Form 10QSB for STAR ENERGY CORP
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21-Aug-2007
Quarterly Report
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion should be read in conjunction with our financial statements and notes thereto included in this report.
Forward Looking Statements and Factors That May Affect Future Results and Financial Condition
This Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this report contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can be identified by words such as "may," "should," "anticipates," "intends," "expects," "believes," "plans," "predicts," "estimates," "strategy" and similar terms. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. These statements are subject to risks and uncertainties and are based upon assumptions and beliefs that may or may not materialize. These risks and uncertainties include, but are not limited to, the following, many of which are beyond our control: our ability to obtain waivers or renegotiate the terms of our 8% Secured Convertible Debentures; the sufficiency of existing capital resources; our ability to raise additional capital to fund cash requirements for future operations; our ability to obtain and maintain sufficient energy reserves to fund and maintain operations; the market for any oil and gas production we may generate; domestic and foreign political conditions; the overall level of supply of and demand for oil and gas; the price of imports of oil and gas; weather conditions; the price and availability of alternative fuels; the proximity and capacity of oil pipelines and other transportation facilities; uncertainties related to our future business prospects, including with possible future acquisitions; the volatility of the stock market in general and our common stock specifically; our ability to maintain the quotation of our common stock on the Over the Counter Bulletin Board; and general economic conditions.
We also wish to advise readers not to place any undue reliance on the forward looking statements contained in this report, which reflect our beliefs and expectations only as of the date of this report. We assume no obligation to update or revise these forward looking statements to reflect new events or circumstances or any changes in our beliefs or expectations, other than as required by law.
Overview
We were incorporated in Nevada on December 7, 1999. From November 21, 2002 until October 6, 2006, we were engaged, as an independent oil and natural gas producer, in the exploration, development, production and sale of gas derived from five oil and gas wells, known as the "Galvan Ranch Gas Wells," located in Webb County, West Texas, Texas, in each of which we had a 15% working interest and a 12% net revenue interest. The wells were on five separate parcels of land spread over 425 acres of the Galvan Ranch.
On October 6, 2006, we entered into an Assignment and Bill of Sale with Ruairidh Campbell, at the time one of our officers and directors, pursuant to which we assigned to Mr. Campbell all of our interests in and to the Galvan Ranch Gas Wells. In consideration therefor, Mr. Campbell transferred to us, for cancellation and return to our authorized but unissued common shares, the 3,250,000 shares of our common stock owned by him. As a result, since October 6, 2006, we no longer have had any interest in the Galvan Ranch Gas Wells and are no longer engaged in the oil and gas business in Texas.
Pursuant to a Stock Purchase Agreement, on October 6, 2006, we acquired 100% of the capital stock of Volga-Neft Limited Company, a Russian limited liability company primarily engaged in the processing and sale of crude oil in Samara, Russia ("Volga-Neft") in consideration for our issuance to the stockholders of Volga-Neft of an aggregate of 10,000,000 shares of our common stock, representing at
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the time 25.6% of our issued and outstanding shares. Thereafter we advanced $3,000,000 of working capital to Volga-Neft. Volga-Neft (i) sells to local oil exporters, wholesalers, and distributors crude oil it has purchased from local oil developers and (ii) processes crude oil purchased from local oil developers, selling the processed petroleum products in the local market to oil exporters, wholesalers, and distributors. As a result of this acquisition, Volga-Neft became our wholly-owned subsidiary.
On April 13, 2007, we were advised by RSM Top-Audit that the financial statements of Volga-Neft, purportedly audited by RSM Top-Audit in Russia for periods prior to our acquisition of Volga-Neft, were not audited by that firm.
We therefore concluded that those financed statements could not be relied upon. By a Rescission Agreement of Stock Purchase Agreement dated June 14, 2007 among us, Volga-Neft and the individuals from whom we acquired the shares of Volga-Neft, the Stock Purchase Agreement was rescinded, we returned the shares of Volga-Neft we received to the former stockholders who, in turn, returned to us the 10,000,000 shares of our common stock that we had previously issued to them. In addition, Volga-Neft issued a $4,200,000 promissory note in our favor which we, in turn, sold to an unaffiliated third party on a non-recourse basis for $3,000,000.
As a result of the rescission, we have not included the assets, liabilities or results of operations of Volga-Neft in our financial statements for any period. However, the Rescission Agreement does not affect the rights that any third parties may have against us with respect to agreements, transactions or events under or with respect to agreements or understandings entered into, or transactions or events that occurred, prior to the Rescission Agreement or with respect to breaches of agreements to which we are a party that may have resulted from the Rescission Agreement.
In this regard, the rescission of the acquisition of Volga-Neft may result in the acceleration of the maturity of some or all of our $7,500,000 principal amount of 8% Secured Convertible Debentures we issued in February 2007 and that otherwise would be due on February 11, 2010, or earlier upon acceleration following an event of default, as defined in the Debentures. See "Liquidity and Capital Resources," below.
On July 23, 2007, we received a report from Nixon Peabody, LLP, which was based upon certain documentation, and certain interviews conducted with personnel, made available by us, Volga-Neft and RSM Top-Audit, which report did not constitute a comprehensive analysis because a number of key witnesses and certain sources of documentary evidence were not available to Nixon Peabody. Following receipt of that report, we concluded that it is unlikely that RSM Top-Audit performed any audit of Volga-Neft's financial statements, that RSM Top-Audit may not, in fact, have been engaged by Volga-Neft to perform an audit, and that, while actions taken by various individuals in Russia, at least one of whom was employed by RSM Top-Audit, may have resulted in our receipt of the purported audit report of RSM Top-Audit, neither the Company nor any of its officers or directors knew of these facts or the absence of the audits prior to RSM Top-Audit's advice on April 13, 2007 that RSM Top-Audit had not audited the financial statements of Volga-Neft.
Future Operations
In previous years, we were primarily engaged in domestic energy operations. We have shifted entirely to operations situated in areas of the world that are considered emerging markets and are moving towards capitalizing on the opportunities available to us in Ukraine. In light of our prior experience and taking into consideration the risk factors inherent to operating in emerging markets, we have retained western legal, accounting, and geological consultants.
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On August 3, 2007, we entered into separate letter agreements, dated August 1, 2007, with three unaffiliated third parties pursuant to which we acquired certain rights and interests of those parties which, in essence, affords us the right to contract for the purchase of interests in three projects in the Ukraine, which consist of an aggregate of seven oil and gas fields, two of which are producing.
Results of Operations
The Company had no operations during the first half of 2007, as a result of its disposition of the Galvan Ranch Wells in October 2006 and, therefore, had no oil and gas revenues, production costs or equipment depreciation expense in the 2007 periods.
Other income of $12,806 in the six month and $8,630 in the second quarter of 2007 was primarily interest income related to the investment of the proceeds of the Company's private placement in February 2007 of $7,500,000 of 8% Secured Convertible Debentures.
Our principal operating expenses for the 2007 periods consisted of:
Professional fees for the 2007 six and three month periods ended June 30, 2007 were $1,068,388 and $932,781, respectively. Nearly half of the amount spent during the three months ended June 30, 2007 was used to pay for due diligence expenses incurred for the collection of extensive geographic, seismic, audit data on potential acquisition targets. The remaining funds were spent primarily on general legal an auditing services, including the preparation of our Annual Report on Form 10-KSB for the year ended December 31, 2006 and the audit of our financial statements contained therein and preparation of our Quarterly Report on Form 10-QSB for the quarter ended March 31, 2007.
Consulting expenses of $1,031,016 in the six months ended June 30, 2007 services were paid primarily for fees of $870,000 related to the rescission of the Volga-Neft acquisition and $130,000 for other consulting services. For the three months ended June 30, 2007, consulting fees were $126,016 primarily for general consulting services.
Salary and benefits were $738,929 and $369,212 for the 2007 six month and three month periods ended June 30, 2007, respectively. Of these amounts, $589,281 in the six month period and $297,469 of the second quarter represents the amortized portion of compensation expense related to the issuance of shares to certain officers and directors. The balance of these amounts, $149,648 in the six-month period and $77,663 during the second quarter was cash compensation and benefits for officers, directors and other employees.
Virtually all of the interest expense and bank charges of $252,019 in the six months ended June 30, 2007 and $151,359 in the three months ended June 30, 2007 represented accrued interest on our $7,500,000 8% Secured Convertible Debentures issued on February 9, 2007.
Advertising and promotion of $224,654 in the six month period ended June 30, 2007 includes expenses related to investor presentations and promotion related to our acquisition of Volga-Neft, of which only $73,682 was spent in the second quarter of the period before we were advised, on April 13, 2007, by RSM Top-Audit that the financial statements of Volga-Neft, purportedly audited by RSM Top-Audit in Russia for periods prior to our acquisition of Volga-Neft, were not audited by that firm.
Office and general expense was $116,993 for the six month period ended June 30, 2007 was primarily for investor relations services of $60,514 and Board of Director fees of $30,000 and for the second quarter was $63,735 consisting primarily of $30,000 for investor relations services and $15,000 for Board of Directors fees.
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Travel expenses of $43,945 for the six month period and $17,341 in the second quarter of 2007 were for trips to the Russian Federation with respect to Volga-Neft and also to the Ukraine for due diligence gathering and for a Board of Directors meeting at our New York headquarters.
During the first half and second quarter of 2007 we incurred rent expenses of $23,548 and $18,848, respectively, with respect to our move in 2007 into different premises in New York City.
Insurance expenses were $15,108 and $8,910 in the six and three month ended June 30, 2007, respectively, related to director and officer insurance.
Telephone expense was $6,591 and $5,339 for the first half and second quarter of 2007, respectively, most of which was long-distance telephone related to Volga-Neft and our search for other foreign properties.
Liquidity and Capital Resources
In February 2007, we sold $7,500,000 principal amount of our 8% Secured Convertible Debentures to institutional investors for a total purchase price of $7,500,000 (the "Debenture Financing"). We paid Rodman & Renshaw LLC, placement agent for the Debenture Financing, $525,000 (7% of the gross proceeds from the sale of such Debentures), plus $25,000 in reimbursement of its expenses, under a placement agency agreement. An additional $58,000 was paid to an unaffiliated third party in shares of our common stock for its assistance in identifying potential institutional investors.
Of the net proceeds of the Debenture Financing, estimated at $6,975,000, we advanced $3,000,000 to Volga-Neft for the payment of its liabilities. At the time of the rescission of our acquisition of Volga-Neft, we received, in addition to the return of the 10,000,000 shares of our common stock that we had issued in consideration for our acquisition, a $4,200,000 promissory note in full settlement of all monetary claims we may have against Volga-Neft or its stockholders from which we acquired Volga-Neft. We, in turn, sold the promissory note to an unaffiliated third party on a non-recourse basis for $3,000,000.
During the six months ended June 30, 2007, we used $2,330,560 in operating activities, mostly to support our cash loss of $2,562,985 (being our loss for financial reporting purposes of $3,607,196 less non-cash expenses of $946,000 of expenses paid through our issuance of shares of our stock and $98,211 of deferred financing costs.
Investing activities during the first six months of 2007 provided net cash of $798,901 principally from our collection of a loan receivable from Volga-Neft of $1,000,000 partially offset by our investment of $201,099 of cash in marketable securities.
Financing Activities provided net cash of $5,891,100 during the first half of 2007 resulting from the Debenture Financing discussed above, $1,000,000 of the net proceeds of which was used to repay a loan.
We intend to use our remaining available cash of $4,361,144 at June 30, 2007 to fund strategic initiatives and to repay certain liabilities. We expect that these funds will be sufficient to fund our operations in 2007.
Potential Acceleration of Our 8% Secured Convertible Debentures
As a result of the rescission on June 14, 2007 of the Stock Purchase Agreement which resulted in the return by us of all of the capital stock of Volga-Neft to the former shareholders thereof and the return by
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them to us of 10,000,000 shares of our common stock, each holder of an 8% Secured Debenture issued by us as part of the offering and sale of an aggregate $7,500,000 of the Debentures in February 2007 may elect to declare the outstanding principal amount of such holder's Debenture, plus accrued and unpaid interest, liquidated damages and other amounts owing in respect of the holder's Debenture due and payable at its "Mandatory Default Amount." The Mandatory Default Amount is defined in the Debenture, which, at a minimum would be 130% of the outstanding principal amount of the Debenture plus all accrued and unpaid interest thereon. Commencing five trading days after the occurrence of an event of default that results in the eventual acceleration of a Debenture, the Debentures are to accrue interest at an interest rate equal to the lesser of 18% per annum or the maximum rate permitted under applicable law.
Pursuant to the terms of a Registration Rights Agreement by and between us and the purchasers of the Debentures, dated as of February 9, 2007, we agreed to prepare and file, by April 15, 2007, with the Securities and Exchange Commission a registration statement on Form SB-2 for the purpose of registering for resale all of the shares of our common stock issuable upon conversion of the Debentures and the exercise of the Warrants issued in the private placement. We have not, to date, filed the Registration Statement. The Registration Rights Agreement provides that, if we did not file the Registration Statement by April 15, 2007, the Registration Statement was not declared effective by the Securities and Exchange Commission by July 15, 2007, and in certain other circumstances (including if the Registration Statement did not remain continuously effective except for certain limited periods for specified reasons), we are to pay, on the applicable date and each monthly anniversary of that date, as partial liquidated damages, 1.5% of the principal amount of the Debentures then held by the Debentureholders. If we fail to pay any of these amounts within seven days after the date payable, the Registration Rights Agreement provides that we are to pay interest thereon at the rate of 18% per annum. To date, we have not made any of these payments.
We intend to seek appropriate waivers from the holders of the Debentures. There can be no assurance that we will be successful in our efforts or, if we are successful, the terms of any modification of the Debentures or Registration Rights Agreement.
Off-Balance Sheet Financing
The Company has no off-balance sheet financing arrangements, within the meaning of Item 303(c) of Securities and Exchange Commission Regulation S-B.