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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
For the fiscal year ended December 31, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period From __________ to __________
Commission File Number 0-19365
CROWN ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
UTAH 87-0368981
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization
215 South State, Suite 650
Salt Lake City, Utah 84111
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (801) 537-5610
Securities registered pursuant to Section 12(b) of the Act: (None)
Securities registered pursuant to Section 12(g) of the Act:
$0.02 PAR VALUE COMMON STOCK
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days.
YES [ ] NO [X]
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 common stock, par value $0.02 per share,
held by non-affiliates of the registrant on May 24, 1999 was $10,391,916 using
the average bid and asked price for Registrant's common stock. As of May 24,
1999, registrant had 13,285,581 shares of its common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
(None)
Transitional Small Business Disclosure Format (check one) YES [ ] NO [X]
PART I.
STATEMENTS MADE OR INCORPORATED IN THIS ANNUAL REPORT INCLUDE A NUMBER OF
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934.
FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS CONTAINING
THE WORDS "ANTICIPATES", "BELIEVES", "EXPECTS", "INTENDS", "FUTURE", AND WORDS
OF SIMILAR IMPORT WHICH EXPRESS MANAGEMENT'S BELIEF, EXPECTATIONS OR INTENTIONS
REGARDING THE COMPANY'S FUTURE PERFORMANCE OR FUTURE EVENTS OR TRENDS. RELIANCE
SHOULD NOT BE PLACED ON FORWARD-LOOKING STATEMENTS BECAUSE THEY INVOLVE KNOWN
AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS, WHICH MAY CAUSE ACTUAL
RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY TO DIFFER MATERIALLY FROM
ANTICIPATED FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSLY OR IMPLIED BY
SUCH FORWARD-LOOKING STATEMENTS. IN ADDITION, THE COMPANY UNDERTAKES NO
OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENT, WHETHER
AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.
ITEM 1. BUSINESS
General
Crown Energy Corporation is a Utah corporation that specializes in the
production and distribution of premium asphalt products to meet the new, higher
quality standards for federal and state highways. The Company is based in Salt
Lake City, Utah and operates primarily through two wholly owned subsidiaries,
Crown Asphalt Corporation ("CAC") and Crown Asphalt Products Company ("Capco"),
both of which are Utah corporations. CAC operates the asphalt production
business through its minority interest in Crown Asphalt Ridge, L.L.C., a Utah
limited liability company ("Crown Ridge"), and Capco operates the asphalt
distribution business through its majority interest in Crown Asphalt
Distribution, L.L.C., a Utah limited liability company ("Crown Distribution").
Crown Energy Corporation's consolidated financial statements and
results of operations include the accounts and results of operations of CAC,
Capco and Crown Distribution. Accordingly, references in this Annual Report to
"Crown" or the "Company" include, unless otherwise noted, CAC, Capco and Crown
Distribution.
The Company was formed in 1981 as an oil and gas production company.
The Company changed its business focus to concentrate on the production and
distribution of premium asphalt products in 1995. The Company's results of
operations for the preceding three fiscal years reflect this change in focus. In
particular, for the years ended December 31, 1996 and 1997, the Company reported
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declining revenues from oil and gas sales of $224,855 and $86,781, respectively,
as oil and gas operations were phased out. For the year ended December 31, 1998,
the Company reported revenues from the sale of asphalt products of approximately
$24 million. See "Item 6 - Selected Data." Most of these revenues were recorded
in the last half of 1998 as a result of Crown Distribution's asphalt product
sales.
The Company's recent accomplishments include the formation and ongoing
progress of two joint ventures. One such joint venture, Crown Ridge, constructed
an approximate $22 million Asphalt Oil Sand Production Facility at Asphalt
Ridge, near Vernal, Utah (the "Facility"). Through another joint venture entity,
Crown Distribution, the Company has acquired ownership interests in asphalt
distribution facilities located in Utah, Arizona, Colorado and Nevada.
In August 1997, the Company formed Crown Ridge with MCNIC Pipeline &
Processing Company, a Michigan corporation ("MCNIC"), to construct, own and
operate the Facility at the Company's Asphalt Ridge deposit in northeast Utah.
MCNIC is a wholly-owned subsidiary of MCN Energy Group, Inc. ("MCN") (NYSE:MCN),
a large diversified energy holding company with over $4 billion in assets and
investments throughout North America and India. MCN is involved in oil and gas
exploration and production, natural gas gathering, processing, transmission and
storage, energy marketing, electric power generation and distribution, and other
energy-related businesses and serves 1.2 million customers in more than 500
communities throughout Michigan. Information about MCN Energy Group is available
on the World Wide Web at http://www.mcnenergy.com. The Company has contributed
significant resources, including certain Oil Sand Resources and a technology
sublicense through which Crown Ridge may utilize certain proprietary technology
to extract marketable products from the oil sand reserves, in order to further
the continued development of the Facility by Crown Ridge. To date, Crown Ridge
has invested approximately $22 million in the Facility. The construction of the
Facility has been substantially completed, however the Facility has encountered
certain construction technical difficulties which the Company believes will be
resolved. The Facility has a designed capacity of 100,000 tons of asphalt per
year and the Company believes it will be operational in the second half of 1999.
The Company presently owns a 25% equity interest in Crown Ridge and MCNIC holds
the remaining 75% equity interest. The Company has the right to acquire up to a
60% equity interest in Crown Ridge contingent, however, upon MCNIC's receipt of
certain preferential returns and Crown Ridge's election to pursue certain
expansion opportunities. See "Item 1. Business - Asphalt Production - Crown
Asphalt Ridge, L.L.C." below.
In August 1997, contemporaneous with the Company's Crown Ridge joint
venture with MCNIC, the Company also closed on an agreement for the private sale
of $5 million of the Company's $10 Series A Cumulative Convertible Preferred
Stock (the "Series A Preferred") to Enron Capital & Trade Resources Corp.
("ECT"), a subsidiary of Enron Corp. ("Enron"), (NYSE:ENE). Enron is a major
buyer and seller of natural gas with assets of approximately $20 billion. Enron
also builds and manages worldwide natural gas transportation, power generation,
liquids and clean fuels facilities. Information about Enron is available on the
World Wide Web at http://enron.com. Proceeds from the sale of stock to ECT have
been used for working capital and to finance the Company's share of construction
and start-up costs related to Crown Ridge, which includes the construction of
the Facility. Certain rights, preferences and limitations relating to the Series
A Preferred are detailed in "Item 5. Market Price for the Company's Common
Equity and Related Stockholder Matters" below.
3
In June 1998, the Company, through Capco, entered into a joint venture
by forming Cowboy Asphalt Terminal, L.L.C., a Utah limited liability company
("CAT LLC"), with Foreland Asphalt Corporation, a Utah corporation engaged in
the asphalt roofing products business ("Foreland"). CAT LLC was formed to
acquire an asphalt terminal and its underlying real property located in North
Salt Lake City. The asphalt terminal property of CAT LLC was apportioned and
portions designated for the exclusive uses of either Capco or Foreland, each of
which will retain all revenues and profits generated from their respective
exclusive operations. Crown Distribution, through the exercise of an option on
or about December 21, 1998, owns 66.67% of CAT LLC and the remaining 33.33% is
owned by Foreland. CAT LLC is a majority owned and controlled subsidiary of
Crown Distribution and the accounts and results of operations of CAT LLC will be
included within the Company's consolidated financial statements and results of
operations. See "Item 1. Business - Asphalt Distribution - Cowboy Asphalt
Terminal, L.L.C." below.
On July 2, 1998, Crown Distribution was formed as a second joint
venture between the Company (through its Capco subsidiary) and MCNIC. Crown
Distribution is owned 50.01% by the Company and 49.99% by MCNIC. Crown
Distribution was formed to acquire the inventory and assets of Petro Source
Asphalt Company, a Texas corporation. By completing this acquisition, the
Company acquired ownership or leasehold interests in certain asphalt
distribution facilities located in Utah, Arizona, Colorado and Nevada. These
asphalt distribution facilities enable the Company to purchase oil products and
related raw materials from its suppliers and to store, process, blend and
otherwise produce various grades of asphalt and asphalt products for sale to its
customers in the western United States. The Company's revenues during the year
ended December 31, 1998 were generated primarily through Crown Distribution's
asphalt product operations. See "Item 1. Business - Asphalt Distribution - Crown
Asphalt Distribution, L.L.C." below.
The Company's control of Crown Distribution and CAT LLC complement the
Company's interest in Crown Ridge and Crown Ridge's ownership and operation of
the newly constructed Facility. The asphalt distribution capabilities of Crown
Distribution and CAT LLC offer vertical integration for the Company's operations
- - the Company can now produce, process, blend, store, transport, distribute and
sell finished asphalt products in its western United States target market. These
operations rely primarily upon the purchase of oils, hydrocarbons and other raw
materials from third party suppliers. As Crown Ridge's extraction and processing
operations at the Facility produce commercial quantities of asphalt products,
management of the Company expects that all of such products will be marketed,
distributed and sold through Crown Distribution's asphalt terminals, thereby
displacing some of the raw materials purchased by Crown Distribution from third
party suppliers for resale.
On April 17, 1999, the Company acquired fixed terminal assets at Laurel
(Billings), Montana and Williston, North Dakota along with the associated
inventory, and certain contractual agreements of Asphalt Supply & Services, Inc.
and Inoco, Inc. for $4,000,000, consisting of $750,000 in cash and 2,500,000
shares of unregistered common stock. In the event that the bid price of the
common stock is less than $1.10 for 120 consecutive trading days at any time
between April 17, 1999 and December 31, 2000, the seller has the right to
require the Company to purchase all shares for $1.10 per share. The Company has
the right to repurchase up to 2,000,000 of the shares of common stock from the
seller, at any time, for $2.05 per share. The acquisition has been accounted for
as a purchase.
4
On May 12, 1999, the Company entered into an agreement to acquire an
asphalt terminal in Rawlins, Wyoming and inventory for $2,291,571 from S&L
Industrial. Upon closing of this transaction, the Company will assume S&L's debt
of approximately $1,800,000, issue a note payable to S&L for $225,000, and make
a cash payment of $266,571 to S&L. Closing of this transaction will occur when
all conditions have been satisfied, such as the delivery of consents of third
parties. The Company expects closing to occur in the near future. Under the
Company's contractual joint venture relationships with MCNIC, MCNIC may have
certain rights to participate in additional business opportunities, if any,
which may be pursued by the Company. See "Item 1. Business - Asphalt
Distribution Crown Asphalt Distribution, L.L.C. - Additional Opportunities."
As the Company increases its asphalt products marketing and
distribution activities at its asphalt terminals, the Company remains open to
other asphalt related business opportunities and is actively seeking to acquire
asphalt terminals which can complement the Company's existing asphalt
distribution capabilities.
More detailed information about the asphalt industry and the Company's
asphalt production and distribution businesses is provided below.
The Asphalt Industry
The United States asphalt market is estimated to be a 30 million-ton
market which historically has been supplied by the large U.S. oil refiners. In
recent years, management of the Company believes that the U.S. asphalt market
has undergone significant changes. In particular, national and international
demand for asphalt has increased. Further, recently established standards which
require the use of higher quality asphalt for federal and state highways in the
United States have increased the demand for higher quality asphalts. At the same
time, recent reductions of heavy crude production have resulted in a decrease in
asphalt supply. The Company believes that these changes are favorable to asphalt
producers and suppliers such as the Company.
Deterioration of the nation's infrastructure has drawn increasing
public attention and concern, and the emphasis in the highway industry is
shifting from construction of new roads and bridges to maintenance and
replacement of aging facilities. As the U.S. government, state and federal
agencies focus on decaying infrastructure and facilities, the need for better
techniques and materials to build longer-lasting roads and to repair existing
ones cost-effectively has developed. Congress authorized the Strategic Highway
Research Program (SHRP) as a coordinated national effort to meet the tough
challenges facing the highway industry. SHRP was a five year, $150 million
research program funded through state-apportioned federal highway aid funds. Its
research was tightly focused on the development of pragmatic products of
immediate use to the highway agencies. Using a wide range of advanced materials
characterization techniques that had not been applied to asphalt previously,
SHRP determined how asphalt material properties affect pavement performance. The
new performance graded (PG) specifications focus on the climate conditions of a
given location and the specific temperature band in which the PG asphalt must
work within. The recommendation for the improved PG asphalt binder
specifications has been adopted by the Federal Highways Administration (FHWA)
and many states. The remaining states are in different stages of implementation
5
and will be required to have implemented the new PG specifications by the year
2000. The result of the more stringent SHRP performance grades in the western
United States is that most asphalts used on state and federal projects will need
to be modified with polymers or high performance asphalts, or both, to meet the
required specifications.
The Company believes that the Facility will produce asphalt products
which meet the SHRP performance specifications. However, until the asphalt is
produced at the Facility in commercial quantities there can be no assurance of
its quality or performance.
Through its relationships with producers, refiners, suppliers,
transporters and users of asphalt, including state and federal governmental
departments, asphalt associations, consultants and private sector companies; as
well as its strategically located asphalt distribution terminals, PG asphalt
blending processes and Asphalt Ridge reserves, the Company believes that it is
well positioned to meet the needs of the changing asphalt market. However, the
Company will be competing with several larger companies in the regional asphalt
supply business. Competition in the asphalt supply business is based primarily
on price and quality. Further, the Company will be competing with traditional
refineries with respect to the production of asphalt products. In general, these
competitors have significant financial, technical, managerial and marketing
resources and, both separately and combined, represent significant competition
for the Company in its markets.
The asphalt industry is seasonal. Demand for asphalt decreases
significantly during the winter months when cold weather and snow interferes
with highway construction and repair. Notwithstanding the decrease in demand for
asphalt and asphalt-related products during the winter months, the Company
believes that it can continue producing asphalt, and storing such product, to
meet the peak demands of spring and summer. In addition, the Company expects to
continue purchasing asphalt from outside suppliers in the winter months, when
prices are lower, for storage at its asphalt terminals and resale in the spring
and summer.
Asphalt Distribution
Crown Asphalt Distribution, L.L.C.
Formation and Current Development Status. On July 2, 1998, Crown
Distribution was formed as a second joint venture between the Company and MCNIC.
The Company and MCNIC (sometimes referred to hereafter as the members) possess
sharing ratios ("sharing ratios") of 50.01% and 49.99%, respectively, in the
profits, losses and obligations of Crown Distribution. Accordingly, the Company
holds a majority and controlling interest in Crown Distribution and the accounts
and results of operations of Crown Distribution are included within the
Company's consolidated financial statements.
On July 2, 1998, Crown Distribution purchased the inventory and assets
of Petro Source Asphalt Company, a Texas corporation. The purchased assets
included asphalt supply and marketing contracts, owned and leased equipment,
personal property, fixtures, equipment leases, real estate leases, technology
licenses, other related agreements, certain intellectual property, products
6
inventory, ownership interests in and to asphalt distribution facilities in
Utah, Colorado, Nevada and Arizona and certain processing rights at a refinery
in Santa Maria, California (see below).
These assets (excluding products inventory) were purchased for $7.5
million, the amount determined by the parties to be the fair market value of
such assets, with capital contributed to Crown Distribution by MCNIC. The
products inventory was also purchased by Crown Distribution for $6,797,932 and
this portion of the purchase price was funded by a loan to Crown Distribution
from MCNIC.
Collectively, the asphalt distribution facilities purchased from Petro
Source Asphalt Company enable the Company to purchase asphalt products and
related raw materials from third party vendors and to produce various grades of
asphalt for sale to its customers. During the period between July 2, 1998 and
December 31, 1998, these asphalt distribution facilities distributed
approximately 41,000 tons of asphalt and generated revenue of approximately
$6,423,000 (excluding revenues associated with the Santa Maria processing
agreement discussed below.) Company management believes that Crown
Distribution's acquisition of these assets creates excellent vertical
integration for the Company's overall asphalt business and provides a solid
distribution network for the asphalt production from the Company's Facility at
Asphalt Ridge.
Under the Santa Maria Refinery processing agreement, Crown
Distribution's predecessor (and Crown Distribution since July 2, 1998) marketed
and sold the asphalt products and maintained the inventory at this refinery, in
exchange for approximately 50% of the net profit realized upon the sale of the
processed product. During 1998, the refinery processed on average 3,850 barrels
a day of throughput. Revenues from the processing agreement were approximately
$15.9 million (or roughly 65% of the Company's total consolidated revenues) for
the year ended December 31, 1998. In February 1999, however, the Company
received a notice from the refinery owner that this processing agreement will
terminate as of April 30, 1998. The potential loss of revenues associated with
this processing contract was known to the Company prior to the July 2, 1998
acquisition transaction and factored into the purchase price. Management of the
Company believes that revenues generated from the Company's recently acquired
asphalt terminals will offset a significant portion of such revenues. Further,
the Company is presently negotiating and expects to enter into some arrangement
under which the Santa Maria refinery will process asphalt products for the
Company for sale by the Company in the markets served by the refinery.
Therefore, the Company does not expect the termination of this processing
agreement to have a material adverse impact upon the Company's financial
condition. Subsequent to the termination of the processing contract, the
refinery owner purchased asphalt products located at the refinery from the
Company for a sum, after offsetting certain expense reimbursements owed to the
refinery, of roughly $1.7 million, of which $1,000,000 has been paid to the
Company.
7
The Company and MCNIC are joint venture partners in both Crown Ridge
and Crown Distribution (the Company is in control of Crown Distribution and
MCNIC is in control of Crown Ridge). Although there can be no assurance,
management of the Company expects that Crown Distribution will distribute the
asphalt products extracted and produced by Crown Ridge. Crown Distribution's
asphalt distribution facilities will allow the Company to store, transport,
distribute, market and sell the asphalt products extracted by and produced at
the Facility owned and operated by Crown Ridge, assuming acceptable transfer
pricing and other payment terms will be agreed upon by Crown Distribution and
Crown Ridge.
The Company's original capital contribution to Crown Distribution of a
nominal amount was paid on or about the date of formation of Crown Distribution.
Thereafter, on December 21, 1998, Crown Distribution exercised an option under
its Operating Agreement such that the Company was required to transfer and
assign to Crown Distribution, as an additional capital contribution, its 66.67%
membership interest in CAT LLC. The Company was credited with a $1.5 million
capital contribution to Crown Distribution as a result of the assignment of the
CAT LLC membership interests to Crown Distribution. Subsequent to year end,
Crown Distribution also assumed CAT LLC's payment obligations under a $1,282,070
promissory note. As a result of this assignment, Crown Distribution now holds
66.67% of the ownership interests of CAT LLC, and the remaining 33.33% ownership
interests are owned by Foreland. Crown Distribution's proportionate share of the
accounts and results of operations of CAT LLC are therefore included within the
consolidated financial statements of the Company. See "Item 1. Business Asphalt
Distribution - Cowboy Asphalt Terminal, L.L.C." below for further information
regarding CAT LLC.
MCNIC originally contributed the amount of $100 to the capital of Crown
Distribution. MCNIC also made a capital contribution in the amount of $6 million
(the "Preferential Capital Contribution"). The Preferential Capital
Contribution, together with working capital loans in the amounts of $1,500,000
and $7,141,930 respectively, were used by Crown Distribution to acquire the
assets of Petro Source Asphalt Company and pay related closing and other
acquisition costs. When Crown Distribution elected to take by assignment the
Company's interest in CAT LLC, MCNIC was obligated to, and did, contribute
additional capital in the amount of $1.5 million. That sum, however, was
immediately used by Crown Distribution to pay down the working capital loan
previously advanced by MCNIC. See "Item 1. Business - Asphalt Distribution Crown
Asphalt Distribution, L.L.C. - Working Capital Loans" below.
Management of Crown Distribution; Major Decisions. Crown Distribution
is governed by a management committee consisting of three managers. The Company
is entitled to appoint two managers and MCNIC is entitled to appoint one
manager. Management decisions are generally made by the management committee.
However, one of the managers appointed by the Company shall serve as the
operating manager and have the powers, authority, duties and obligations
specified in the operating agreement, which generally requires the operating
manager to implement the policies and pursue the objectives specified in the
annual operating plan.
The annual operating plan is adopted by the management committee on an
annual basis and addresses all aspects of Crown Distribution's operations for
the coming year, including the nature and extent of the proposed activities,
marketing plans, capital expenditure plans and similar matters. In the event the
management committee is unable to unanimously approve an annual operating plan
for any given calendar year, a majority of the managers shall have the authority
to continue to maintain Crown Distribution's operations at levels comparable to
those approved in its most recent annual operating plan.
Additional Opportunities. The Crown Distribution operating agreement
provides that certain additional business opportunities which are the same as or
similar to Crown Distribution's then current business must be first offered to
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Crown Distribution by its members. Crown Distribution will have a 30-day period
after receipt of notice of any additional opportunity within which to exercise
its right to pursue the additional business opportunity. If this right is
exercised, the Company and MCNIC have agreed to negotiate an appropriate
business structure under which the Company and MCNIC, or their respective
affiliates, have the option, but not the obligation, to acquire up to a 50%
sharing ratio or equity interest in any new opportunity.
Working Capital Loans. MCNIC has extended two working capital loans to
Crown Distribution, each of which bears interest at the rate of 8% per annum.
MCNIC extended the first working capital loan in order for Crown
Distribution to fund the purchase price and related acquisition costs with
respect to the Petro Source Asphalt Company acquisition. The entire outstanding
principal balance of this working capital loan (the outstanding balance as of
December 31, 1998 was $5,810,581), together with all accrued interest thereon,
is due and payable in full on or before December 31, 1999.
MCNIC extended a working capital line in order for Crown Distribution
to fund its inventory purchases and general working capital needs. The entire
outstanding principal balance of this working capital line as of December 31,
1998 was $3,124,640. As of June 10, 1999, the principal balance owed MCNIC for
the working capital line was $7,124,641.
Under related provisions of Crown Distribution's Operating Agreement,
Crown Distribution is obligated to provide MCNIC advance written notice of any
proposed borrowing of additional working capital to fund its operations.
However, MCNIC has verbally indicated its desire and agreement to fund any
additional borrowings of Crown Distribution on terms and conditions acceptable
to both parties and generally prevailing in the market. MCNIC's first working
capital loan and its Preferential Capital Contribution are both secured by a
first priority lien, security interest in and pledge of all the property of
Crown Distribution including, without limitation, Crown Distribution's rights,
title and interest in and to the membership interests in CAT LLC. MCNIC's second
working capital loan is secured by Crown Distribution's inventory and accounts
receivable.
Distributions; Allocations of Profits and Losses. Until such time as
MCNIC has received the return of its Preferential Capital Contribution and a 15%
internal rate of return on its investment in Crown Distribution, Crown
Distribution is obligated to distribute to MCNIC 50% of the net cash flow from
operations. The remaining cash flow balance is distributed roughly 50% to MCNIC
and 50% to the Company (in accordance with their respective sharing ratios).
During 1998, Crown Distribution made distributions of $1,090,989 to MCNIC for
its Preferential Capital Contribution and additional distributions of $545,494
to each of MCNIC and the Company. Upon liquidation, MCNIC would receive 100% of
any and all amounts available for distribution up to its outstanding
Preferential Capital Contribution balance and remaining amounts would be
distributed in proportion to the members capital account balances. Profits and
losses are generally allocated in accordance with the members' respective
sharing ratios. However, after profits are allocated to offset any previous
allocations of losses made to members, in the event of a complete liquidation of
Crown Distribution profits will be allocated 100% to MCNIC until its
Preferential Capital Contribution and 15% rate of return has allocated to it in
the form of profits.
9
Management Agreement. Pursuant to an Operating and Management
Agreement, the Company provides management, supervision and operational services
to Crown Distribution in relation to its annual Operating Plan for Crown
Distribution. As compensation for the services rendered under the Management
Agreement, the Company receives (i) a monthly fee of $5,000, (ii) the payment of
all out-out-pocket expenses incurred through the performance of its duties;
(iii) the reimbursement of the reasonable salaries, wages, overtime and other
similar compensation paid to employees of the Company who are employed full-time
in connection with and dedicated to the management services under the Management
Agreement; and (iv) a monthly home office overhead charge of $10,000.
The term of the Management Agreement is five years, which term will be
automatically extended for unlimited successive one-year periods unless either
party furnishes the other with written notice at least ninety (90) days prior to
the expiration of any such initial or extended period. During the initial term
of the Management Agreement, the Company can be removed only for good cause by
the affirmative vote of the management committee. The Management Agreement also
contains provisions allowing the replacement of the Company as the manager on
economic grounds if Crown Distribution notifies the Company that it believes the
operations may be conducted more efficiently and is willing to become the
operating manager or has a commitment from a third party to do so. Following the
receipt of an economic challenge, the Company will have thirty (30) days to
notify Crown Distribution that it elects to allow Crown Distribution or its
designee to become the operator under the proposed terms or that the Company
elects to continue as the operator under the proposed terms.
Cowboy Asphalt Terminal, L.L.C.
Formation and Acquisition of Assets. CAT LLC is a joint venture between
the Company (through its Capco subsidiary) and Foreland. Foreland is engaged in
the asphalt roofing products business. On June 16, 1998, CAT LLC was formed to
acquire an asphalt terminal and related refinery assets and real estate located
in North Salt Lake City (the "Cowboy Terminal Assets"). The real property
acquired by CAT LLC as part of the Cowboy Terminal Assets is referred to
hereinafter as the "Cowboy Terminal Property." Refinery Technologies, Inc., a
Utah corporation ("Refinery Technologies"), held the rights to acquire the
Cowboy Terminal Assets under a purchase contract with their former owner.
On September 11, 1998, CAT LLC, Capco, Foreland and Refinery
Technologies entered into an Assignment and Agreement (the "Assignment
Agreement") under which Refinery Technologies assigned all of its ownership
rights in and to the Cowboy Terminal Assets purchase contract to CAT LLC. In
turn, CAT LLC agreed to assume all of the obligations under the real property
purchase contract and issued a promissory note in connection with the purchase
in the amount of $1,067,111 to the former owner. The Company's primary objective
in forming this joint venture was to acquire control of the Cowboy Terminal
Property for use as an asphalt storage and terminal facility. The Cowboy
Terminal Property has been divided into portions dedicated (i) to the exclusive
uses of the Company for its asphalt paving products business and (ii) to the
exclusive uses of Foreland for its asphalt roofing products business. Revenues
or profits generated by such exclusive uses will belong to the Company or
Foreland, as the case may be, and the other party will have no right to
participate in the revenues, profits or income generated by the business of the
10
other with respect to such exclusive uses. Further, the use of the Cowboy
Terminal Property by the Company and by Foreland is free of charge or other
cost. The Company anticipates that its exclusive portion of the Cowboy Terminal
Property can be used by the Company to store, process and transport up to
roughly 60,000 tons of throughput per year.
The Company and Foreland initially owned sharing ratios ("sharing
ratios") of 66.67% and 33.33%, respectively, in the profits, losses and
obligations of CAT LLC. However, the Company has assigned its sharing ratios and
ownership interests in CAT LLC to Crown Distribution. See "Item 1. Business -
Asphalt Distribution - Crown Asphalt Distribution, L.L.C."
The Cowboy Terminal Assets were purchased on January 9, 1999 for
$1,477,070. CAT LLC paid $195,000 in cash at closing and executed and delivered
a promissory note in the amount of $1,282,070. This promissory note is payable
in 84 equal monthly installments of $20,627 beginning on February 1, 1999 and
ending on January 1, 2006. The note bears interest at the rate of 9% and is
secured by a deed of trust encumbering the Cowboy Terminal Property. In
connection with the transfer of the 66.67% interest in CAT LLC to Crown
Distribution, Crown Distribution assumed payment obligations under this
promissory note.
The CAT LLC Operating Agreement obligates both the Company and Foreland
to make additional capital contributions equal to one-half of any additional
amounts needed for (i) CAT LLC to fulfill its obligations, not to exceed
$650,000, under any corrective action plan that may be accepted by CAT LLC and
the Utah Department of Environmental Quality with respect to certain
environmental conditions at the Cowboy Terminal Property and (ii) legal costs
incurred in the purchase or related to the environmental matters in (i) of this
paragraph. The CAT LLC Operating Agreement also obligates the Company and
Foreland to make additional capital contributions, in proportion to their
ownership percentages, in order to fund any additional amounts required for CAT
LLC to fulfill its obligations under the purchase contract for the Cowboy
Terminal Assets, for environmental management and containment costs, expenses
for operations, or the construction of certain approved capital improvements to
the Cowboy Terminal Property. None of the foregoing additional contributions
will result in an increase in the number of units or percentage interests held
by the Company or Foreland.
As noted above, CAT LLC has title to the Cowboy Terminal Property and
the Company has the exclusive right to use portions thereof for its asphalt
terminal operations. Refinery Technologies did, however, retain certain contract
rights with respect to the Cowboy Terminal Assets, including rentals generated
from a portion of the Cowboy Terminal Property, certain rights to receive
payments upon any liquidation of CAT LLC and a right of first refusal to
purchase the Cowboy Terminal Property or membership interests in CAT LLC under
certain conditions.
Management of Cowboy Asphalt Terminal, LLC; Major Decisions. CAT LLC is
managed by the Company. The manager generally has authority to conduct the
day-to-day business and affairs of the Company. Certain matters must be approved
by members holding 75% or more of the outstanding units of CAT LLC. The Company
is not compensated for its services as manager.
Asphalt Production
11
Crown Asphalt Ridge, L.L.C.
Formation and Current Development Status. Effective August 1, 1997, the
Company jointly formed Crown Ridge with MCNIC to construct and operate an oil
sand processing facility for the production of premium asphalt oil at Asphalt
Ridge in Uintah County, Utah. The Company believes that the Asphalt Ridge oil
sand reserves constitute one of Utah's largest and most accessible deposits.
There are three "pit" areas along Asphalt Ridge where the recoverable reserves
are principally located. These areas are referred to as the "A", "D" and "South"
tracts. The Company controls, through numerous operating leases, approximately
7,000 acres of private and state land encompassing these tracts, which the
Company believes contains in excess of 100 million barrels of surface minable
reserves (the "Oil Sand Resources").
The Facility constructed by Crown Ridge is located at the "A" tract of
the Oil Sand Resources. The "A" tract contains in excess of 18 million barrels
of surface minable reserves with an average oil saturation of 11% by weight.
This pit is partially opened as a result of prior small scale mining operations
for the production of local asphalt road base. The pit has been mined since the
1940's and provides a natural site to commence operations as overburden has been
removed and an open pit area exists for waste sand storage. The production
process entails three major steps: (1) mining, (2) extraction (separation of the
oil from the sand), and (3) distillation (recovery of the solvent and separation
of light fractions from the asphalt). The "D" and "South" tracts have not yet
been opened for asphalt production by the Company. The "D" tract contains in
excess of 30 million barrels of surface minable reserves with an average oil
saturation of 8.5% by weight. The "South" tract contains in excess of 65 million
barrels of surface minable reserves with an average oil saturation of 7.5% by
weight. Crown Ridge and the Company's joint venture partner in Crown Ridge,
MCNIC, have certain rights to develop the asphalt resources found in the "D" and
"South" tracts. See "Item 1. Business - Asphalt Production - Crown Asphalt
Ridge, L.L.C. - Additional Opportunities Within the Project Area and Areas of
Mutual Interest." MCNIC and the Company (sometimes referred to hereafter as the
"Members") own sharing ratios ("sharing ratios") of 75% and 25%, respectively,
in the profits, losses and obligations of Crown Ridge. However, the Company has
the right to acquire up to a 60% equity interest in Crown Ridge, contingent upon
MCNIC's receipt of certain preferential financial returns (as described below)
and Crown Ridge's election to pursue certain expansion opportunities. The
Company currently owns 25% of Crown Ridge and operates the business pursuant to
an Operating and Management Agreement. The Company holds only a minority
interest in Crown Ridge and the Company's consolidated financial statements and
results of operations only include its net interest in the accounts and results
of operations of Crown Ridge.
Once the economic operations of Crown Ridge are successful to the
extent of paying out to MCNIC an amount equal to 115% of its cash investment in
Crown Ridge, excluding tax benefits, the Company's sharing ratio in Crown Ridge
will increase to 50%. Thereafter, the Members may build other plants to further
develop the Oil Sand Resources. These plants will require additional capital
contributions from the Members, which are described in more detail below. The
Company may participate up to 50% in the additional facilities and up to 60%
after payout of the cash investment in such facilities. There are provisions for
the Company to retain an interest in these facilities after the recoupment of
certain amounts in the event the Company does not participate in the costs of
such additional facilities, as provided in the "Back-In Option."
12
Crown Ridge has been and will be developed in phases in order to
minimize the risks and leverage the resources of the Members. Each phase calls
for the Members to contribute new capital to move Crown Ridge through the next
phase. The first phase called for detailed engineering and verification of the
Oil Sand Resources of the Company. MCNIC and the Company both contributed
capital of $300,000 and $100,000, respectively, to Crown Ridge to cover the
engineering and verification costs and complete the first phase. The second
phase required the Company to contribute the following to Crown Ridge:
1. The Company's rights as a future lessee under certain
equipment leases on mining equipment with a fair market value
of up to $3.5 million dollars. Such equipment will be
contributed to Crown Ridge when the mining requirements for
the project are conclusively known. This contribution was
agreed to have a capital contribution value of $3.5 million;
2. A sublicense of Crown's license of proprietary oil sands
refining technology from Park Guymon Enterprises, Inc., which
is accorded only a nominal value under Crown Ridge's Operating
Agreement (the "Operating Agreement"). Crown Ridge is
responsible for paying the 2-5% royalty required by the
sublicense;
3. Tract "A" of the Oil Sand Resources (these properties are
initially valued by Crown Ridge at $500,000); and
4. An amount of cash needed to bring the Company's new capital
contributions up to 25% capital to construct the Facility,
giving full credit to the $3.5 million of equipment leases and
the $500,000 of property rights in 1 and 3 above.
Under the Crown Ridge Operating Agreement, MCNIC will initially fund
75% of the amounts required by Crown Ridge to construct the Facility and to
operate Crown Ridge. Both Members may make such additional contributions as may
be required or agreed in the course of building the Facility. As of December 31,
1998, the Company has made cash contributions of approximately $1,651,000 to
Crown Ridge and MCNIC has contributed approximately $17,397,000. To date, the
Company has invested a total of approximately $4,600,000 in the development of
Asphalt Ridge, which includes costs incurred prior to the joint venture with
MCNIC.
The Company initially projected that Crown Ridge would be operational
by June, 1998. However, construction of the Facility was delayed as a result of
certain construction technical difficulties. Management of the Company believes
that the construction difficulties experienced are of the type anticipated in
the construction of this type of project, which is a sophisticated asphalt
processing facility utilizing new or evolving processes. The Company believes
the Facility will be operational in the second half of 1999. However, continued
difficulties or the inability to commercially operate the Facility economically
could significantly impact Crown Ridge's ability to continue as a going concern
and would have a materially adverse impact on the Company's operations and
financial condition.
13
The Facility is designed to initially process approximately 3,000 tons
of oil sands daily for an average production of 1,700 barrels of asphalt per
day. The estimated annual production of asphalt is approximately 100,000 tons.
The Company believes that the asphalt produced at the Facility will meet new
stringent highway specifications and will have high durability at lower cost.
However, there can be no assurance that the Facility will be fully operational
within the expected time frame or that the Facility will produce premium asphalt
at lower cost than is presently available in the market.
Crown Ridge may market, distribute and sell its asphalt products
independent of the Company and has no obligation to utilize the asphalt
distribution facilities of the Company. However, it is expected that Crown Ridge
will utilize the asphalt distribution terminals and facilities of Crown
Distribution, subject to acceptable pricing and other compensation arrangements.
Subsequent Plants. Under the Crown Ridge Operating Agreement, the
Members may construct up to two subsequent plants (the "Subsequent Plants")
similar to the Facility if the economics of Crown Ridge's oil sands processing
business so permit. In sum, a Subsequent Plant may be constructed if certain
economic returns (approximately 18% on 50% of its Capital Contributions to Crown
Ridge or any successor joint venture during any 12 month period) have been
experienced by MCNIC from the Facility and if the Members believe or are
independently advised that a sufficient market exists to allow for the operation
of the Subsequent Plants without damaging the competitive position or returns of
the Facility or any other then-existing asphalt processing plants owned or
operated by Crown Ridge or any Successor Entity (as defined below). The
agreement of MCNIC and the Company is that any Subsequent Plant will be held and
operated by a separate legal entity (a "Successor Entity") formed by the Members
with governing terms and provisions similar to Crown Ridge. The Company may
elect to participate in either of the Subsequent Plants and may obtain, at its
option, between 10% and 50% of the interests in the newly-formed entity. A
portion of the Company's obligations to contribute to the Successor Entity may
be satisfied through the value of the contributed properties which the Company
may be credited with, as described below.
Following the determination by both Members or one Member to proceed
with the construction of a Subsequent Plant, Crown Ridge will convey to the
Successor Entity sufficient Oil Sand Resources or other property and water
rights to enable it to sustain operations in accordance with the applicable
projections and market study. If, during the twelve months prior to the sale of
products from the first Subsequent Plant, MCNIC has realized a return of
approximately 30% on 50% of its Capital Contributions to Crown Ridge, the
Company will be credited with a value for these Oil Sand Resources and
properties equal to $.10 per barrel for the products estimated to be produced
from the Subsequent Plant over a 20 year period.
If the Company elects not to proceed with any Subsequent Plant, and to
not make the needed capital contributions to build and operate the Subsequent
Plant, Crown will have a reduced interest in the Subsequent Plant (but will
still be credited with an interest equal to the value of the contributed
properties as described below, if the requisite return is achieved), subject to
an escalation under the Back-In Option described below.
14
Whether or not the Company elects to proceed with either Subsequent
Plant, if the Subsequent Plants reach certain levels of economic success
(approximately 115% of MCNIC's investment in plant 2 without giving effect to
any tax benefits), the Company will receive an increased interest of 10% in the
Subsequent Plant as a result of its oil sand properties and technology being
used by the Subsequent Plant(s).
Management of Crown Ridge; Major Decisions. Crown Ridge is governed by
a management committee consisting of five managers. The Company is entitled to
appoint one manager and MCNIC is entitled to appoint four managers. Management
decisions are generally made by the management committee. However, one of the
managers appointed by the Company shall serve as the operating manager and have
the powers, authority, duties and obligations specified in the operating
agreement, which generally requires the operating manager to implement the
policies and pursue the objectives specified in the annual operating plan. Any
Manager may be removed or replaced from time to time by the Member which
appointed such Manager. If any adjustment is made in the Members' respective
sharing ratios both the Company and MCNIC will be entitled to appoint one
Manager for each 20% of Crown Ridge interest held by that Member (rounded to the
nearest 20% level), provided, that MCNIC and the Company shall each be entitled
to at least one Manager at all times that they are Members of Crown Ridge. The
size of the Management Committee may be increased to six Managers if the
foregoing calculation requires it.
Management decisions shall generally be made through a majority vote of
the Managers. However, certain "Major Decisions," such as: (i) the approval of
the detailed engineering for the Facility; (ii) the approval of, or substantial
amendment to, the annual operating plan described below; and (iii) calls for
additional Capital Contributions (except for calls contemplated by the EPC
Contract as defined in Crown Ridge's Operating Agreement and those required to
maintain Crown Ridge in emergencies), require unanimous approval of all
Managers. Most distributions to the Members require unanimous approval of the
Managers.
Crown Ridge's operations shall be conducted each year pursuant to the
annual operating plan. The annual operating plan shall address all aspects of
Crown Ridge's operations for the coming year, including budgeting for
operations, the mining of oil sand products and the marketing of those products.
In the event the Management Committee is unable to unanimously approve an annual
operating plan for any given calendar year, a majority of the Managers shall
have the authority to continue to maintain Crown Ridge's operations at levels
comparable to those approved under the last annual operating plan.
15
Additional Opportunities Within the Project Area and Area of Mutual
Interest. Crown Ridge may elect to pursue additional opportunities ("Additional
Opportunities") within the Asphalt Ridge project area ("Project Area") which are
brought to its attention by one of its Members. Should Crown Ridge elect to
pursue such an Additional Opportunity, it may do so either through Crown Ridge
or by forming a new company containing terms and provisions substantially
similar to those of Crown Ridge. In the event that Crown Ridge does proceed with
any Additional Opportunity, the Company shall have the right, but not the
obligation, to obtain an equity interest in each such Additional Opportunity of
no less than 10% and no greater than 50% (with MCNIC obtaining the remaining
interest). If the Management Committee determines not to proceed with the
Additional Opportunity, any Member of Crown Ridge may then do so alone, subject
to the Back-In Option, discussed below, of the nonparticipating Member.
If either Member desires to develop any interests in real property,
fixtures or improvements within the State of Utah relating to the processing of
oil sands, bitumen, asphaltum or other minerals or mineral resources into
asphalt, performance grade asphalt, synthetic crude oil, diesel fuel, or any
other product produced using the intellectual property sublicensed by the
Company to Crown Ridge or any derivation thereof (an "AMI Opportunity"), the AMI
Opportunity must first be offered to Crown Ridge. The Company, shall then have
the option, but not the obligation, of acquiring (i) up to a 50% equity interest
if the AMI Opportunity relates to, or is designed for, the production and sale
of asphalt or performance grade asphalt; or (ii) up to a 66% equity interest if
the AMI Opportunity relates to the production of synthetic crude oil, diesel
fuel or any other similar products.
If Crown Ridge elects not to proceed with the AMI Opportunity, the
Member who brought the opportunity to Crown Ridge may proceed alone and the
nonparticipating Member shall have no further interest in the activity covered
by such opportunity. Except as limited in the discussion above, each Member of
Crown Ridge shall have the right to independently engage in any business
activities except that MCNIC shall not be entitled to use the Company's
technology provided to Crown Ridge in connection with such activities.
The Back-In Option. The Back-in Option is a means by which the Member
which initially elects not to participate in a plant may subsequently
participate at a later date upon favorable terms. The Back-in Option applies if:
(i) The Company elects not to proceed with construction of the
Facility following the completion of the detailed engineering
(and MCNIC elects to proceed);
(ii) either Member elects not to participate in the construction of
a Subsequent Plant; or
(iii) either Member elects not to participate in an Additional
Opportunity.
In the case of the Company's election not to participate in Subsequent
Plants or Additional Opportunities, the Company shall be entitled to a 60%
interest in the particular plant or opportunity if it is the non-participating
Member, and MCNIC shall be entitled to a 40% interest if it is the
non-participating Member, after the participating Member has achieved a 200%
payout of the costs of the respective facility.
Distributions; Allocations of Profits and Losses. The Management
Committee shall cause Crown Ridge to distribute Available Cash, as defined
within the Operating Agreement, to the Members quarterly, within 30 days
following the end of each quarter. Distributions will be made in connection with
the respective capital account balances after taking into account all
allocations.
Management Agreement. Pursuant to an Operation and Management Agreement
(the "Management Agreement"), the Company is the "Operator" of the Facility upon
commencement of operations. Under the Management Agreement, the Company will act
as an independent contractor to Crown Ridge and will (i) manage, supervise and
conduct the operations of Crown Ridge; (ii) carry out the terms of the Annual
Operating Plan adopted and approved by the Management Committee of Crown Ridge;
(iii) implement the decisions made and instructions given from time to time by
the Management Committee. As compensation for the services rendered under the
Management Agreement, the Company will receive (i) a monthly fee of $3,000; (ii)
the payment of all out-of-pocket expenses incurred through the performance of
its duties; (iii) the payment of the reasonable salaries, wages, overtime and
other similar compensation paid to employees who are employed full time in
connection with the operations of Crown Ridge; and (iv) a monthly home office
overhead charge of $10,000.
During the first two years, the Company may be removed as Operator only
for "good cause" as defined within the Management Agreement. After this initial
term, the agreement will automatically renew for unlimited succeeding one-year
terms unless either party indicates its desire to not renew within 90 days of
the expiration of the term. Also following the expiration of the initial term,
Crown Ridge may challenge the Company's status as Operator on economic grounds
by serving written notice to the Company that it believes that the operations of
the Facility may be conducted more efficiently and cheaply and that it is
willing to become the Operator (or has a bona fide commitment from a third party
to do so) on a reduced charge basis. Following the receipt of the economic
challenge, the Company will have 30 days to notify Crown Ridge that it elects to
(i) allow Crown Ridge, or its designee, to become the Operator under the
proposed terms, or (ii) continue as the Operator under the proposed terms.
Environment
The Company and its subsidiaries are subject to federal, state and
local requirements regulating the discharge of materials into the environment,
the handling and disposal of solid and hazardous wastes, and protection of
health and the environment generally (collectively "Environmental Laws").
Governmental authorities have the power to require compliance with these
Environmental Laws, and violators may be subject to civil or criminal penalties,
injunctions or both. Third parties may also have the right to sue for damages
and/or enforce compliance and to require remediation or contamination.
The Company and its subsidiaries are also subject to Environmental Laws
that impose liability for costs of cleaning up contamination resulting from past
spills, disposal and other releases of substances. In particular, an entity may
be subject to liability under the Federal Comprehensive Environmental Response,
Compensation and Liability Act and similar state laws that impose liability
without a showing of fault, negligence, or regulatory violations - for the
generation, transportation or disposal of hazardous substances that have caused
or may cause environmental contamination. In addition, an entity could be liable
for cleanup of property it owns or operates even if it did not contribute to
contamination of such property.
The Company expects that it may be required to expend funds to comply
with federal, state and local provisions and orders which relate to the
environment. Based upon information available to the Company at this time, the
Company believes that compliance with such provisions will not have a material
effect on the capital expenditures, earnings and competitive position of the
Company.
16
Subsidiaries of the Company
Crown Asphalt Corporation was formerly known as Buena Ventura Resources
Corporation, a Utah Corporation. Crown Asphalt Corporation was organized October
24, 1985 and was acquired by the Company on September 30, 1992. Crown Asphalt
Corporation is a member of and holds roughly 25% of the membership interests in
Crown Ridge. The Company includes its net share of the net assets and results of
operations of Crown Ridge in its consolidated financial statements.
Crown Asphalt Products Company ("Capco") was formerly known as Energy
Technologies Corporation. Capco was formed in 1991, but until 1998 has been a
dormant entity. The Company recently activated Capco for the purpose of
developing an asphalt marketing and distribution business. Capco is a member of
and holds 50.01% of the membership interests in Crown Distribution. Crown
Distribution is a member of and holds 66.67% of the membership interests in CAT
LLC. The Company includes within its consolidated financial statements the
accounts and results of operations of both Crown Distribution and CAT LLC.
On July 2, 1998, Crown Distribution was formed as a second joint
venture between the Company and MCNIC. Crown Distribution is owned 50.01% by the
Company and 49.99% by MCNIC. Crown Distribution was formed to acquire the
inventory and assets of Petro Source Asphalt Company, a Texas corporation.
Applied Enviro Systems, Inc. is a dormant Oregon corporation.
Employees
As of May 31, 1999, the Company had 88 full and part-time employees.
None of the Company's employees are represented by a union or other collective
bargaining group. Management believes that its relations with its employees are
good.
ITEM 2. PROPERTIES
The Company conducts its business operations at 215 South State, Suite
650, Salt Lake City, Utah, where it has approximately 6,571 square feet of
office space under lease until July 30, 2003. Under the terms of the lease, the
Company pays $9,172 per month through July 30, 1999; $9,493 per month through
July 30, 2000; $9,825 per month through July 30, 2001; $10,169 per month through
July 30, 2002; and $10,525 through the lease expiration date of July 30, 2003.
There is no renewal option under the terms of this lease. Management of the
Company believes that its current office lease is sufficient for its needs and
believes that it will either be able to negotiate a new lease on its existing
space or obtain suitable other space in the Salt Lake City area upon the
expiration of the existing lease. As described above in the section captioned
"Item 1. Business - Asphalt Production - Crown Asphalt Ridge, L.L.C.," the
Company controls through operating leases certain Oil Sand Resources consisting
of approximately 7,000 acres of private and state land encompassing at Asphalt
Ridge in Uintah County, Utah. The Asphalt Ridge oil sand deposit is located in
the Uintah Basin in eastern Utah near the town of Vernal.
17
Extensive reserve studies, including core drilling performed by Bechtel
and Sohio between the late 1950's and mid-1980's, estimate surface minable
reserves to be in excess of 100 million barrels. The Company controls the Oil
Sand Resources through certain long term operating leases and the Company has
the right to extract mineral reserves on these tracts so long as the Company
continues to conduct active operations under such leases, pay required royalties
and otherwise comply with the terms of the leases.
In connection with the formation and development of Crown Ridge, the
Company contributed the operating leases related to the "A" tract to Crown Ridge
and Crown Ridge holds certain rights to develop the "D" and "South" tracts. The
Company believes it and Crown Ridge are in compliance with, and not in material
default under, such operating leases. Further information regarding the Oil Sand
Resources controlled by the Company is found at "Item 1. Business - Asphalt
Production - Crown Asphalt Ridge, L.L.C." above.
Crown Distribution owns asphalt distribution facilities located in
Utah, Colorado, Nevada and Arizona. These properties are used by Crown
Distribution to process, blend, store, transport, distribute and sell finished
asphalt products, and may be used with respect to the asphalt products produced
from the oil sands ore expected to be extracted by Crown Ridge's Facility
constructed at Asphalt Ridge. All of Crown Distribution's assets are encumbered
by the lien and security interest of MCNIC, which advanced the purchase price
for such assets and has made certain working capital loans to Crown
Distribution. See "Item 1. Business - Asphalt Distribution - Crown Asphalt
Distribution, L.L.C."
CAT LLC's asphalt distribution and storage facility is located just
north of Salt Lake City, Utah. CAT LLC owns all of the underlying Cowboy
Terminal Property, which is encumbered by a Deed of Trust in favor of the
seller.
ITEM 3. LEGAL PROCEEDINGS
On May 21, 1998, Road Runner Oil, Inc. ("Road Runner") and Gavilan
Petroleum, Inc. ("Gavilan") filed an action in the Third Judicial District
Court, Salt Lake County, State of Utah, as Civil Number 98-0905064 against the
Company and its President. The action relates to the purchase by Road Runner of
100% of the stock of Gavilan in 1997, and generally seeks to (i) obtain
corporate records of Gavilan in the Company's possession relating to the amount
of oil and gas royalties potentially owed to third parties prior to the
aforementioned stock sale, and (ii) to determine the amount of royalties owed.
The action further alleges, on behalf of Gavilan, claims of breach of fiduciary
duty, professional negligence and mismanagement against the Company's President
for alleged mismanagement of Gavilan's affairs. The Plaintiffs seek injunctive
relief requiring the tendering by the Company of the referenced records and such
damages as may be proven at trial. The Company believes that the Plaintiffs
claims are groundless and that it is entitled to payment of the $75,000 plus
interest still owed by Road Runner as part of the purchase price for Gavilan. In
addition, since the action was filed, the Company has tendered substantial
quantities of corporate records to the Plaintiffs for their review. On June 17,
1998, an order was entered granting an open extension to the Company of its
obligation to file an answer to the above-described Complaint so that the
parties may informally pursue a settlement, if any, of the matter. The Company
is aware that the new principals of Gavilan have experienced extensive legal
18
difficulties and the law firm which previously represented Gavilan has withdrawn
as counsel in this matter. Gavilan has taken no action to prosecute this matter
for some months, and the Company has not been notified that Gavilan has engaged
new legal counsel. Accordingly, the Company expects, although there can be no
assurance, that Gavilan will fail or refuse to prosecute this matter further.
The Company is not certain as to whether or not the outstanding balance under
the promissory note is collectible by the Company.
On February 10, 1999 CEntry Constructors and Engineers L.L.C.
("CEntry") filed a demand for arbitration with the American Arbitration
Association for claims arising out of the November 5, 1997 Engineering,
Construction and Procurement Agreement between Crown Ridge and CEntry (the
"Contract") for the design and construction of Crown Ridge's Facility near
Vernal, Utah. CEntry seeks damages in excess of $1.0 million for amounts
allegedly due to CEntry under the Contract, including a retention or liquidated
damages amount ($803,660), as well as amounts for modifications to the Contract
allegedly made by Crown Ridge. Crown Ridge has denied the claims and filed its
own counterclaims against CEntry. Crown Ridge asserts, among other things, that
Crown Ridge is entitled to the retention amount based upon certain breaches of
the Contract by CEntry and that Crown Ridge is entitled to liquidated damages
for CEntry's failure to meet a mechanical completion deadline specified in the
Contract. An arbitration panel has been selected and arbitration will begin
August 2, 1999. The arbitration will take place in Salt Lake City, Utah and the
case is currently in the discovery phase. Due to the uncertainties inherent in
any litigation or arbitration proceeding, there can be no assurance that Crown
Ridge will or will not prevail or that significant damages will not be awarded
against Crown Ridge.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On November 18, 1998, the Company held an annual meeting of its
shareholders to elect members of the Company's Board of Directors and to approve
the appointment of Deloitte & Touche LLP as independent accountants for the
Company. Proxies for the meeting were solicited pursuant to Regulation 14A under
the Securities and Exchange Act of 1934. At the meeting, 7,201,011 shares of
common stock of the Company were represented in person or by proxy out of a
total of 12,668,512 shares issued and outstanding as of the record date
established with respect to such meeting.
All three of the Company's directors were re-elected to successive
terms as directors of the Company. With respect to the election of James A.
Middleton, 6,746,686 shares were voted in favor of his election, 429,450 shares
were voted against and 24,925 either abstained from voting or were broker
non-votes.
With respect to the election of Jay Mealey, 6,588,180 shares were voted
in favor of his election, 587,956 shares were voted against and 24,875 either
abstained from voting or were broker non votes. Lastly, with respect to the
election of Richard S. Rawdin, 6,528,430 shares were voted in favor of his
election, 647,706 shares were voted against and 24,875 either abstained from
voting or were broker non votes. The Company's shareholders also voted in favor
of appointing the accounting firm of Deloitte & Touche LLP as the Company's
independent auditors for the next fiscal year, with 7,188,939 shares voting in
favor of the appointment, 9,372 shares voting against, and 2,700 shares
abstaining or were broker non-votes.
No other matters were presented to the Company's shareholders for their
approval in the fourth quarter of the Company's 1998 fiscal year.
19
PART II.
ITEM 5. MARKET PRICE FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been traded in the over-the-counter
market since 1980. The common stock is currently listed on the NASD OTC Bulletin
Board under the symbol CROE. At the present time, only the common stock is
publicly traded. The following table sets forth the range of high and low bid
quotations, as adjusted for stock splits, of the Company's common stock as
reported by the National Quotation Bureau for each full quarter during the two
most recent fiscal years. The table represents prices between dealers, and does
not include retail markups, markdowns or commissions, and may not represent
actual transactions:
CALENDAR QUARTER ENDED HIGH BID LOW BID
March 31, 1998 1.56 1.19
June 30, 1998 2.13 1.47
September 30, 1998 2.16 1.25
December 31, 1998 1.50 0.97
March 31, 1997 1.25 0.63
June 30, 1997 1.03 0.53
September 30, 1997 1.50 0.63
December 31, 1997 2.00 1.22
As of May 25, 1999, the high bid and low offer quotations reported by
the National Quotation Bureau were $.97 and $1.00, respectively. On May 23,
1999, approximately 748 shareholders of record held the Company's common stock.
The Company declared and paid in 1999 the 8% dividend on the Company's Series A
Preferred Stock which accumulated and was due with respect to the 1998 calendar
year. The Company paid this dividend by issuing 317,069 shares of its common
stock on or about February 2, 1999 to Sundance Assets, L.P., a controlled
affiliate of ECT which now owns the Company's Series A Preferred stock. The
Company relied upon the exemption from registration afforded by Section 4(2) of
the Securities Act of 1933, as amended, and other available exemptions.
The Company has not paid any dividends or made any other distributions
on its common shares. It is the present policy of the Board of Directors of the
Company to retain any earnings for use in the business, and therefore, the
Company does not anticipate paying any cash dividends on its common stock in the
foreseeable future. The terms of the Company's Series A Preferred Stock prohibit
the payment of dividends on common stock at any time that dividends on the
Series A Preferred Stock are due yet unpaid.
By letter agreement dated April 3, 1998, the Company retained Ladenburg
Thalmann & Co., Inc. ("Ladenburg") as its financial advisor to provide corporate
finance assistance, review Company operations and financial condition, analyze
financing alternatives and strategies, evaluate potential transactions and
20
enhance the market for the Company's stock. In exchange for these services, the
Company is obligated to issue to Ladenburg warrants to acquire 400,000 shares of
the Company's common stock. The warrants will be exercisable for five years from
the date of issuance at the following prices: 150,000 shares at $1.50 a share,
150,000 shares at $2.00 per share and 100,000 shares at $2.50 per share. The
Company relied upon the exemption from registration afforded by Section 4(2) of
the Securities Act of 1933, as amended, and other available exemptions.
The Series A Preferred shares are convertible at the option of its
holder(s) into approximately 24% of the common stock of the Company. The number
of shares of common stock issuable upon conversion of the Series A Preferred is
subject to adjustment upon the issuance of additional shares of the Company's
common stock resulting from stock splits, share dividends and other similar
events as well as upon the issuance of additional shares or portions which are
issued (i) in connection with the Company's venture with MCNIC in Crown Ridge,
or (ii) as compensation to any employee, director, consultant or other service
provider of the Company or any subsidiary (other than options to acquire up to
5% of the Company's common stock at or less than the then fair market value).
Dividends accrue on the outstanding Series A Preferred shares at the rate of 8%
per annum and may be paid through cash or common shares of the Company at the
option of the holder(s) of such stock. Subject to the holder(s)' right to
convert the Series A Preferred, the Company may redeem such stock at any time
from the date on which it was issued at a percentage of the Series A Preferred's
stated value ($10) which will vary depending on when the Company exercises such
right. The holder(s) of the Series A Preferred may also require the Company to
redeem its Series A Preferred under certain circumstances after the eighth
anniversary of the issuance of such stock.
The holder(s) of the Series A Preferred have the right, but not the
obligation, to appoint 20% of the Company's Board of Directors. To date, the
holders(s) have not appointed any Directors. In addition, the holder(s) of the
Series A Preferred have certain voting rights upon any attempt by the Company to
alter the rights and preferences, redemption, voting or dividend rights senior
to the Series A Preferred, increase the number of Series A Preferred, reclassify
the Company's securities or enter into specified extraordinary events. All
voting rights of the Series A Preferred expire upon the issuance by the Company
of a notice to redeem such shares.
ITEM 6. SELECTED FINANCIAL DATA
The financial data included in the following table has been derived
from the financial statements for the periods indicated. The financial
statements as of and for the years ended December 31, 1994 through 1997 were
audited by Pritchett, Siler & Hardy, P.C., independent public accountants. The
financial statements as of and for the year ended December 31, 1998 were audited
by Deloitte & Touche, LLP, independent public accountants. The following
financial data should be read in conjunction with the financial statements and
related notes and with management's discussion and analysis of financial
conditions and results of operations included elsewhere herein.
21
Year Ended December 31
(In thousands except per share)
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Net Revenues $23,836 $87 $225 $214 $326
Income (Loss from
Continuing Operations) ($498) ($1,153) ($422) ($234) ($230)
Income (Loss) Per Share
From Continuing Operations ($0.07) ($0.11) ($0.04) ($0.03) ($0.03)
Total Assets $23,571 $6,610 $4,591 $4,344 $4,351
Total Long-Term Obligations $4,326 $0.00 $182 $794 $964
Redeemable Preferred Stock $4,783 $4,726 -0- -0- -0-
Cash Dividends Per Common Share $0.00 $0.00 $0.00 $0.00 $0.00
Common Stockholders' Equity $767 $1,749 $3,018 $2,611 $2,940
The foregoing selected financial data is presented on a historical
basis and may not be comparable from period to period due to changes in the
Company's operations. Common Stockholders' Equity was restated as of January 1,
1996 to reflect the amortization of $453,649 in research and development
expenditures previously capitalized by the Company.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT
OF OPERATIONS
The following discussion and analysis of the Company's financial
condition, results of operations and related matters includes a number of
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements include, by way of illustration and not limitation,
statements containing the works "anticipates," "believes," "expects," "intends,"
"future" and words of similar import which express, either directly or by
implication, management's beliefs, expectations or intentions regarding the
Company's future performance or future events or trends which may affect the
Company or its results of operations.
Forward-looking statements are subject to known and unknown risks,
uncertainties and other factors, including but not limited to changes in
economic conditions generally or with respect to the Company's asphalt products
market in particular, new or increased governmental regulation, increased
competition, shortages in labor or materials, delays or other difficulties in
shipping or transporting the Company's products, technical or operational
difficulties at the Facility of Crown Ridge, difficulties in integrating the
Company's recent joint venture and acquisition related businesses and other
similar risks inherent in the Company's operations or in business operations
generally. Any such risks or uncertainties, either alone or in combination with
other factors, may cause the actual results, performance or achievements of the
Company to differ materially from its anticipated future results, performance or
achievements (which may be expressed or implied by such forward looking
statements). Consequently, the following management's discussion and analysis,
including all forward-looking statements contained therein, is qualified and
22
limited by the foregoing cautionary factors. Interested persons are advised to
consider all forward-looking statements within the context of such cautionary
factors.
Liquidity and Capital Resources
At December 31, 1998, the Company had cash and other current assets of
$11,044,600 as compared to cash and other current assets of $3,288,989 at
December 31, 1997. The increase of $7,755,611 was primarily due to the Company's
formation and the related capitalization of its majority owned subsidiary, Crown
Distribution. Crown Distribution had current assets of $10,104,000 as of
December 31, 1998 which includes approximately $2.8 million in cash, $4.4
million in inventory and $2.8 million in accounts receivable. Crown Distribution
operations require a working capital line for inventory purchases and other
operating expenses. MCNIC, the minority interest owner, has established such
line, in addition to a working capital loan provided, at an interest rate of 8%.
At December 31, 1998, the line had a balance of $3,124,641 and the working
capital loan had a balance of $5,810,581.
The Company also owed MCNIC an additional $5,325,723 at December 31,
1998 with respect to the Preferential Capital Contribution which funded Crown
Distribution's acquisition of the assets of Petro Source Asphalt Company. See
"Item 1. Business Asphalt Distribution - Crown Asphalt Distribution, L.L.C." The
Preferential Capital Contribution requires payment of a 15% rate of return and
is payable solely from 50% of the cash flow from Crown Distribution's
operations. At December 31, 1998, the Company has estimated $1,000,000 of this
balance to be current.
The Company believes its asphalt distribution business, which is
operated through Capco, is a growth business whose success is not dependent on
the Company's interest in the Crown Ridge Project. However, the asphalt
distribution business is capital intensive and requires substantial investments
to acquire terminal storage, blending and raw material assets. The Company
recently acquired several terminals in transactions requiring substantial
capital commitments. On April 17, 1999, the Company acquired the asphalt
terminal fixed assets in Laurel, Montana and Williston, North Dakota along with
certain contractual agreements of Asphalt Supply & Services, Inc. and Inoco,
Inc. for $4,000,000, consisting of $750,000 in cash and 2,500,000 shares of
unregistered common stock. On May 12, 1999, the Company acquired an asphalt
terminal in Rawlins, Wyoming along with inventory for $2,291,571 from S&L
Industrial. The purchase price consisted of the Company assuming S&L's debt of
approximately $1,800,000, entering into a note payable to S&L for $225,000, and
a cash payment of $266,571. The Company remains open to other asphalt related
business opportunities to complement its existing asphalt distribution
capabilities. There can be no assurance that the Company can obtain additional
capital financing required to finance such transactions on acceptable terms and
conditions.
Under the Company's contractual relationships with MCNIC, MCNIC may
have certain rights to participate in additional business opportunities, if any,
which may be pursued by the Company. In the event MCNIC participates in these
business opportunities, the Company expects that MCNIC will fund its
23
proportionate share of the capital expenditures needed to pursue such
opportunities.
The Company believes it has sufficient capital to meet all of its
current working capital requirements from its cash reserve, working capital line
and other financing sources. However, the Company is required to fund 25% of
Crown Ridge's capital costs, start-up costs and operating expenses. As of
December 31, 1998, the Company has made cash contributions of approximately
$1,651,000. Crown Ridge has experienced certain technical difficulties which the
Company believes will be resolved. However, should such delays continue, or
should the facility be unable to operate economically, the Company believes this
would significantly impact Crown Ridge's ability to continue as a going concern
and would adversely impact the Company's operations and financial condition. See
- - "Item 1. Business - Asphalt Production - Crown Asphalt Ridge, L.L.C."
Results of Operations
1998 vs. 1997
During the 1998 fiscal year, the Company made significant progress in
the development of Crown Distribution and its asphalt terminal, blending,
emulsion and distribution facilities. In particular, the Company acquired
facilities located in Utah, Arizona, Colorado, Nevada, Wyoming, Montana and
North Dakota. These asphalt distribution facilities enable the Company to
purchase oil products and related raw materials from its suppliers and to store,
process, blend and otherwise produce various grades of asphalt and asphalt
products for sale to its customers in the western United States. As a result,
the Company's revenues during the year ended December 31, 1998 were generated
primarily from the asphalt product operations of Crown Distribution. Management
of the Company expects these operations to increase in importance as the Company
pursues it business plans. See "Item 1. Business."
The Company's results for the year ended December 31, 1998 include
expenses of $880,186 relating to the Company's early adoption of Statement of
Position (SOP) No. 98-5 which requires expensing of start-up costs. The Company
could have deferred this expense until 1999 but elected to record this change in
accounting principle in 1998. Of this amount, $615,323 relates to expenses
incurred in prior years and $264,863 relates to the current period. Also
included in 1998 results is the value of certain warrants issued totaling
$186,256. These warrants have exercise prices of $1.50, $2.00 and $2.50 per
share. The total of these expenses of $1,066,442 represents approximately 96% of
the Company's loss for 1998.
Total revenue increased from $86,781 for the year ended December 31,
1997 to $23,835,734 for the year ended December 31, 1998, an increase of
$23,748,953. The increase was due to revenue from the Company's recently
acquired subsidiary, Crown Distribution. Crown Distribution is an asphalt
distribution business that was formed to acquire the assets of Petro Source
Asphalt Company, a Texas corporation. Crown Distribution sold approximately
151,000 tons of asphalt during the period.
24
Cost of sales increased from $54,653 for the year ended December 31,
1997 to $21,916,816 for the year ended December 31, 1998, an increase of
$21,862,163. This increase was due to the cost of asphalt sold from the
Company's recently acquired asphalt distribution business. Cost of sales
includes asphalt costs of $17,465,416 and asphalt terminal operating costs of
$4,451,400.
General and administrative expenses increased from $815,401 for the
year ended December 31, 1997 to $1,253,953 for the year ended December 31, 1998,
an increase of $438,552 (54%). This change was due to an increase in the
Company's overhead related to its asphalt distribution business.
Interest and other income/expenses increased from net expenses of
$803,290 for the year ended December 31, 1997 to net expenses of $922,283 for
the year ended December 31, 1998, a decrease of $118,993. The 1998 total was
comprised of interest costs related to the Company's working capital line and
preferential loan for its asphalt distribution business of $851,917, start-up
costs of $264,863 related to Crown Ridge which were expensed pursuant to a
change in accounting principle and $186,256 of expenses related to the valuation
of warrants issued. These amounts were partially offset by interest and other
income of $380,753. The 1997 total was comprised primarily of an $801,461
expense related to a loss on the sale of a subsidiary.
Minority interest of $300,971 represents MCNIC's approximate 49%
interest in Crown Distribution.
1996 vs. 1997
Oil and gas revenue decreased from $224,855 for the year ended December
31, 1996 to $86,781 for the year ended December 31, 1997, a decrease of $138,074
(61%). This decrease was due to the sale of the Company's oil and gas producing
subsidiary, Gavilan Petroleum, Inc. in July, 1997.
Oil and gas production costs decreased from $137,340 for the year ended
December 31, 1996 to $54,653 for the year ended December 31, 1997, a decrease of
$82,687 (60%). This decrease was due to the sale of the Company's oil and gas
producing subsidiary, Gavilan Petroleum, Inc. in July, 1997.
General and administrative expenses increased from $631,463 for the
year ended December 31, 1996 to $815,401 for the year ended December 31, 1997,
an increase of $189,938 (29%). This increase was primarily due to an increase in
expenses relating to the Asphalt Ridge oil sand project financing.
Other income/expenses increased from total expenses of $6,682 for the
year ended December 31, 1996, to total expenses of $803,290 for the year ended
December 31, 1997, an increase of $796,608. This increase was due to the loss
recorded on the sale of Gavilan Petroleum, Inc.
25
Year 2000 Assessment
Like many other companies, the "Year 2000 problem" creates risks for
the Company. The "Year 2000 problem" is the result of computer systems and other
equipment with embedded chips or processors using two digits, rather than four,
to define a specific year and potentially being unable to accurately process,
provide and/or receive date and time data from, into and between the twentieth
and twenty-first centuries, including the years 1999 and 2000, and leap year
calculations. The Year 2000 problem, if not identified and corrected in a timely
manner, could result in system failures or miscalculations, causing disruptions
to various Company activities and operations and adversely impact its financial
condition and results of operations.
The Company is addressing the Year 2000 problem in three overlapping
phases: (i) the identification and assessment of all critical equipment,
hardware and software systems requiring modification or replacement prior to
2000; (ii) the remediation and testing of modifications to critical items; and
(iii) the development of contingency and business continuation plans to mitigate
the extent of any disruption to the Company's operations arising from the Year
2000 problem.
The Company began its assessment of Year 2000 issues in the first
quarter of 1999 and the Company continues to assess the Year 2000 problem and
its potential impact on its information technology ("IT") and non-IT systems.
These activities are intended to encompass all major categories of systems in
use by the Company, including oil sands extraction functions, asphalt
processing, transportation and logistics systems, sales and finance and
accounting. The Company is also actively working with critical suppliers of
products and services to determine that the suppliers' operations and the
products and services they provide are Year 2000 compliant or to monitor their
progress toward year 2000 compliance. The Company expects that assessment,
remediation and contingency planning activities will continue throughout 1999
with the goal of appropriately resolving all material internal systems and third
party issues. However, there can be no assurance that the Company will be able
to complete its assessment, remediate problems or implement effective
contingency plans before the end of 1999. Further, the Company's recent
acquisitions of asphalt terminals, and the Company's continuing efforts to
integrate these assets and new personnel into the Company's overall operations,
present additional difficulties in the Company's assessment and remediation
efforts.
The Company and its affiliated joint venture entity, Crown Ridge,
employ a number of IT systems in their operations, including, without
limitation, computer networking systems, financial systems and other similar
systems. In 1998, the Company and its subsidiaries began conversion of their
principal computer software systems to a new integrated system to support future
growth and improve productivity. Although no independent assessment has been
conducted, management of the Company believes that the new computer system is
Year 2000 compliant based upon indications from its computer systems vendors
that the new computer systems incorporate current technology and software which
are Year 2000 compliant.
26
The Facility constructed by Crown Ridge incorporates state of the art
technology and the Company believes that its IT and non-IT systems are Year 2000
compliant. However, the sophisticated nature of this Facility and the fact that
it is in its initial operational phase requires that the Company continue to
assess its Year 2000 readiness.
The Company is also assessing its non-IT systems containing embedded
electronic circuits. The Company's has identified the operations of Crown Ridge,
Crown Distribution and CAT LLC, the Company's joint venture operating companies,
as having the most non-IT Year 2000 operational risks since the Company's
revenues and income are or will be derived primarily from these operations. As
of March 15, 1999, the Company has not identified any material non-IT systems
that are not Year 2000 compliant, although the Company's assessment efforts are
ongoing.
The Company is highly dependant upon electric power, natural gas,
asphalt, petroleum based products and chemicals, as well as the delivery of such
items by all forms of transportation, including, pipeline, shipping, rail and
truck. A shortage of any of the foregoing products or a failure of or delays in
one or more methods of transportation could have a material adverse affect on
the Company and Crown Ridge and their respective operations.
Although the Company has obtained assurances from some of its key
suppliers, it has not independently evaluated whether its key suppliers are or
will be Year 2000 compliant, and therefore the Company's contingency plans will
assume that at least some of these suppliers will have disruptions in their
deliveries and services to the Company or Crown Ridge. Given that assumption
(and the risk that some of the Company's IT or non-IT systems will experience
unidentified or unremediated Year 2000 problems), some of the worst case Year
2000 scenarios the Company might experience include a complete shut-down of
Crown Ridge's Facility and one or more of the asphalt terminals of Crown
Distribution, or a failure or substantial delay in the transportation of the
Company's asphalt products. The occurrence of any of these events could result
in lost revenues, lost customers, increased processing, storage or
transportation costs, increased financing costs related to inventory shortages
or sales order backlogs, substantial remediation costs and other similar costs
and expenses.
The potential costs, if any, to remediate direct or indirect Year 2000
problems the Company may have or identify has not been determined, nor can such
costs, if any, be accurately predicted or determined given the ongoing nature of
the Company's assessment efforts. At present, the Company has spent
approximately $96,000 upgrading its IT systems and has spent roughly $5,000 to
assess or remediate non-IT issues (excluding salaries of Company personnel). The
Company currently expects that the total cost of these programs, including both
incremental spending and redeployed resources, will not be in excess of
$150,000. The total cost estimate is based on the current assessment of the
projects and is subject to change as the project's progress.
The Company has not yet developed any contingency plans in the event
that it or its subsidiaries' IT or non-IT systems fail or in the event that
material suppliers of goods or services fail or have significant disruptions in
deliveries to the Company and its subsidiaries.
The foregoing disclosure is based on the Company's current
expectations, estimates and projections, which could ultimately prove to be
27
inaccurate. Because of uncertainties, the actual effects of the Year 2000
problem on the Company may be different from the Company's current assessment.
Factors, many of which are outside the control of the Company, that could affect
the Company's ability to be Year 2000 compliant by the end of 1999 include the
failure of customers, suppliers, governmental entities and others to achieve
compliance; the inability or failure to identify all critical Year 2000 issues
or to develop appropriate contingency plans for all Year 2000 issues that
ultimately may arise.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATE
The financial statements required by this item are set forth following
Item 14 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On June 2, 1998, the Company terminated its independent auditor
relationship with Pritchett, Siler & Hardy, P.C. ("Pritchett").
Pritchett's report on the financial statements of the Company for the
fiscal year ended December 31, 1997 did not contain an adverse opinion or a
disclaimer of opinion, and were not qualified or modified as to uncertainty,
audit scope or accounting principles. The Pritchett report for the fiscal year
ended December 31, 1996 contained a statement as to the ability of the Company
to continue as a going concern. Other than the foregoing, there were no adverse
opinions or disclaimers of opinion, or qualifications or modifications as to
uncertainty, audit scope or accounting principles.
The decision to change accountants was approved by the Company's Board
of Directors.
During the fiscal years ended December 31, 1997, 1996 and 1995, and the
period January 1, 1998 through June 2, 1998, there were no disagreements with
Pritchett on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedures or any reportable events.
On June 2, 1998, the Company engaged Deloitte & Touche LLP ("Deloitte")
as its independent auditors to audit and report on the financial statements of
the Company for the fiscal year ended December 31, 1998. During the audit for
the year ended December 31, 1998, certain prior period R & D expenditures
totaling $453,649 have been reclassified as an expense as of January 1, 1996.
Prior to engaging Deloitte, neither the Company nor anyone acting on
its behalf consulted with Deloitte regarding the application of accounting
principles to any specified transaction or the type of audit opinion that might
be rendered on the Company's financial statements. In addition, during the
Company's fiscal years ended December 31, 1997 and 1996, and during the period
January 1, 1998 through June 2, 1998, neither the Company nor anyone acting on
28
its behalf consulted with Deloitte with respect to any matters that were the
subject of a disagreement (as defined in Item 304(a)(1)(iv) of Regulation S-K)
or a reportable event (as described in Item 304(a)(1)(v) of Regulation S-K).
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors of the Company, their ages and
their positions are set forth below:
NAME AGE POSITION
James A. Middleton 63 Chairman of the Board of Directors
Jay Mealey 42 Chief Executive Officer
President, Treasurer, Director
Alexander L. Searl 56 Chief Operating and Financial Officer
Richard S. Rawdin 40 Vice President, Secretary, Director
James A. Middleton has served as a director since February 1996 and
served as Chief Executive Officer from December 1996 until his resignation on
April 16, 1999. Mr. Middleton will continue to serve as a director until a new
director is duly elected and qualified. Mr. Middleton was an Executive Vice
President and director of Atlantic Richfield Co. from October 1987 to September
1994 and is presently a director of Texas Utilities Co.
Jay Mealey has served as President and Chief Operating Officer and as a
director of the Company since 1991. Mr. Mealey was appointed as Chief Executive
Officer on April 16, 1999 and will serve as Chief Executive Officer, President
and Treasurer and as a director, until a new officer and director, respectively,
are elected and qualified. Mr. Mealey has been actively involved in the oil and
gas exploration and production business since 1978. Prior to employment with the
Company, Mr. Mealey served as Vice President of Ambra Oil and Gas Company and
prior to that worked for Belco Petroleum Corporation and Conoco, Inc. in their
exploration divisions. Mr. Mealey is responsible for managing the day-to-day
operations of the Company.
Alexander L. Searl was appointed as Chief Operating Officer and Chief
Financial Officer of the Company on June 4, 1999. Prior to joining the Company,
Mr. Searl was Senior Vice President and Chief Financial Officer of TheraTech,
Inc., a publicly-held pharmaceutical drug delivery company. Prior to joining
Theratech, Mr. Searl was employed by American Stores Company, one of the
nation's leading food and drug retailers, where he was Executive Vice President
and Treasurer. He previously served 21 years in management positions of
increasing responsibility with Hercules Incorporated, including several years as
the international chemical manufacturer's corporate vice president and
treasurer.
29
Richard S. Rawdin has served as a Vice President and Secretary and as a
director of the Company since 1991 and will serve as Vice-President and
Secretary and as a director, until a new officer and director, respectively, are
elected and qualified. From February 1986 to September 1991, Mr. Rawdin served
as Controller and Vice President of Finance for Kerry Petroleum Company, Inc.
Prior to that, he was employed as a senior consultant with Deloitte and Touche.
Mr. Rawdin is a Certified Public Accountant.
Compliance with Section 16(a) of the Securities and Exchange Act of 1934
Section 16(a) of the Securities and Exchange Act of 1934 (the "Exchange
Act") requires the Company's executive officers and directors and certain
shareholders to file initial reports of ownership and reports of changes in
ownership with the Securities and Exchange Commission (the "Commission"). Such
persons are required by Commission regulations to furnish the Company with
copies of all Section 16(a) forms they file. Based solely on a review of the
copies of such forms furnished to the Company and written representations from
the Company's executive officers and directors, the Company notes that James A.
Middleton, a director of the Company and it former Chief Executive Officer, was
late in reporting that he was granted, on February 6, 1998, options to acquire
75,000 shares of Company common stock at an exercise price of $1.50 per share.
Mr. Middleton filed a Form 5 on February 16, 1999 reporting the grant of such
options.
ITEM 11. EXECUTIVE COMPENSATION
The compensation of James A. Middleton, the Company's Chief Executive
Officer and the Company's two highly paid executive officers (collectively, the
"Named Officers") is discussed in the following tables.
Summary Compensation Table
The following table contains information regarding compensation paid to
the Company's Named Officers for the fiscal years listed. No other executive
officer of the Company earned compensation in excess of $100,000 in fiscal year
1998.
=============================== ===================================================== ========================================
Annual Compensation Long Term
Compensation
=============================== ===================================================== ========================================
Name and Principal Position Salary Bonus ($) Other Annual Securities All Other
Year ($) Compensation ($) Underlying Compensation ($)
Options/SARS (#)
- ------------------------------- ---------- ------------ ---------- ------------------ --------------------- ------------------
James A. Middleton, Chief 1998 $0 $0 $0 0 0
Executive Officer(1) 1997 $0 $0 $0 0 0
1996(1) $0 $0 $0 0 0
- ------------------------------- ---------- ------------ ---------- ------------------ --------------------- ------------------
Jay Mealey, President 1998 $155,000 $0 $48,539(4) 0 $539(5)
1997 $100,000 $56,250 $0 450,000 (3) 0
1996 $78,000 $0 $0 0 0
- ------------------------------- ---------- ------------ ---------- ------------------ --------------------- ------------------
Richard S. Rawdin, Vice 1998 $78,000 $0 $31,672(4) 0 0
President and Secretary 1997 $52,500 $56,250 $0 0(3) 0
1996(2) * * * * *
=============================== ========== ============ ========== ================== ===================== ==================
30
(1) Mr. Middleton resigned as Chief Executive Officer on April 16, 1999.
(2) Although employed by the Company, Mr. Rawdin did not earn compensation in
excess of $100,000 in 1996.
(3) Does not include 148,148 options to purchase Common Stock of the Company at
the purchase price of $.5625 per share which were previously granted to both Mr.
Mealey and Mr. Rawdin in May 1995 and which became exercisable upon satisfaction
of a condition precedent to vesting and exercise, namely, the receipt and
completion of financing on the Company's Asphalt Ridge project.
(4) Includes non-cash compensation expense in the amounts of $40,139 and $31,672
for Mr. Mealey and Mr. Rawdin, respectively, recorded by the Company in
connection with their exercise of options to acquire Company common stock. The
foregoing sums represent the value of such options, generally determined by the
difference between the fair market value of the stock subject to the options and
the exercise price paid for the common stock. Mr. Mealey's amount also includes
a car allowance of $8,400.
(5) Represents life insurance paid for Mr. Mealey.
Option/SAR Grants Table
The following table sets forth information with respect to individual
grants of stock options made by the Company to the Named Officers during the
fiscal year ended December 31, 1998. The Company did not grant any stock
appreciation rights during the fiscal year ended December 31, 1998.
============================ ============= ==================== =================== ============== ===========================
Number of % of Total Options Exercise or Base Expiration Potential Realizable Value
Securities Granted to Price ($/Sh) Date for at Assumed Annual Rates of
Name Underlying Employees in Fiscal Option Term Stock Price Appreciation
Options year for Option Term
Granted (#)
============================ ============= ==================== =================== ============== ===========================
James A. Middleton (1) 75,000 100% $1.50 per share 1/29/03 $22,500
Jay Mealey 0 N/A N/A N/A N/A
Richard S. Rawdin 0 N/A N/A N/A N/A
============================ ============= ==================== =================== ============== ===========================
(1) Granted as of February 6, 1998 under Mr. Middleton's Employment Agreement
dated January 26, 1996, which obligated the Company to grant such options as
additional compensation for services during the period February 6, 1997
- -February 6, 1998.
31
Aggregated Option/SAR Exercises and Fiscal Year-End Option/SAR Value Table
The following table contains information regarding the fiscal year-end
value of unexercised options held by the Named Officers. The aggregate value of
the options was calculated using the average bid and asked price for the
Company's Common Stock on December 31, 1998.
========================= ================= =============== ================================== ==================================
Number of securities underlying Value of unexercised in-the-money
unexercised options/SARs at options/SARs at fiscal year end
fiscal year end ($)
(#)
---------------------------------- ----------------------------------
Shares Value
Name Acquired Realized
on Exercise (#) ($) Exercisable Unexercisable Exercisable Unexercisable
========================= ================= =============== ================================== ==================================
James A. Middleton 0 0 450,000 0 $0 $0
Jay Mealey 548,148 $40,139(1) 0 450,000 (2) $0 $0
Richard S. Rawdin 398,148 $31,672(1) 0 398,148 $0 $0
========================= ================= =============== ================================== ==================================
(1) Includes non-cash compensation expense in the amounts of $40,139 and $31,672
for Mr. Mealey and Mr. Rawdin, respectively, recorded by the Company in
connection with their exercise of options to acquire Company common stock. The
foregoing sums represent the value of such options, generally determined by the
difference between the fair market value of the stock subject to the options and
the exercise price paid for the common stock.
(2) Represents three tranches of 150,000 options granted in a single grant to
Mr. Mealey in November of 1997. The first tranche of options vested on November
1, 1997, but is not exercisable until the average offer price of the Company's
Common Stock equals or exceeds $2.00 per share for thirty days. The second
tranche of options vested in November 1, 1998, provided that Mr. Mealey is
employed by the Company, but will not be exercisable until the average offer
price of the Company's Common Stock equals or exceeds $3.00 per share for thirty
days. The third tranche of options will vest on November 1, 1999, provided that
Mr. Mealey is employed by the Company, but will not be exercisable until the
average offer price of the Company's Common Stock equals or exceeds $4.00 per
share for thirty days.
Director Compensation
The Company does not presently offer any compensation to its directors
for their service as members of the Company's Board of Directors. Directors,
however, are reimbursed for their expenses in attending Board meetings and are
not precluded from serving the Company in any other capacity and receiving
compensation therefor. Following his resignation as Chief Executive Officer of
the Company on April 16, 1999, James A. Middleton serves the Company only in the
capacity as a director and is therefore the Company's only outside director.
32
Employment Contracts
On January 26, 1996, the Company entered into an employment agreement
with James A. Middleton, the Chief Executive Officer and Chairman of the Board
of the Company. Mr. Middleton's employment agreement terminated on February 6,
1999. The agreement provided for a base salary equal to five percent of the
Company's net profits from operations before depletion, depreciation, tax
credits and amortization, but after interest on debt, with a salary cap of
$1,000,000 per calendar year. Under his employment agreement, Mr. Middleton was
granted options to purchase 300,000 shares of the Company's Common Stock at an
exercise price of $.66 per share pursuant to the employment agreement. Mr.
Middleton was also granted, on February 6, 1998 and 1999, additional options to
purchase 75,000 shares of the Company's Common Stock (when combined, these
options allow Mr. Middleton to acquire 150,000 shares of Common Stock). Mr.
Middleton has resigned his position as Chief Executive Officer of the Company
and now serves only as a director.
On November 1, 1997, the Company entered into an employment agreement
with Jay Mealey, the Company's President and Treasurer. Mr. Mealey's employment
agreement expires on December