ITEM 1. BUSINESS
HISTORY
The Corporation was incorporated under Texas law on June 5, 1979 to engage generally in the oil and gas business. Its offices and phone number are 414 E. Elm Street, Gainesville, Texas 76240, (817) 668-1271.
DESCRIPTION OF BUSINESS
Since its formation, the Corporation has engaged in exploration for and development of oil and gas reserves, primarily onshore in the Northeastern and Southwestern area of the United States. To a lesser extent, the Corporation has also acquired and sold oil and gas properties.
In December, 1992, the Board of Directors approved a Private Placement Memorandum, The Loch Exploration, Inc. 1993 A 12% Secured Convertible Debenture, in the maximum amount of $350,000. There were seventy (70) units available for private sale, each unit being comprised of a $5,000 debenture along with 25,000 shares of the Company's Common Stock. The minimum placement was 10 units. At the close of the offering on October 31, 1993, subscriptions for 25.6 Units ($128,000) had been received.
The funds raised were used for acquiring producing oil and gas properties through public auctions as well as privately negotiated transactions.
The 1993-A 12% Secured Convertible Debentures are payable on or before May 1, 1999. Interest only will be payable during the first three years at 12% per annum of the first on each month, continuing through May 1, 1996, with the unpaid principal balance being payable in 36 equal consecutive monthly installments, plus interest, commencing June 1, 1996 through May 1, 1999. The Units are secured by first mortgage covering the Corporation's interest in the producing oil and gas properties acquired with the net proceeds from this Placement. The debenture holders have the option, exercisable only during May or June of 1996, to convert the unpaid principal balance of their Debentures into their pro rata portion of 75% of the Corporation's interest in the producing oil and gas properties which secure payment of the Debentures. The Debentures are convertible in multiples of $1,000 at holder's option at $.025 per Share in 1st year, $.035 per Share in 2nd year, $.05 per Share in 3rd year and thereafter at greater of $.05 per Share or average of "bid/asked" price during prior 20 day trading period.
On November 1, 1994, $63,000 in debentures were converted into Loch Exploration, Inc. common stock at a one-time conversion price of $.02 per share. In addition to lowering the conversion price to $.02 per share, the Board of Directors approved the continuation of the monthly interest payments on these converted Debentures for one year after the conversion date of November 1, 1994.
On October 5, 1995, Loch Exploration, Inc. sold sixteen natural gas producing wells along with their respective oil and gas leases, located in Chautauqua and Cattaragus Counties, New York. The properties were sold to a corporation not affiliated with the Registrant for a total price of $124,500, which was paid at closing. The subject properties were acquired from a corporation not affiliated with the Registrant for a total purchase price of $29,668 which was paid at closing on May 31, 1995.
COMPETITION
Significant competition exists for the acquisition of producing oil and gas properties and undeveloped leases. Many of the Company's competitors have greater financial capabilities and more sophisticated means for in-house evaluation than the Company possesses. The principal means of competition for oil and gas properties is the amount and terms of the consideration offered. The oil and gas exploration and development industry has been highly competitive, particularly with respect to the acquisition of desirable undeveloped oil and gas leases. However, due to the deterioration in prices the demand for oil and gas leases has dropped significantly. Competitors include the major oil companies, independent oil and gas concerns and individual producers and operators, many of which have financial resources, staffs and facilities substantially greater than those of the Company. In time of high drilling activity, exploration for and production of oil and gas may be affected by availability of the equipment and supplies and by competition for drilling rigs. The Company cannot predict the effect these factors will have on its operations. The Company owns no drilling rigs, and all of its drilling is conducted by third parties. The demand for drilling rigs and equipment has declined sharply due to the decline in the number of oil and gas wells being drilled. This has led to a decline in prices being paid to drillers. The principal means of competition in oil and gas exploration and development are product availability and price. The Company may be at a competitive disadvantage in acquiring oil and gas prospects since it must compete with such companies, many of which have greater financial resources and larger technical staffs.
REGULATION
The production and sale of oil and gas is regulated by various state and federal authorities.
STATE REGULATION OF OIL AND GAS PRODUCTION. The State of Texas and other states in which the Company conducts oil and gas activities regulate the production and sale of oil and natural gas, including requirements for obtaining drilling permits, the method of developing new fields, the spacing and operation of wells and the prevention of waste of oil and gas resources. In addition, most states, including Texas, regulate the rate of production and may establish maximum daily production allowable from both oil and gas wells on a market demand or conservation basis. As a result of recent domestic crude oil shortages, producers have been permitted to produce 100% of allowable daily production on the basis of market demand since mid-1972; however, production continues to be regulated for conservation purposes.
ENVIRONMENTAL REGULATIONS. The Company's activities are also subject to existing federal and state laws and regulations governing environmental quality and pollution control. The existence of such regulations has had no material effect on the Company's individual operations and the cost of such compliance has not been material to date. It is anticipated that compliance with federal, state and local laws, rules and regulations regulating the discharge of material will not significantly effect upon the capital expenditures, earnings or competitive position of the Company.
OIL PRICE REGULATION. Historically, regulatory policy affecting crude oil pricing was derived for the Emergency Petroleum Allocation Act of 1973, as amended, which provided for mandatory crude oil price controls until June 1, 1979, and discretionary controls through September 30, 1981. On April 5, 1979, President Carter directed the Department of Energy to complete administrative procedures designed to phase out, commencing June 1, 1979, price controls on all domestically produced crude oil by October 1, 1981. However, on January 28, 1981, President Reagan ordered the elimination of remaining federal controls on domestic oil production, effective immediately. Consequently, oil may currently be sold at unregulated prices.
GAS PRICE REGULATION. The Natural Gas Act of 1938 (the "NA") regulates the interstate transportation and certain sales for resale of natural gas. The Natural Gas Policy Act of 1978 (the"NGPA") regulates the maximum selling prices of certain categories of natural gas and provided for graduated deregulation of price controls for first sales of several categories of natural gas. With certain exceptions, all price deregulation contemplated under the NGPA as originally enacted in 1978 has already taken place. Under current market conditions, deregulated gas prices
under new contracts tend to be substantially lower than most regulated price sellings prescribed by the NGPA.
On July 26, 1989, the Natural Gas Wellhead Decontrol Act of 1989 ("Decontrol Act") was ended. The Decontrol Act amends the NGPA to remove as of July 27, 1989 both price and non-price controls from natural gas not subject to a first sale contract in affect on July 26, 1989. The Decontrol Act also provided for the phasing out of all price regulation under the NGPA by January 1, 1993. The FERC is currently considering the promulgation of regulations pertaining to the Decontrol Act but has taken no action to date other than to propose such new rules. The Company is unable to predict the consequences of the Decontrol Act on its operations.
EMPLOYEES
The Registrant presently has one full-time officer. In addition, the Registrant employs consultants from time-to-time to assist it in acquiring and evaluating oil and gas properties. Pursuant to industry practice, the Registrant expects it will pay its consultants a retainer and a cash and/or overriding bonus on properties which prove productive which were brought to the Registrant's attention by one or more such consultants.
ITEM 2.

ITEM 2. PROPERTIES
(A) PHYSICAL FACILITIES -------------------
The Company's executive and administrative offices are located at 414 E. Elm, Gainesville, Texas 76240, telephone 817-668-1271. The Company's offices, consisting of approximately 1,000 square feet are leased on a monthly basis at a rate of $562 per month. It is expected that this office space will serve the Company's needs adequately for the foreseeable future.
(B) OIL AND GAS DRILLING ACTIVITIES ------------------------------- None
(C) OIL AND GAS PROPERTIES ----------------------
The Following information is provided pursuant to Item 102 of Regulation S-K. All of the Registrant's reserves are located in the United States. The Registrant has no interests in oil and gas applicable to long-term supply or similar agreements with foreign governments or authorities in which the Registrant acts as producer of and share of revenues from the reserves of investors accounted for by the equity method, and hence, no information pertaining to those categories is presented herein.
As of December 31, 1995 the Registrant owned an aggregate of 16,718 gross (3,877 net) acres of developed oil and gas leases.
The oil and gas properties in which the Registrant owns an interest are held under oil and gas leases negotiated directly with private mineral owners. The leases were generally for a specific primary term, such as five years, and so long thereafter as oil or gas is produced in paying quantities. The leases generally reserve a royalty of 12-1/2% to the mineral owner and require a payment of up to $1 per acre per year as rentals to retain the lease during the primary term. Some of the leases held by the Registrant were also subject to overriding royalty burdens reserved by various predecessors-in- title and geologists.
The Registrant paid $7,688 in rental costs on oil and gas leases for 1995.
The estimated net proved and proved developed reserves of oil and gas, together with the estimated future net revenue of those reserves, and present value of estimated future net revenue attributable to those reserves as set forth in the following tables have been estimated as of December 31, 1995, by an in-house petroleum engineer.
OIL AND GAS RESERVES - -------------------- The following table sets forth the estimated net quantities of proved and proved developed oil and gas reserves as of December 31, 1995, 1994 and 1993.
(1) For purposes of all tabular information included in Item 2, proved oil and gas reserves are the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements, but not on escalations based upon future conditions.
(2) For purposes of all tabular information included in Item 2, proved developed oil and gas reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods.
(3) Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery are included as "proved developed reserves" only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved.
PRESENT VALUE OF ESTIMATED FUTURE NET REVENUE - --------------------------------------------- The following table sets forth information as to the present value of estimated future net revenues of proved reserves and proved developed reserves attributable to the Registrant as of December 31, 1995, 1994 and 1993. Present Value of future net revenues for the years shown below were computed by applying current contract prices of oil and gas to estimated future production of proved oil and gas revenues after deducting production taxes, direct lease operating expenses and ad valorem taxes, discounted by 10% per year, in accordance with Securities and Exchange Commission rules and regulations.
The Registrant has a gas sales contract with U.S. Gypsum Company which expires on 30 days written notice by either party. The Registrant has no long-term oil contracts. The Registrant would not be adversely affected by loss of the U.S. Gypsum Company contract.
OIL AND GAS RESERVE ESTIMATES FILED - ----------------------------------- No reserve reports pertaining to the Registrant's proved or proved developed reserve estimates were filed by the Registrant with or included in reports to any federal authority or agency since the beginning of the last fiscal year.
NET QUANTITIES OF OIL AND GAS PRODUCED FOR LAST FISCAL YEAR - ----------------------------------------------------------- The following table sets forth information as to quantities of oil and gas produced, net to the Registrant's interest, for the years ended December 31, 1995, 1994 and 1993.
(1) Includes production that is owned by the Registrant and produced to its interest, less royalties and production due others.
(2) Includes only marketable production of a gas on an "as sold" basis. Recovered gas-lift gas and reproduced gas may not be included until sold.
AVERAGE SALES PRICES AND PRODUCTION COSTS - ----------------------------------------- The following table sets forth information as to the average sales price (including transfers) per unit of oil or gas produced and the average production cost (lifting cost) per unit of production for the last fiscal years ended December 31, 1995, 1994 and 1993.
(1) Production (lifting) costs do not include depreciation, depletion, and amortization of capitalized acquisitions, exploration, and development costs, and indirect management costs.
GROSS AND NET PRODUCTIVE OIL AND GAS WELLS AND DEVELOPED ACRES - -------------------------------------------------------------- The following table sets forth, as of December 31, 1995, the Registrant's interest in productive oil and gas wells and developed acres:
DEVELOPED ACRES (4) PRODUCTIVE WELLS (1) ------------------- --------------------- GROSS (2) NET (3) GROSS (2) NET (3) ------------------- --------------------- Oil Gas Oil Gas --- --- --- --- 16,718 3,877 66 53 2.8 19 ------ ----- -- -- --- --
The Registrant's interests in oil and gas wells are all operated by third party operators. Information as to multiple completions is not available to the Registrant.
(1) Includes producing wells and wells capable of production. One or more completions in the same bore hole are counted as one well.
(2) A gross well or acre is a well or acre in which a working interest is owned.
(3) 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 of acres expressed as whole numbers and fractions thereof.
(4) Includes acres spaced or assignable to productive wells.
UNDEVELOPED ACREAGE AS OF DECEMBER 31, 1995 - ------------------------------------------- 4632 acres
PRODUCTIVE AND DRY EXPLORATORY AND DEVELOPMENT WELLS - ---------------------------------------------------- The following table sets forth the number of gross and net productive and dry development wells drilled in which the Registrant had an interest in each fiscal year indicated below:
(1) Refers to the number of wells (holes) completed any time during the fiscal year regardless of when drilling was initiated.
(2) A productive well is an exploratory or a development well that is not a dry hole.
(3) A dry well (hole) is an exploratory or a development well found to be incapable of producing either oil or gas in sufficient quantities to justify completion as an oil or gas well.
(D) NET OIL AND GAS PRODUCTION -------------------------- Same as (C)
(E) UNIT SALES PRICE AND PRODUCTION COST ------------------------------------ Same as (C)
(F) RESERVES -------- Same as (C)
(G) GAS COMPRESSION EQUIPMENT ------------------------- The Company owns two (2) gas compressors. The compressors are currently servicing wells in Palo Pinto and Parker Counties, Texas which are operated by Spindletop Oil & Gas Co. and are covered by written lease agreements between the Company and Spindletop Oil & Gas Co. The current monthly rental payable to the Company under the terms of the rental agreements is $3,064.00 less maintenance costs. The Company and Spindletop Oil & Gas Co. are brother-sister companies as defined by the Internal Revenue Service Code. Paul E. Cash is a substantial working interest owner in the above described wells and is also the majority shareholder of Spindletop Oil & Gas Co.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
The Registrant knows of no material pending legal proceedings to the subject and no such proceedings are known to the Registrant to be contemplated by governmental authorities.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
The Company's Common Stock is traded in the over-the-counter market, and at various times has been listed in the "OTC Bulletin Board". The following table sets forth the range of high and low bid quotations as reported by security dealers, do not include retail mark-up, mark-down or commission, and do not necessarily represent actual transactions.
The Company has not paid cash dividends on shares of its common stock since its inception and does not anticipate the payment of cash dividends on its Common Stock in the foreseeable future. It is expected that any earnings which may be generated from operations would be used to finance the growth of the Company. Holders of shares of Common Stock are entitled to receive such dividends as may be declared by the Company's Board of Directors.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes certain selected historical financial data for the five years ended December 31, 1995 and is qualified in its entirety by the more detailed financial statements included in this report and should be read in conjunction with such financial statements, the notes thereto and with Management's Discussion and Analysis of Financial Condition and Results of Operations included in this report.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
LIQUIDITY AND CAPITAL RESOURCES
The Company plans to invest funds in capital assets necessary to the growth of its oil and gas exploration and related activities. The funding of these expenditures is planned from equity offerings, cash flow, bank borrowings, debenture sales, joint ventures and limited partnerships and it is the Company's intent to continue the use of all these capital sources in future periods.
RESULTS OF OPERATIONS
1995 COMPARED TO 1994 - ---------------------
Total revenues for 1995 were $327,075 as compared to $222,723 in 1994, primarily due to the gain on sale of oil and gas properties totaling approximately $95,000. Costs and expenses have increased from $221,049 in 1994 to $284,105 in 1995. This increase was due to general administration and lease operating expenses.
1994 COMPARED TO 1993 - ---------------------
Total revenues for 1994 were $222,723 as compared to $97,808 in 1993, primarily as the result of a full year of revenues generated by production related to reserves acquired during 1993. Costs and expenses have increased from $128,064 in 1993 to $221,049 in 1994. This increase was due to depletion, depreciation, and lease operating expenses.
1993 COMPARED TO 1992 - ---------------------
Total revenues for 1993 were $97,808 as compared to $97,910 in 1992. Costs and expenses have increased from $108,105 in 1992 to $128,064 in 1993. This increase was due to depletion, depreciation, general administration, and lease operating expenses.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The audited financial statements and schedules are included on pages through.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
In January 1996, the Company's Board of Directors accepted the resignation of Rigler, Hess & Rohmer, P.C., Certified Public Accountants and named Farmer, Fuqua, Hunt & Munselle, P.C., Certified Public Accountants as the Company's new independent auditors.
There were no disagreements with Rigler, Hess & Rohmer, P.C. on any matters of accounting principles or practices, financial statement disclosure or auditing scope or procedure.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Directors and executive officers of Loch and certain information concerning each of them are set forth in the following table:
NAME AGE POSITION - ---- --- --------
Glenn L. Loch 60 President, Chief Executive Officer, Treasurer and Director Paul E. Cash 63 Vice President, Secretary and Director K. Paul Cash 39 Vice President, Assistant Secretary and Director
GLENN L. LOCH graduated from the Louisiana State University with a B.S. degree in Petroleum Engineering in 1960. He has served as President of the Company from June 1979 through March 1989 and from January 1, 1990 to present. For more than five years preceding 1979, he served as president of Loch & Tracy Engineering Company, and Vice President of Scientific Petroleum, Inc. He is past Chairman of Texas Chapter, A.P.I. and received the Meritorious Service Award for the A.P.I. in 1968. He is past mayor of Gainesville, Texas, and was a member of the Governor's State Manpower Board.
PAUL E. CASH is a graduate of The University of Texas (B.B.A. Accounting) and is a Certified Public Accountant. He has been active in the oil and gas industry for over 20 years, during which time he has served as financial officer of two publicly owned companies, Texas Gas Producing Co., and Landa Oil Co., and also served as president of publicly owned Continental American Royalty Co., Aledo Oil & Gas Co., Prairie States Energy Co., Spindletop Oil & Gas Co., and Double River Oil & Gas Co. During the last 10 years, Mr. Cash has also been an officer and part owner of a large number of private oil and gas companies and partnerships, including EnnTex Oil & Gas Co. and Spindletop Oil & Gas Co. He is currently serving as President and a Director of Spindletop Oil & Gas Co., and is an officer and director of Double River Oil & Gas Co. and Loch Exploration, Inc. Mr. Cash was formerly the Mayor of Sunnyvale, Texas.
K. PAUL CASH is a geologist and received his degree in geology from the University of Texas at Arlington in 1981. He has been serving as Vice President and Director of Spindletop Oil & Gas Co. since 1993. Prior to 1993, he had been a Director and President of Daltex Oil & Gas Co., a privately held company for more than ten years.
FAMILY RELATIONSHIPS
K. Paul Cash is the son of Paul E. Cash.
DIRECTORSHIP
Glenn Loch, director of the Registrant is not a director of any other company with a class of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended ("1934 Act"). No Director of the Registrant is subject to the requirements of Section 15(d) of the Act or any company registered as an investment company under the Investment Company Act of 1940. Paul E. Cash is a director of other companies with a class of Securities Registered pursuant to Section 12 of the 1934 Act as shown: officer/director of Spindletop Oil & Gas Co., and officer/director of Double River Oil & Gas Co.
POTENTIAL CONFLICTS OF INTEREST
Both Paul E. Cash and K. Paul Cash, officers and directors of the Company are actively involved in the management of other companies, and are owners of rental equipment and personally invest in oil and gas properties. In some instances, business opportunities in the oil and gas industry known to them or developed by them may be offered first to other companies or individuals, and the Registrant may not be able to participate in such ventures.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The Company had no director or officer, nor group of directors and officers whose aggregate renumeration exceeded $60,000 during twelve (12) months ended December 31, 1995.
The Company is not a party to any employment contract, nor does it have any pension, profit sharing, bonuses, stock option plan or royalty pools in effect or under consideration. Such plans may be adopted in the future if deemed in the best interest of the Company by its Board of Directors.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the ownership of the Company's Common Stock $.001 par value per share as of February 1, 1996, by (i) each director of the Company, (ii) each person who is known by the Company to own beneficially more than 5% of the outstanding shares of its Common Stock, and (iii) information as to the shares beneficially owned by all directors and officers of the Company as a group.
(1) Glenn Loch, officer and director of the registrant, owns 50% of Sonel Companies, Inc.
The Registrant knows of no contractual arrangements which might at a subsequent date result in a change in control of the Registrant.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On February 24, 1994, Mr. Paul E. Cash purchased 35,310,000 shares of Loch Exploration, Inc. common stock from Double River Oil & Gas Co. There was no change of control of the Company since Mr. Cash was the majority owner of Double River Oil & Gas Co., at the time of the exchange.
The Company serves as its own stock transfer agent, and charges a fee of $5.00 per new certificate issued for such services. Computer services and records of such shareholder transactions are furnished and maintained by Spindletop Oil & Gas Co. Spindletop charges a fee to the Company for such services, which approximate the $5.00 stock transfer fee. Paul E Cash is president and a director of Spindletop, and owns in excess of 80% of the common stock of Spindletop.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are filed as a part of this report.
Financial Statements (included herein at Pages through
Report of Independent Certified Public Accountants.
Balance Sheets - December 31, 1995 and 1994................
Statements of Operations for the years ended December 31, 1995, 1994 and 1993..............................................
Statements of Stockholders' Equity for the years ended December 31, 1995, 1994 and 1993........................................
Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993..............................................
Notes to Financial Statements..............................
Reports on Form 8-K
A report on Form 8-K was filed on February 24, 1994, a copy of which is attached.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
LOCH EXPLORATION, INC.
By Glenn L. Loch ----------------------------------- Glenn L. Loch President
Dated: April 10, 1996
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
NAME TITLE DATE - ---- ----- ----
Glenn L. Loch President, Chief April 10, 1996 - ----------------------- Executive Officer, Glenn L. Loch Treasurer and Director
Paul E. Cash Vice President, April 10, 1996 - ----------------------- Secretary and Director Paul E. Cash
K. Paul Cash Vice President, April 10, 1996 - ----------------------- Assistant Secretary K. Paul Cash and Director
LOCH EXPLORATION, INC. Index to Financial Statements and Schedules
Page ---------
Independent Auditors' Report
Balance Sheets - December 31, 1995 and 1994 -
Statements of Operations for the years ended December 31, 1995, 1994 and 1993
Statements of Changes in Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993
Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993
Notes to Financial Statements
All schedules have been omitted because they are not applicable, not required, or the information has been supplied in the financial statements or notes thereto.
[FARMER, FUQUA, HUNT & MUNSELLE, P.C. LETTERHEAD APPEARS HERE]
INDEPENDENT AUDITORS' REPORT ----------------------------
Board of Directors Loch Exploration, Inc.
We have audited the accompanying balance sheets of Loch Exploration, Inc. (a Texas Corporation) as of December 31, 1995 and 1994, and the related statements of operations, changes in shareholders' equity and cash flows for the years ended December 31, 1995, 1994 and 1993. 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 financial statements referred to above present fairly, in all material respects, the financial position of Loch Exploration, Inc. as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years ended December 31, 1995, 1994 and 1993, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the index of financial statements are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state, in all material respects, the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ Farmer, Fuqua, Hunt & Munselle, P.C.
Dallas, Texas April 3, 1996
LOCH EXPLORATION, INC. Balance Sheets December 31,
ASSETS
The accompanying notes are an integral part of these statements.
LOCH EXPLORATION, INC. Balance Sheets - (Continued) December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY
The accompanying notes are an integral part of these statements.
LOCH EXPLORATION, INC. Statements of Operations Years Ended December 31,
The accompanying notes are an integral part of these statements.
LOCH EXPLORATION, INC. Statements of Changes in Shareholders' Equity Years Ended December 31, 1995, 1994, and 1993
The accompanying notes are an integral part of these statements.
LOCH EXPLORATION, INC Statements of Cash Flows Years Ended December 31,
The accompanying notes are an integral part of these statements.
LOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS December 31, 1995, 1994 and 1993
NOTE 1 - ORGANIZATION AND NATURE OF OPERATIONS
Organization - ------------
Loch Exploration, Inc. (the Company) was originally organized under the laws of the State of Texas, on June 5, 1979.
The Company filed for Chapter 11 bankruptcy in April 1989, and was reorganized in connection with its Plan of Reorganization (the Plan), effective November 17, 1989. In connection with the Plan, approximately 3,500,000 shares of the Company's common stock are expected to be issued to the Company's former shareholders, to be exchanged as follows: one share of the Company's $.001 par value common stock for each eight shares of the Company's pre-reorganization common stock. As of December 31, 1995, 1994 and 1993, 3,391,152, 3,390,726, and 3,390,726 and shares, respectively, have been issued to former shareholders in connection with the Plan.
Nature of Operations - --------------------
The Company is engaged in the exploration for and development of oil and gas reserves, primarily in the Northeastern and Southwestern United States. To a lesser extent, the Company also acquires and sells oil and gas properties.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Oil and Gas Properties - ----------------------
The Company follows the full cost method of accounting for its oil and gas exploration and development activities. Under this method, the Company capitalizes leasehold acquisition, exploration (including unsuccessful exploration) and development costs into one cost center. If unamortized costs within the cost center exceed the cost center ceiling, as defined, the excess will be charged to expense during the year in which the excess occurs.
Depreciation and amortization for each cost center are computed on a composite unit-of-production method, based on estimated provided reserves attributable to the respective cost center. All costs associated with oil and gas properties are currently included in the base for computation and amortization. Such costs include all acquisition, exploration and development costs. All of the Company's oil and gas properties are located within the continental United States.
Gains and losses on sales of oil and gas properties are treated as adjustments of capitalized costs. Gains or losses on sales of property and equipment, other than oil and gas properties, are recognized as part of operations. Expenditures for renewals and improvements are capitalized, while expenditures for maintenance and repairs are charged to operations as incurred.
LOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -CONTINUED
Oil and Gas Properties - Continued - ----------------------------------
Costs of oil and gas properties including leases are periodically evaluated by management and losses are recognized if a property becomes impaired or the net value of the capitalized cost center exceeds the present value of discounted future net cash flows.
Property and Equipment - ----------------------
Depreciation is provided in amounts sufficient to relate to the cost of depreciable assets to operations over their estimated service lives (5 to 15 years). The straight-line method of depreciation is used for financial reporting purposes, while accelerated methods are used for tax purposes.
Statement of Cash Flows - -----------------------
The Company does not consider any of its assets to meet the definition of a cash equivalent.
Income Taxes - ------------
The Company accounts for income taxes pursuant to Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes", which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement carrying amounts and tax bases of assets and liabilities, using enacted tax rates in effect in the years in which the differences are expected to reverse. These temporary differences primarily relate to depreciation, depletion and intangible drilling costs.
Use of Estimates - ----------------
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
NOTE 3 - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
LOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993
NOTE 4 - LONG-TERM DEBT
The debentures are convertible into shares of the Company's common stock, in multiples of $1,000, at the holder's option, at the rate of $.025 per share in the first year, $.035 per share in the second year, $.05 per share in the third year, and, thereafter, at the greater of $.05 per share or the average of the bid/asked price of the Company's common stock during the prior 20 day trading period. In 1994, the Company's Board of Directors approved a one-time, lowered conversion price of $.02 per share, and approved the continuation of interest payments on the converted debentures, for one year after the conversion date of November 1, 1994. On November 1, 1994, debentures totaling $56,700, net of the related unamortized discount, were converted into 3,150,000 shares of the Company's common stock, at the lowered conversion price of $.02 per share.
Future maturities of long-term debt are as follows:
LOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993
NOTE 5 - SHAREHOLDERS' EQUITY
In connection with a private placement offering (the Offering) of its debentures in May 1993, the Company acquired 640,000 shares of its $.001 par value common stock as treasury stock by donation from two shareholders. The shares were sold in units with the debentures in the Offering, with a minimum unit consisting of $5,000 debentures and 25,000 shares of the Company's $.001 par value common stock. The Company recorded $12,800 as additional paid-in capital in accordance with the private placement memorandum, and a discount of an equal amount was recorded with respect to the debentures. The discount is being amortized over the life of the debentures.
During 1994, two of the Company's shareholders contributed 2,500,000 shares of the Company's common stock back to the Company. This treasury stock was issued by the Company to a third party, in exchange for an oil and gas property, in a transaction recorded at $150,000, based on the estimated fair value of the assets acquired.
NOTE 6 - INCOME TAXES
There was no income tax expense recorded in 1995 or 1994, due to the availability of a nonconventional source fuel credit, which eliminated any federal income taxes. This credit is available to the extent of the current year tax liability, and is not available for carryover to future years.
Deferred taxes have not been provided because temporary differences between book and taxable income are not significant.
NOTE 7 - RELATED PARTY TRANSACTIONS
In June 1993, the Company entered into an agreement with a wholly-owned subsidiary of Spindletop Oil & Gas Co. (Spindletop), a related party, whereby the parties agreed to combine their talents and resources to evaluate and acquire producing and non-producing oil and gas properties at various auctions. Any properties acquired under the terms of this agreement are to be acquired by initial assignment to Spindletop. Spindletop has agreed to provide the Company with a recordable assignment of its interest, such interest to be determined by the proportionate share of monies expended for the acquisition of said properties. All costs are borne by the Company and Spindletop in the same proportions as their respective ownership interests. Spindletop serves as administrator for the properties acquired in connection with this agreement, and is entitled to an overhead reimbursement for properties for which it serves as operator. This agreement had an initial term of six months, and continues month- to-month, thereafter, until cancelled by either party. No properties were acquired in connection with this agreement during 1995. During 1994 and 1993, the Company acquired interests in approximately seven and 78 properties, respectively, with total costs of approximately $7,000 and $81,000, respectively, in connection with this agreement.
LOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993
NOTE 7 - RELATED PARTY TRANSACTIONS - CONTINUED
At December 31, 1994, the Company had notes payable to Spindletop, totaling $34,800, consisting of a promissory note in the amount of $14,800, and an 8% convertible promissory note in the amount of $20,000. The first promissory note bore interest at 8% per annum, due quarterly, beginning April 1, 1993. The second promissory note had an interest rate of 8% per annum and was due and payable on December 31, 1997. Interest on the second note was due annually, payable in cash or common stock of the Company at the request of either the holder or the Company, at valuation rates detailed in the note. The first such interest payment was due December 31, 1993. The accrued interest on both notes, in the amount of $2,800, that was due and payable on December 31, 1993, was converted to 70,000 shares of the Company's $.001 par value common stock on May 25, 1994. Both notes were repaid in 1995.
The Company leases its compressors to Spindletop. During the years ended December 1995, 1994 and 1993, Spindletop paid the Company approximately $35,000, $40,000, and $42,000, respectively, under the lease agreements for the compressors.
The Company operates an oil and gas partnership drilling program, Loch Exploration, Inc. 1980A, for which it makes commitments, pays expenses and collects an operating fee.
NOTE 8 - CASH FLOW INFORMATION
The Company paid approximately $17,000, $19,000, and $2,000 for interest in 1995, 1994 and 1993, respectively.
Excluded from the Statements of Cash Flows were the effects of certain non-cash investing and financing activities, as follows:
NOTE 9 - EARNINGS PER SHARE
Earnings per common share is based on the weighted average number of shares outstanding during each year.
LOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993
NOTE 10 - CONCENTRATIONS OF CREDIT RISK
Accounts receivable as of December 31, 1995 and 1994 are primarily from oil and gas operators, including Spindletop, related to the Company's interests in oil and gas wells, and its compressor leases.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
The Company leases its office facilities on a month to month basis. Total rent expense incurred was approximately $7,800, $7,100 and $7,600 in 1995, 1994 and 1993, respectively.
NOTE 12 - ADDITIONAL OPERATIONAL AND BALANCE SHEET INFORMATION
Certain information about the Company's operations for the years ended December 31, 1995, 1994 and 1993 follows.
LOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993
NOTE 12 - ADDITIONAL OPERATIONAL AND BALANCE SHEET INFORMATION - CONTINUED
In October 1995, the Company sold, for $124,500, its interests in 16 natural gas producing properties. These properties had been acquired in May 1995 for approximately $30,000. The full cost method of accounting requires that sales of oil and gas properties shall be accounted for as adjustments of capitalized costs, unless such adjustments would significantly, alter the relationship between capitalized costs and proved reserves attributable to a cost center. Due to the significance of the effect of this sale on the relationship between capitalized costs and proved reserves, a gain was recognized in the sale in the 1995 statement of operations.
NOTE 13 - SUPPLEMENTARY INCOME STATEMENT INFORMATION
NOTE 14 - SUPPLEMENTAL RESERVE INFORMATION (UNAUDITED)
The Company's net proved oil and gas reserves as of December 31, 1995, 1994 and 1993 have been estimated by Company personnel in accordance with guidelines established by the Securities and Exchange Commission. Accordingly, the following reserve estimates were based on existing economic and operating conditions. Oil
LOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993
NOTE 14 - SUPPLEMENTAL RESERVE INFORMATION (UNAUDITED) - CONTINUED
and gas prices in effect at December 31 of each year were used. Operating costs, production and ad valorem taxes and future development costs were based on current costs with no escalation.
There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting the future rates of production and timing of development expenditures. The following reserve data represents estimates only and should not be construed as being exact. Moreover, the present values 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.
Changes in Estimated Quantities of Proved Oil and Gas Reserves
Standardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Oil and Gas Reserves (Unaudited)
The Standardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Oil and Gas Reserves ("Standardized Measures") does not purport to present the fair market value of a company's oil and gas properties. An estimate of such value should consider, among other factors, anticipated future prices of oil and gas, the probability of recoveries in excess of existing proved reserves, the value of probable
LOCH EXPLORATION, INC NOTES TO FINANCIAL STATEMENTS - Continued December 31, 1995, 1994 and 1993
NOTE 14 - SUPPLEMENTAL RESERVE INFORMATION (UNAUDITED) - CONTINUED
Standardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Oil and Gas Reserves (Unaudited) - Continued
reserves and acreage prospects, and perhaps different discount rates. It should be noted that estimates of reserve quantities, especially from new discoveries, are inherently imprecise and subject to substantial revision.
Future net cash flows were computed using the contract price, which was not escalated. Future production includes operating costs and taxes. No deduction has been made for interest, general corporate overhead, depreciation or amortization. The annual discount of estimated future net cash flows is defined, for use herein, as future cash flows discounted at 10% per year, over the expected period of realization.