John D. Oil and Gas Company - Recent Material Event2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
John D. Oil and Gas Company and Subsidiary
Consolidated Balance Sheets
The accompanying notes to consolidated financial statements are an integral part of these
statements.
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John D. Oil and Gas Company and Subsidiary
Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited)
The accompanying notes to consolidated financial statements are an integral part of these
statements.
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John D. Oil and Gas Company and Subsidiary
Consolidated Statements of Shareholders’ Equity For The Nine Months Ended September 30, 2007
The accompanying notes to consolidated financial statements are an integral part of these
statements.
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John D. Oil and Gas Company and Subsidiary
Consolidated Statements of Cash Flows (Unaudited)
The accompanying notes to consolidated financial statements are an integral part of these
statements.
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John D. Oil and Gas Company and Subsidiary
Notes to Unaudited Consolidated Financial Statements 1. Summary of Significant Accounting Policies
General
John D. Oil and Gas Company, formerly Liberty Self-Stor, Inc. (the “Company”), is a
corporation organized under the laws of the State of Maryland. In 1999, the Company succeeded to
the business of Meridian Point Realty Trust ‘83. Meridian was a California business trust that
commenced operation in 1983. Meridian was originally known as “Sierra Real Estate Equity Trust
‘83,” changing its name in 1991.
In 1999, the stockholders elected trustees and approved certain proposals including, but not
limited to, approval of the reincorporation of Meridian into the Company, a perpetual-life REIT,
and the formation of an operating partnership, LSS I Limited Partnership (“LSS”), a Delaware
limited partnership, with the members of Liberty Self-Stor, Ltd., an Ohio limited liability company
(the “Ohio LLC”). The members of the Ohio LLC consisted of Richard M. Osborne (“Mr. Osborne”),
Chairman and Chief Executive Officer of the Company, Thomas J. Smith, the former President and
Chief Operating Officer of the Company, and Retirement Management Company, an Ohio corporation
owned by Mr. Osborne.
Each member of the Ohio LLC exchanged their membership interests for Class A limited
partnership interests in LSS, resulting in LSS being the sole member of the Ohio LLC. The Company
contributed its net assets, primarily cash and investments, to LSS in exchange for the sole general
partner interest therein and Class B limited partnership interests. The Class A limited
partnership interests are redeemable for cash or, at the election of the Company, convertible into
shares of the Company’s stock based on an exchange factor. The exchange factor, previously one
share for each unit, was recalculated pursuant to the amendment to the partnership agreement of LSS
after the sale of the eighteen facilities on April 5, 2005 to U-Store-It, L.P. (“U-Store-It”). The
current exchange factor is .1377148 of a share for each unit. The Class B limited partnership
interests are not entitled to redemption, conversion or a preferred return. At September 30, 2007,
the Company and the former members of the Ohio LLC had 29.9% and 70.1% equity interests in LSS,
respectively, and operated one self-storage facility. Because LSS’s losses reduced the initial
investment by the minority interest to a receivable, the Company wrote-off the minority interest in
2006 as it was deemed not to be collectible.
In conjunction with the name change from Liberty Self-Stor, Inc. to John D. Oil and Gas
Company on June 27, 2005, the Company approved a change to its business plan to permit it to enter
into the business of extracting and producing oil and natural gas products. The Company is
actively drilling oil and natural gas wells in Northeast Ohio. The Company cannot guarantee
success under the new business plan as drilling wells for oil and natural gas is a high-risk
enterprise and there is no guarantee the Company will become profitable.
The Company currently has one self-storage facility located in Painesville, Ohio. The Company
may, if business and time warrant, sell the Painesville facility in the future.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance
with the rules and regulations for the Securities and Exchange Commission (“SEC”) for interim
financial information and with instructions to Form 10-QSB and, accordingly, do not include all
information and footnotes required under accounting principles generally accepted in the United
States of America for complete financial statements. In the opinion of management, these interim
consolidated financial statements contain all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation of the consolidated financial position of
the Company as of September 30, 2007 and the results of its operations and cash flows for the three
and nine months ended September 30, 2007 and 2006. Interim results of operations are not
necessarily indicative of the results to be expected for the remainder of the year. These
unaudited consolidated financial statements
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John D. Oil and Gas Company and Subsidiary
Notes to Unaudited Consolidated Financial Statements should be read in conjunction with the Company’s Annual Report on Form 10-KSB for the year ended
December 31, 2006. Certain prior year amounts have been reclassified to conform to the September
30, 2007 presentation.
Principles of Consolidation
Pursuant to the terms of the partnership agreement of LSS, the Company, as sole general
partner, controls LSS. Accordingly, the Company accounts for its investment in LSS utilizing the
consolidation method. Investment in unconsolidated affiliate, Kykuit Resources LLC, is accounted
for using the equity method. All significant inter-company transactions and balances have been
eliminated.
Accounts Receivable
The Company’s accounts receivable, arising from the self-storage business, are due from
individuals as well as business entities. Tenants are required to pay their rent on the first day
of each month. Past due amounts are those that are outstanding longer than the contractual payment
terms. If an account is more than 75 days past due, the Company generally writes off the balance
directly to expense. For such past due accounts, the Company has the right to auction the contents
of the rented space, which allows for recovery of written-off balances. Any such recoveries are
credited to income when received.
The Company has certain trade receivables consisting of oil and natural gas sale obligations
due under normal trade terms. The Company currently sells its production to a related party
through an oil and natural gas agreement, extending credit on an unsecured basis to them. In
evaluating its allowance for possible losses, the Company performs a review of outstanding
receivables. The trade receivables outstanding are typically three months of natural gas
production due to the timing and accounting treatment by the main distribution pipeline company in
Northeast Ohio. At September 30, 2007 and December 31, 2006, the Company’s credit evaluation
indicated that it has no need for an allowance for possible losses.
Property and Equipment
All property and equipment is depreciated using the straight-line method over estimated useful
lives of twenty five years for buildings and improvements and five to seven years for furniture and
equipment.
The Company uses the successful efforts method of accounting for oil and natural gas producing
activities. Under this method, acquisition costs for proved and unproved properties are
capitalized when incurred. Exploration costs, including geological and geophysical costs, the costs
of carrying and retaining unproved properties and exploratory dry hole drilling costs, are
expensed. Development costs, including the costs to drill and equip development wells and
successful exploratory drilling costs to locate proved reserves, are capitalized. Upon sale or
retirement of a proved property, the cost and accumulated depreciation and depletion and
amortizations are eliminated from property accounts and the resultant gain or loss is recognized.
Exploratory drilling costs are capitalized when incurred pending the determination of whether
a well has found proved reserves. If a well is determined to be successful, the capitalized
drilling costs will be reclassified as part of the cost of the well. If a well is determined to be
unsuccessful, the capitalized drilling costs will be charged to expense in the period the
determination is made. The Company has some limited participation in exploratory drilling. The
Company’s participation in the Kykuit Resources LLC joint venture, however, will increase
exploratory operations significantly.
Development costs of proved oil and natural gas properties, including estimated dismantlement,
restoration, abandonment costs and acquisition costs, are depreciated and depleted on a well by
well basis by the units-of-production method using estimated proved developed reserves. The costs
of unproved oil and natural gas properties are periodically assessed for impairment.
Asset Impairment
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John D. Oil and Gas Company and Subsidiary
Notes to Unaudited Consolidated Financial Statements The Company reviews its self-storage property and capitalized well costs for impairment when
events or changes in circumstances indicate the carrying amounts of the properties may not be
recoverable. When such conditions exist, management estimates future cash flows from operations
and ultimate disposition of the individual properties. If the estimated undiscounted future cash
flows are less than the carrying amount of the asset, an adjustment to reduce the carrying amount
to the related property’s estimated fair market value would be recorded and an impairment loss
would be recognized. In evaluating its capitalized well costs, the Company wrote off the costs
related to two wells amounting to $676,485 during the three months ended September 30, 2007.
Future impairments and dry wells cannot be predicted.
Asset Retirement Obligation
The Company accounts for its asset retirement obligations in accordance with FASB Statement
No. 143, “Accounting for Asset Retirement Obligations.” This statement requires that the fair
value of an asset retirement obligation be recognized in the period in which it is incurred if a
reasonable estimate of fair value can be made. For the Company, asset retirement obligations
primarily relate to the abandonment, dismantling and plugging of oil and natural gas wells. The
present value of the estimated asset retirement cost is capitalized as part of the long-lived
asset. The capitalized asset retirement cost is depreciated and the asset retirement obligation is
accreted to interest expense over the estimated life of the well.
The following table presents the Company’s current asset retirement obligation activity for the
nine months ended September 30, 2007.
Revenue Recognition
The Company’s revenue from self-storage operations is derived primarily from monthly rentals
of self-storage units. Rental revenue is recognized in the period the rent is earned which is
typically on a monthly basis.
The Company also leases certain commercial space in its Painesville property under long-term
lease agreements. Total lease revenue related to these leases was $143,301 and $162,789 for the
nine months ended September 30, 2007 and 2006, respectively. Revenue under these long-term lease
agreements is recognized on a straight-line basis over the respective lease terms.
Future minimum lease revenue for continuing operations under non-cancelable leases for each of
the five succeeding annual periods ending September 30 are as follows:
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John D. Oil and Gas Company and Subsidiary
Notes to Unaudited Consolidated Financial Statements The Company recognizes revenue from its oil and natural gas interests in producing wells as
oil and natural gas is sold to a purchaser at a fixed or determinable price when delivery has
occurred, title and risk of loss have transferred to the purchaser and the collectability of
revenue is reasonably assured. The Company has a management agreement with a related party to
transport the Company’s natural gas production through the related party’s pipeline and include
this natural gas with the related party’s natural gas in order to fulfill production contracts they
currently have in place. The actual funds are typically received within three months due to the
accounting treatment by the main distribution pipeline company in Northeast Ohio.
Comprehensive Income
Statement of Financial Accounting Standard (“SFAS”) No. 130, “Reporting Comprehensive Income”
requires disclosure of comprehensive income and its components in a full set of financial
statements. Comprehensive income is defined as changes in shareholders’ equity from non-owner
sources and, for the Company, includes fair market value adjustments to available for sale
securities, in compliance with SFAS No. 133, as amended.
Stock-Based Compensation
The 1999 Stock Option Plan (the “Plan”), which was approved by stockholders, permits the grant
of non-statutory stock options (“NSSOs”), incentive stock options (“ISOs” and together with NSSOs,
“options”) and restricted shares. The Plan was adopted to attract and retain qualified and
competent persons who are key to the Company, including key employees, officers, and directors.
The Plan provides for the grant to employees of ISOs within the meaning of Section 422 of the
Internal Revenue Code, for grant of NSSOs to eligible employees (including officers and directors)
and non-employee directors and for the grant of restricted share awards. The Company may grant up
to 300,000 options or restricted shares pursuant to the Plan. For the nine months ended September
30, 2007 and 2006, 35,000 stock options were outstanding. During the second quarter of 2006, the
former President and Chief Operating Officer of the Company was awarded 35,000 restricted shares
with a fair value of $22,750 with compensation expense to be amortized ratably over a five year
vesting period. The compensation expense recorded for the restricted shares during the nine months
ended September 30, 2007 and 2006 was $3,411 and $727, respectively.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS
No. 123R, “Share-Based Payment,” using the modified prospective transition method, and thus the
results of operations for prior periods will not be restated. Prior to the adoption of SFAS 123R,
the Company applied the intrinsic-value-based method of accounting prescribed by Accounting
Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.”
Income Taxes
Prior to 2006, the Company elected to be taxed as a real estate investment trust (“REIT”)
pursuant to Section 856(c)(1) of the Internal Revenue Code of 1986, as amended. The change in the
Company’s business plan to oil and gas production resulted in the loss of the Company’s REIT status
in 2006. Therefore, the Company’s Board of Directors determined it was in the best interest of the
Company to terminate the REIT status effective January 1, 2006. After that date, the Company
became a “C” Corporation for tax purposes.
In establishing a provision for income taxes, the Company must estimate when in the future
certain items will affect taxable income. Deferred taxes are recorded for future tax consequences
of events that have been recognized in the financial statements or tax returns, based upon enacted
tax laws and rates. Deferred tax assets are recognized subject to management’s judgment that
realization is more likely than not.
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John D. Oil and Gas Company and Subsidiary
Notes to Unaudited Consolidated Financial Statements In June 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation
(FIN) No. 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement
No. 109.” FIN No. 48 addresses the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with Statement of Financial Accounting Standards
(SFAS) No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes specific criteria for the
financial statement recognition and measurement of the tax effects of a position taken or expected
to be taken in a tax return. This interpretation also provides guidance on de-recognition of
previously recognized tax benefits, classification of tax liabilities on the balance sheet,
recording interest and penalties on tax underpayments, accounting in interim periods, and
disclosure requirements.
The Company adopted the provisions of FIN No. 48 on January 1, 2007. The implementation of
FIN No. 48 did not have a material effect on the Company’s financial statements. The Company has
net operating loss carry forwards (NOLS) and a valuation allowance to offset any tax effects. The
Company has no unrecognized tax benefits and therefore, there is no anticipated effect on the
Company’s effective tax rate. Any tax penalties or interest expense will be recognized in income
tax expense.
The Company is open to federal and state tax audits until the applicable statute of
limitations expire. There are currently no federal or state income tax examinations underway for
the Company. The Company is no longer subject to U.S. federal tax examinations by tax authorities
for tax years before 2003 and for state and local tax authorities for years before 2002. The
Company does, however, have prior year net operating losses which remain open for examination.
Use of Estimates
The preparation of 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, the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates.
The Company’s financial statements are based on a number of significant estimates, including
reliability of receivables, selection of useful lives for property and equipment and timing and
costs associated with its retirement obligations. Estimated oil and natural gas reserve quantities
are the basis for the calculation of depreciation, depletion and impairment of oil and natural gas
properties.
The Company’s oil and natural gas business makes it vulnerable to changes in wellhead prices
of crude oil and natural gas. Such prices have been volatile in the past and can be expected to
continue to be volatile. Proved reserves are based on current oil and natural gas prices and
estimated reserves, which is considered a significant estimate by the Company, and is subject to
change.
Fair Value of Financial Instruments
The fair-value of the Company’s financial instruments is determined by using available market
information and appropriate valuation methodologies. The Company’s principal financial instruments
are cash, accounts receivable, accounts payable and long term debt. Cash, accounts receivable and
accounts payable, due to their short maturities, and liquidity, are carried at amounts which
reasonably approximate fair value. Based upon rates available for similar borrowings, the
Company’s book value approximated the fair value of its long-term debt at September 30, 2007 and
December 31, 2006.
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Notes to Unaudited Consolidated Financial Statements Recently Issued Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which establishes
a formal framework for measuring fair values of assets and liabilities in financial statements that
are already required by U.S. generally accepted accounting principles (GAAP) to be measured at fair
value. SFAS No. 157 clarifies guidance in FASB Concepts Statement (CON) No. 7 which discusses
present value techniques in measuring fair value. Additional disclosures are also required for
transactions measured at fair value. No new fair value measurements are prescribed, and SFAS No.
157 is intended to codify the several definitions of fair value included in various accounting
standards. However, the application of this Statement may change current practices for certain
companies. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The
Company is currently evaluating what impact SFAS No. 157 may have on its financial position,
results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets
and Financial Liabilities-Including an Amendment of FASB Statement No. 115.” SFAS No. 159 permits
entities to choose to measure many financial instruments and certain other items at fair value.
Unrealized gains and losses on items for which the fair value option has been elected will be
recognized in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal
years beginning after November 15, 2007. The Company is currently evaluating what impact SFAS No.
159 may have on its financial position, results of operations or cash flows.
2. Discontinued Operations
On May 21, 2007, the Company completed the sale of its self-storage facility located in
Gahanna, Ohio pursuant to the Purchase and Sale Agreement (the “Agreement”) among Liberty
Self-Storage, LTD. (the trade name of the Company), Columbus Tile Yard, LLC and Buckeye Storage of
Gahanna LLC, or its nominee, for the purchase price of $1,400,000. The assets of the Gahanna, Ohio
self-storage facility consisted primarily of property and equipment with a net book value of
approximately $924,000. The liabilities consisted primarily of a mortgage of approximately
$708,000. The original purchase price was reduced by $50,000 pursuant to an amendment to the
Agreement in December 2006. $150,000 of the purchase price was allocated to Columbus Tile Yard for
the vacant land that it owned. Richard M. Osborne, the Company’s Chairman of the Board and Chief
Executive Officer, is the owner of Columbus Tile Yard.
Prior to the date of the sale, the Company was uncertain as to its completion due to several
delays requested by the purchaser. The Company’s results of operations have been restated to
reclassify the net earnings of the self-storage facility sold as discontinued operations for all
periods presented. The following table summarizes income and loss from discontinued operations:
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Notes to Unaudited Consolidated Financial Statements
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