE AND ARE HEREBY SOLD AND ACCEPTED BY ASSIGNEE ON AN "AS IS, WHERE IS, AND WITH ALL FAULTS" BASIS. ASSIGNOR MAKES NO REPRESENTATION, COVENANT, OR WARRANTY, EXPRESS, STATUTORY, OR IMPLIED AS TO THE VALUE, MERCHANTABILITY, DESIGN, CONDITION, OPERATION, QUANTITY, DURABILITY, QUALITY OR MATERIAL OR WORKMANSHIP, FITNESS FOR USE, OR AGAINST ANY TYPE OF INFRINGEMENT OF THE PERSONAL PROPERTY DESCRIBED HEREIN WHETHER ARISING FROM THE COURSE OF PERFORMANCE, COURSE OF DEALING, USAGE OF TRADE, OR OTHERWISE. ASSIGNEE hereby agrees to assume responsibility for the Personal Property in and on the Wells, and all other property used on or in connection therewith, from and after the Effective Date of this Assignment, including the costs of plugging and abandoning the Wells located thereon as of the Effective Date of this Assignment. E. ASSIGNEE agrees to protect, defend, indemnify and hold ASSIGNOR free and harmless from and against any and all costs, expenses, claims, demands and causes of action of every kind and character arising out of, incident to, or in connection with the operation and ownership of the Interests from and subsequent to the Effective Date. ASSIGNOR agrees to protect, defend, indemnify and hold ASSIGNEE free and harmless from and against any and all costs, expenses, claims, demands and causes of action of every kind and character arising out of, incident to, or in connection with the ownership of the Interests during the period of Assignor's ownership and prior to the Effective Date. F. ASSIGNOR covenants that it has good right and authority to assign and convey the Interests, and that the same are free and clear of all liens and encumbrances and that the ASSIGNOR warrants that it will forever defend the title to the Leasehold Interests against all claims arising by, under and through, ASSIGNOR, but not otherwise. EXCEPT AS SPECIFICALLY PROVIDED ABOVE, HOWEVER, THIS ASSIGNMENT IS MADE WITHOUT ANY WARRANTY OF TITLE WHATSOEVER, EITHER EXPRESSED OR IMPLIED, AND WITHOUT WARRANTY OF ANY KIND OR NATURE WHATSOEVER RELATING TO THE (1) PHYSICAL, OPERATIONAL, OR ENVIRONMENTAL CONDITIONS OF ANY OF THE REAL PROPERTY, PERSONAL PROPERTY, OR OIL AND GAS OPERATIONS THAT ARE A PART OF OR RELATED TO THE INTERESTS, OR ARE COVERED BY, BEING A PART OF, HELD SUBJECT TO, OR CONDUCTED UNDER THE TERMS AND CONDITIONS OF ANY LEASES OR OTHER AGREEMENTS THAT ARE A PART OF, THE INTERESTS, OR (2) THE ISSUANCE, REISSUANCE, OR TRANSFER OF ANY PERMITS RELATING TO ANY OF THE INTERESTS. G. ASSIGNOR hereby covenants and agrees with ASSIGNEE to execute and deliver to ASSIGNEE such other and further instruments of conveyance, assignment, and transfer, and to do, or cause to be done, all such acts and things as may be necessary to more fully convey, assign, and transfer to and vest in ASSIGNEE the above specified interests in all of the lands, leases, and properties, rights and interests herein transferred, assigned and conveyed or intended so to be. H. This Assignment is made and delivered pursuant to, and is subject to the terms of, that certain Purchase and Sale Agreement dated February 2, 1998 by and between ASSIGNOR and ASSIGNEE, and to all overriding royalty' interest and other burdens on production of record as of the Effective Date. I. The terms, conditions or exceptions contained herein shall constitute covenants running with the lands and shall be binding upon, and for the benefit of, the respective successors and assigns of PLAINS PETROLEUM OPERATING COMPANY and EAGLE SPRINGS PRODUCTION LIMITED LIABILITY COMPANY. J. Separate assignments of the Interest may be executed on officially approved forms by ASSIGNOR to ASSIGNEE, in sufficient counterparts to satisfy applicable statutory and regulatory requirements. Those assignments shall be deemed to contain all of the exceptions, reservations, warranties, rights, titles, powers and privileges set forth herein as though they were set forth in each such assignments. The interest conveyed by such separate assignments are the same, and not in addition to, the Interest conveyed herein. K. This Assignment may be executed in any number of counterparts, and each counterpart hereof shall be deemed to be an original instrument, but all such counterparts shall constitute but one assignment. L. This Assignment shall bind and inure to the benefit of ASSIGNOR and ASSIGNEE and their respective successors. Executed on February 2, 1998, to be effective for all purposes as of the Effective Date. ASSIGNOR Plains Petroleum Operating Company By: Joseph P. Barrett Vice President - Land ASSIGNEE Eagle Springs Production Limited Liability Company By: Name: Title: STATE OF COLORADO ) ) ss. COUNTY OF JEFFERSON ) On this day of , 1998, before me, a Notary Public in and for said County and State, personally appeared of Eagle Springs Production Limited Liability Company, and he stated that said instrument was signed on behalf of said limited liability company and acknowledged said instrument to be the free act and deed of said limited liability company. Witness my hand and seal the date first above written. My Commission Expires: Notary Public STATE OF COLORADO ) ) ss. COUNTY OF DENVER ) On this day of , 1998, before me, the undersigned Notary Public in and for said County and State, personally appeared Joseph P. Barrett, Vice President - Land and Assistant Secretary of Plains Petroleum Operating Company, and he stated that said instrument was signed on behalf of said corporation by authority of its Board of Directors and acknowledged said instrument to be the free act and deed of said corporation. Witness my hand and seal the date first above written. My Commission Expires: Notary Public EXHIBIT "A" Attached to and made a part of that certain Assignment, Conveyance and Bill of Sale dared effective December 31, 1997, by and between PLAINS PETROLEUM OPERATING COMPANY, Assignor, and EAGLE SPRINGS PRODUCTION LIMITED LIA13ILIl Y COMPANY, Assignee SCHEDULE OF LEASES As to all of Plains Petroleum Operating Company interest in Tract I and Tract II: TRACT I NVN-012321 Township 9 North, Range 57 East. M. D. M. Section 35: S/2N/2SW/4 Nye County, Nevada TRACT 11 NVN-4234 1 Township 9 North. Range 57 East. M. D. M. Section 35: S/2N/2SE/4, S/2S/2 Section 36: S/2N/2S/2, S/2S/2 Nye County, Nevada EXHIBIT "B" ATTACHED TO AND MADE A PART OF THAT CERTAIN ASSIGNMENT, CONVEYANCE AND BILL OF SALE DATED EFFECTIVE DECEMBER 31, 1997 BETWEEN PLAINS PETROLEUM OPERATING COMPANY, AS ASSIGNOR AND EAGLE SPRINGS PRODUCTION LIMITED LIABILITY COMPANY, AS ASSIGNEE NYE COUNTY, NEVADA SCHEDULE OF WELLS, FIXTURES, FACILITIES AND EQUIPMENT Pumpjack: None Pad: None Motor: None Electric Panel: None Chemical Feed: None Wellhead: Standard Surface Casing: 506.36'9 5/8" 36# J-55 Production Casing: 2278.82'7" 26# CF-50 2278.72'7" 23# K-55 Rod String: None Tubing String: 4345' 2 7/8" Downhole Pump: None Other Equipment: Flowline Production Storage: To GR Battery Pumpjack: None Pad: None Motor: None Electric Panel: None Chemical Feed: None Wellhead: Standard Surface Casing: 535.93' 10 3/4" 40.5# J-55 Production Casing: 4552.09' 7" 26# CF-50; 80.12' 6" K-55 Rod String: None Tubing String: 4343.74 2/8" Downhole Pump: None Other Equipment: Flowline: 798' 2.5" Coated Production Storage: To GR Battery Pumpjack: 320 AmericanPad: Wood Motor: 30 HP 1200 RPM Teco Motor Electric Panel: 100 Amp-30 HP Panel Chemical Feed: None Wellhead: 118 Recond. Wellhead Surface Casing: 502' 10 3/4" 40.5# J-55 Production Casing: 4417.44' 7" 26# CF-50; 355' 7" Rod String: 2500' 3/4"; 1900' 7/8"; 7/8" x 6' Pony Tubing String: 4526' 2 7/8" Downhole Pump: 2.5x2 x20 #382 Other Equipment: Flowline 1192.8' 2.5" Coated Production Storage: To GR Battery 1000 BBL. Oil Storage Tank 1000 BBL. Oil Storage Tank 3000 BBL. Oil Storage Tank-Gun Barrell (2)400 BBL. Water Storage Tanks Recycle Pump Dual End Texteam Chemical Pump 4'x 12' 750,000 BTU Line Heater 6'x 20' 75# PSI Horizontal Heater Treater Lact Unit Lact Dual Counter Shifter 15 HP 1800 RPM Lincoln Motor (Backup Load Pump) Storage Building EX-23 4 INDEPENDENT AUDITOR'S CONSENT We consent to the incorporation by reference in the registration statements of Foreland Corporation on Forms S-3, SEC File Nos. 333-19063 and 333-3779 and the registration statement on Form S-8, SEC File No. 333-45025 of our report dated March 21, 1997, on our audits of the consolidated financial statements of Foreland Corporation as of December 31, 1997 and 1996, and for each of the years in the three-year period ended December 31, 1997, which report is included in this Annual Report on Form 10-K. /s/ HEIN + ASSOCIATES LLP Denver, Colorado March 31, 1997 EX-23 5 MALKEWICZ HUENI ASSOCIATES March 27, 1998 Kruse, Landa & Maycock, L.L.C. 50 West Broadway 8th Floor Salt Lake City, Utah 84101-2034 We consent to the use of our report respecting Foreland Corporation's (the "Company"), properties and the discussion of such report as contained in the Company's annual report on Form 10-K for the year ended December 31, 1997 and to the incorporation by reference of such report as it is referred to in the Company's annual report to the Registration Statements on Form S-3, SEC File Nos. 333-19063 and 333-03779 and the Registration Statement on Form S-8, SEC File Nos. 333-45025. Sincerely, Malkewicz Hueni Associates, Inc. /s/ Gregory B. Hueni Vice President 14142 Denver West Parkway, Suite 190 Golden, Colorado 80401 U.S.A. (303) 277-0270 Fax: (303) 277-0267 EX-27 6 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE SHEET AS OF DECEMBER 31, 1997, AND STATEMENTS OF OPERATIONS FOR THE YEAR THEN ENDED, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 40,631 0 245,041 0 61,108 358,778 12,240,507 (5,346,333) 7,953,172 853,933 642,951 8,468 0 762 6,447,058 7,953,172 2,213,336 2,300,744 0 904,652 4,460,069 0 (169,176) (3,066,657) 0 (3,066,657) 0 0 0 (3,066,657) (0.46) (0.33)
EX-10 7 Petro Source Refining Corporation 9801 Westheimer Suite 900 Houston, Texas 77042 Telephone (713) 972-2000 Facsimile (713) 972-2035 Purchase Contract Confirmation Customer: Agreement Date: 12/15/97 Foreland Corporation Contract No. 1 7419 2561 South 1560 West, #200 Customer Contract No Wood Cross, Utah 84087 Pursuant to the conversation between Bill Townsend and Bruce Decker, we hereby confirm the agreement between Petro Source Refining Corporation and Foreland Corporation as follows: Petro Source Receives: Product: Crude Oil produced from wells located in Nevada ("Nevada Crude Oil"). Quantity: All Nevada Crude Oil which Foreland has or will have the right to sell which is not released herefrom pursuant to other provisions of this contract. Delivery: Into Buyer's designated carrier at point of production. Price: An amount, which varies according to the field from which the oil is produced, equal to Chevron's posting for Southwest Wyoming Sweet crude oil adjusted for actual API gravity, less the amount set forth opposite the applicable field listed below: Ghost Ranch $4.15 0 to 15,000 barrels per month Pine Valley (20+ API) $4.65 0 to 30,000 barrels per month Eagle Springs $4.65 0 to 15,000 barrels per month Other: To be negotiated Provided, however, if, in Petro Source's opinion, the proceeds from the products derived from Eagle Springs production will not be sufficient to cover the costs attributable to such products, Petro Source may notify Foreland, in which event the parties will negotiate in good faith for 30 days to set a mutually agreeable price. If agreement is not reached pursuant to such negotiations, Petro Source may terminate purchases of such production hereunder, which termination will 1 ) be effective as of the last day of the month in which the 30 day negotiation period ends, and 2) release such oil from this contract during the term of any other contract pursuant to which such oil is sold. Other Oil "Other" is Nevada Crude Oil in excess of the range for the listed fields and Nevada Crude Oil from fields not listed above, as, if and when it becomes available for sale by Foreland. Foreland will give Petro Source prompt notice when Other oil becomes available for sale. The parties will thereupon negotiate in good faith to establish mutually agreeable terms under which such production will be sold to Petro Source. If within such time no agreement is reached. such oil will be released from this contract during the term of any other contract pursuant to which such oil is sold. Payment: By wire transfer on or before the 20th day of the month following delivery. Term: 12/15/97 to 1/31/98, automatically renewing monthly until either party cancels by providing the other with written notice at least 30 days prior to the effective cancellation date. Right to Match: 12/31/98 to 12/31/01, Petro Source will have the right to purchase Foreland's Nevada Crude Oil by matching any bona fide third party offer received by Foreland for such production at the time such production is available for purchase. Petro Source shall within five (5) days, after receipt of Foreland's notice of a bona fide third party offer for Foreland's Nevada Crude Oil, inform Foreland as to whether Petro Source will exercise its option to purchase such Nevada Crude Oil. Such purchase of Nevada Crude Oil shall be based upon Petro Source's general terms and conditions. Delivera- bility: Petro Source acknowledges that some of Foreland's Nevada Crude Oil is currently committed to other purchasers. Foreland will use best efforts to obtain the right to sell such oil to Petro Source hereunder. Contin- gency: This Agreement will become effective concurrently with the Option and Purchase Agreement currently being negotiated by the parties. This Agreement is made subject to Petro Source Corporation's General Provisions' which are incorporated herein by reference. If any of the above terms do not reflect your understanding of this agreement, please respond within ten (10) days from receipt of this confirmation. If no response is received within that time, this confirmation will be considered accepted and binding. Best Regards By: /s/ Harvey H. Cody III Agreed to and accepted on January 8, 1998 by: FORELAND CORPORATION By: /s/ N. Thomas Steele Name: N. Thomas Steele Title: President Date: January 8, 1998 -----END PRIVACY-ENHANCED MESSAGE-----