UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
(Mark one)
[X] Quarterly Report Under Section 13 or 15(d) of The Securities Exchange Act
of 1934
For the quarterly period ending June 30, 2006
[_] Transition Report Under Section 13 or 15(d) of The Securities Exchange Act
of 1934
For the transition period from ______________ to _____________
Commission File Number: 0-29613
TIDELANDS OIL & GAS CORPORATION
(Exact name of small business issuer as specified in its charter)
Nevada 66-0549380
------------------------ ------------------------
(State of incorporation) (IRS Employer ID Number)
1862 West Bitters Rd., San Antonio, TX 78248
--------------------------------------------
(Address of principal executive offices)
(210) 764-8642
(Issuer's telephone number)
Securities registered under Section 12 (b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock - $0.001 par value
Check whether the issuer has (1) filed all reports required to be files by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period the Company was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definitions of "accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ], Accelerated filer [ ], Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined by
Rule 12b-2of the Exchange Act. Yes [ ] No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS
As of June 30, 2006, there were 80,565,815 shares of Common Stock issued and
outstanding.
Transitional Small Business Disclosure Format : Yes [ ] No [X]
TIDELANDS OIL & GAS CORPORATION
FORM 10-Q
INDEX
Page
PART I - Financial Information
Item 1 - Financial Statements
Condensed Consolidated Balance Sheets as of
June 30, 2006, and December 31, 2005.......................... 3
Condensed Consolidated Statements of Operations
For the Three Months Ended June 30, 2006 and 2005............. 4
Condensed Consolidated Statements of Operations
For the Six Months Ended June 30, 2006 and 2005............... 5
Condensed Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2006 and 2005............... 6-7
Notes to Condensed Consolidated Financial Statements.......... 8-14
Item 2 - Management's Discussion and Analysis or Plan of Operation..... 15-22
Item 3 - Quantitative and Qualitative Disclosures About Market Risk.... 22
Item 4 - Controls and Procedures....................................... 22-23
PART II - Other Information
Item 1 - Legal Proceedings............................................. 23-27
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds... 27
Item 3 - Defaults Upon Senior Securities............................... 28
Item 4 - Submission of Matters to a Vote of Security Holdings.......... 28
Item 5 - Other Information............................................. 28
Item 6 - Exhibits...................................................... 29
Signature.............................................................. 29
-2-
PART I - Financial Information
Item 1. Financial Statements
TIDELANDS OIL & GAS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
June 30, December 31,
2006 2005
------------ ------------
(Unaudited)
Current Assets:
Cash and Cash Equivalents $ 3,312,026 $ 1,113,911
Accounts and Loans Receivable 306,744 468,458
Inventory 84,346 142,204
Prepaid Expenses 299,811 183,938
------------ ------------
Total Current Assets 4,002,927 2,197,017
------------ ------------
Property Plant and Equipment, Net 11,193,722 10,042,088
------------ ------------
Other Assets:
Deposits 74,004 14,004
Restricted Cash 51,707 76,803
Note Receivable 285,287 288,506
Deferred Charges 1,264,245 0
Goodwill 1,158,937 1,158,937
------------ ------------
Total Other Assets 2,834,180 1,249,744
------------ ------------
Total Assets $ 18,030,829 $ 13,488,849
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current Maturities - Notes Payable $ 225,000 $ 225,000
Accounts Payable and Accrued Expenses 691,015 1,225,554
------------ ------------
Total Current Liabilities 916,015 1,450,554
Long-Term Debt 10,950,183 4,271,768
------------ ------------
Total Liabilities 11,866,198 5,722,322
------------ ------------
Commitments and Contingencies -- --
Stockholders' Equity:
Common Stock, $.001 Par Value per Share,
250,000,000 Shares Authorized, 80,565,815
and 78,495,815 Shares Issued and
Outstanding at June 30, 2006
and December 31, 2005 Respectively 80,567 78,497
Paid-in Capital in Excess of Par Value 42,760,404 40,818,174
Subscriptions Receivable (440,000) (550,000)
Minority Interest -- --
Accumulated (Deficit) (36,236,340) (32,580,144)
------------ ------------
Total Stockholders' Equity 6,164,631 7,766,527
------------ ------------
Total Liabilities and Stockholders' Equity $ 18,030,829 $ 13,488,849
============ ============
See Accompanying Notes to Condensed Consolidated Financial Statements
-3-
TIDELANDS OIL & GAS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Three Months Ended
June 30, 2006 June 30, 2005
------------- -------------
(Restated)
Revenues:
Gas Sales and Pipeline Fees $ 392,108 $ 262,541
Construction Services 15,016 77,995
------------- -------------
Total Revenues 407,124 340,536
------------- -------------
Expenses:
Cost of Sales 206,413 130,569
Operating Expenses 99,587 62,363
Depreciation 116,038 120,954
Interest 373,950 184,073
Beneficial Conversion Feature Interes 0 (4,601,054)
Sales, General and Administrative 1,599,803 2,858,659
Impairment Losses 0 5,200,000
------------- -------------
Total Expenses 2,395,791 3,955,564
------------- -------------
(Loss) From Operations (1,988,667) (3,615,028)
Derivative Gain (Loss) 0 8,062,500
(Loss) on Sale of Asset 0 0
Interest and Dividend Income 28,118 33,659
------------- -------------
Net Income (Loss) $ (1,960,549) $ 4,481,131
============= =============
Net Income (Loss) Per Common Share:
Basic and Diluted $ (0.03) $ 0.07
============= =============
Weighted Average Number of Common
Shares Outstanding 80,080,815 68,321,251
============= =============
See Accompanying Notes to Condensed Consolidated Financial Statements
-4-
TIDELANDS OIL & GAS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Six Months Ended Six Months Ended
June 30, 2006 June 30, 2005
------------- -------------
(Restated)
Revenues:
Gas Sales and Pipeline Fees $ 1,064,614 $ 849,490
Construction Services 144,404 119,121
------------- -------------
Total Revenues 1,209,018 968,611
------------- -------------
Expenses:
Cost of Sales 583,279 415,248
Operating Expenses 184,118 129,137
Depreciation 231,802 236,395
Interest 485,009 393,860
Beneficial Conversion Feature Interest 0 135,789
Sales, General and Administrative 3,442,745 4,677,070
Impairment Losses 0 5,200,000
------------- -------------
Total Expenses 4,926,953 11,187,499
------------- -------------
(Loss) From Operations (3,717,935) (10,218,888)
Derivative Gain (Loss) 0 5,168,000
(Loss) on Sale of Equipment 0 (3,167)
Interest and Dividend Income 61,739 69,651
------------- -------------
Net (Loss) $ (3,656,196) $ (4,984,404)
============= =============
Net (Loss) Per Common Share:
Basic and Diluted $ (0.05) $ (0.07)
============= =============
Weighted Average Number of Common
Shares Outstanding 79,896,700 67,941,251
============= =============
See Accompanying Notes to Condensed Consolidated Financial Statements
-5-
TIDELANDS OIL & GAS CORPORATION
STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS
(UNAUDITED)
Six Months Ended Six Months Ended
June 30, 2006 June 30, 2005
------------- -------------
(Restated)
Cash Flows Provided (Required) By
Operating Activities:
Net (Loss) $ (3,656,196) $ (4,984,404)
Adjustments to Reconcile Net (Loss)
to Net Cash Provided (Required) By
Operating Activities:
Depreciation 231,802 236,395
Loss on Disposal of Equipment 0 3,167
Change in Derivative Liability 0 (5,168,000)
Issuance of Common Stock:
For Services Provided 1,499,300 2,677,125
Beneficial Conversion Feature Interest 0 135,789
Changes in:
Accounts Receivable 161,714 207,064
Inventory 57,858 6,950
Prepaid Expenses (115,873) 184,957
Deferred Charges (1,264,245) 116,250
Deposits (60,000) (2,500)
Restricted Cash 25,096 0
Accounts Payable and
Accrued Expenses (89,539) 82,078
Impairment Losses 0 5,200,000
------------- -------------
Net Cash (Required) By Operating Activities (3,210,083) (1,305,129)
------------- -------------
Cash Flows Provided (Required)
By Investing Activities:
Acquisitions of Property, Plant
and Equipment (1,383,436) (784,640)
Disposals of Equipment 0 800
------------- -------------
Net Cash (Required) By Investing Activities (1,383,436) (783,840)
------------- -------------
See Accompanying Notes to Condensed Consolidated Financial Statements
-6-
TIDELANDS OIL & GAS CORPORATION
STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS
(CONTINUED)
(UNAUDITED)
Six Months Ended Six Months Ended
June 30, 2006 June 30, 2005
------------- -------------
(Restated)
Cash Flows Provided (Required)
by Financing Activities:
Proceeds from Stock Subscriptions
Receivable 110,000 0
Proceeds from Long-Term Loans 6,678,415 149,108
Repayment of Loan to Related Party 3,219 492
------------- -------------
Net Cash Provided by Financing Activities 6,791,634 149,600
------------- -------------
Net Increase (Decrease) in Cash 2,198,115 (1,939,369)
Cash at Beginning of Period 1,113,911 5,484,054
------------- -------------
Cash at End of Period $ 3,312,026 $ 3,544,685
============= =============
Supplemental Disclosures of
Cash Flow Information:
Cash Payments for Interest $ 408,657 $ 266,938
============= =============
Cash Payments for Income Taxes $ 0 $ 0
============= =============
Non-Cash Investing and Financing Activities:
Issuance of Common Stock:
Repayment of Note $ 0 $ 2,512,500
Repayment of Convertible Debentures 0 2,520,000
Payment of Accrued Expense 445,000 0
------------- -------------
Total Non-Cash Investing and
Financing Activities $ 445,000 $ 5,032,500
============= =============
See Accompanying Notes to Condensed Consolidated Financial Statements
-7-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
NOTE 1 - BASIS OF PRESENTATION
------ ---------------------
The accompanying unaudited condensed consolidated financial statements
for the six month periods ended June 30, 2006, and 2005, have been
prepared in conformity with accounting principles generally accepted in
the United States of America for interim financial information and with
the instructions to Form 10-Q and Regulation S-X. The financial
information as of December 31, 2005, is derived from the registrant's
Form 10-K for the year ended December 31, 2005. Certain information or
footnote disclosures normally included in financial statements prepared
in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission.
The preparation of condensed consolidated financial statements in
conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates. In the opinion of management, the accompanying
financial statements include all adjustments necessary (which are of a
normal and recurring nature) for the fair presentation of the results
of the interim periods presented. While the registrant believes that
the disclosures presented are adequate to keep the information from
being misleading, it is suggested that these accompanying financial
statements be read in conjunction with the registrant's audited
consolidated financial statements and notes for the year ended December
31, 2005, included in the registrant's Form 10-K for the year ended
December 31, 2005.
Operating results for the six-month period ended June 30, 2006, are not
necessarily indicative of the results that may be expected for the
remainder of the fiscal year ending December 31, 2006. The accompanying
unaudited condensed consolidated financial statements include the
accounts of the registrant, its wholly-owned subsidiaries, Rio Bravo
Energy, LLC, Sonora Pipeline, LLC, Arrecefe Management, LLC, Marea
Associates, LP, Reef Ventures, LP, Reef International, LLC, Reef
Marketing, LLC, Terranova Energia S. de R. L. de C. V., and Esperanza
Energy, LLC. All significant inter-company accounts and transactions
have been eliminated in consolidation.
-8-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
NOTE 2 - LITIGATION
------ ----------
On January 6, 2003, we were served as a third party defendant in a
lawsuit titled Northern Natural Gas Company vs. Betty Lou Sheerin vs.
Tidelands Oil & Gas Corporation, ZG Gathering, Ltd. and Ken Lay, in the
150th Judicial District Court, Bexar County, Texas, Cause Number
2002-C1-16421. The lawsuit was initiated by Northern Natural Gas
(Northern) when it sued Betty Lou Sheerin (Sheerin) for her failure to
make payments on a note she executed payable to Northern in the
original principal amount of $1,950,000. Northern's suit was filed on
November 13, 2002. Sheerin answered Northern's lawsuit on January 6,
2003. Sheerin's answer generally denied Northern's claims and raised
the affirmative defenses of fraudulent inducement by Northern,
estoppel, waiver and the further claim that the note does not comport
with the legal requirements of a negotiable instrument. Sheerin seeks a
judicial ruling that Northern be denied any recovery on the note.
Sheerin's answer included a counterclaim against Northern, ZG
Gathering, Ltd., and Ken Lay generally alleging, among other things,
that Northern, ZG Gathering, Ltd ., and Ken Lay, fraudulently induced
her execution of the note. Northern has filed a general denial of
Sheerin's counterclaims. Sheerin's answer included a third party cross
claim against Tidelands Oil and Gas Corporation (Tidelands). She
alleges that Tidelands entered into an agreement to purchase the Zavala
Gathering System from ZG Gathering, Ltd., and that, as a part of the
agreement, Tidelands agreed to satisfy all of the obligations due and
owing to Northern, thereby relieving Sheerin of all obligations she had
to Northern on the $1,950,000 promissory note in question. Tidelands
and Sheerin agreed to delay the Tidelands' answer date in order to
allow time for mediation of the case. Tidelands participated in
mediation on March 11, 2003. The case was not settled at that time.
Tidelands answered the Sheerin suit on March 26, 2003. Tidelands'
answer denies all of Sheerin's allegations.
On May 24 and June 16, 2004, respectively, Betty Lou Sheerin filed her
first and second amended original answer, affirmative defenses, special
exceptions and second amended original counterclaim, second amended
original third party cross-actions and requests for disclosure. In
these amended pleadings, she sued Michael Ward, Royis Ward, James B.
Smith, Carl Hessel and Ahmed Karim in their individual capacities. Her
claims against these individuals are for fraud, breach of contract,
breach of the Uniform Commercial Code, breach of duty of good faith and
fair dealing and conversion. Sheerin has now non-suited her claims
against Michael Ward, Royis Ward, and James B. Smith.
-9-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
NOTE 2 - LITIGATION (CONTINUED)
------ ----------------------
In September 2002, as a pre-closing deposit to the purchase of the
Zavala Gathering System, the Company executed a $300,000 promissory
note to Betty L. Sheerin, a partner of ZG Gathering, Ltd. In addition,
the Company issued 1,000,000 shares of its common stock to various
partners of ZG Gathering, Ltd. On December 3, 2003, Sheerin filed a
separate lawsuit against Tidelands in the 150th District Court of Bexar
County, Texas on this promissory note seeking a judgment against
Tidelands for the principle amount of the note, plus interest. On
December 29, 2003, Tidelands answered this lawsuit denying liability on
the note. On April 1, 2004, Tidelands filed a plea in abatement asking
the court to dismiss or abate Sheerin's lawsuit on the $300,000
promissory note as it was related to and its outcome was dependent on
the outcome of the Sheerin third party cross action against Tidelands
in Cause Number 2002-C1-16421. The Company believes that the promissory
note and shares of common stock should be cancelled based upon the
outcome of the litigation described above. Accordingly, our financial
statements reflect this belief.
On September 15, 2004, and again on October 15, 2004, respectively,
Sheerin amended her pleadings to include a third and fourth amended
third party cross action against Tidelands adding a claim for the
$300,000 promissory note. In these amended pleadings, Sheerin also
deleted her claims against Carl Hessel and Ahmed Karim. After adding
the claim on the $300,000 promissory note to the third party claims of
Sheerin against Tidelands in Cause No. 2002-C1-16421, Sheerin dismissed
Cause Number 2002-C1-16421.
Tidelands won a partial summary judgment against Sheerin as to all of
her tort claims pled against Tidelands, save and except only her claim
for conversion of 500,000 shares of Tidelands' stock.
Sheerin seeks damages against Tidelands for indemnity for any sums
found to be due from her to Northern Natural Gas Company, unspecified
amounts of actual damages, statutory damages, unspecified amounts of
exemplary damages, attorneys fees, costs of suit, and prejudgment and
post judgment interest.
-10-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
NOTE 2 - LITIGATION (CONTINUED)
------ ----------------------
On August 5, 2005, Northern Natural Gas Company filed its Fourth
Amended Original Petition which, for the first time, named Tidelands as
a defendant to Northern. Northern seeks to impose liability on
Tidelands for $1,950,000 promissory note signed by McDay Energy
Partners, Ltd. (the predecessor to ZG Gathering, Ltd.) and Sheerin and
the $1,700,000 promissory note signed by McDay only. Northern contends
that Tidelands is alternatively liable to Northern for payment of both
such promissory notes totaling $3,709,914 plus interest because
Northern is a third-party beneficiary under a December 3, 2001 purchase
and sale agreement between ZG Gathering, Ltd., and Tidelands claiming
that in such agreement Tidelands agreed to assume and satisfy all
indebtedness due and owing Northern by Sheerin and ZG Gathering, Ltd.
Northern also claims that it is entitled to foreclosure of a lien on
the gas gathering system and pipeline that was the subject of the
promissory notes in question.
On March 6, 2006, Tidelands won a summary judgment motion it filed
against Northern and the court has now dismissed Northern's claims
against Tidelands.
On November 28, 2005, ZG Gathering, Ltd. and ZG Pipeline Management
("ZG") filed its answer to Northern's Fifth Amended Petition, its
counter-claim against Northern, and its answer and cross claim against
Tidelands. ZG contends that the promissory notes given by ZG and
Sheerin to Northern were procured by Northern's fraudulent
misrepresentations and it claims unspecified amounts of damages against
Northern. ZG's cross action against Tidelands claims that Tidelands
entered into an agreement to purchase the Zavala Gathering System from
ZG and that, as part of that agreement, Tidelands agreed to satisfy the
$3,700,914 Northern indebtedness of ZG, and to defend, indemnify, and
hold ZG and Sheerin harmless from such indebtedness to pay off a
Sheerin loan of $300,000, and to issue 1 million shares of Tidelands'
stock, of which 500,000 was to be free-trading shares. ZG claims that
Tidelands breached this agreement by failing to satisfy the Northern
indebtedness, failing to defend and indemnify it from such debt,
failing to pay off the $300,000 note, failing to issue the free-trading
shares in Tidelands, and by placing a stop transfer order on the
restricted stock that was issued by Tidelands. ZG seeks specific
performance of the agreement, recovery of an unspecified amount of
damages, and its attorney's fees.
Much of the discovery has been completed at this time. Based on
investigation, and discovery to date, Tidelands appears to have a
number of potential defenses to the claims of Sheerin and Northern.
Tidelands intends to aggressively defend these lawsuits. The complexity
of the issues in this case and the inherent uncertainties in litigation
of this kind prevent a more definitive evaluation of the extent of
Tidelands' liability exposure.
-11-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
NOTE 2 - LITIGATION (CONTINUED)
------ ----------------------
During April and May, 2005, three separate legal actions were initiated
against Sonterra Energy Corporation (Sonterra), a wholly-owned
subsidiary of the Company. Two of the actions concern claims made by
developers against Sonterra for their failure to pay rent and easement
use fees as a result of their asset purchase from Oneok Propane
Distribution Company on November 1, 2004. The third action involves a
claim made by a builder that Sonterra does not have a proper easement
for the current use of certain property. The Company believes that the
three actions filed are without merit and intend to vigorously defend
itself. Litigation regarding these three actions are still in their
early stages, therefore, potential financial impacts, if any, cannot be
determined at this time.
In accordance with Statement of Financial Accounting Standards No. 5,
"Accounting for Contingencies," management has reached the conclusion
that there is a remote possibility that any or all of the
aforementioned claims would be upheld at trial and has also determined
that the amount of the claims cannot be reasonably estimated.
Accordingly, the Company's financial statements reflect no accrual of a
loss contingency with response to the above legal matters.
-12-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
NOTE 3 - COMMON STOCK TRANSACTIONS
------ -------------------------
On May 10, 2006, the Company issued 10,000 shares of its restricted
common stock valued at $7,900 to an employee/officer of a subsidiary of
the Company.
On May 10, 2006, the Company issued 60,000 shares of its restricted
common stock valued at $47,400 pursuant to an employment contract with
an officer of the Company.
On June 7, 2006, the Company issued 500,000 shares of its restricted
common stock valued at $542,500 pursuant to an employment contract with
an officer of the Company.
On June 27, 2006, the Company issued 20,000 shares of its restricted
common stock valued at $16,000 to an employee of the Company.
On June 27, 2006, the Company issued 20,000 shares of its restricted
common stock valued at $16,000 to an employee of the Company.
NOTE 4 - RELATED PARTY TRANSACTION
------ -------------------------
The Company executed an agreement in January 2004 with a related party
to provide charter air transportation for its employees, customers and
contractors to job sites and other business related destinations. A
$300,000 5% interest bearing loan due in January 2007 was made by the
Company regarding the transaction. The loan balance is credited by
airtime charges at standard industry rates offset by interest charges
computed on the average monthly balance. At June 30, 2006, the loan
balance was $285,287.
During 2006, the President acquired the airplane being utilized to
provide charter air transportation for the Company. The transaction
includes assumption of the $300,000 5% interest bearing loan due in
January 2007 to the Company.
-13-
TIDELANDS OIL & GAS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006
NOTE 5 - DEBT FINANCING
------ --------------
On January 20, 2006, the Company completed a private placement of
$6,569,750 of convertible debt with seven institutional investors. The
net proceeds realized by the Company were $4,964,410. The Company
issued original issue discount debentures with a maturity date of
January 20, 2008, and a conversion feature which permitted the holders
to convert into common stock of the Company at a price of $0.87 per
share. The investors also received three year "Series A Common Stock
Warrants" to purchase, in the aggregate, 2,491,975 shares of common
stock of the Company at a conversion price of $0.935 per share.
Additionally, the Company issued to the investors "Series B Common
Stock Warrants" which provided for a thirteen month exercise period, at
a conversion price of $1.275 per share, and an aggregate purchase total
of 7,551,432 shares of common stock of the Company.
In accordance with this private placement, the Company entered into a
"Registration Rights Agreement" with the investors, whereby, among
other terms and conditions, the Company must comply with various
effective dates and periods or, if in default of said dates and/or
periods, be subject to liquidated damages as outlined in the master
agreement. During June 2006, the investors billed and were paid $64,566
liquidated damages for not meeting the required effective date.
NOTE 6 - SUBSEQUENT EVENTS
------ -----------------
On July 9, 2006, the Company acquired a 50% interest in a 24-mile
natural gas pipeline located in Medina, Atascosa and Bexar Counties in
the state of Texas. In addition, the Company also acquired an undivided
50% working interest in two leases with 5 recompleted natural gas wells
on approximately 1,000 acres with at least 10 additional natural gas
wells for re-entry. These leases are located in Atascosa and Medina
counties. The Company expects to participate in acquiring additional
leases which could be developed around the area serviced by the
pipelines. Total consideration for these transactions is $500,000 which
is being paid to a related party.
-14-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operation
Business Overview
Our products and services are primarily focused on development and operation of
transportation, processing, distribution and storage projects for natural gas
and natural gas liquids in the northeastern states of Mexico (Chihuahua,
Coahuila, Nuevo Leon and Tamaulipas) and the state of Texas in the United States
of America. The Company has also begun a feasibility study for the potential
development of an offshore LNG regasification terminal and connecting natural
gas pipeline in the vicinity of Long Beach, California.
We derive our revenue from transportation fees from delivery of natural gas to
Conagas, the local distribution company in Piedras Negras, Coahuila, through the
pipeline owned by Reef Ventures, L.P. Additionally, revenues are derived from
the provision of construction services for yard lines and meter sets installed
to a homeowner's lot, and the sale of propane gas to residential customers in
Central Texas through the assets owned by Sonterra Energy Corporation.
Recent Developments
In the six months ended June 30, 2006, several significant developments occurred
with respect to the businesses operated by the Company.
Financing Transaction
On January 20, 2006, the Company entered into Securities Purchase Agreements
with seven accredited investors (collectively, "Purchasers or Holders"). We sold
$6,569,750 Dollars, in the aggregate principal amount, of discounted convertible
debentures ("Debentures") and Series A and Series B Warrants to purchase common
stock ("Warrants") for an aggregate payment of $5,396,098 after deduction for
the interest discount. The Company paid an 8% commission to the placement agent,
HPC Capital Management, LLC, a registered broker-dealer. The Company granted HPC
Capital Management Series A Common Stock Purchase Warrants as additional
transaction compensation. The Company received net proceeds of $4,949,291.88
after deduction of legal costs, commissions and interest discount. We intend to
use the proceeds for working capital.
-15-
The sale of these securities required the Company to increase its authorized
common stock capital because it had insufficient authorized capital to comply
with all of the Debenture conversion and Warrant exercise provisions contained
in the Transaction Documents. We have reserved 9,000,000 common shares of our
unissued authorized common stock capital for the transaction. On April 17, 2006,
an amendment to the articles of incorporation of the Company was approved via
written consent in lieu of a special meeting of the shareholders of the Company
and on April 19, 2006, the Company amended its articles of incorporation by
increasing its authorized common stock capital from One Hundred Million
(100,000,000) shares, par value $0.001 per share to Two Hundred Fifty Million
(250,000,000) shares, par value $0.001 per share, thus satisfying the
requirements of the financing documents.
We have also agreed to file a registration statement on Form S-1 with the U.S.
Securities and Exchange Commission ("SEC") to register the common stock
underlying the Debentures and Warrants.
We sold these securities in an exempt transaction under the Securities Act of
1933, (the "Act") as amended, pursuant to Section 4(2) and Regulation D Rule
506. These are restricted securities and may not be resold without registration
under the Act or an exemption from the registration requirements of the Act.
The Debentures are Original Issue Discount Convertible Debentures with an
aggregate face amount of $6,569,750. The purchasers paid an aggregate principal
sum of $5,396,098. The face amount of the Debentures is due January 20, 2008.
The difference between the face amount and the aggregate principal paid
represents the interest expense. The Debenture Holder may convert all or part of
the Debenture face amount into shares of Tidelands common stock at any time at
an initial conversion rate of $0.87 per share.
The Purchasers have agreed to restrict their ability to convert their Debentures
or Exercise their Warrants and receive our shares such that the number of shares
of common stock held by each of them individually in the aggregate after such
conversion or exercise does not exceed 4.99% of the then issued and outstanding
Company common shares. This beneficial ownership limitation may be waived by the
Holder.
Subject to specific terms and conditions in the Debenture, the Company has the
option to force conversion of the Debentures into common shares if the Company's
share price as quoted on the Over-the-Counter Electronic Bulletin Board exceeds
250% of the then Conversion Price for a period of time based on a Volume
Weighted Average Price (VWAP) formula. The VWAP share price must exceed this
250% price for at least 20 consecutive Trading Days.
The conversion price will be subject to adjustment for corporate events, such as
stock splits, stock dividends, and stock combinations, as more specifically
outlined in the transaction documents.
We granted the Purchasers Series A Common Stock Purchase Warrants (Series A
Warrants) to purchase 2,491,974 shares of our common stock at $0.935 per share.
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We also granted HPC Capital Management 65,697 Series A Common Warrants to
purchase our common stock at $0.935 per share.
The Series A Warrants may be exercised immediately by the Purchasers and will
terminate on January 20, 2009. Subject to specific terms and conditions in the
Series A Warrant including an effective registration statement registering
underlying shares, the Company has the call option to force conversion of this
Warrant into common shares if the Company's share price as quoted on the
Over-the-Counter Electronic Bulletin Board exceeds 250% of the then effective
Exercise Price for a period of time based on a Volume Weighted Average Price
(VWAP) formula. The VWAP share price must exceed this 250% threshold price for
at least 20 consecutive Trading Days.
If at any time after one year from the date of issuance there is no effective
registration statement registering, or no current prospectus available for the
resale of the underlying shares, then this Warrant may also be exercised by
means of "cashless exercise" as determined by a formula described in the
Warrant. The exercise price will be subject to adjustment for corporate events,
such as stock splits, stock dividends, and stock combinations, as more
specifically outlined in the transaction documents.
We granted the Purchasers Series B Common Stock Purchase Warrants ("Series B
Warrants") to purchase 7,551,432 shares of our common stock at $1.275 per share.
The Purchasers have the right to exercise the Series B Warrants commencing at
any time on, or after January 20, 2007 and on, or before February 19, 2007.
Subject to specific terms and conditions in the Series B Warrant, including an
effective registration statement registering underlying shares, the Company has
the option to force the exercise of this Warrant into common shares if the
Company's share price as quoted on the Over-the-Counter Electronic Bulletin
Board exceeds 150% of the then effective Exercise Price for a period of time
based on a Volume Weighted Average Price (VWAP) formula. The VWAP share price
must exceed this 150% threshold price for at least 20 consecutive Trading Days.
If at any time after one year from the date of issuance there is no effective
registration statement registering, or no current prospectus available for the
resale of the underlying shares, then this Warrant may also be exercised by
means of "cashless exercise" as determined by a formula described in the
Warrant. The exercise price will be subject to adjustment for corporate events,
such as stock splits, stock dividends, and stock combinations, as more
specifically outlined in the transaction documents.
We have granted the Purchasers and HPC Capital Management registration rights on
the shares underlying the Debentures and the Warrants. The Common Stock
underlying the Debentures and Warrants will be registered under the Securities
Act of 1933, as amended, for re-offer and re-sale by the Purchasers and HPC
Capital Management. If the Company fails to timely file a registration statement
or is unable to have the registration statement declared effective by the SEC
within the stated periods of time, we will trigger a default and be subject to
among other things, acceleration of the Debentures, at the Purchasers' options,
additional default interest payment and monetary liquidated damages. The
liquidated damages will be capped at 20% of the Debentures face amounts.
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Esperanza Energy LLC
Esperanza Energy LLC ("Esperanza") was formed as a wholly owned subsidiary of
the Company in March 2006 to evaluate the feasibility of developing an offshore,
deep-water liquefied natural gas (LNG) regas terminal in the offshore waters
near Long Beach, California. Esperanza would utilize TORP Technology's HiLoad
LNG Regas unit which attaches to an LNG tanker, directly vaporizes the LNG as it
is offloaded and injects the regasified natural gas into an undersea pipeline
for transportation of the natural gas to onshore metering stations and
transmission pipelines to supply nearby gas markets. The TORP HiLoad LNG Regas
unit eliminates the need for extensive above-ground storage tanks or large
marine structures required for berthing and processing of the LNG.
Esperanza is conducting the feasibility study for this project with the
assistance of best-in-class LNG, environmental, pipeline and legal experts that
include:
o David Maul, former Manager of the California Energy Commission Natural Gas
Office,
o ENTRIX, Inc., a professional environmental consulting company specializing
in environmental permitting and compliance for major offshore oil and gas
projects in California and the United States,
o Project Consulting Services, Inc., a leader in engineering, construction,
management, and inspection of onshore and offshore pipelines, and
o Pillsbury Winthrop Shaw Pittman, LLP, an interdisciplinary law firm with
leading practices in environmental, land use and energy legal advice and in
project development and finance.
Active consultations continue with California stakeholders, commercial
counterparties, financial investors, and the above mentioned team regarding the
optimal design and operational configuration of the project. A primary objective
of the project feasibility study is to design the project to exceed California
environmental, public health and safety requirements.
Sonora Pipeline, LLC and Terranova Energia, S. de R.L. de C.V.
The cross-border gas pipeline and storage development activities of the above
entities to establish the Burgos Hub Export/Import project progressed forward in
two principal areas:
Permitting Activities -
Sonora Pipeline, LLC continued its efforts to finish all activities necessary to
move from NEPA pre-filing status to a submission for Certification for its two
International Pipeline U.S. segments, the Progreso International Pipeline and
the Mission International Pipeline. Sonora believes it has filed all needed
revisions to the Draft Environmental Report for both pipeline segments with FERC
for purposes of the NEPA Environmental Assessment requirements. The Progreso
International Pipeline is the eastern leg of the U.S. pipelines which will
interconnect with the Tennessee Gas Pipeline transmission lines at the Alamo
Station and deliver natural gas to the Brasil Storage facility approximately 17
miles south of the U.S./Mexico border at Progreso, Texas. The Mission
International Pipeline segment was re-designed in the first quarter of 2006 due
to a routing conflict with a fiber optic line. It will be approximately 24 miles
long and will commence at the existing HPL Valero-Gilmore gas plant in Hidalgo
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County, Texas and extend southward to the Arguelles crossing of the Rio Grande
River into Mexico near the city of Mission, Texas. We anticipate the issuance of
an Environmental Assessment by the staff of FERC in the third quarter of 2006 to
be followed by a complete application for a Certificate of Public Convenience
and Necessity to construct, own, operate and maintain the proposed pipelines.
The current catalog of FERC correspondence for Sonora's activities is located at
www.ferc.gov under Docket No. PF05-15.
On May 23, 2006, Terranova Energia, S. de R.L. de C.V. ("Terranova"), a wholly
owned subsidiary of the Company, was awarded a permit by the Comision Reguladora
de Energia de Mexico ("CRE") to construct its 30 inch diameter natural gas
pipeline segment in Mexico to link to the Sonora Pipeline LLC United States
pipelines and Terranova's proposed underground natural gas storage facility in
the Brasil field (located approximately 17 miles south of Nuevo Progreso on the
U.S./Mexico border in Texas). Terranova submitted the application for the
storage facility permit to the CRE on August 5, 2005 and it was accepted for
full review on October 14, 2005. Several unique questions are presented by the
filing of this permit due to the proposed location and the lack of previous
storage permit applications having been considered by the CRE. The CRE has
recently selected GEOSTOCK (an entity owned 50% by Total, 25% by BP, and 25% by
Entrepose Contracting) as its technical consultant to review the storage
facility permit application. GEOSTOCK is an international engineering group with
over 40 years experience in the design, construction and operation of all types
of underground storage facilities for liquid, liquefied or gaseous hydrocarbons.
The technical review of the permit application is expected to be completed by
the end of 2006. Management expects the storage permit application will be
presented for decision by staff to the CRE Commissioners in the first quarter of
2007.
Commercial Activities -
The Company continues to present the pipeline and storage segments of the Burgos
Hub Export/Import project to commercial audiences in efforts to solicit their
interest and participation in the project at various levels. There have been
numerous introductory meetings with staff of the CFE and the Monterrey
industrial consumers of natural gas with a view toward clarifying their need and
usage of the proposed project facilities. Future efforts will concentrate on the
development and negotiation of precedent agreements for capacity reservation of
the project facilities. Preliminary evaluation of demand for storage capacity
reservation based upon direct discussion with the various customers is
conservatively estimated at 40 Bcf for the market area influenced by the
project. Similarly, several discussions continue with interested parties in the
U.S. and Mexico regarding the execution of a joint development agreement between
Terranova and their firms for the funding, development and ownership of the
project.
FORWARD-LOOKING STATEMENTS:
We have included forward-looking statements in this report. For this purpose,
any statements contained in this report that are not statements of historical
fact may be deemed to be forward looking statements. Without limiting the
foregoing, words such as "may", "will", "expect", "believe", "anticipate",
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"estimate", "plan" or "continue" or the negative or other variations thereof or
comparable terminology are intended to identify forward-looking statements.
These statements by their nature involve substantial risks and uncertainties,
and actual results may differ materially depending on a variety of factors.
Factors that might cause forward-looking statements to differ materially from
actual results include, among other things, overall economic and business
conditions, demand for the Company's products, competitive factors in the
industries in which we compete or intend to compete, natural gas availability
and cost and timing, impact and other uncertainties of our future acquisition
plans.
Results of Operations
Three Months Ended June 30, 2006, Compared with Three Months Ended June 30, 2005
REVENUES: The Company reported revenues of $ 407,124 for the three months ended
June 30, 2006 versus revenues of $340,536 for the three months ended June 30,
2005 which is an improvement of 19.5% for the quarter ended June 30, 2006 versus
the quarter ended June 30, 2005. The revenue increase resulted from increasing
volumes and product prices of propane sold by our Sonterra Energy Corporation
subsidiary to residential consumers.
TOTAL COSTS AND EXPENSES: Total Costs and Expenses for the three months ended
June 30, 2006 were $2,395,791 versus $3,955,564 for the three months ended June
30, 2005 which is a decrease of 39% for the quarter ended June 30, 2006 versus
the quarter ended June 30, 2005. The primary reason for this decrease was the
$1,258,856 decrease in Sales, General and Administrative expenses for the
quarter ended June 30, 2006 versus the quarter ended June 30, 2005. A secondary
reason for the decrease was the absence of Beneficial Conversion Interest Income
and Impairment Losses in the quarter ended June 30, 2006 versus the quarter
ended June 30, 2005.
NET INCOME (LOSS): Net Loss for the three months ended June 30, 2006 was
($1,960,549) versus a Net Income for the three months ended June 30, 2005 of
$4,481,131. The primary reason for this difference was the absence of Derivative
Gain in the quarter ended June 30, 2006 versus a Derivative Gain of $8,062,500
for the quarter ended June 30, 2005.
Six Months Ended June 30, 2006, Compared with Six Months Ended June 30, 2005
REVENUES: The Company reported revenues of $1,209,018 for the six months ended
June 30, 2006 as compared with revenues from continuing operations of $968,611
for the six months ended June 30, 2005. The revenue increase resulted primarily
from increasing revenues of Sonterra Energy Corporation due to an increase in
total customers served and product prices in the first six months of 2006 versus
the first six months of 2005.
TOTAL COSTS AND EXPENSES: Total costs and expenses from continuing operations
decreased from $11,187,489 for the six months ended June 30, 2005 to $4,926,953
for the six months ended June 30, 2006. The principal reason for this amount of
decrease was the lack of expense for Beneficial Conversion Feature Interest and
Impairment Loss in the six months ended June 30, 2006 versus the six months
ended June 30, 2005.
COST OF SALES: Total Cost of Sales increased from $415,248 for the six months
ended June 30, 2005 to $583,279 for the six months ended June 30, 2006. This
increase resulted from the increased cost and volume of propane sold by Sonterra
Energy Corporation in the six months ended June 30, 2006 versus June 30, 2005.
OPERATING EXPENSES: Operating expenses from continuing operations increased from
$129,137 for the six months ended June 30, 2005 to $184,118 for the six months
ended June 30, 2006. This increase was primarily due to additional operating
expenses incurred by Sonterra Energy Corporation in its operations for the
period which were not present in the comparative six months for 2005.
Depreciation expense declined in the first six months of 2006 versus the first
six months of 2005, decreasing from $236,395 for the six months ended June 30,
2005 to $231,802 for the six months ended June 30, 2006 reflecting a minor
decrease in depreciable assets for the respective periods due to impairment
charges.
INTEREST EXPENSE: Interest expense increased from $393,860 for the six months
ended June 30, 2005 to $485,009 for the six months ended June 30, 2006 as a
result of interest rate increases related to the note owed to Impact
International LLC. No expense for Beneficial Conversion Feature Interest was
recorded for the six months ended June 30, 2006 as compared to $135,789 for the
six months ended June 30, 2005 (as restated). The market price for the Company's
common stock at the relevant measurement dates during the six months ended June
30, 2006 was less than the conversion price for the debentures issued on January
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20, 2006. Accordingly, there was no benefit to the holders of the debentures in
the event of conversion during those periods and no beneficial conversion
interest charge was recorded.
SALES, GENERAL AND ADMINISTRATIVE: Sales, General & Administrative Expenses
decreased by $1,234,325 during the six months ended June, 2006 to a total amount
of $3,442,745 as compared $4,677,070 for the six months ended June 30, 2005.
This decrease was due primarily to the absence of financing costs paid to Impact
International LLC during the period ended June 30, 2006 as compared to financing
costs of $1,272,500 paid to Impact International LLC during the period ended
June 30, 2005.
IMPAIRMENT LOSS: No expense for impairment loss was recorded for the six months
ended June 30, 2006 compared to $5,200,000 of impairment of goodwill recorded as
a loss for the period ended June 30, 2005.
DERIVATIVE GAIN: Gain from embedded derivative instrument liabilities decreased
from ($5,168,000) for the six months ended June 30, 2005 (as restated) to zero
for the six months ended June 30, 2006. The warrants issued in connection with
the January 20, 2006 financing had an exercise price that was greater than the
fair market value of the Company's common stock at the relevant measurement
dates. Accordingly, no derivative gain or reduction in liability for the
issuance of the warrants in this financing transaction was recorded for the six
months ended June 30, 2006.
NET LOSS: Net loss of ($4,984,404) for the six months ended June 30, 2005 (as
restated) decreased to ($3,656,196) for the six months ended June 30, 2006, a
decrease in the amount of loss of $1,328,208. The principal reason for this
amount of decline in net loss was the reduction in Sales, General and
Administrative Expenses achieved in the six months ended June 30, 2006 versus
the six months ended June 30, 2005. Included in the net loss of ($3,656,196) for
the six months ended June 30, 2006 is $1,499,300 of expenses for employment
contract costs and legal fees paid by issuance of common stock.
LIQUIDITY AND CAPITAL RESOURCES: With regard to liquidity and adequacy of
capital resources, management believes that adequate liquidity and cash
resources exist to sustain current corporate activities for the remainder of the
fiscal year. However, in the event that a decision to proceed with the offshore
LNG regas terminal project in Southern California is made during the upcoming
months, additional funding for the permit process will be needed. Management
will evaluate the required budget and funding alternatives for such an effort as
an integral part of the project feasibility study underway. Direct capital
expenditures during the six months ended June 30, 2006 totaled $1,383,436. The
capital expenditures were composed of increased pre-construction costs regarding
potential international pipeline crossings and storage facilities in Mexico,
pre-construction costs regarding an offshore LNG terminal in Southern
California, and additional machinery, equipment, trucks, autos and trailers for
the operation of the Sonterra Energy Corporation propane systems. Total debt
increased from $5,722,322 at December 31, 2005 to $ 11,866,198 at June 30, 2006.
The increase in total debt is due primarily to the issuance of $6,569,750 of
convertible debentures in the financing transaction of January 20, 2006. Net
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loss for the six months ended June 30, 2006 was ($3,656,196) a decrease in net
loss of 27% from the net loss of ($4,984,404) for the six months ended June 30,
2005. Basic and diluted net loss per common share decreased 28.6% to ($0.05).
The net loss per share calculation for the six months ended June 30, 2006
included an increase in actual and equivalent shares outstanding.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Cash and Cash Equivalents
We have historically invested our cash and cash equivalents in short-term, fixed
rate, highly rated and highly liquid instruments which are reinvested when they
mature throughout the year. Although our existing investments are not considered
at risk with respect to changes in interest rates or markets for these
instruments, our rate of return on short-term investments could be affected at
the time of reinvestment as a result of intervening events. As of June 30, 2006,
we had cash and cash equivalents in the aggregate $3,312,026.
The Company does not issue or invest in financial instruments or their
derivatives for trading or speculative purposes. The operations of the Company
are conducted primarily in the United States, and, are not subject to material
foreign currency exchange risk. Although the Company has outstanding debt and
related interest expense, market risk of interest rate exposure in the United
States is currently not material.
Debt
The interest rate on our Impact International debt obligation is generally
determined based on the prime interest rate plus two percent and may be subject
to market fluctuation as the prime rate changes.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
As of the end of the reporting period, June 30, 2006, we carried out an
evaluation, under the supervision and with the participation of our management,
including the Company's Chairman and Chief Executive Officer/Principal
Accounting Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Rule 13a-15(e) of the Securities
Exchange Act of 1934 (the "Exchange Act"), which disclosure controls and
procedures are designed to insure that information required to be disclosed by a
company in the reports that it files under the Exchange Act is recorded,
processed, summarized and reported within required time periods specified by the
SEC's rules and forms. Based upon that evaluation, the Chairman and the Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company required to be included in the Company's period SEC filings.
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(b) Changes in Internal Control.
Subsequent to the date of such evaluation as described in subparagraph(a)above,
there were no changes in our internal controls or other factors that could
significantly affect these controls, including any corrective action with regard
to significant deficiencies and material weaknesses.
(c) Limitations.
Our management, including our Principal Executive Officer and Principal
Financial Officer, does not expect that our disclosure controls or internal
controls over financial reporting will prevent all errors or all instances of
fraud. However, we believe that our disclosure controls and procedures are
designed to provide reasonable assurance of achieving this objective. A control
system, no matter how well designed and operated, can provide only reasonable,
not absolute, assurance that the control system's objectives will be met.
Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within our Company have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty, and that breakdowns can occur because of simple error or mistake.
Controls can also be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls. The
design of any system of controls is based in part upon certain assumptions about
the likelihood of future events, and any design may not succeed in achieving its
stated goals under all potential future conditions. Over time, controls may
become inadequate because of changes in conditions or deterioration in the
degree of compliance with policies or procedures. Because of the inherent
limitation of a cost-effective control system, misstatements due to error or
fraud may occur and not be detected.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Matter No. 1:
On January 6, 2003, we were served as a third party defendant in a lawsuit
titled Northern Natural Gas Company vs. Betty Lou Sheerin vs. Tidelands Oil &
Gas Corporation, ZG Gathering, Ltd. and Ken Lay, in the 150th Judicial District
Court, Bexar County, Texas, Cause Number 2002-C1-16421. The lawsuit was
initiated by Northern Natural Gas when it sued Betty Lou Sheerin for her failure
to make payments on a note she executed payable to Northern in the original
principal amount of $1,950,000. Northern's suit was filed on November 13, 2002.
Sheerin answered Northern's lawsuit on January 6, 2003. Sheerin's answer
generally denied Northern's claims and raised the affirmative defenses of
fraudulent inducement by Northern, estoppel, waiver and the further claim that
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the note does not comport with the legal requirements of a negotiable
instrument. Sheerin seeks a judicial ruling that Northern be denied any recovery
on the note. Sheerin's answer included a counterclaim against Northern, ZG
Gathering, and Ken Lay generally alleging, among other things, that Northern, ZG
Gathering, Ltd. and Ken Lay, fraudulently induced her execution of the note.
Northern has filed a general denial of Sheerin's counterclaims. Sheerin's answer
included a third party cross claim against Tidelands. She alleges that Tidelands
entered into an agreement to purchase the Zavala Gathering System from ZG
Gathering Ltd. and that, as a part of the agreement, Tidelands agreed to satisfy
all of the obligations due and owing to Northern, thereby relieving Sheerin of
all obligations she had to Northern on the $1,950,000 promissory note in
question. Tidelands and Sheerin agreed to delay the Tidelands' answer date in
order to allow time for mediation of the case. Tidelands participated in
mediation on March 11, 2003. The case was not settled at that time. Tidelands
answered the Sheerin suit on March 26, 2003. Tidelands' answer denies all of
Sheerin's allegations.
On May 24 and June 16, 2004 respectively, Betty Lou Sheerin filed her first and
second amended original answer, affirmative defenses, special exceptions and
second amended original counterclaim, second amended original third party
cross-actions and requests for disclosure. In these amended pleadings, she sued
Michael Ward, Royis Ward, James B. Smith, Carl Hessell and Ahmed Karim in their
individual capacities. Her claims against these individuals are for fraud,
breach of contract, breach of the Uniform Commercial Code, breach of duty of
good faith and fair dealing and conversion. Sheerin has now non-suited her
claims against Michael Ward, Royis Ward, and James B. Smith.
In September 2002, as a pre-closing deposit to the purchase of the Zavala
Gathering System, the Company executed a $300,000 promissory note to Betty L.
Sheerin, a partner of ZG Gathering, Ltd. In addition, the Company issued
1,000,000 shares of its common stock to various partners of ZG Gathering, Ltd.
On December 3, 2003, Sheerin filed a separate lawsuit against Tidelands in the
150th District Court of Bexar County, Texas on this promissory note seeking a
judgment against Tidelands for the principle amount of the note, plus interest.
On December 29th, 2003, Tidelands answered this lawsuit denying liability on the
note. On April 1, 2004, Tidelands filed a plea in abatement asking the court to
dismiss or abate Sheerin's lawsuit on the $300,000 promissory note as it was
related to and its outcome was dependent on the outcome of the Sheerin third
party cross action against Tidelands in Cause Number 2002-C1-16421. The company
believes that the promissory note and shares of common stock should be cancelled
based upon the outcome of the litigation described above. Accordingly, our
financial statements reflect this belief.
On September 15, 2004 and again on October 15, 2004 respectively, Sheerin
amended her pleadings to include a third and fourth amended third party cross
action against Tidelands adding a claim for the $300,000 promissory note. In
these amended pleadings, Sheerin also deleted her claims against Carl Hessell
and Ahmed Karim. After adding the claim on the $300,000 promissory note to the
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third party claims of Sheerin against Tidelands in Cause No. 2002-C1-16421,
Sheerin dismissed Cause Number 2002-C1-16421.
Tidelands won a partial summary judgment against Sheerin as to all of her tort
claims pled against Tidelands, save and except only her claim for conversion of
500,000 shares of Tidelands stock.
Sheerin seeks damages against Tidelands for indemnity for any sums found to be
due from her to Northern Natural Gas Company, unspecified amounts of actual
damages, statutory damages, unspecified amounts of exemplary damages, attorneys
fees, costs of suit, and prejudgment and post judgment interest.
On August 5, 2005, Northern Natural Gas Company filed its Fourth Amended
Original Petition which, for the first time, named Tidelands as a defendant to
Northern. Northern seeks to impose liability on Tidelands for $1,950.000
promissory note signed by McDay Energy Partners, Ltd. (the predecessor to ZG
Gathering, Ltd.) and Sheerin and the $1,700,000 promissory note signed by McDay
only. Northern contends that Tidelands is alternatively liable to Northern for
payment of both such promissory notes totaling $3,709,914 plus interest because
Northern is a third party beneficiary under a December 3, 2001 purchase and sale
agreement between ZG and Tidelands claiming that in such agreement Tidelands
agreed to assume and satisfy all indebtedness due and owing Northern by Sheerin
and ZG. Northern also claims that it is entitled to foreclosure of a lien on the
gas gathering system and pipeline that was the subject of the promissory notes
in question.
Tidelands has won a summary judgment motion it filed against Northern and the
court has now dismissed Northern's claims against Tidelands.
On November 28, 2005, ZG Gathering, Ltd. and ZG Pipeline Management ("ZG") filed
its answer to Northern's Fifth Amended Petition, its counter-claim against
Northern, and its answer and cross claim against Tidelands. ZG contends that the
promissory notes given by ZG and Sheerin to Northern were procured by Northern's
fraudulent misrepresentations and it claims unspecified amounts of damages
against Northern. ZG's cross action against Tidelands claims Tidelands entered
into an agreement to purchase the Zavala Gathering System from ZG and that, as
part of that agreement, Tidelands agreed to satisfy the $3,700,914 Northern
indebtedness of ZG, and to defend, indemnify, and hold ZG and Sheerin harmless
from such indebtedness, to pay off a Sheerin loan of $300,000, and to issue 1
million shares of Tidelands stock, of which 500,000 was to be free trading
shares. ZG claims that Tidelands breached this agreement by failing to satisfy
the Northern indebtedness, failing to defend and indemnify it from such debt,
failing to pay off the $300,000 note, failing to issue the free trading shares
in Tidelands, and by placing a stop transfer order on the restricted stock that
was issued by Tidelands. ZG seeks specific performance of the agreement,
recovery of an unspecified amount of damages, and its attorney's fees.
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Much of the discovery has been completed at this time. Based on investigation,
and discovery to date, Tidelands appears to have a number of potential defenses
to the claims of Sheerin and Northern. Tidelands intends to aggressively defend
these lawsuits. The complexity of the issues in this case and the inherent
uncertainties in litigation of this kind prevent a more definitive evaluation of
the extent of Tidelands' liability exposure.
Matter No. 2:
On May 4, 2005, HBH Development Company, LLC, ("HBH") initiated legal action
against Sonterra Energy Corporation in the District Court of Travis County,
Texas, 98th Judicial District, Cause No. GN 501626 HBH Development Co., LLC vs.
Sonterra Energy Corp. This action involves the developer of the Austin's Colony
Subdivision in Travis County, Texas and the propane distribution system
originally constructed by Southern Union Company. Southern Union entered into a
letter agreement with HBH concerning the construction and operation of a propane
distribution system in the subdivision to be owned and operated by Southern
Union. Southern Union assigned the letter agreement and its interests in the
propane system to Oneok, Inc., the parent company of Oneok Propane Company.
Sonterra acquired its interest in the propane system from Oneok Propane
Distribution Company. HBH is claiming that Sonterra has failed or refused to pay
HBH rent and easement use fees under the terms of the letter agreement. HBH
alleges that Sonterra's actions cause a failure of the assignment whereby it
acquired rights in the propane system or alternatively, if the assignment is
effective, for breach of contract. HBH seeks to have the court terminate
Sonterra's rights in the propane distribution system, award unspecified monetary
damages, cancellation of the contract and rights associated with the propane
distribution system, issue to HBH a writ of possession for the property, and for
attorneys fees. HBH has amended its complaint adding claims for mutual mistake
and reformation as to the letter agreement and a developer's bonus under terms
of the letter agreement.
Sonterra is defending the legal action. It believes that under the terms of the
letter agreement between HBH Development Company and Southern Union Company,
that the easement use fees terminated when Southern Union conveyed its interest
in the propane distribution system to Oneok Propane Company.
Matter No. 3:
On May 4, 2005, Senna Hills, Ltd. initiated legal action against Sonterra Energy
Corporation in the District Court of Travis County, Texas, 53rd Judicial
District Cause No. GN 501625 Senna Hills, Ltd. vs Sonterra Energy Corp. This
action involves the developer of the Senna Hills Subdivision in Travis County,
Texas and the propane distribution system originally constructed by Southern
Union Company. Southern Union entered into a letter agreement with Senna Hills
concerning the construction and operation of a propane distribution system in
the subdivision to be owned and operated by Southern Union. Southern Union
assigned the letter agreement and its interests in the propane system to Oneok,
Inc., the parent company of Oneok Propane Company. Sonterra acquired its
interest in the propane system from Oneok Propane Distribution Company. Senna
Hills is claiming that Sonterra has failed or refused to pay Senna Hills rent
and easement use fees under the terms of the letter agreement. Senna Hills
alleges that Sonterra's actions cause a failure of the assignment whereby it
acquired rights in the propane system or alternatively, if the assignment is
effective, for breach of contract. Senna Hills seeks to have the court terminate
Sonterra's rights in the propane distribution system, award unspecified monetary
damages, and cancellation of the contract and rights associated with the propane
distribution system, issue to Senna Hills a writ of possession for the property,
and attorneys fees.
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Senna Hills sold certain undeveloped sections of Senna Hills Subdivision to a
new owner. Sonterra believes that it has the right to expand its distribution
system into such undeveloped sections of the subdivision. Sonterra plans to
expand the distribution system into these sections under an agreement with the
new owner. Senna Hills has stated that although it is not presently objecting to
Sonterra's expansion of the system at this time, it is reserving its claim that
Sonterra does not have the right to do so and that it intends to ask the court
to cancel Sonterra's right to use and possession of the propane distribution
system, including the system in the new sections of the subdivision. Senna Hills
has amended its complaint adding claims for mutual mistake and reformation as to
the letter agreement and a developer's bonus under terms of the letter
agreement.
Sonterra is defending the legal action. It believes that under the terms of the
letter agreement between Senna Hills and Southern Union Company, that the
easement use fees terminated when Southern Union conveyed its interest in the
propane distribution system to Oneok Propane Company.
Matter No. 4:
On April 7, 2005, Goodson Builders, Ltd. named Sonterra Energy Corporation in a
legal action titled, Goodson Builders, Ltd, Plaintiff vs. Jim Blackwell and BNC
Engineering, LLC, Defendants. The legal action is in the District Court of
Travis County, Texas 345th Judicial District. This legal action arises from a
claim that an underground propane storage tank and underground distribution
lines is situated on the Plaintiff's lot in the Hills of Lakeway subdivision,
Travis County, Texas. Plaintiff alleges that there is no recorded easement
setting forth the rights and obligations of the parties for use of the propane
tank and lines. However, there is reference to a "suburban propane easement" on
the plat document. Plaintiff alleges that the property is being used without
permission and the use constitutes an on-going trespass. Plaintiff asks the
court to determine that his lot is not subject to a "suburban propane easement",
declare the propane equipment the property of plaintiff, enjoin Sonterra from
use of Plaintiff's land, and award damages. The Plaintiff seeks damages of
$165,000 based on a market rental rate he claims to be $5,000 per month, $50,000
damages for depreciation of the value of the lot, an unspecified amount of
exemplary damages, and attorneys' fees. Sonterra is defending the claims.
Item 1A. Risk Factors
n/a
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During this fiscal quarter, we issued the following common stock:
On May 10, 2006, we issued Jason Jones, a Tidelands' subsidiary employee, 10,000
common shares valued at $7,900 pursuant to his employment agreement.
On May 10, 2006, we issued Robert Dowies, a Tidelands' officer, 60,000 common
shares valued at $97,400 under the terms of his employment agreement.
On June 7, 2006, we issued Michael Ward, a Tidelands' officer, 500,000 common
shares valued at $542,500 under the terms of his employment agreement.
On June 27, 2006, we issued Fran Jenkins, a Tidelands' employee, 20,000 common
shares valued at $16,000 as employee compensation.
On June 27, 2006, the Company issued 20,000 common shares to Natasha Dempsey, a
Tidelands' employee, as compensation.
These are restricted securities and may not be resold absent registration under
the Securities Act of 1933, as amended (the "Securities Act") or an exemption
from the registration provisions of the Securities Act. We relied on Section
4(2) of the Securities Act as securities transaction exemption.
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Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
During the first and second quarters, the Company solicited shareholder written
consents in lieu of a special meeting of the shareholders. The consents were
counted and effective April 17, 2006. The Company obtained a 77.5% majority
shareholder consent to amend our Company's Certificate of Incorporation
increasing our authorized Capital Stock from 100,000,000 shares to 250,000,000
shares.
Item 5. Other Information
Regency Energy Transaction
--------------------------
On July 9, 2006, Tidelands Exploration and Production, Inc., ("TEPI") a
corporation formed by Tidelands Oil & Gas Corporation ("TIDE"), entered into a
Participation Agreement (Exhibit 10.1) and Joint Operating Agreement (Exhibit
10.2) with Regency Energy, Inc. ("Regency"), a Texas corporation. TEPI has
agreed to participate and jointly operate natural gas wells and a pipeline
located in Texas. When the agreements are performed, we will acquire a 50%
interest in a 24-mile natural gas pipeline located in Medina, Atascosa and Bexar
counties, Texas. Additionally, we will acquire a 50% working interest in two
leases with five re-completed natural gas wells located in Medina and Atascosa
counties, Texas. We have agreed to pay $500,000 to Regency for these interests.
TIDE deposited the sum of $250,000 with Regency on behalf of TEPI. Regency is
principally owned and controlled by Royis Ward, the father of Michael Ward,
Tidelands Oil & Gas Corporation President and member of the board of directors.
TEPI was recently organized as a Texas corporation for this transaction with
Regency. TEPI will be a wholly owned subsidiary of TIDE when it completes its
organizational phase. No TEPI operations have commenced and these interests have
not been formally transferred to TEPI as of the date of this report.
Scoot Aviation, LLC Transaction
-------------------------------
Tidelands Oil & Gas Corporation executed an Aircraft Prepaid Lease/ Use
Agreement (Exhibit 10.3) in January 2004 with Royis Ward, to provide charter air
transportation in his Beechcraft King Air, for Tidelands' employees, customers
and contractors to job sites and other business related destinations. A $300,000
5% interest bearing loan (Exhibit 10.4) due in January 2007 was made by the
Company to Royis Ward regarding the transaction. The loan balance was credited
by airtime charges at standard industry rates offset by interest charges
computed on the average monthly balance. At December 31, 2005, the loan balance
was $288,506. On April 14, 2006, Michael Ward, through Scoot Aviation, LLC,
acquired the Royis Ward aircraft and the loan obligation. As of June 30, 2006,
the outstanding loan balance was $285,287.
Small Business Issuer Ineligibility
-----------------------------------
Tidelands will commence filing its periodic reports with the Securities and
Exchange Commission under Regulation S-X instead of S-B due to the fact that the
Company had exceeded the $25,000,000 public float (the aggregate market value of
its outstanding common equity held by non-affiliates) limitations of Regulation
S-B. As a result of this limitation and at the request of the Securities and
Exchange Commission, Tidelands will be re-filing its Annual Report on Form 10-K
for the period ending December 31, 2005 and re-filing its Quarterly Report on
Form 10-Q for the period ending March 31, 2006.
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Item 6. Exhibits
a) Exhibits
Exhibit No. Exhibit Name
10.1 Regency Energy Participation Agreement
10.2 Regency Energy Joint Operating Agreement
10.3 Aircraft Prepaid Lease/Use Agreement
10.4 Promissory Note for Aircraft Prepaid Lease/Use Agreement
31.1 Chief Executive Officer-Section 302 Certification pursuant
to Sarbanes-Oxley Act.
31.2 Chief Financial Officer- Section 302 Certification pursuant
to Sarbanes-Oxley Act.
32.1 Chief Executive and Financial Officer-Section 906
Certification pursuant to Sarbanes-Oxley Act.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
TIDELANDS OIL & GAS CORP.
Dated: August 21, 2006 /s/ Michael Ward
--------------------------------
By: Michael Ward
Title: President, CEO
Dated: August 21, 2006 /s/ James B. Smith
--------------------------------
By: James B. Smith
Title: CFO, Principal Accounting
Officer