Joseph D. Steffe & Associates Due Diligence Services DUE DILIGENCE REPORT MANNON L. WALTERS, LLC PROGRAM MANNON OIL 2007A LP PROGRAM REVIEW July 18, 2007 Prepared for: MANNON OIL, LLC Prepared By: Joseph D. Steffe & Associates Analyst: Joseph D. Steffe 11188 Provencal Place San Diego, CA 92128 Phone: (858) 451-3401 Cell: (858) 414-3415 Email: email@example.com BIOGRAPHICAL INFORMATION Joseph D. Steffe & Associates Joseph D. Steffe & Associates was formed in 2004 to provide third party due diligence and consulting services to the broker dealer community. The firm was founded with the philosophy that broker dealers want more from their due diligence reports and less. We specialize in performing on-site inspections and drawing informed opinionated conclusions based on our work. You will find our reports to be fair and balanced in a concise, opinionated manner. We also provide consulting services designed to help newer sponsor’s structure offerings, develop due diligence and marketing materials and advise them on the nuances of working with the broker dealer community. Our firm produces three basic types of reports. This is driven by the needs of the broker dealer and/or the sponsor. Full Sponsor and Program Report…An on-site is performed and reports written outlining our findings at the sponsor level and an analysis of the current program. Program Review Only…No on-site is conducted and the report is based on an analysis of the current offering only. Program Pro/Con Analysis…No on-site is performed and a two-page pro/con analysis is produced. Mr. Steffe’s due diligence career began in 1983 as an intern at Private Ledger reviewing tax shelter limited partnerships. Upon receiving a BS degree in Finance from San Diego State University, Mr. Steffe worked on the retail side of the business at New England Life. In 1984 Mr. Steffe was offered the position of Senior Analyst at Sentra Securities. From 1986 to 1992 and again from 1995 to 2000, Mr. Steffe worked for CI Holding. This is a holding company for three financial service subsidiaries. Mr. Steffe was a Director of the holding company, Vice President of PIM Financial Services, an NASD broker dealer, Vice President of Centurion Counsel, a Registered Investment Advisory firm, and President of Bishop Crown Investment Research, Inc., a contract due diligence firm. During his time at the company Mr. Steffe reviewed thousands of direct participation products, conducted over 300 on- sites and wrote over 500 research reports. Mr. Steffe has also served as the National Sales Manager for three different sponsors in the businesses of golf course development, investment advisory services and equipment leasing. Mr. Steffe has performed due diligence and written research reports on the following investment products: * 1031 TIC’s * Venture Capital * Receivables and Factoring * REIT’s * Private Equity * Investment Advisory * Mortgage REIT’s * Section 42 Tax Credits * Commodities * Equipment Leasing * Misc. Operating Businesses * Financing Transactions * 721 Exchange * IPO’s * Oil & Gas Mr. Steffe holds NASD licenses 6, 7, 24 and 66 INTRODUCTION Joseph D. Steffe & Associates (“Analyst”) has been retained by Mannon Oil, LLC (“Sponsor/Company”) to prepare a “Program Review” on Mannon Oil 2007 A LP (The “Program”). The engagement is for this Program only and may be extended for future offerings at the option of the Sponsor. The Analyst performed an on site visit to the offices of the Sponsor in July of 2005 and produced a sponsor report along with a report on the Mannon L. Walters 2005-A program. In addition a report was prepared on the Mannon Oil 2006 A offering. No report was prepared by the Analyst for the Mannon Oil 2006 B offering. No new on site was conducted for this review. This report will summarize the findings of the Analyst and will bring attention to the reader any questions, comments, concerns or suggestions based on the Analyst’s review. Both strengths and items for consideration will be discussed in a fair and balanced format. The information and documents provided by the Sponsor are believed to be true and accurate. The Analyst is not responsible for any omission of material facts or disclosures. This report is designed to summarize our findings and discuss the facts and issues in a short, concise manner. It should be read in conjunction with the due diligence materials and Private Placement Memorandum provided by the Sponsor. PLEASE NOTE THAT THIS IS A PROGRAM REPORT ONLY. ALTHOUGH SOME SPONSOR TOPICS WILL BE DISCUSSED THIS IS NOT INTENDED TO BE A COMPLETE SPONSOR REVIEW. NO NEW ON SITE WAS CONDUCTED AS PART OF THIS ENGAGEMENT. PROGRAM HIGHLIGHTS Program Name: Mannon Oil 2007 A LP Sponsor Name: Mannon Oil, LLC. (Managing General Partner/ MGP) Operator: Mannon L. Walters, Inc. Maximum Offering: $25,000,000 (May be divided into more than one partnership) Minimum Offering: $1,000,000 Program Type: Private Reg D. Program Structure: Limited Partnership Minimum Investment: $50,000 (one-half units may be available) Liquidity: Limited. See repurchase offer Asset Type: Oil & Gas Types of Wells: Developmental and up to 20% exploratory Location of Wells: White and Hamilton Counties, in southern Illinois and other areas such as north central Texas, southern Louisiana, several areas of Oklahoma, and eastern New Mexico Total # of Wells: 20 to 40 if maximum is raised. 10 wells if only minimum is raised. Turnkey Contract: Yes Suitability: Accredited only Projected Partnership Life: 25 to 30 years Cash Distributions: Monthly…To begin approximately nine months after the close of each partnership. Expected Payout: 36 to 48 months (cash on cash) / 24 to 36 months with tax benefits. Tax Benefits: 80% to 90% 1st year write-off ON-SITE INPECTION We performed an on-site visit to the offices of the Sponsor on August 18 and 19, 2005 located in Evansville, Indiana. We DID NOT perform a new on site visit for this report. THIS REPORT IS INTENDED TO BE “PROGRAM REVIEW” only. During the original on site we had an opportunity to visit with Mr. Walters, Ms. Morris and other employees. Everyone was very cooperative and willing to share any information requested. The offices were at the time located on the same site as Mr. Walters’s personal resident. There was nothing pretentious about Mr. Walters or his staff, they appear to be all very hard working and very dedicated. While in the offices we discussed such matters as the growth of the Company, economics of the transaction, technologies that have been applied to the site, Mr. Walters’s track record and accounting procedures. We gathered documents such as: tax returns, succession plan of Mr. Walters, production data for current wells, financial models and a variety of Program and securities related documents. The key to the visit was our inspection of the Illinois Basin well sites. The site is approximately one hour from their offices in Southern Illinois. We visited the active wells and most the sites for the 2005 Program. We had a brief chance to meet several field operators employed by the Company. One of the distinct advantages is the topography of the land. It is very flat and almost all farmland. Corn and soybeans are the crops of choice. This provides easy access to the well sites year around. In many cases wells are drilled in very difficult areas, which add to the cost and during bad weather may have to be shut in. The only infrastructure work necessary is to build roads for equipment access. On our return to the main offices we visited Countrymark Cooperative located in Mount Vernon, Indiana. They are about 39 miles from the wells and 10 miles from the Sponsor’s offices. This is where all the Sponsor’s programs sell all the oil. The oil produced by the partnerships will flow directly into storage tanks where it is picked up and delivered to Countrymark. Another advantage we see is the consolidation of the operation. Mr. Walters has lived and worked in this area for many years, they drill in their own “backyard” and the delivery system is easy and fast. PROGRAM REVIEW PROGRAM SUMMARY The current Program(2007 A) is a $25,000,000 private placement in one limited partnership. Mannon Oil, LLC is the Managing General Partner. Mannon L. Walters, LLC was the Managing General Partner of the 2005 programs, however, in 2006 the name has changed to Mannon Oil, LLC. According to the Sponsor this is the same entity. The name was changed simply to avoid confusing the MGP entity with Mannon L. Walters Inc., the driller-operator. The proceeds of the offering will be used to drill primarily developmental wells, with up to 20% of the proceeds used to drill exploratory wells. Investor General Partner Units are available as well as Limited Partner Units. Most, if not all, investors will come in as Investor General Partners in order to receive the tax benefits then convert to a Limited Partner after one- year. The write off is anticipated to be between 80% and 90% in the year the investment is made. A major drilling area lies in a region of southeastern Illinois, known as the Hamilton Warsaw Prospect Area. Since 1930, thousands of wells have been drilled including more than 20 by the Sponsor. The wells will be drilled at least 900 feet from producing wells. Each identified well is expected to have a minimum of 30,000 to 70,000 barrels of oil reserves. A turnkey drilling and completion contract will be in place, which will help protect the investors from any cost overruns during the drilling phase. The cost for each Illinois Warsaw well is $576,000 per well. The General Partner anticipates only 20% of the proceeds will be used to drill in the Illinois Basin. They have also taken a substantial position in Louisiana and Texas. The Old Glory field in northern Texas is comprised of over 2,000 acres surrounded by fields that have produced 28.8 million barrels of oil and 7.8 BCF of gas. The first phase to be developed is a 642-acre anomaly estimated to contain 3.9 million barrels of oil and 0.8 BCF of gas. The turnkey price of Old Glory wells is $1,250,000 per well. In addition, they have acquired 5,000 acres in the main Barnett Shale gas thoroughfare in a shallower portion of the basin. All these wells will be developmental. Further detail regarding proposed drilling activity, geology, location and general discussion on the oil and gas industry can be found in the PPM and will not be discussed in detail in this report. FEES The following is a breakdown of the fees: Commissions: 8.0% Due Diligence Allowance: 1.0% Administrative Expenses: 1.0% TOTAL: 10.0% 1) TURNKEY DRILLING AND COMPLETION…Each well in the Old Glory field will have a turnkey cost of drilling and completion to each partnership of $1,250,000. 2) COST OF PROSPECTS…The Managing General Partner will receive a credit to its capital account for each prospect representing approximately 43% of its capital contribution to the Program. 3) OPERATING AND ON-GOING COSTS…All operating, direct, and administrative costs will be paid in the same ratio as the related production revenues are being credited. 4) SHARING ARRANGEMENT…The Managing General Partner will receive 30% of all revenues. 5) PREFERRED RETURN…If, over the course of the 5-year “Preferred Return Period”, the cumulative cash distributed is less than 60% of the investors gross contributions, the investors’ share of income will be increased from 70% to 85% until the shortfall is made up. 6) PER WELL CHARGES…$350 per well per month for wells in the Illinois Basin, local rates in Texas, Louisiana and Oklahoma may differ. ECONOMICS There are no projections included in the PPM, however we asked the Sponsor to give us their expectations for production of the Illinois Basin wells. Description of Project: Lower risk, higher return potential Price of Oil: $55 to $60 Hit Rate: 90% 1st year tax write-off: 80% to 90% 1st check: Nine months to 1-year after well completed and placed online Payout: 36 to 48 months after all wells are completed and on line Life of Wells: 20 to 30 years Decline Curve: Flat for 1st year, 4% decline next 5 years, then level Potential Return: 7 times money back by 25th year 14 to 1 return after tax Projected Cash Flow: 12% per year for 1st five years NOTE: The Sponsor has stated the following in regards to wells outside the Illinois Basin. “Our criteria in selecting drilling prospects outside the Illinois Basin require that the economic opportunity equals or exceeds that represented by Illinois Basin wells with similar probability of success.” INSURANCE COVERAGES We have received and reviewed the insurance binder for the Sponsor’s Umbrella Excess Liability and Commercial General Liability coverage’s. The PPM sates that before drilling commences, the managing general Partner must have in place: Workers’ Compensation Commercial General Liability $10,000,000 Control of Well protection (Blowout protection) Property Damage Liability Automobile Liability of $1,000,000. Employers Liability of $500,000 Pollution Liability with $10 million umbrella ESCROW ACCOUNT We have received and reviewed. All appears to be in order and meets with rule 15c2-4. TRACK RECORD Although this is not a “Sponsor” review we felt it important to review the Sponsor’s drilling track record. This information is included in Schedule “A” in the PPM. During the period 1994 – 2000, Mannon L. Walters Inc. helped to organize six programs and since has organized four programs offered to the broker dealer community. The following is the “cash-on-cash” returns thus far NOT INCLUDING TAX BENEFITS. (Through 12/31/06) Program #1 345.44% Program #2 252.95% Program #3 65.39% Program #4 178.08% Program #5 147.40% Program #6 100.92% 2005 A-1 6.45% 2005 A-2 2.93% 2006 A 0.00% 2006 B 0.00% QUESTIONS & ANSWERS The following are questions we asked the General Partner prior to the 2006-A report, which we feel is still useful information to the reader. The following are the General Partner’s responses. QUESTION: There is a new General Partner for this Program. Why was the change made and how well capitalized is the new GP? ANSWER: We don’t have a new General Partner. We’ve simply changed the name of Mannon L. Walters LLC to Mannon Oil, LLC to better differentiate it from Mannon L. Walters Inc. We will have audited financial statements available shortly that will provide you with capitalization information but the preliminary statements indicate about $3.8 million in equity. QUESTION: Will there be up to as many as 3 partnerships in this Program like there were in 2005A? ANSWER: We've reduced the overall offering size from $30 million to $25 million to better accommodate the 500 participant limit with $50,000 units. As long as we average anything over a full unit per investor we'll be under the limitation. We do have the option of subdividing the offering into multiple partnerships (the memorandum does not specify how many). Our most likely scenario is that if the funds come in slowly we'll close a partnership about half way and end up with two partnerships. If the money comes in as quickly as it seems it probably will, we'll just let the program fill up as one partnership. QUESTION: Please list any significant changes between last year’s program and this one. ANSWER: The most significant change is the identity of drilling prospects across a half dozen states. The Illinois Basin, along with it being our company’s roots, continues to be an important part of our future plans. But we also slightly changed the investment structure – we reduced the offering expenses from 10.5% to 10% making the total write-off 90%, however we’ve made a provision that allows up to 10% of the investor capital to be applied to tangible equipment expense if necessary. QUESTION: What is the 1st year write off in the 2006 A Program? ANSWER: First year write-off will be a minimum of 80% and possible as much as 90%. QUESTION: How much money was raised in 2005? How much was expended? How many wells have been drilled? ANSWER: Last year’s program ultimately was sub-divided into 2 partnerships. Each closed with just over $14 million (total of a little over $28 million was raised). The two partnerships will ultimately participate in somewhere around 40 to 45 wells when all is said and done. QUESTION: What have been the results of the 2005A wells that have been drilled? ANSWER: So far we’ve continued to have 100% drilling success. QUESTION: What percent of the 2006A proceeds will be used to drill in Warsaw County, I.E. The Illinois Basin? ANSWER: Right around half the money from 2005 was spent in the Illinois Basin drilling not only Warsaw wells but also New Albany shale wells. For the 2006 programs we expect that to be around 20%. QUESTION: Have you exhausted the leases in Warsaw County? ANSWER: We haven’t exhausted the drilling prospects in Illinois. In fact, in the course of drilling the wells we already had defined last year, we’ve identified further expansion of the field and the New Albany wells extend well beyond what was anticipated at the beginning of the 2005 program. QUESTION: In last years program you contributed each well to the program for a cost of $154,500 each based on the formula discussed in the 2005A report. This appears to have changed in the current offering. Please clarify the cost the Program is paying for each well. ANSWER: We’ll continue to contribute Warsaw wells at the same prospect cost. Outside the Illinois Basin, we will apply the same formula basis as we used for the Warsaw wells in Illinois. For wells that are not PUDS, we will contribute the leases at cost. QUESTION: Has any other fees or sharing arrangements changed from the last program? ANSWER: Yes. We’ve reduced the overall offering costs from 10.5% to 10%. The Managing General Partner does not take any fees. The 10% in offering costs are allocated 7% for rep commissions; 1% for offering B-D due diligence & marketing costs; 1% for the Managing Broker Dealer and 1% for the partnership to cover its administrative and organization costs. This has slightly changed for the 2007 A offering. Commissions are 8%, due diligence 1%, and Administrative fees 1%. QUESTION: Has the economics changed from the last program to this one considering you will be drilling outside the Illinois Basin? ANSWER: Our criteria in selecting drilling prospects outside the Illinois Basin requires that the economic opportunity equals or exceeds that represented by Illinois Basin wells with similar probability of success. QUESTION: The PPM list several areas that you will be drilling in including: north central Texas, southern Louisiana, Oklahoma, and New Mexico. What is your experience in these regions? ANSWER: Aside from adding to our management team engineering, technical and geological experts in each of the areas into which we’ve expanded, we’ve formed strategic alliances with industry partners in those areas who also contribute to the expertise and experience. FINAL SPONSOR COMMENTS (2006 A Report) The economic success of our 2005 Oil and Gas Drilling Programs has opened the door to larger and more exciting opportunities in 2006 and 2007. This provides for our investors the possibility of much greater returns without increasing risk. With this growth, we have been able to retain the services of several key industry professionals and therefore our management and technical teams have grown significantly. The long term relationships that Mannon has developed over the years are now paying off in this dynamic and exciting time in the energy industry. The combination of our drilling capabilities, powerful industry relationships, and capital contributions from our partners will lead to great successes and significant returns for our Programs in 2006. FINAL SPONSOR COMMENTS (2007 A Report) Since 2005 the Company has significantly grown its infrastructure from both a technical and the administrative perspective. In addition to relocating our Evansville, Indiana offices into a commercial facility, we have added office facilities in the Dallas, Texas. Area to oversee operations of our Texas, Oklahoma, Louisiana and other gulf coast interests. We have successfully drilled and completed over 80 wells across six states since 2005. Both of our 2005 drilling partnerships have been distributing income checks for over a year, although, because the monthly distribution rate has not yet reached maturity, the Managing General Partner has been supplementing investor distributions through the implementation of the subordination feature since April 2007. The 2006-A partnership made one distribution at about nine months and both 2006-A and 2006-B are one to two months away from the commencement of regular monthly distributions. STRENGTHS 1) The Sponsor has substantial experience and has concentrated almost its’ entire business efforts on the Illinois Basin. A substantial, but not all, of the Program’s wells will be drilled in this region. 2) The wells in the Indiana Basin are very close to producing wells. 3) The Sponsor has spent time and money, approximately $4.7 million to prove up this area. 4) 3-D seismic has been done and confirms the areas potential production. 5) The risk of multiple dry holes seems remote. 6) The Sponsor originally agreed to get all related entities audited. However, we have not seen any audited financials on any of the prior programs. (See IFC #1) 7) It states in the PPM that each partnership interest will be properly recorded. 8) There is potential for substantial returns especially if oil prices remain high. 9) The track record of the Sponsor’s operating wells is in line with what is being promoted. 10) The fees in the Program seem reasonable. 10.0% front-end load. This has been reduced by one-half percent from last year’s program. 11) Strong 1st year write-off. 12) Short-term payout potential. . 13) They own their own rig, which is operated by a full time crew employed by an affiliate of the General Partner. 14) The 2005 program’s closed with over $28 million raised and divided into two partnerships. Combined there will be 40 to 45 wells drilled. 15) According to the General Partner they have continued to have 100% drilling success. 16) There will be a minimum of $10 million general liability insurance coverage in place. 17) The preferred return is a positive. 18) Simple and straightforward sharing arrangement. ITEMS FOR CONSIDERATION 1) The Sponsor and Company are predominately owned by Mr. Walters. Since last year he has significantly expanded the executive and professional staff. As the head of the company Mr. Walters still makes the final decisions, but not without the counsel of his advisors and executives. The decision making and integrity of the team will be paramount to the Program’s success. 2) The Sponsor is relatively new to the broker dealer community. Therefore, their ability to raise money and guarantee program diversification is a concern. In response, they have hired seasoned oil and gas wholesalers that should help with introductions. They raised $22,314,412 in the 2006 A program but only $3,910,679 in 2006 B through 12/31/06, which was only open for about 3 weeks between 12/7/06 through 12/31/06. 3) We have not seen any audited financial statements although we were told by the Sponsor these would be prepared on each program. The Sponsor states that the audits are currently underway and being conducted by KBA Group, a very substantial CPA firm with headquarters in Dallas, Texas. 4) The Managing General Partner was minimally capitalized at inception although the Company guarantees all liabilities. We suggested transferring certain assets from the Company to the MGP. We have not seen a financial statement yet for the 2005 and 2006 programs, however, we understand that the MGP’s net worth is now substantial. 5) When I first visited the company there did not appear to be much accounting depth and experience. I suggested at that time this would be an area that as the Sponsor grows they may want to add a CFO type person. Since that time the company has brought on board a Chief Financial Officer whose oil & gas investment program experience spans more than 25 years. He has implemented formal accounting control procedures and engaged outside CPA firms to prepare audited financial statements as well as provide both tax return preparation and general accounting services. 6) The operating costs and on-going expenses the Limited Partners will be responsible for are open ended. There are no cap or maximum expenses dictated in the PPM. 7 ) There is no way to determine the turnkey profit payable to the MGP. 8) The Sponsor will utilize a majority of the proceeds to drill in areas they have limited experience. At the time of our original on site the “story” of the Sponsor was its’ experience in the Illinois Basin and the number of wells drilled and the time leases were held awaiting for higher oil prices. Although the language in the PPM is vague it appears that less than 20% of the wells will be drilled in the Illinois Basin. However, the Company has added key professionals with significant experience in these areas of expanded operations. 9) To our knowledge the last 3rd party due diligence report prepared on the Sponsor was the one produced by our firm dated August of 2005. We have not visited the offices of the Sponsor since that time. 10) Due to an abundance amount of rain this past year several of the recently formed partnerships are behind projected cash distribution rates.
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