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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10–Q

(Mark One)

[X]  

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2004

[    ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______________ to _______________

(604) 913-1462

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [  ]  No [X]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes [  ]  No [X]

As of May 25, 2004, the registrant had 171,212,635 shares of common stock outstanding.

EUROGAS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

       Page

PART I — FINANCIAL INFORMATION

Item 1.  Financial Statements

Condensed Consolidated Balance Sheets (Unaudited) as of March 31,

  2004 and December 31, 2003

 3

Condensed Consolidated Statements of Operations (Unaudited) as of March 31,

  2004 and March 31, 2003

 4

Condensed Consolidated Statements of Cash Flows (Unaudited) as of March 31,

  2004 and March 31, 2003

 5

Notes to Condensed Consolidated Financial Statements (Unaudited)

 6

Item 2.  Managements Discussion and Analysis of Financial Condition

Results of Operations

 14

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

19

Item 4.

Controls and Procedures

19

PART II — OTHER INFORMATION

Item 1.  Legal Proceedings

 20

Item 5.

Other Information

20

Item 6.  Exhibits and Reports on Form 8-K

 20

Signatures

 26

PART I — FINANCIAL INFORMATION

Item 1.  Financial Statements

EUROGAS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(The following statements have only been reviewed by EuroGas, Inc. management)

The accompanying notes are an integral part of these condensed consolidated financial statements.

EUROGAS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE LOSS

(UNAUDITED)

(The following statements have only been reviewed by EuroGas, Inc. management)

EUROGAS, INC. AND SUBSIDIARIES

EUROGAS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(The following statements have only been reviewed by EuroGas, Inc. management)

The accompanying notes are an integral part of these condensed consolidated financial statements.

EUROGAS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Condensed Interim Financial Statements — The accompanying unaudited condensed consolidated financial statements include the accounts of EuroGas, Inc. and its subsidiaries ("EuroGas" or the "Company").  These financial statements are condensed and, therefore, do not include all disclosures normally required by accounting principles generally accepted in the United States of America. These statements should be read in conjunction with EuroGas' most recent annual financial statements included in the Company's report on Form 10-K for the year ended December 31, 2003.  In particular, EuroGas' significant accounting principles were presented as Note 1 to the Consolidated Financial Statements in that Report.  In the opinion of management, all adjustments necessary for a fair presentation have been included in the accompanying condensed consolidated financial statem ents and consist of only normal recurring adjustments.  The results of operations presented in the accompanying condensed consolidated financial statements are not necessarily indicative of the results that may be expected for the full year ending December 31, 2004.

Business Condition — EuroGas has accumulated a deficit of $157,278,077 through March 31, 2004. EuroGas has had no revenue, losses from operations and negative cash flows from operating activities during the years ended December 31, 2003 and 2002. At March 31, 2004, the Company had a working capital deficiency of $22,304,439 and a capital deficiency of $11,125,982. The Company has impaired most of its oil and gas properties. These conditions raise substantial doubt regarding the Company's ability to continue as a going concern. Realization of the investment in properties and equipment is dependent upon management obtaining financing for exploration, development and production of its properties. In addition, if exploration or evaluation of property and equipment is unsuccessful, all or a portion of the remaining recorded amount of those properties will be recognized as impairment losses. Paymen t of current liabilities will require substantial additional financing. Management of the Company plans to finance operations, explore and develop its properties and pay its liabilities through borrowing, through sale of interests in its properties, through advances received against future talc sales and through the issuance of additional equity securities. Realization of any of these planned transactions is not assured.

Principles of Consolidation — The accompanying consolidated financial statements include the accounts of EuroGas, Inc., its majority-owned subsidiaries and EuroGas' share of properties held through joint ventures. All significant intercompany accounts and transactions have been eliminated in consolidation.

Stock-Based Compensation — At March 31, 2004, the Company had options outstanding that had been previously granted to employees and consultants. The Company accounts for stock options granted to employees under APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations and accounts for options granted to non-employees at their fair value under SFAS No. 123, Accounting for Stock-Based Compensation. No stock-based employee compensation expense is reflected in net loss during the periods presented in the accompanying financial statements as all options had an exercise price equal to the market value of the underlying common stock on the date of grant or the related compensation was recognized in earlier periods. There would not have been any effect to net loss or to basic and diluted loss per common share if the Company had appl ied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation as the related compensation was recognized in earlier periods.

 Reclassifications — Certain reclassifications have been made to the accompanying December 31, 2003 and March 31, 2004 financial statements to conform to the current period presentation.

Cumulative Effect of Accounting Change – The Company adopted SFAS No. 143, Accounting for Asset Retirement Obligations, effectively on January 1, 2003. In accordance with the transition provisions of SFAS No. 143, the Company recorded asset retirement costs of $140,187, liabilities of $326,177, and recognized the cumulative effect on prior years of $185,990 as an expense during the three months ended March 31, 2004, which had no effect on basic and diluted loss per common share.

Recent Accounting Pronouncements — The Company adopted SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of January 1, 2003. Among other provisions, this statement modifies the criteria for classification of gains or losses on debt extinguishment such that they are not required to be classified as extraordinary items if they do not meet the criteria for classification as extraordinary items in APB Opinion No. 30, Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. The adoption of this standard did not have any effect on the Company’s financial position or results of operations.

The Company also adopted SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities as of January 1, 2003. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. The provisions of this statement did not have any effect on the Company’s financial position or results of operations.

NOTE 2 — INVESTMENT IN SECURITIES

The Company’s primary investment in securities consists of 209,550 shares of Enterra Energy Ltd. The Enterra shares are held as collateral by Oxbridge Limited under a claim, as discussed in Note 3. At June 30, 2003, the Company changed its expectation of realizing proceeds from sale of the Enterra shares to more than one year and reclassified the investment in the Enterra shares as a long-term asset. The Company’s investments in equity securities, including the Enterra shares, are accounted for as available for sale, as defined by SFAS No. 115, as they have readily determinable fair values and are not restricted other than in connection with being pledged as collateral. Accordingly, the investments in securities available for sale are carried at market value with unrealized gains and losses included in accumulated other comprehensive income (loss). The cost of securities sold is determined by the aver age-cost method. The investments in securities consisted of the following:

During the three months ended March 31, 2004, the Company made no sales or purchases of investment securities.

NOTE 3 — ACCRUED SETTLEMENT OBLIGATIONS

Oxbridge Settlement — During 1997, Oxbridge Limited requested EuroGas convert 2,391,968 Series 1995 Preferred Stock into EuroGas common shares but was effectively prevented in doing so by an agreed order with the Trustee in the McKenzie bankruptcy case described below. As a result, Oxbridge was unable to receive proceeds from the sale of the conversion shares when the average market prices and trading volume would have resulted in substantial proceeds and has made a claim against EuroGas for its losses. During 2002, EuroGas estimated the cost to settle the Oxbridge claim to be approximately $6,800,000. That amount is included in the accrued settlement obligation as of March 31, 2004.

McKenzie Bankruptcy Claim — This litigation is being brought by Steve Smith, Chapter 7 Trustee (the “Trustee”) for the bankruptcy estates of Harven Michael McKenzie, Debtor; Timothy Stewart McKenzie, Debtor; Steven Darryl McKenzie, Debtor (case no. 95-48397-H2-7, Chapter 7; case no. 95-48474-H2-7, Chapter 7; and case no. 95-50153-H2-7, Chapter 7, respectively), pending in the United States Bankruptcy Court for the Southern District of Texas, Houston Division.

In March 1997, the Trustee commenced the following cause of action:  W. Steve Smith, Trustee, v. McKenzie Methane Poland Co., Francis Wood McKenzie, EuroGas, Inc. GlobeGas, B.V. and Pol-Tex Methane, (Adv. No. 97-4114 in the United States Bankruptcy Court for the Southern District of Texas, Houston Division) (hereafter “97-4114”).  The Trustee’s initial claim appears to allege that the Company may have paid inadequate consideration for its acquisition of GlobeGas from persons or entities acting as nominees for the McKenzies, and therefore McKenzies’ creditors are the true owners of the proceeds received from the development of the Pol-Tex Concession in Poland.  The Company has contested the jurisdiction of the Court, and the Trustee’s claim against a Polish corporation (Pol-Tex), and the ownership of Polish mining rights. The Company further contends that it paid su bstantial consideration for GlobeGas (Pol-Tex’s parent), and that there is no evidence that the creditors of the McKenzies invested any money in the Pol-Tex Concession.

In March of 1997, the Trustee brought a related suit W. Steve Smith, Trustee v. Bertil Nordling, Rolf Schlegal, MCK Development B.V. Claron N.V., Jeffrey Ltd., Okibi N.V., McKenzie Methane Poland Co., Harven Michael McKenzie, Timothy Stewart McKenzie, Steven Darryl McKenzie and EuroGas, Inc.,  (Adv. No. 97-4155) in each of the three McKenzie individual bankruptcy cases.  In general, the action asserts that the defendants, other than the Company, who acquired an interest in the Polish Project, received a fraudulent transfer of assets belonging to the individual McKenzie bankruptcy estates, or are alter egos or the strawmen for the McKenzies.  As a result, the Trustee asserts that any EuroGas stock or cash received by these defendants should be accounted for and turned over to the Trustee.  As to the Company, the Trustee asserts that as transfer agent, the Company should turn over the preferred stock pre sently outstanding to the defendants or reserve such shares in the name of the Trustee and that any special considerations afforded these defendants should be canceled. It appears the Company was named to this litigation only because of its relationship as transfer agent to the stock in question.  This suit has been administratively consolidated with 97-4114, and is currently pending before the Houston bankruptcy court.  

In October 1999, the Trustee filed a Motion for Leave to Amend and Supplement Pleadings and Join Additional Parties in the consolidated adversary proceedings, seeking to add new parties, including Wolfgang and Reinhard Rauball and assert additional causes of action against EuroGas and the other defendants in this action.  These new causes of action include claims for damages based on fraud, conversion, breach of fiduciary duties, concealment and perjury.  These causes of action claim that the Company and certain of its officers, directors or consultants cooperated or conspired with the McKenzies to secret or conceal the proceeds from the sale of the Polish Concession from the Trustee.  In January 2000, this motion was granted by the bankruptcy court.  The Company is vigorously defending this suit.  On March 18, 2002, the court considered motions to dismiss filed by EuroGas and the Rauba lls (other named defendants). These motions are currently pending before the Court. No trial date has been set.

In June 1999, the Trustee filed another suit in the same bankruptcy cases styled Steve Smith, Trustee, vs. EuroGas, Inc., GlobeGas, B.V., Pol-Tex Methane, SP. Z.O.O., et al (Adv. No. 99-3287).  That suit sought sanctions against the defendants for actions allegedly taken by the defendants during the bankruptcy cases which the Trustee considered improper.  The defendants filed a motion to dismiss the lawsuit, which was granted in August 1999.  In July 1999, the Trustee also filed a suit in the same bankruptcy cases styled Steve Smith, Trustee, vs. EuroGas, Inc., GlobeGas, B.V., Pol-Tex Methane, SP. Z.O.O. (Adv. No. 99-3444).  This suit seeks damages in excess of $170,000 for the defendants’ alleged violation of an agreement with the Trustee executed in March 1997.  EuroGas disputes the allegations and has filed a motion to dismiss or alternatively, to abate this suit, which motion is currently pending before the court.

On March 18, 2002, the court considered motions to dismiss filed by EuroGas and the Rauballs (other named defendants).  On September 10, 2002, the Court entered an Order which required the Trustee to specify the causes of action asserted against each Defendant.  A few days prior to this Order, the Trustee filed his Second Motion for Leave to Amend and Supplement Pleadings and to Drop Certain Defendants (the “Second Motion”).  On October 21, 2002, EuroGas and other Defendants filed their Response to the Second Motion.  On November 11, 2002, the Trustee filed his Motion and Reply to this Response under which, in part, Trustee sought court approval to file a Third Amended Complaint. On March 13, 2003 the Court entered and Order Granting Trustee’s Motion for Leave to Amend.  

On March 13, 2003 the Trustee filed his Third Amended Complaint, which is now styled Steve Smith, Trustee v. Harven Michael McKenzie, McKenzie Methane Poland, Inc., EuroGas, Inc., Wolfgang Rauball, Reinhard Rauball, MCK Development, B.V., Claron, N.V., Jeffrey, Ltd. and Okibi N.V. (Adv. No. 97-4114 and 97-4115). As to EuroGas, the Third Amended Complaint asserts claims for breach of contract, fraud in the inducement, conspiracy, aiding and abetting civil conspiracy, fraudulent transfer and punitive damages. As to Wolfgang and Reinhard Rauball, the Complaint asserts claims for turnover under Section 542 and 543 (Reinhard Rauball only) of the Bankruptcy Code, conversion, post-petition avoidable transfers, civil conspiracy, aiding and abetting civil conspiracy and punitive damages. The Company has filed a Motion to Dismiss the Third Amended Complaint. A trial date set for November 2003 was postponed pending a settlement agreement described below.

Management’s estimate of the amounts due under the claims made by the Trustee and his attorneys have been adequately accrued in the accompanying financial statements.

Kukui, Inc. Claim — In November 1996, the Company entered into a settlement agreement with Kukui, Inc. ("Kukui"), a principal creditor in the McKenzie bankruptcy case, whereby the Company issued 100,000 common shares and an option to purchase 2,000,000 additional common shares, which option expired on December 31, 1998. The Company granted registration rights with respect to the 100,000 common shares issued. On August 21, 1997, Kukui asserted a claim against EuroGas, which was based upon an alleged breach of the 1996 settlement agreement as a result of the Company's failure to file and obtain the effectiveness of a registration statement for the resale by Kukui of the 100,000 shares delivered to Kukui in connection with the 1996 settlement. In addition, the Estate of Bernice Pauahi Bishop (the “Bishop Estate”), Kukui's parent company, entered a claim for failure to registe r the resale of common shares subject to its option to purchase up to 2,000,000 common shares of EuroGas. EuroGas denied any liability and filed a counterclaim against Kukui and the Bishop Estate for breach of contract concerning their activities with the McKenzie Bankruptcy Trustee.

In December 1999, EuroGas signed a settlement agreement with the bankruptcy Trustee, and other parties, including Kukui, Inc., and the Trustees of the Bishop Estate, which had pursued separate claims against EuroGas (the “Settlement Agreement”).  The Settlement Agreement, in part, required EuroGas to pay $900,000 over 12 months and issue 100,000 shares of registered common stock to the Bishop Estate by June 30, 2000.  The bankruptcy court approved the Settlement Agreement on May 23, 2000.  The claims of Kukui, Inc. and the Trustees of the Bishop Estate have been dismissed pursuant to the terms of the Settlement Agreement.  Under the terms of the Settlement Agreement, EuroGas recorded an accrued settlement obligation and litigation settlement expense of $1,000,000 during 1999, paid Kukui $782,232 of the settlement obligation in 2000 and accrued an additional settlement obligation li ability and expense of $251,741 during 2000. During 2000, EuroGas issued the Bishop Estate 100,000 registered common shares, which were valued at $100,000, or $1.00 per share. The resulting accrued settlement obligation of $369,509 for the estimated cost of settling the claim included an estimated default penalty and interest. The Company contends that it has fully performed under the Settlement Agreement and that the Settlement Agreement additionally entitles the Company to a complete release and dismissal of all suits filed by the Bankruptcy Trustee.  The Bankruptcy Trustee contends that EuroGas defaulted under the Settlement Agreement and is not entitled to a release or dismissal.  

Holbrook Claim — On February 9, 2001, James R. Holbrook, a documents escrow agent appointed under the Settlement Agreement, filed his Complaint of Escrow Agent for Interpleader and for Declaratory Relief against EuroGas, the Trustee and the other parties to the settlement in an action styled James R. Holbrook v. W. Steve Smith, Trustee, Kukui, Inc., EuroGas, Inc. and Kruse Landa & Maycock, L.L.C., (Adv. No. 01-3064) in the McKenzie bankruptcy cases.  Under this complaint, Holbrook sought a determination of the defendants’ rights in certain EuroGas files that he had received from Kruse Landa and Maycock, former attorneys for EuroGas.  Through this litigation, the Trustee sought turnover of all these files pursuit to the Settlement Agreement.  EuroGas has opposed turnover of privileged materials and filed a cross-claim in the suit asking for a declar atory judgment that the Settlement Agreement is enforceable and that the Trustee be ordered to specifically perform his obligations under the Settlement Agreement.  The Trustee filed a counterclaim requesting specific performance by EuroGas and other relief.  At the direction of the court, both parties filed motions for summary judgment.  On December 17, 2001, the court entered an order granting Trustee’s Motion for Summary Judgment and denying a related Motion to Strike Affidavit, which EuroGas had filed.  EuroGas has appealed this order to the United States District Court for the Southern District of Texas. On September 25, 2002 the District