Large accelerated filer o		Accelerated filer o
Non-accelerated filer o		Smaller reporting company x
(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

The number of shares of the registrant’s common stock outstanding as of June 30, 2008: 127,121,536 shares.

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MAXIM TEP, INC.

 

Form 10-Q

For the Quarterly Period Ended June 30, 2008

Table of Contents

		Page
PART I—FINANCIAL INFORMATION
Item 1.	Financial Statements	2
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 4T.	Controls and Procedures	26
PART II—OTHER INFORMATION
Item 1.	Legal Proceedings	27
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3.	Default Upon Senior Securities	29
Item 4.	Submission of Matters to a Vote of Security Holders	29
Item 5.	Other Information	29
Item 6.	Exhibits	29
SIGNATURES		30

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PART I—FINANCIAL INFORMATION

Item 1.  Financial Statements

 

Maxim TEP, Inc.

Consolidated Balance Sheets

 

		June 30,			December 31,
		2008			2007
		Unaudited
Assets
Current assets:
Cash and cash equivalents		$	158,661		$	166,412
Accounts receivable			416,567			231,617
Other receivable			326,477			364,000
Note Receivable			306,000			-
Inventories			88,868			88,868
Prepaid expenses and other current assets			60,776			107,721
Deferred financing costs, net			-			51,800
Current assets of discontinued operations			-			1,316,514
Total current assets			1,357,349			2,326,932
Oil and natural gas properties (successful efforts method of accounting)
Proved			13,335,448			18,048,705
Unproved			2,619,240			3,706,590
			15,954,688			21,755,295
Less accumulated depletion, depreciation and amortization			(1,366,240	)		(1,142,662	)
Oil and natural gas properties, net			14,588,448			20,612,633
Property and equipment:
Land			112,961			112,961
Buildings			215,445			240,500
Leasehold improvements			244,025			244,025
Office equipment and computers			81,020			79,769
Furniture and fixtures			211,581			211,581
Field service vehicles and equipment			690,261			738,463
Drilling equipment			174,082			174,082
			1,729,375			1,801,381
Less accumulated depreciation			(369,850	)		(310,036	)
Property and equipment, net			1,359,525			1,491,345
Intangible assets, net			4,458,145			4,881,302
Other assets			487,705			496,046
Long term assets of discontinued operations			-			5,130,021
Total assets		$	22,251,172		$	34,938,279

2

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Maxim TEP, Inc.

Consolidated Balance Sheets (Continued)

 

		June 30,			December 31,
		2008			2007
		Unaudited
Liabilities and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable		$	3,308,960		$	4,144,402
Accounts payable to operators			-			-
Interest payable			371,503			646,726
Accrued payroll and related taxes and benefits			849,312			1,056,272
Accrued liabilities			1,353,038			1,078,353
Current maturities of notes payable, net of discount			500,000			6,400,000
Current maturities of notes payable, related parties, net of discount			700,000			5,161,025
Current maturity of notes payable,  discontinued operations			-			37,408,772
Current liabilities of discontinued operations			-			5,626,511
Total current liabilities			7,082,813			61,522,061
Notes payable, net of current maturities and discount			-			1,750,000
Notes payable, related parties, net of current maturities and discount			-			1,250,000
Production payment payable			6,774,172			6,877,945
Deferred revenue			70,000			125,000
Asset retirement obligation			1,219,360			1,506,304
Long term liabilities of discontinued operations			-			672,969
Total liabilities			15,146,345			73,704,279
Commitments and contingencies			-			-
Stockholders’ equity (deficit):
Preferred stock, $0.00001 par value; 50,000,000
shares authorized; 5,454,545 and zero shares issued and
outstanding			55			-
Common stock, $0.00001 par value; 250,000,000
shares authorized; 127,134,869 and 85,604,516 shares
issued and 127,084,869 and 85,579,516 shares
outstanding at June 30, 2008 and
December 31, 2007, respectively			1,271			856
Additional paid-in capital			85,350,568			50,477,255
Accumulated deficit			(78,247,066	)		(89,244,111	)
Treasury stock, at cost (50,000 and 25,000 shares
at June 30, 2008 and December 31, 2007,
respectively)				(1)		-
Total stockholders’ equity (deficit)			7,104,827			(38,766,000	)
Total liabilities and stockholders’ equity (deficit)		$	22,251,172		$	34,938,279

See accompanying notes to consolidated financial statements

3

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Maxim TEP, Inc.

Consolidated Statements of Operations (Unaudited)

		Three Months Ended June 30,						Six Months Ended June 30,
		2008			2007			2008			2007
		(In thousands except per share amounts)
Revenue:
Oil and natural gas revenues		$	634,896		$	607,216		$	1,207,415		$	1,292,155
License fees, royalties and related services			7,192			244,700			34,692			297,500
Total revenues			642,088			851,916			1,242,107			1,589,655
Cost and expenses:
Production and lease operating expenses			236,418			488,656			561,406			1,001,246
Drilling operating expenses			-			156,021			3,741			169,666
Costs attributable to license fees and related services			-			12,000			-			31,421
Exploration costs			-			185,133			-			622,903
Revenue sharing royalties			17,782			12,082			40,227			25,232
Depletion, depreciation and amortization			477,973			399,701			974,995			842,012
Impairment of investments			-			1,065,712			-			1,065,712
Accretion of asset retirement obligation			28,620			25,434			60,451			51,460
General and administrative expenses			4,668,968			1,427,276			9,043,396			2,675,123
Total cost and expenses			5,429,761			3,772,015			10,684,216			6,484,775
Loss from operations			(4,787,673	)		(2,920,099	)		(9,442,109	)		(4,895,120	)
Other income (expense):
Gain on transfer of assets			782,822			-			782,822			-
Interest expense, net			(196,049	)		(1,013,063	)		(1,780,557	)		(2,061,121	)
Other miscellaneous income, net			-			102,458			163,528			115,779
Total other income (expense), net			586,773			(910,605	)		(834,207	)		(1,945,342	)
Net loss before discontinued operations			(4,200,890	)		(3,830,704	)		(10,276,316	)		(6,840,462	)
Loss from discontinued operations			(75,073	)		(1,165,680	)		(1,562,416	)		(9,251,861	)
Gain on disposal of assets from discontinued operations			22,835,777			-			22,835,777			-
Net income (loss)		$	18,559,804		$	(4,996,384	)	$	10,997,045		$	(16,092,323	)
Net loss per common share:
Basic		$	0.20		$	(0.06	)	$	0.11		$	(0.21	)
Diluted		$	0.20		$	(0.06	)	$	0.11		$	(0.21	)
Weighted average common shares outstanding:
Basic			94,626,027			76,914,576			101,950,115			77,015,904
Diluted			94,626,027			76,914,576			101,950,115			77,015,904

See accompanying notes to consolidated financial statements

4

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Maxim TEP, Inc.

Consolidated Statements of Stockholders’ Equity (Unaudited)

For the Six Months Ended June 30, 2008

														Additional									Total
		Preferred Stock						Common Stock						Paid-In			Accumulated			Treasury			Stockholders’
		Shares			Amount			Shares			Amount			Capital			Deficit			Stock			Equity (Deficit)
Balance at December 31, 2007			-		$	-			85,604,516		$	856		$	50,477,255		$	(89,244,111	)	$	-		$	(38,766,000	)
Common stock issued for cash			-			-			1,770,798			18			1,328,081			-			-			1,328,099
Common stock issued for services, employee			-			-			5,177,544			51			3,883,107			-			-			3,883,158
Common stock issued for services, non employee or employees			-			-			4,760,000			48			3,569,952			-			-			3,570,000
Common stock issued upon the conversion of debt and accrued interest, related party			-			-			7,199,788			72			5,399,769			-			-			5,399,841
Common stock issued upon the conversion of debt and accrued interest			-			-			21,722,223			217			16,291,450			-			-			16,291,667
Common stock issued in connection with sale of net revenue interests			-			-			900,000			9			674,991			-			-			675,000
Purchase of common stock, 25,000 shares, at cost			-			-			-			-			-			-			(1	)		(1	)
Common stock offering costs			-			-			-			-			(28,488	)		-			-			(28,488	)
Common stock warrants issued as offering costs			-			-			-			-			28,488			-			-			28,488
Common stock warrants issued in connection with notes payable, related parties			-			-			-			-			15,778			-			-			15,778
Common stock warrants issued to extend notes payable terms			-			-			-			-			5,734			-			-			5,734
Common stock warrants issued to extend notes payable terms, related party			-			-			-			-			4,096			-			-			4,096
Common stock warrants issued in connection with sale of net revenue interests			-			-			-			-			60,459			-			-			60,459
Common stock options issued to officers for services			-			-			-			-			307,885			-			-			307,885
Common stock options issued to non-employee directors for services			-			-			-			-			306,212			-			-			306,212
Common stock warrants granted for extension			-			-			-			-			10,076			-			-			10,076
Beneficiary conversion feature in connection with convertible note payable, related party			-			-			-			-			15,778			-			-			15,778
Preferred stock issued associated with debt conversion, related party			2,272,727			23			-			-			1,249,977			-			-			1,250,000
Preferred stock issued associated with debt conversion			3,181,818			32			-			-			1,749,968			-			-			1,750,000
Net income			-			-			-			-			-			10,997,045			-			10,997,045
Balance at June 30, 2008			5,454,545		$	55			127,134,869		$	1,271		$	85,350,568		$	(78,247,066	)	$	(1	)	$	7,104,827

5

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Maxim TEP, Inc

Consolidated Statements of Cash Flows (Unaudited)

		Six Months Ended June 30,
		2008			2007
Cash flows from continuing operating activities:
Net loss for continuing operations		$	(10,276,316	)	$	(6,840,462	)
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:
Depletion, depreciation and amortization			974,995			842,012
Accretion of asset retirement obligation			60,451			51,460
Gain on disposal of assets			(782,822	)		-
Impairment of investment			-			1,065,712
Amortization of debt discount			487,530			-
Amortization of deferred financing costs			69,970			945,612
Common stock issued for services, employee			3,883,158			-
Common stock issued for services, non employees			3,570,000			-
Common stock warrants issued to non-employees for services			70,535			-
Stock based compensation, options, officers			307,885			-
Stock based compensation, options, non employee directors			306,212			-
Changes in operating assets and liabilities, net of effects of acquisitions and divestitures:
Notes receivable			(306,000	)		-
Accounts receivable			(184,951	)		1,573,979
Other receivable			18,990			801,324
Inventories			-			375,021
Prepaid expenses and other current assets			16,266			(683,834	)
Other assets			8,342			(3,647	)
Accounts payable			(355,861	)		426,409
Accounts payable to operators						(627,311	)
Accrued payroll and related taxes and benefits			(206,960	)		134,866
Interest payable and accrued liabilities			977,190			(2,151,548	)
Interest expense accrued related to production payment			(103,773	)		(48,672	)
Deferred revenue and other liabilities			(55,000	)		(5,000	)
Net cash used in operating activities			(1,520,159	))		(4,144,079	)
Cash flows from continuing investing activities:
Capital expenditures for oil & gas properties			(259,159	)		(448,751	)
Capital expenditures for property & equipment			(1,251	)		(46,665	)
Proceeds from disposition of oil & gas properties			-			2,500,000
Change in oil and gas properties accrual			(627,949	))		290,175
Proceeds from sale of net revenue interests and sharing agreements			675,000			-
Proceeds from sale of other assets			-			500,000
Net cash provided by (used in) investing activities			(213,261	)		2,794,759
Cash flows from continuing financing activities:
Payment on production payment payable			-			(14,482	)
Proceeds - issuance of notes payable			100,000			-
Principal payments on notes payable			-			(629,475	)
Proceeds - issuance of notes payable - related parties			300,000			394,333
Principal payments on notes payable - related parties			(2,331	)		(130,000	)
Proceeds - issuance of common stock			1,328,099			-
Net cash provided by (used in) financing activities			1,725,768			(379,624	)
Cash flows from discontinued operations:
Operating activities
Net income (loss) from discontinued operations			21,273,361			(9,251,861	)
Gain on disposal of discontinued operations			(22,835,777	)		-
Cash flow from other operating assets and liabilities			1,562,416			8,906,073
Investing activity:

Proceeds from disposition of oil & gas properties			35,825,722
Capital expenditures for oil & gas properties						(500,000	)
Financing:
Repayment of debt			(35,825,722	)		-
Net cash used in discontinued operations			-			(845,788	)
Decrease in cash and cash equivalents			(7,751	)		(2,574,732	)
Cash and cash equivalents - beginning of year			166,412			2,965,893
Cash and cash equivalents - end of year		$	158,661		$	391,161

6

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Maxim TEP, Inc.

Consolidated Statements of Cash Flows (Continued) (Unaudited)

		Six Months Ended June 30,
		2008			2007
Supplementary cash flow information:
Cash paid for interest		$	248,097		$	556,726
Non-cash investing and financing activities:
Notes payable and accrued interst exchanged for common stock, related party		$	(150,000	)	$	-
Other liabilities exchanged for common stock, related party		$	150,000		$	-
Common stock exchanged for net revenue interest		$	675,000		$	-
Common stock issued upon conversion of debt & interest, related party		$	5,399,841		$	-
Common stock issued upon conversion of debt & interest		$	16,291,667		$	-
Notes payable and accrued interest exchanged for preferred stock		$	1,750,000		$	-
Notes payable and accrued interest exchanged for preferred stock, related party		$	1,250,000		$	-
Asset retirement obligation incurred		$	1,529		$	11,333
Common stock warrants granted in connection with NP, related party		$	15,778		$	-
Common stock warrants granted in connection with sale of net revenue interest		$	60,459		$	-
Common stock warrants granted to extend notes payable terms		$	5,734		$	291,665
Net payable issued in connection with purchase of oil and natural gas property		$	-		$	375,000
Common stock warrants granted to extend notes payable terms, related party		$	4,096		$	-
Common stock warrants granted to extend put agreement terms		$	10,076		$	-
Common stock warrants granted as offering costs, related party		$	-		$	606,000
Common stock warrants granted as offering costs		$	-		$	376,781
Beneficial conversion feature in connection with convertible debt, related parties.		$	15,778			-

 

See accompanying notes to consolidated financial statements

7

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Maxim TEP, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements

 

Note 1 -

Financial Statement Presentation

Organization and nature of operations

Maxim TEP, Inc. was formed in 2004 as a Texas corporation to acquire, develop, produce and exploit oil and natural gas properties. The Company’s major oil and natural gas properties are located in California, Kentucky, Arkansas, Louisiana and New Mexico. The Company’s executive offices are located in The Woodlands (Houston), Texas.

Going concern

 

The Company has done much to alleviate financial pressures from debt service by converting or repaying substantial portion of our outstanding debt and interest and by lowering our overall cash cost of operations through the significant reduction of personnel and general cost cutting measures. In the six months ended June 30, 2008, the Company has paid off and/or converted over $58.0 million in principal and interest owed related to indebtedness. Concurrently, in the same time period, the Company has undergone a major cost restructuring in an effort to streamline operations and transform the Company into an efficient operation. It has eliminated over 35 contracted and non contracted personnel at both the corporate and field levels with annualized saving of over $3.0 million. The cost reductions extended to consulting services and day to day operating costs which amounted to approximately $2.0 million in annual savings. While the Company has no future borrowings or funding sources available under existing financing arrangements, management believes that the reduction in debt and its enhanced balance sheet in conjunction with the cost restructurings will allow the Company to raise additional financings as additional capital expenditures will be necessary to develop the Company’s oil and natural gas properties, which consist primarily of proved reserves that are non-producing, before significant positive operating cash flows will be achieved. 

In addition, management continues to negotiate to settle certain trade payables with stock, deferral of certain scheduled payments, and sales of certain non-core properties, as considered necessary. In addition, management is pursuing business partnering arrangements for the acquisition and development of its properties as well as debt and equity funding through private placements. Without outside investment from the sale of equity securities, debt financing or partnering with other oil and natural gas companies, management now believes that operating activities and overhead expenses have been reduced to a pace that available operating cash flows will support.

Note 2 -

Summary of Significant Accounting Policies

Principles of consolidation

The accompanying unaudited consolidated financial statements are presented in accordance with U.S. generally accepted accounting principles.  The unaudited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after elimination of all significant intercompany transactions and balances.  The financial statements reflect necessary adjustments, all of which were of a recurring nature and are in the opinion of management necessary for a fair presentation.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  The Company believes that the disclosures presented are adequate to allow the information presented not to be misleading.  The financial statements included herein should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Registration Statement on Form 10 for the year ended December 31, 2007.

8

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Maxim TEP, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements

 

Note 2 -

Summary of Significant Accounting Policies (Continued)

Major Customers

The Company sold oil and natural gas production representing more than 10% of its oil and natural gas revenues as follows:

		Three Months Ended June 30,
		2008			2007
Interconn Resources, Inc. (1)			68	%		44	%
Lion Oil Trading & Transportation, Inc. (1)			15	%		8	%
Plains Marketing, LP (1)			-			9	%
Orchard Petroleum, Inc. (2)			16	%		38	%

		Six Months Ended June 30,
		2008			2007
Interconn Resources, Inc. (1)			53	%		39	%
Lion Oil Trading & Transportation, Inc. (1)			20	%		10	%
Plains Marketing, LP (1)			-			12	%
Orchard Petroleum, Inc. (2)			27	%		39	%

(1) The Company does not have a formal purchase agreement with this customer, but sells production on a month-to-month basis at spot prices adjusted for field differentials.

(2) Orchard Petroleum, Inc. is the operator of the Company’s wells in California and sells production on the Company’s behalf to Kern Oil & Refining, Co. and Aera Energy, LLC.

 

Accounting estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods reported. Actual results could differ from these estimates.

Significant estimates include volumes of oil and natural gas reserves used in calculating depletion of proved oil and natural gas properties, future net revenues and abandonment obligations, impairment of proved and unproved properties, future income taxes and related assets and liabilities, the fair value of various common stock, warrants and option transactions, and contingencies. Oil and natural gas reserve estimates, which are the basis for unit-of-production depletion and the calculation of impairment, have numerous inherent uncertainties. The accuracy of any reserve estimate is a function of the quality of available data, the engineering and geological interpretation and judgment. Results of drilling, testing and production subsequent to the date of the estimate may justify revision of such estimate. Accordingly, reserve estimates are often different from the quantities of oil and natural gas that are ultimately recovered. In addition, reserve estimates are 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 be volatile in the future.

 

These significant estimates are based on current assumptions that may be materially effected by changes to future economic conditions such as the market prices received for sales of volumes of oil and natural gas, interest rates, the fair value of the Company’s common stock and corresponding volatility, and the Company’s ability to generate future taxable income. Future changes to these assumptions may affect these significant estimates materially in the near term.

9

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Maxim TEP, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements

 

Note 2 -

Summary of Significant Accounting Policies (Continued)

Oil and natural gas properties

The Company accounts for its oil and natural gas operations using the successful efforts method of accounting. Under this method, all costs associated with property acquisitions, successful exploratory wells, all development wells, including dry hole development wells, and asset retirement obligation assets are capitalized. Additionally, interest is capitalized while wells are being drilled and the underlying property is in development. Costs of exploratory wells are capitalized pending determination of whether each well has resulted in the discovery of proved reserves. Oil and natural gas mineral leasehold costs are capitalized as incurred. Items charged to expense generally include geological and geophysical costs, costs of unsuccessful exploratory wells, and oil and natural gas production costs. Capitalized costs of proved properties including associated salvage are depleted on a well-by-well or field-by-field (common reservoir) basis using the units-of-production method based upon proved producing oil and natural gas reserves. Dispositions of oil and natural gas properties are accounted for as adjustments to capitalized costs with gain or loss recognized upon sale. A gain (loss) is recognized to the extent the sales price exceeds or is less than original cost or the carrying value, net of impairment. Oil and natural gas properties are also subject to impairment at the end of each reporting period. Unproved property costs are excluded from depletable costs until the related properties are developed. See impairment discussed in “Long-lived assets and intangible assets” below.

We depreciate other property and equipment using the straight-line method based on estimated useful lives ranging from five to 10 years.

Long-lived assets and intangible assets

The Company accounts for intangible assets in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, "Accounting for Goodwill and Other Intangible Assets .” Intangible assets that have defined lives are subject to amortization over the useful life of the assets. Intangible assets held having no contractual factors or other factors limiting the useful life of the asset are not subject to amortization but are reviewed at least annually for impairment or when indicators suggest that impairment may be needed.

 

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with SFAS No. 144, “ Accounting for the Impairment and Disposal of Long-Lived Assets” (“SFAS No. 144”). If the carrying amount of the asset, including any intangible assets associated with that asset, exceeds its estimated future undiscounted net cash flows, the Company will recognize an impairment loss equal to the difference between its carrying amount and its estimated fair value. The fair value used to calculate the impairment for a producing oil and natural gas field that produces from a common reservoir is first determined by comparing the undiscounted future net cash flows associated with total proved properties to the carrying value of the underlying evaluated property. If the cost of the underlying evaluated property is in excess of the undiscounted future net cash flows, the future net cash flows are used discounted at 10%, which the company believes approximates fair value, to determine the amount of impairment.

 

For unproved property costs, management reviews these investments for impairment on a property-by-property basis at each reporting period or if a triggering event should occur that may suggest that an impairment may be required.

Accordingly, the Company recorded $7,195,367 as impairment of proved oil and natural gas properties and related equipment on the South Belridge Field during the three months ended March 31, 2007 which is reflected within discontinued operations for the six months ended June 30, 2007. There was no impairment of proved or unproved properties required at June 30, 2008.

Asset retirement obligation

SFAS No. 143, “ Accounting for Asset Retirement Obligations,” requires that the fair value of the liability for asset retirement costs be recognized in an entity’s balance sheet, as both a liability and an increase in the carrying values of such assets, in the periods in which such liabilities can be reasonably estimated. The present value of the estimated future asset retirement obligation (“ARO”), as of the date of acquisition or the date at which a successful well is drilled, is capitalized as part of the costs of proved oil and natural gas properties and recorded as a liability. The asset retirement costs are depleted over the production life of the oil and natural gas property on a unit-of-production basis.

The ARO is recorded at fair value and accretion expense is recognized as the discounted liability is accreted to its expected settlement value. The fair value of the ARO liability is measured by using expected future cash outflows discounted at the Company’s credit adjusted risk free interest rate.

10

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Maxim TEP, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements

 

Note 2 -

Summary of Significant Accounting Policies (Continued)

Amounts incurred to settle plugging and abandonment obligations that are either less than or greater than amounts accrued are recorded as a gain or loss in current operations. Revisions to previous estimates, such as the estimated cost to plug a well or the estimated future economic life of a well, may require adjustments to the ARO and are capitalized as part of the costs of proved oil and natural gas property.

The following table is a reconciliation of the ARO liability for continuing operations for the three months and six months ended June 30:

		Three Months Ended June 30,						Six Months Ended June 30,
		2008			2007			2008			2007
Asset retirement obligation at beginning of period		$	1,553,406		$	1,197,168		$	1,506,304		$	1,132,137
Liabilities incurred			-			-			1,529			11,333
Dispositions			(362,666	)		(80,412	)		(348,924	)		(66,576	)
Accretion expense			28,620			25,434			60,451			51,460
Asset retirement obligation at end of period		$	1,219,360		$	1,773,652		$	1,219,360		$	1,773,652

 

Income taxes

The Company accounts for income taxes in accordance with the provisions of SFAS No. 109, “ Accounting for Income Taxes .” Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. Deferred tax assets include tax loss and credit carryforwards and are reduced by a valuation allowance if, based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

On January 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “ Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48 prescribes a measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return.  Additionally, FIN 48 provides guidance regarding uncertain tax positions relating to derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  The Company will classify any interest and penalties associated with income taxes as interest expense.  At June 30, 2008, the Company had no material uncertain tax positions and the tax years 2004 through 2007 remained open to review by federal and various state tax jurisdictions.

 

Stock based compensation

Beginning January 1, 2006, the Company adopted SFAS No. 123(R), “Accounting for Stock Based Compensation,” to account for its Incentive Compensation Plan (the “2005 Incentive Plan”). SFAS No. 123(R) requires all share-based payments to employees (which includes non-employee Board of Directors), including employee stock options, warrants and restricted stock, be measured at the fair value of the award and expensed over the requisite service period (generally the vesting period). The fair value of common stock options or warrants granted to employees is estimated at the date of grant using the Black-Scholes option pricing model by using the historical volatility of comparable public companies. The calculation also takes into account the common stock fair market value at the grant date, the exercise price, the expected life of the common stock option or warrant, the dividend yield and the risk-free interest rate.

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Maxim TEP, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements

 

Note 2 -

Summary of Significant Accounting Policies (Continued)

Under the 2005 Incentive Plan, the Company from time to time may issue stock options, warrants and restricted stock to acquire goods or services from third parties. Restricted stock, options or warrants issued to other than employees or directors are recorded on the basis of their fair value, which is measured as of the date required by Emerging Issues Task Force (“EITF”) Issue 96-18, “ Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” In accordance with EITF 96-18, the options or warrants are valued using the Black-Scholes model on the basis of the market price of the underlying equity instrument on the “valuation date,” which for options and warrants related to contracts that have substantial disincentives to non-performance, is the date of the contract, and for all other contracts is the vesting date. Expense related to the options and warrants is recognized on a straight-line basis over the shorter of the period over which services are to be received or the vesting period.

During the second quarter June 30, 2008, the Company granted options to purchase 574,156 shares, of the Company’s common stock vesting immediately at an exercise price of $0.75 per share to the new Chief Executive Officer for services provided. These options expire ten years from the date of grant. The estimated fair value of these stock options was determined on the grant date using the Black-Scholes option pricing model to be $246,641.

Earnings per share

Basic earnings per share is computed using the weighted average number of common shares outstanding. Diluted earnings per share reflects the potential dilutive effects of common stock equivalents such as options, warrants and convertible securities. Due to the Company incurring a net loss during the three months and six months ended June 30, 2007, basic and diluted loss per share are the same as all potentially dilutive common stock equivalents are anti-dilutive. Under SFAS No. 150, “ Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” entities that have issued mandatorily redeemable shares of common stock or entered into forward contracts that require physical settlement by repurchase of a fixed number of the issuer’s equity shares of common stock in exchange for cash shall exclude the common shares that are to be redeemed or repurchased in calculating basic and diluted earnings per share. For the six months ended June 30, 2008, the Company excluded 230,833 weighted average common shares outstanding for shares issued with put options that were recorded as a derivative liability within accrued liabilities, from its earnings per common share calculation.

 

Recently Issued Accounting Pronouncements

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) establishes principles and requirements to recognize the assets acquired and liabilities assumed in an acquisition transaction and determines what information to disclose to investors regarding the business combination. SFAS No. 141(R) is effective for business combinations for which the acquisition date is on or after the beginning of the first annual period beginning after December 15, 2008.

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statement—amendments of ARB No. 51.” SFAS No. 160 states that accounting and reporting for minority interests will be recharacterized as non-controlling interests and classified as a component of equity.  The statement also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners.  SFAS No. 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding non-controlling interest in one or more subsidiaries or that deconsolidate a subsidiary.  This statement is effective as of the beginning of an entity’s first fiscal year beginning after December 15, 2008. The Company currently has no subsidiary subject to this standard and does not expect a material impact from SFAS No. 160 on its consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. The provisions of SFAS 161 are effective for the fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the impact of adopting SFAS 161 on its consolidated financial statement disclosures.  

 

On May 9, 2008 the FASB issued FASB Staff Position APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” APB 14-1 requires the issuer to separately account for the liability and equity components of convertible debt instruments in a manner that reflects the issuer’s nonconvertible debt borrowing rate. The guidance will result in companies recognizing higher interest expense in the statement of operations due to amortization of the discount that results from separating the liability and equity components. APB 14-1 will be effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company is currently evaluating the impact of adopting APB 14-1 on it consolidated financial statements.

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Maxim TEP, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements

 

Note 3 -

Debt

Notes payable consists of the following at June 30, 2008 and December 31, 2007:

 

		June 30, 2008			December 31, 2007
Notes payable		$	500,000		$	400,000
Notes payable, related party			-			3,597,001
Convertible notes payable			-			7,750,000
Convertible notes payable, discontinued operations			-			37,408,772
Convertible notes payable, related party			700,000			3,270,000
			1,200,000			52,425,773
Less unamortized debt discount			-			(455,976	)
			1,200,000			51,969,797
Less current maturities:
Notes payable, net of discount			(500,000	)		(43,808,772	)
Notes payable, related party, net of discount			(700,000	)		(5,161,025	)
Notes payable, net of current maturities and discount		$	-		$	3,000,000

Notes payable

The Company issued note payable to an individual investor aggregating $400,000 at June 30, 2008. This notes payable matured on September 30, 2007 bearing interest at fixed rates of 18%. Simple interest will accrue from the note issue date and is due and payable either at maturity or quarterly or semi-annually until maturity. The Company is in default on this note payable at June 30, 2008 and is in the process of renegotiating its terms. This note payable in default is accruing interest at an additional 10% (28%) and additional late fees may apply. This note payable is unsecured. During the second quarter, the Company borrowed an additional $100,000 from an individual. The note is a demand note payable at any time. This note payable is unsecured.

Convertible notes payable

Maxim TEP, PLC, South Belridge and Orchard Petroleum

During April 2008, the Company sold its South Belridge Field in a three party transaction that involved Mercuria Partners, a majority shareholder in Orchard Petroleum, and Maxim TEP, PLC as an all inclusive deal to eliminate all debt, joint interest rights and obligations amongst all three parties, for a cash consideration of $35,781,654 and the issuance of 21,700,000 shares of common stock of the Company issued to Maxim TEP, PLC. With this cash and stock consideration, the Company retired $37,408,772 in current notes payable and approximately $6,068,427 in interest payable. South Belridge Field had a carrying cost of $4,366,422 at the date of closing. At the closing of this transaction, the Company had no further interest, rights or obligations in the South Belridge Field and has satisfied in full all debt, interests and other obligations owed to Maxim TEP, PLC and its parent, the Greater European Fund, as well as any interest, rights or obligations under the Joint Venture agreement with Orchard Petroleum. The financial results of the Company’s South Belridge operations are reported as discontinued operations for all periods presented.

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Maxim TEP, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements

 

Note 3 -

Debt (Continued)

Convertible notes payable (continued)

Days Creek Field

During November 2006, the Company entered into three convertible notes payable totaling $2,000,000 each ($6,000,000 in total) bearing interest at a rate of 10% which matured on October 31, 2007, secured by the leases in the Days Creek Field. These notes payable were originally convertible into shares of the Company’s common stock at an exchange rate of $1.50 per share, or into approximately 4,000,000 shares of common stock. These notes are collateralized by the Company’s oil and natural gas properties in Days Creek. During 2007, the maturity dates on these notes were extended to mature on February 1, 2008, whereby the Company agreed to pay an additional $300,000 to the note holders as a fee for the extension. In February 2008, these notes were extended again to mature on April 30, 2008 for an additional extension fee of $300,000 and the exchange rate of $1.50 per share was amended to $0.75 per share, resulting in the $6,000,000 in convertible notes being convertible into 8,000,000 shares of common stock. In May of 2008, the Company exchanged a 75% working interest in its Days Creek field in consideration for the $6,000,000 convertible note that it owed to the three note holders (“each holding a $2,000,000 note”) effective May 1, 2008, keeping a net 10% working interest in the field. The Company and the note holders are currently negotiating the accounts payables due to vendors for the field that are currently owed by the Company and all interest and fees charged by the note holders to the Company.

 

Other

During the six month ended June 30, 2008, related party note holders converted notes payable of $420,000 and $8,841 of accrued interest into 571,788 share of the Company’s common stock at a conversion rate of $0.75 share. In case of early extinguishment, any unamortized debt discount or loan origination costs were recorded to interest expense.

During the second quarter of 2008, a related party holding of a note payable of $1,200,000 with a 20% imputed interest rate, maturing in one year from the note date converted the note payable into common stock of the Company at a conversion rate of $0.75 per dollar of principal. The entire outstanding balance of $1,200,000 was converted into 1,600,000 shares of the Company’s common stock.

During the second quarter of 2008, the Company converted $3,000,000 of corporate notes to 5,454,545 shares of Series A Preferred Stock which were originally associated with the purchase in October, 2007 of various working interests in certain wills located in the South Belridge Field from several individuals, totaling $3,000,000.

Beneficial conversion features

From time to time, the Company may issue convertible notes that have detached warrants and may contain an imbedded beneficial conversion feature. A beneficial conversion feature exists on the date a convertible note is issued when the fair value of the underlying common stock to which the note is convertible into is in excess of the remaining unallocated proceeds of the note after first considering the allocation of a portion of the note proceeds to the fair value of the warrants, if related warrants have been granted. In accordance with EITF 00-27 “ Application of Issue No. 98-5 to  Certain Convertible Instruments ,” the intrinsic value of the beneficial conversion feature is recorded as a debt discount with a corresponding amount to additional paid in capital. The debt discount is amortized to interest expense over the life of the note using the interest method. There were no transactions recorded in the second quarter.

Production Payment with BlueRock Energy Capital, LTD

Effective May 1, 2008, the Company finalized its negotiations with BlueRock Energy Capital, LTD (“BlueRock”) to restructure its monthly production payment facility on its Marion Field. The new agreement calls for a reduction of the interest rate from its current 18% to 8% and to give back to the Company up to $25,000 of its production payment per month so that the field would be cash flow positive. The Company’s obligations under these new terms would be to seek refinancing of the production payment payable or the outright purchase of the production payable by no later than the anniversary of the execution of the new agreement. Should the Company not meet this obligation, BlueRock has the option of taking back the field in full payment of the production payment payable or revert back to the previous terms under the existing agreement.