UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2006
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to __________
Commission file number: 000-51152
PETROHUNTER ENERGY CORPORATION
(Name of small business issuer as specified in its charter)
MARYLAND 98-0431245
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1875 LAWRENCE STREET, SUITE 1400, DENVER, COLORADO 80203
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (303) 572-8900
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, $0.001 PAR VALUE
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
State issuer's revenues for its most recent fiscal year: $35,656
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as of a
specified date within the past 60 days: $249,298,342 ON NOVEMBER 30, 2006
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 219,928,734 ON NOVEMBER 30, 2006
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report constitute
"forward-looking statements". These statements, identified by words such as
"plan", "anticipate," "believe," "estimate," "should," "expect" and similar
expressions include our expectations and objectives regarding our future
financial position, operating results and business strategy. These statements
reflect the current views of management with respect to future events and are
subject to risks, uncertainties and other factors that may cause our actual
results, performance or achievements, or industry results, to be materially
different from those described in the forward-looking statements. Such risks and
uncertainties include those set forth under the caption "Management's Discussion
and Analysis or Plan of Operation" and elsewhere in this Annual Report. We do
not intend to update the forward-looking information to reflect actual results
or changes in the factors affecting such forward-looking information. We advise
you to carefully review the reports and documents we file from time to time with
the Securities and Exchange Commission (the "SEC").
All subsequent written and oral forward-looking statements attributable
to us, or persons acting on our behalf, are expressly qualified in their
entirety by the cautionary statements. We assume no duty to update or revise our
forward-looking statements based on changes in internal estimates or
expectations or otherwise.
CURRENCIES
All amounts expressed herein are in US dollars unless otherwise
indicated.
GLOSSARY
Unless otherwise indicated in this document, oil equivalents are
determined using the ratio of six Mcf of natural gas to one barrel of crude oil,
condensate or natural gas liquids so that six Mcf of natural gas are referred to
as one barrel of oil equivalent.
AMI. Area of Mutual Interest.
API GRAVITY. A specific gravity scale developed by the American
Petroleum Institute (API) for measuring the relative density of various
petroleum liquids, expressed in degrees. API gravity is gradated in degrees on a
hydrometer instrument and was designed so that most values would fall between
10(degree) and 70(degree) API gravity. The arbitrary formula used to obtain this
effect is: API gravity = (141.5/SG at 60(degree)F) - 131.5, where SG is the
specific gravity of the fluid.
ANTICLINE. An arch-shaped fold in rock in which rock layers are
upwardly convex.
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BBL. One stock tank barrel, or 42 U.S. gallons liquid volume, used in
reference to oil or other liquid hydrocarbons.
BCF. One billion cubic feet of natural gas at standard atmospheric
conditions.
CAPITAL EXPENDITURES. Costs associated with exploratory and development
drilling (including exploratory dry holes); leasehold acquisitions; seismic data
acquisitions; geological, geophysical and land related overhead expenditures;
delay rentals; producing property acquisitions; other miscellaneous capital
expenditures; compression equipment and pipeline costs.
CARRIED INTEREST. The owner of this type of interest in the drilling of
a well incurs no liability for costs associated with the well until the well is
drilled, completed and connected to commercial production/processing facilities.
CENTIPOISE. A unit of measurement for viscosity equivalent to
one-hundredth of a poise.
COMPLETION. The installation of permanent equipment for the production
of oil or natural gas.
DARCY. A standard unit of measure of permeability. One darcy describes
the permeability of a porous medium through which the passage of one cubic
centimeter of fluid having one centipoise of viscosity flowing in one second
under a pressure differential of one atmosphere where the porous medium has a
cross-sectional area of one square centimeter and a length of one centimeter.
DEVELOPED ACREAGE. The number of acres that are allocated or assignable
to producing wells or wells capable of production.
DEVELOPMENT WELL. A well drilled within the proved area of an oil or
natural gas reservoir to the depth of a stratigraphic horizon known to be
productive.
EXPLOITATION. The continuing development of a known producing formation
in a previously discovered field. To make complete or maximize the ultimate
recovery of oil or natural gas from the field by work including development
wells, secondary recovery equipment or other suitable processes and technology.
EXPLORATION. The search for natural accumulations of oil and natural
gas by any geological, geophysical or other suitable means.
EXPLORATORY WELL. A well drilled to find and produce oil or natural gas
in an unproved area, to find a new reservoir in a field previously found to be
productive of oil or natural gas in another reservoir, or to extend a known
reservoir.
FIELD. An area consisting of either a single reservoir or multiple
reservoirs, all grouped on or related to the same individual geological
structural feature and/or stratigraphic condition.
FINDING AND DEVELOPMENT COSTS. The total capital expenditures,
including acquisition costs, and exploration and abandonment costs, for oil and
gas activities divided by the amount of proved reserves added in the specified
period.
GROSS ACRES OR GROSS WELLS. The total acres or wells, as the case may
be, in which we have a working interest.
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LEASE. An instrument which grants to another (the lessee) the exclusive
right to enter to explore for, drill for, produce, store and remove oil and
natural gas on the mineral interest, in consideration for which the lessor is
entitled to certain rents and royalties payable under the terms of the lease.
Typically, the duration of the lessee's authorization is for a stated term of
years and "for so long thereafter" as minerals are producing.
MBO. One thousand barrels of oil.
MCF. One thousand cubic feet of natural gas at standard atmospheric
conditions.
MMBO. One million barrels of oil
MMCF. One million cubic feet of natural gas.
NET ACRES OR NET WELLS. A net acre or well is deemed to exist when the
sum of our fractional ownership working interests in gross acres or wells, as
the case may be, equals one. The number of net acres or wells is the sum of the
fractional working interests owned in gross acres or wells, as the case may be,
expressed as whole numbers and fractions thereof.
OPERATOR. The individual or company responsible to the working interest
owners for the exploration, development and production of an oil or natural gas
well or lease.
OVERRIDING ROYALTY. A revenue interest in oil and gas, created out of a
working interest which entitles the owner to a share of the proceeds from gross
production, free of any operating or production costs.
PARTICIPANT GROUP. The individuals and/or companies that, together,
comprise the ownership of 100% of the working interest in a specific well or
project.
PAYOUT. The point at which all costs of leasing, exploring, drilling
and operating have been recovered from production of a well or wells as defined
by contractual agreement.
PRODUCTIVE WELL. A well that is found to be capable of producing
hydrocarbons in sufficient quantities such that proceeds from the sale of the
production exceed production expenses and taxes.
PROSPECT. A specific geographic area which, based on supporting
geological, geophysical or other data and also preliminary economic analysis
using reasonably anticipated prices and costs, is deemed to have potential for
the discovery of commercial hydrocarbons.
PROVED RESERVES. The estimated quantities of oil, natural gas and
natural gas liquids which geological and engineering data demonstrate with
reasonable certainty to be commercially recoverable in future years from known
reservoirs under existing economic and operating conditions.
RE-ENTRY. Entering an existing well bore to redrill or repair.
RESERVES. Natural gas and crude oil, condensate and natural gas liquids
on a net revenue interest basis, found to be commercially recoverable.
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RESERVOIR. A porous and permeable underground formation containing a
natural accumulation of producible natural gas and/or oil that is confined by
impermeable rock or water barriers and is separate from other reservoirs.
ROYALTY. An interest in an oil and natural gas lease that gives the
owner of the interest the right to receive a portion of the production from the
leased acreage, or of the proceeds of the sale thereof, but generally does not
require the owner to pay any portion of the costs of drilling or operating the
wells on the leased acreage. Royalties may be either landowner's royalties,
which are reserved by the owner of the leased acreage at the time the lease is
granted, or overriding royalties, which are usually reserved by an owner of the
leasehold in connection with a transfer to a subsequent owner.
SPUD. To start the well drilling process by removing rock, dirt and
other sedimentary material with the drill bit.
TCF. One trillion cubic feet.
3-D SEISMIC. The method by which a three-dimensional image of the
earth's subsurface is created through the interpretation of reflection seismic
data collected over a surface grid. 3-D seismic surveys allow for a more
detailed understanding of the subsurface than do conventional surveys and
contribute significantly to field appraisal, exploitation and production.
UNDEVELOPED ACREAGE. Lease acres on which wells have not been drilled
or completed to a point that would permit the production of commercial
quantities of oil and gas regardless of whether or not such acreage contains
proved reserves.
WORKING INTEREST. An interest in an oil and gas lease that gives the
owner of the interest the right to drill and produce oil and gas on the leased
acreage and requires the owner to pay a share of the costs of drilling and
production operations. The share of production to which a working interest owner
is entitled will always be smaller than the share of costs that the working
interest owner is required to bear, with the balance of the production accruing
to the owners of royalties.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
PetroHunter Energy Corporation ("PetroHunter"), formerly Digital
Ecosystems Corp. ("Digital"), through the operations of its wholly owned
subsidiary, PetroHunter Operating Company, is a global oil and gas exploration
and production company with primary assets consisting of a working interest in
oil and gas leases and related interests in various oil and natural gas
prospects, including approximately 220,000 net acres in Colorado, Utah and
Montana and approximately seven million net acres in the Northern Territory of
Australia. The properties are managed and operated in three groups: Heavy Oil,
Piceance Basin, and Australia.
PetroHunter Operating Company (formerly GSL Energy Corporation) was
formed in June 2005 as a Maryland corporation, and on May 12, 2006 completed a
stock exchange by which its stockholders received more than 85% of Digital's
outstanding stock. The business of PetroHunter Operating Company became the
business of Digital. Subsequent to May 2006, Digital acquired all the remaining
outstanding stock of PetroHunter Operating Company, and effective August 14,
2006, Digital changed its name from Digital Ecosystems Corp. to PetroHunter
Energy Corporation and changed its domicile to Maryland. Digital was
incorporated on February 21, 2002 under the laws of the State of Nevada.
In October 2006, GSL Energy Corporation ("GSL") changed its name to
PetroHunter Operating Company. On November 8, 2005, GSL formed Paleotechnology,
Inc. ("Paleo") as a wholly-owned subsidiary for the purpose of exploring and
developing new products and processes using by-products of petroleum extraction
environments. On September 11, 2006, PetroHunter formed PetroHunter Heavy Oil
Ltd. as a wholly-owned subsidiary for the purpose of holding and developing its
heavy oil assets. PetroHunter formed PetroHunter Energy NT Ltd. on October 20,
2006 for the purpose of holding and developing its assets in the Northern
Territory of Australia. Collectively, PetroHunter and its subsidiaries are
referred to herein as the "Company," "we," "us" or "our".
Our principal executive offices are located at 1875 Lawrence Street,
Suite 1400, Denver, Colorado 80202. The telephone number is (303) 572-8900, the
facsimile number is (303) 572-8927 and our web site is WWW.PETROHUNTER.COM. Our
periodic and current reports filed with the Securities and Exchange Commission
(the "SEC") can be found on our web site at www.petrohunter.com and on the SEC's
website at www.sec.gov.
MAB RESOURCES LLC
Effective July 1, 2005, we entered into a Management and Development
Agreement (the "Development Agreement") with MAB Resources LLC ("MAB"). MAB is a
Delaware limited liability company controlled by Marc A. Bruner, our largest
shareholder. MAB is in the business of oil and gas exploration and development.
MAB has acquired various oil and gas properties and related assets through
several purchase and sale agreements and lease development agreements
(collectively, the "MAB/Third-Party Agreements").
Commencing shortly after our formation, we entered into a series of
exploration and development agreements (the "EDAs") and the Development
Agreement with MAB, under which MAB has assigned an undivided 50% working
interest in the oil and gas properties which MAB obtained under the
MAB/Third-Party Agreements. Under the EDAs and the Development Agreement, MAB
has the continuing obligation to assign to us an undivided 50% working interest
in additional properties which
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MAB acquires (including leases, concessions, permits and related oil and gas
interests and assets) throughout the world, subject to reservation of a
specified overriding royalty and subject to our specified obligations certain of
which are described below.
All of the MAB/Third-Party Agreements establish one or more areas of
mutual interest ("AMIs"). In the course of negotiating each MAB/Third-Party
Agreement, MAB secured each selling party's obligation to obtain substantial
additional acreage and/or oil and gas leases (including producing properties)
within each AMI and to convey to MAB 100% of the working interest in each lease
and production asset obtained by seller. Under the EDAs and the Development
Agreement, we have a continuing right to acquire an undivided 50% working
interest in all such properties.
The Development Agreement sets forth: (a) MAB's obligation to assign to
us a minimum 50% undivided interest in any and all oil and gas assets which MAB
acquires from third parties in the future; and (b) our long-term relationship
with MAB regarding the ownership and operation of all jointly-owned properties.
Each of the Properties acquired is covered by a property-specific EDA that is
consistent with the terms of the Development Agreement.
Each EDA and the Development Agreement include the following material
terms:
o OWNERSHIP: MAB and we each own an undivided 50% working
interest in all oil and gas leases, production facilities, and
related assets (collectively, the "Properties").
o OPERATOR: We are named as Operator, and have appointed a
related controlled entity, MAB Operating Company LLC, as
sub-operator. MAB and we will sign a joint operating
agreement, governing all operations.
o COSTS AND REVENUES: Each party pays its proportionate share of
costs and receives its proportionate share of revenues,
subject to us bearing the following burdens:
a) MAB OVERRIDING ROYALTY INTEREST: Each assignment of
Properties from MAB to us reserves an overriding
royalty equivalent to 3% of 8/8ths (proportionately
reduced to 1.5% of our undivided 50% working interest
in the Properties) (the "MAB Override"), payable out
of production and sales.
b) PROJECT COSTS: Each EDA provides that we shall pay
100% of the cost of acquisitions and operations
("Project Costs") up to a specified amount, after
which time each party shall pay its proportionate 50%
share of such costs. The maximum specified amount of
Project Costs of which we must pay 100%, under the
Development Agreement for Properties acquired in the
future, is $100 million for each Property or project
acquired in the future. There is no "before payout"
or "after payout" in the traditional sense of a
"carried interest" because our obligation to expend
the specified amount of Project Costs and MAB's
receipt of its 50% share of revenues apply without
regard to whether "payout" has occurred. Therefore,
our payment of all Project Costs up to such specified
amount might occur BEFORE actual payout, or might
occur AFTER actual payout, depending on each project
and set of Properties.
c) PROJECT DEVELOPMENT COSTS: Under the Development
Agreement, we pay to MAB a monthly advance of Project
Development Costs representing a specified portion of
MAB's "carried" Project Costs. The total amount of
such advances
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paid to MAB by us will be deducted from MAB's portion
of the Project Costs carried by us.
o RIGHTS AND OBLIGATIONS: MAB conveys to us an undivided 50%
working interest in all rights and benefits under each EDA
(such as additional Assets acquired under AMIs), and we assume
our share of all duties and obligations under each EDA (such
as drilling and development obligations).
Effective January 1, 2007, we entered into an Acquisition and
Consulting Agreement with MAB, which replaces the previous joint ownership
agreement between the parties. Under the new agreement, MAB has relinquished and
assigned to us all of MAB's 50% working interest, resulting in us now owning
100% working interest in the leases, permits and licenses covering 7.2 million
net mineral acres that were previously owned 50/50. As a direct result of that
assignment, MAB's carried interest (totaling 50% of our estimated $700 million
in capital expenditures) is void and no longer applicable. In addition, MAB's
monthly advance payments of Project Development Costs ($600,000 as of December
31, 2006) are replaced with a monthly consulting fee of $25,000 and monthly
payments of $225,000 under the $13.5 million promissory note.
In consideration for MAB's full relinquishment of its working interest
and the carried interest, and the reduction in the monthly payment, and in
connection with MAB's ongoing consulting services, our new agreement with MAB
provides for the following consideration to MAB:
a) The new agreement increases MAB's previous 3% overriding
royalty interest to a 10% override. However, one-half of the
override (5%) is deferred for a three-year period, during
which time we receive the cash attributable to that 5% portion
of the override, with such amount to be repaid at the end of
the three-year period.
b) The new agreement provides for the issuance of 50 million
shares of our common stock to MAB.
c) MAB has the right and opportunity to receive up to an
additional 50 million shares, to be held in escrow and
released over a five-year period in specified numbers of
shares that are tied to our performance in booking reserves.
The agreement provides for thresholds, beginning with the
issuance of the first five million shares if and when we
achieve proved reserves of 150 billion cubic feet of gas. All
50 million shares would be issued to MAB if and when we book
one trillion cubic feet of proved reserves by January 1, 2012.
If we do not achieve one trillion cubic feet of proved
reserves by that date, the balance of shares in escrow, if
any, will be returned to us.
d) MAB will receive a promissory note in the principal amount of
$13.5 million, payable in arrears by monthly installments of
$225,000, commencing January 31, 2007, accruing interest at
the London Interbank Offered Rate (LIBOR) (to be adjusted
quarterly), and which shall be unsecured and subordinated to
any other indebtedness in existence as of the date of the
agreement or which is incurred by us or any affiliate or
subsidiary in the future.
The transfer of MAB's working interest for our shares (including the
carried interest), the revised override and MAB foregoing monthly capital cost
advances, will be analyzed in an independent economic evaluation, and the
closing of this agreement, which is to occur by the end of January 2007, will be
subject to such evaluation concluding that the consideration exchanged by the
parties reflects a fair and reasonable market value for us.
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PROPOSED ACQUISITION OF POWDER RIVER BASIN PROPERTIES
On December 29, 2006, we entered into a Purchase and Sale Agreement
(the "PSA") with Galaxy Energy Corporation ("Galaxy") and its wholly owned
subsidiary, Dolphin Energy Corporation ("Dolphin"). Pursuant to the PSA, we
agreed to purchase all of Galaxy's and Dolphin's oil and gas interests in the
Powder River Basin of Wyoming and Montana (the "Powder River Basin Assets").
Marc A. Bruner, who is our largest shareholder, also is a 14.3%
beneficial shareholder of Galaxy. Marc A. Bruner is the father of Marc E.
Bruner, the President, Chief Executive Officer and director of Galaxy. Marc E.
Bruner is the stepson of Carmen J. Lotito, the Chief Financial Officer and a
director of the Company.
The purchase price for Powder River Basin Assets is $45 million, with
$20 million to be paid in cash and $25 million to be paid in shares of our
common stock at the rate of $1.50 per share.
Closing of the transaction is subject to approval by Galaxy's secured
noteholders, approval of all matters in its discretion by our Board of
Directors, including the Company obtaining outside financing on terms acceptable
to its Board of Directors, and various other terms and conditions. Either party
may terminate the agreement if closing has not occurred by February 28, 2007.
Within ten (10) days of signing the PSA, we were required and did make
an initial earnest money payment of $1.4 million. On or before January 31, 2007,
we will make an additional earnest money payment of $600,000. In the event the
closing does not occur for any reason other than a material breach by us, the
deposit shall convert into a promissory note (the "Note"), payable to us, and
shall be an unsecured subordinated debt of both Galaxy and Dolphin, which is
payable only after repayment of Galaxy's and Dolphin's senior indebtedness.
We became the contract operator of the Powder River Basin Assets
beginning January 1, 2007. At closing, the operating expenses incurred by us as
the contract operator will be credited toward the purchase price, or if closing
does not occur, will be added to the principal amount of the Note.
MAB has orally agreed to guarantee the performance of Galaxy and
Dolphin under the PSA (including but not limited to all their obligations under
the Note), and has orally agreed to reimburse us for certain losses and damages
which might be incurred as a result of those parties entering into the PSA. We
expect that a written agreement will be entered into by the parties prior to
closing.
PALEO
On November 14, 2006, we, through our subsidiary, Paleo, and the Box
Hill Institute signed an agreement which commenced a five-year research
collaboration with the BioSkills Specialist Centre for Biotechnology Training at
the Box Hill Institute in Melbourne, Australia. As part of the agreement, Paleo
and the Box Hill Institute share laboratory space and offer training
opportunities for Box Hill students. The team will target a broad array of
applications including energy/petrochemical, environmental remediation, timber
and plant resources, agricultural and consumer products.
COMPETITION
We operate in the highly competitive oil and gas areas of acquisition
and exploration, areas in which other competing companies have substantially
larger financial resources, operations, staffs and facilities. Such companies
may be able to pay more for prospective oil and gas properties or prospects
9
and to evaluate, bid for and purchase a greater number of properties and
prospects than our financial or human resources permit.
EMPLOYEES
At December 31, 2006, we had 16 full time employees and 16 total
employees.
ENVIRONMENTAL MATTERS
Operations on properties in which we have an interest are subject to
extensive federal, state and local environmental laws that regulate the
discharge or disposal of materials or substances into the environment and
otherwise are intended to protect the environment. Numerous governmental
agencies issue rules and regulations to implement and enforce such laws, which
are often difficult and costly to comply with and which carry substantial
administrative, civil and criminal penalties and in some cases injunctive relief
for failure to comply.
Some laws, rules and regulations relating to the protection of the
environment may, in certain circumstances, impose "strict liability" for
environmental contamination. These laws render a person or company liable for
environmental and natural resource damages, cleanup costs and, in the case of
oil spills in certain states, consequential damages without regard to negligence
or fault. Other laws, rules and regulations may require the rate of oil and gas
production to be below the economically optimal rate or may even prohibit
exploration or production activities in environmentally sensitive areas. In
addition, state laws often require some form of remedial action, such as closure
of inactive pits and plugging of abandoned wells, to prevent pollution from
former or suspended operations.
Legislation has been proposed in the past and continues to be evaluated
in Congress from time to time that would reclassify certain oil and gas
exploration and production wastes as "hazardous wastes." This reclassification
would make these wastes subject to much more stringent storage, treatment,
disposal and clean-up requirements, which could have a significant adverse
impact on our operating costs. Initiatives to further regulate the disposal of
oil and gas wastes are also proposed in certain states from time to time and may
include initiatives at the county, municipal and local government levels. These
various initiatives could have a similar adverse impact on our operating costs.
The regulatory burden of environmental laws and regulations increases
our cost and risk of doing business and consequently affects our profitability.
The federal Comprehensive Environmental Response, Compensation and Liability
Act, or CERCLA, also known as the "Superfund" law, imposes liability, without
regard to fault, on certain classes of persons with respect to the release of a
"hazardous substance" into the environment. These persons include the current or
prior owner or operator of the disposal site or sites where the release occurred
and companies that transported, disposed or arranged for the transport or
disposal of the hazardous substances found at the site. Persons who are or were
responsible for releases of hazardous substances under CERCLA may be subject to
joint and several liability for the costs of cleaning up the hazardous
substances that have been released into the environment and for damages to
natural resources, and it is not uncommon for the federal or state government to
pursue such claims.
It is also not uncommon for neighboring landowners and other third
parties to file claims for personal injury or property or natural resource
damages allegedly caused by the hazardous substances released into the
environment. Under CERCLA, certain oil and gas materials and products are, by
definition, excluded from the term "hazardous substances." At least two federal
courts have held that certain wastes associated with the production of crude oil
may be classified as hazardous substances under CERCLA. Similarly, under the
federal Resource, Conservation and Recovery Act, or RCRA,
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which governs the generation, treatment, storage and disposal of "solid wastes"
and "hazardous wastes," certain oil and gas materials and wastes are exempt from
the definition of "hazardous wastes." This exemption continues to be subject to
judicial interpretation and increasingly stringent state interpretation. During
the normal course of operations on properties in which we have an interest,
exempt and non-exempt wastes, including hazardous wastes, that are subject to
RCRA and comparable state statutes and implementing regulations are generated or
have been generated in the past. The federal Environmental Protection Agency and
various state agencies continue to promulgate regulations that limit the
disposal and permitting options for certain hazardous and non-hazardous wastes.
We believe that the operator of the properties in which we have an
interest is in substantial compliance with applicable laws, rules and
regulations relating to the control of air emissions at all facilities on those
properties. Although we maintain insurance against some, but not all, of the
risks described above, including insuring the costs of clean-up operations,
public liability and physical damage, there is no assurance that our insurance
will be adequate to cover all such costs, that the insurance will continue to be
available in the future or that the insurance will be available at premium
levels that justify our purchase. The occurrence of a significant event not
fully insured or indemnified against could have a material adverse effect on our
financial condition and operations. Compliance with environmental requirements,
including financial assurance requirements and the costs associated with the
cleanup of any spill, could have a material adverse effect on our capital
expenditures, earnings or competitive position. We do believe, however, that our
operators are in substantial compliance with current applicable environmental
laws and regulations. Nevertheless, changes in environmental laws have the
potential to adversely affect our operations. At this time, we have no plans to
make any material capital expenditures for environmental control facilities.
RISK FACTORS
RISKS RELATED TO OUR BUSINESS:
WE HAVE A LIMITED OPERATING HISTORY AND HAVE GENERATED ONLY VERY LIMITED
REVENUES. WE HAVE INCURRED SIGNIFICANT LOSSES AND WILL CONTINUE TO INCUR LOSSES
FOR THE FORESEEABLE FUTURE.
We are a development stage oil and gas company and have earned very
limited production revenue. Our principal activities have been raising capital
through the sale of our securities and identifying and evaluating potential oil
and gas properties.
The report of our independent registered public accounting firm on the
financial statements for the year ended September 30, 2006, includes an
explanatory paragraph relating to the uncertainty of our ability to continue as
a going concern. From inception to September 30, 2006, we have generated a
cumulative net loss of $22,810,834. For the 2007 fiscal year, we do not expect
our operations to generate sufficient cash flows to provide working capital for
our ongoing overhead, the funding of our lease acquisitions, and the exploration
and development of our properties. Without adequate financing, we may not be
able to successfully develop any prospects that we have or acquire and we may
not achieve profitability from operations in the near future or at all.
THE LACK OF PRODUCTION AND ESTABLISHED RESERVES FOR OUR PROPERTIES IMPAIRS OUR
ABILITY TO RAISE CAPITAL.
As of September 30, 2006, we have established very limited production
of natural gas from a limited number of wells, and have no properties for which
reserves have been established, making it more difficult to raise the amount of
capital needed to fully exploit the production potential of our properties.
Therefore, we may have to raise capital on terms less favorable than we would
desire. This may result in increased dilution to existing stockholders.
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TERMS OF SUBSEQUENT FINANCINGS MAY ADVERSELY IMPACT YOUR INVESTMENT.
We may have to engage in common equity, debt, or preferred stock
financing in the future. Your rights and the value of your investment in the
common stock could be reduced by any type of financing we do. Interest on debt
securities could increase costs and negatively impacts operating results, and
investors in debt securities may negotiate for other consideration or terms
which could have a negative impact on your investment. Preferred stock could be
issued in series from time to time with such designations, rights, preferences,
and limitations as needed to raise capital, and the terms of preferred stock
could be more advantageous to those investors than to the holders of common
stock. If we need to raise more equity capital from the sale of common stock,
institutional or other investors may negotiate terms at least as, and possibly
more, favorable than the terms of your investment. In addition, any shares of
common stock that we sell could be sold into the market and subsequent sales
could adversely affect the market price of our stock.
MARC A. BRUNER AND HIS AFFILIATES CONTROL A SIGNIFICANT PERCENTAGE OF OUR
OUTSTANDING COMMON STOCK, WHICH WILL ENABLE THEM TO CONTROL MANY SIGNIFICANT
CORPORATE ACTIONS AND MAY PREVENT A CHANGE IN CONTROL THAT WOULD OTHERWISE BE
BENEFICIAL TO OUR STOCKHOLDERS.
Marc A. Bruner beneficially owned approximately 33.4% of our common
stock as of November 30, 2006. Under the terms of the new Acquisition and
Consulting Agreement with MAB, he will acquire beneficial ownership of at least
50 million additional shares and up to as many as 100 million shares. This
control by Mr. Bruner could have a substantial impact on matters requiring the
vote of the stockholders, including the election of our directors and most of
our corporate actions. This control could delay, defer or prevent others from
initiating a potential merger, takeover or other change in our control, even if
these actions would benefit our stockholders and us. This control could
adversely affect the voting and other rights of our other stockholders and could
depress the market price of our common stock.
OUR OFFICERS, DIRECTORS, AND ADVISORS ARE ENGAGED IN OTHER BUSINESSES, WHICH MAY
RESULT IN CONFLICTS OF INTEREST.
Certain of our officers, directors, and advisors also serve as
directors of other companies or have significant shareholdings in other
companies. Marc A. Bruner, our largest shareholder, is the controlling owner of
MAB Resources LLC, the entity with which we have agreements affecting all of our
oil and gas properties. Mr. Bruner also serves as the chairman of the board of
Gasco Energy, Inc. and chairman of the board, chief executive officer and
president of Falcon Oil & Gas Ltd. ("Falcon"), and is involved with other
natural resource companies. He is a significant shareholder of Galaxy Energy
Corporation ("Galaxy") and the father of Galaxy's President, Marc E. Bruner. He
is also a significant shareholder of Exxel Energy Corp., a British Columbia
corporation, whose stock is traded on the TSX Venture Exchange. Carmen Lotito,
our Executive Vice President, Chief Financial Officer and Treasurer, is the
stepfather of Galaxy's President, Marc E. Bruner, a former officer and director
of Galaxy, and a director of Gasco Energy, Inc. To the extent that such other
companies participate in ventures in which we may participate, or compete for
prospects or financial resources with us, these officers and directors will have
a conflict of interest in negotiating and concluding terms relating to the
extent of such participation. In the event that such a conflict of interest
arises at a meeting of the board of directors, a director who has such a
conflict must disclose the nature and extent of his interest to the board of
directors and abstain from voting for or against the approval of such
participation or such terms.
In addition to the agreement with MAB Resources LLC, we have an office
sharing arrangement with Falcon and have entered into a purchase and sale
agreement with Galaxy to purchase its oil and gas interests in the Powder River
Basin of Wyoming and Montana.
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RESERVE ESTIMATES DEPEND ON MANY ASSUMPTIONS THAT MAY TURN OUT TO BE
INCONCLUSIVE, SUBJECT TO VARYING INTERPRETATIONS, OR INACCURATE.
Estimates of natural gas and oil reserves are based upon various
assumptions, including assumptions relating to natural gas and oil prices,
drilling and operating expenses, capital expenditures, ownership and title,
taxes and the availability of funds. The process of estimating natural gas and
oil reserves is complex. It requires interpretations of available geological,
geophysical, engineering and economic data for each reservoir. Therefore, these
estimates are inherently imprecise. Further, potential for future reserve
revisions, either upward or downward, is significantly greater than normal
because 100% of our reserves are undeveloped.
Actual natural gas and oil prices, future production, revenues,
operating expenses, taxes, development expenditures and quantities of
recoverable natural gas reserves will most likely vary from those estimated. Any
significant variance could materially affect the estimated quantities and
present value of future net revenues at any time. A reduction in natural gas and
oil prices, for example, would reduce the value of reserves and reduce the
amount of natural gas and oil that could be economically produced, thereby
reducing the quantity of reserves. At any time, there might be adjustments of
estimates of reserves to reflect production history, results of exploration and
development, prevailing natural gas prices and other factors, many of which are
beyond our control.
Undeveloped reserves, by their nature, are less certain. Recovery of
undeveloped reserves requires significant capital expenditures and successful
drilling operations. Any reserve data assumes that we will make significant
capital expenditures to develop our reserves. To the extent that we have
prepared estimates of our natural gas and oil reserves and of the costs
associated with these reserves in accordance with industry standards, we cannot
assure you that the estimated costs are accurate, that development will occur as
scheduled or that the actual results will be as estimated.
MARKET CONDITIONS OR OPERATION IMPEDIMENTS MAY HINDER OUR ACCESS TO NATURAL GAS
AND OIL MARKETS OR DELAY OUR PRODUCTION.
The marketability of our production depends in part upon the
availability, proximity and capacity of pipelines, natural gas gathering systems
and processing facilities. This dependence is heightened where this
infrastructure is less developed. Therefore, if drilling results are positive in
certain areas of the Properties, a new gathering system would need to be built
to handle the potential volume of gas produced. We might be required to shut in
wells, at least temporarily, for lack of a market or because of the inadequacy
or unavailability of transportation facilities. If that were to occur, we would
be unable to realize revenue from those wells until arrangements were made to
deliver production to market.
Our ability to produce and market natural gas and oil is affected and
also may be harmed by:
o the lack of pipeline transmission facilities or carrying capacity;
o government regulation of natural gas and oil production;
o government transportation, tax and energy policies;
o changes in supply and demand; and
o general economic conditions.
13
WE MIGHT INCUR ADDITIONAL DEBT IN ORDER TO FUND OUR EXPLORATION AND DEVELOPMENT
ACTIVITIES, WHICH WOULD CONTINUE TO REDUCE OUR FINANCIAL FLEXIBILITY AND COULD
HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION OR RESULTS
OF OPERATIONS.
If we incur indebtedness, our ability to meet our debt obligations and
reduce our level of indebtedness depends on future performance. General economic
conditions, oil and gas prices and financial, business and other factors affect
our operations and future performance. Many of these factors are beyond our
control. We cannot assure you that we will be able to generate sufficient cash
flow to pay the interest on our debt or that future working capital, borrowings
or equity financing will be available to pay or refinance such debt. Factors
that will affect our ability to raise cash through an offering of our capital
stock or a refinancing of our debt include financial market conditions, the
value of our assets and performance at the time we need capital. We cannot
assure you that we will have sufficient funds to make such payments. If we do
not have sufficient funds and are otherwise unable to negotiate renewals of our
borrowings or arrange new financing, we might have to sell significant assets.
Any such sale could have a material adverse effect on our business and financial
results.
WE HAVE SIGNIFICANT FUTURE CAPITAL REQUIREMENTS. IF THESE OBLIGATIONS ARE NOT
MET, OUR GROWTH AND OPERATIONS COULD BE NON-FUNCTIONAL.
Our future growth depends on our ability to make large capital
expenditures for the development of the working interests we have acquired. In
addition, we may acquire interests in additional oil and gas leases where we
will be required to pay for a specific amount of the initial costs and expenses
related to the development of those leases. We intend to finance our foreseeable
capital expenditures through additional fundings for which we have no
commitments at this time. Future cash flows and the availability of financing
will be subject to a number of variables, such as:
o the success of the leases;
o success in locating and producing new reserves; and
o prices of natural gas and oil.
Additional financing sources will be required in the future to fund
developmental and exploratory drilling. Issuing equity securities to satisfy our
financing requirements could cause substantial dilution to our existing
stockholders. Additional debt financing could lead to:
o a substantial portion of operating cash flow being dedicated to
the payment of principal and interest;
o the Company being more vulnerable to competitive pressures and
economic downturns; and
o restrictions on our operations.
Financing might not be available in the future, or we might not be able
to obtain necessary financing on acceptable terms, if at all. If sufficient
capital resources are not available, we might be forced to curtail drilling and
other activities or be forced to sell some assets on an untimely or unfavorable
basis, which would have an adverse affect our business, financial condition and
results of operations.
THE LEASES AND/OR FUTURE PROPERTIES MIGHT NOT PRODUCE AS ANTICIPATED, AND WE
MIGHT NOT BE ABLE TO DETERMINE RESERVE POTENTIAL, IDENTIFY LIABILITIES
ASSOCIATED WITH THE PROPERTIES OR OBTAIN PROTECTION FROM SELLERS AGAINST THEM,
WHICH COULD CAUSE US TO INCUR LOSSES.
Although we have reviewed and evaluated the leases in a manner
consistent with industry practices, this review and evaluation might not
necessarily reveal all existing or potential problems. This is also true for any
future acquisitions made by us. Inspections may not always be performed on every
14
well, and environmental problems, such as groundwater contamination, are not
necessarily observable even when an inspection is undertaken. Even when problems
are identified, a seller may be unwilling or unable to provide effective
contractual protection against all or part of those problems, and we often
assume environmental and other risks and liabilities in connection with the
acquired properties.
WE DO NOT PLAN TO INSURE AGAINST ALL POTENTIAL OPERATING RISKS. WE MIGHT INCUR
SUBSTANTIAL LOSSES AND BE SUBJECT TO SUBSTANTIAL LIABILITY CLAIMS AS A RESULT OF
OUR NATURAL GAS AND OIL OPERATIONS.
We do not intend to insure against all risks. We intend to maintain
insurance against various losses and liabilities arising from operations in
accordance with customary industry practices and in amounts that management
believes to be prudent. Losses and liabilities arising from uninsured and
underinsured events or in amounts in excess of existing insurance coverage could
have a material adverse effect on our business, financial condition or results
of operations. Our natural gas and oil exploration and production activities
will be subject to hazards and risks associated with drilling for, producing and
transporting natural gas and oil, and any of these risks can cause substantial
losses resulting from:
o environmental hazards, such as uncontrollable flows of natural
gas, oil, brine, well fluids, toxic gas or other pollution
into the environment, including groundwater and shoreline
contamination;
o abnormally pressured formations;
o mechanical difficulties, such as stuck oil field drilling and
service tools and casing collapse;
o fires and explosions;
o personal injuries and death;
o regulatory investigations and penalties; and
o natural disasters.
Any of these risks could have a material adverse effect on our ability
to conduct operations or result in substantial losses. We might elect not to
obtain insurance if we believe that the cost of available insurance is excessive
relative to the risks presented. In addition, pollution and environmental risks
generally are not fully insurable. If a significant accident or other event
occurs and is not fully covered by insurance, it could have a material adverse
effect on our business, financial condition and results of operations.
RISKS RELATING TO THE OIL AND GAS INDUSTRY:
A SUBSTANTIAL OR EXTENDED DECLINE IN NATURAL GAS AND OIL PRICES MAY ADVERSELY
AFFECT OUR ABILITY TO MEET OUR CAPITAL EXPENDITURE OBLIGATIONS AND FINANCIAL
COMMITMENTS.
Our revenues, operating results and future rate of growth are
substantially dependent upon the prevailing prices of, and demand for, natural
gas and oil. Declines in the prices of, or demand for, natural gas and oil may
adversely affect our financial condition, liquidity, ability to finance planned
capital expenditures and results of operations. Lower natural gas and oil prices
may also reduce the amount of natural gas and oil that we can produce
economically. Historically, natural gas and oil prices and markets have been
volatile, and they are likely to continue to be volatile in the future. A
decrease in natural gas or oil prices will not only reduce revenues and profits,
but will also reduce the quantities of reserves that are commercially
recoverable and may result in charges to earnings for impairment of the value of
these assets. If natural gas or oil prices decline significantly for extended
periods of time in the future, we might not be able to generate enough cash flow
from operations to meet our obligations and make planned capital expenditures.
Natural gas and oil prices are subject to wide fluctuations in response to
relatively minor changes in the supply of, and demand for, natural gas and oil,
market uncertainty and a
15
variety of additional factors that are beyond our control. Among the factors
that could cause this fluctuation are:
o changes in supply and demand for natural gas and oil;
o levels of production and other activities of the Organization
of Petroleum Exporting Countries, or OPEC, and other natural
gas and oil producing nations;
o market expectations about future prices;
o the level of global natural gas and oil exploration,
production activity and inventories;
o political conditions, including embargoes, in or affecting
other oil producing activity; and
o the price and availability of alternative fuels.
Lower natural gas and oil prices may not only decrease our revenues on
a per unit basis, but also may reduce the amount of natural gas and oil that we
can produce economically. A substantial or extended decline in oil or natural
gas prices may materially and adversely affect our business, financial condition
and results of operations.
DRILLING FOR AND PRODUCING NATURAL GAS AND OIL ARE HIGH-RISK ACTIVITIES WITH
MANY UNCERTAINTIES THAT COULD ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION
OR RESULTS OF OPERATIONS.
Our future success depends on the success of our exploration,
development and production activities of our leases. These activities are
subject to numerous risks beyond our control, including the risk that we will
not find any commercially productive natural gas or oil reservoirs. Our
decisions to purchase, explore, develop or otherwise exploit prospects or
properties will depend in part on the evaluation of data obtained through
geophysical and geological analyses, production data and engineering studies,
the results of which are often inconclusive or subject to varying
interpretations. The cost of drilling, completing and operating wells is often
uncertain before drilling commences. Overruns in budgeted expenditures are
common risks that can make a particular project uneconomical. Further, many
factors may curtail, delay or prevent drilling operations, including:
o unexpected drilling conditions;
o pressure or irregularities in geological formations;
o equipment failures or accidents;
o pipeline and processing interruptions or unavailability;
o title problems;
o adverse weather conditions;
o lack of market demand for natural gas and oil;
o delays imposed by or resulting from compliance with
environmental and other regulatory requirements;
o shortages of or delays in the availability of drilling rigs
and the delivery of equipment; and
o reductions in natural gas and oil prices.
Our future drilling activities might not be successful, and drilling
success rate overall or within a particular area could decline. We could incur
losses by drilling unproductive wells. Although we have identified numerous
potential drilling locations, we cannot be sure that we will ever drill them or
will produce natural gas or oil from them or from any other potential drilling
locations. Shut-in wells, curtailed production and other production
interruptions may negatively impact our business and result in decreased
revenues.
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COMPETITION IN THE OIL AND GAS INDUSTRY IS INTENSE, AND MANY OF OUR COMPETITORS
HAVE GREATER FINANCIAL, TECHNOLOGICAL AND OTHER RESOURCES THAN WE DO, WHICH MAY
ADVERSELY AFFECT OUR ABILITY TO COMPETE.
We operate in the highly competitive areas of oil and gas exploration,
development and acquisition with a substantial number of other companies. We
face intense competition from independent, technology-driven companies as well
as from both major and other independent oil and gas companies in each of the
following areas:
o seeking oil and gas exploration licenses and production
licenses;
o acquiring desirable producing properties or new leases for
future exploration;
o marketing natural gas and oil production;
o integrating new technologies; and
o acquiring the equipment and expertise necessary to develop and
operate properties.
Many of our competitors have substantially greater financial,
managerial, technological and other resources. These companies might be able to
pay more for exploratory prospects and productive oil and gas properties and may
be able to define, evaluate, bid for and purchase a greater number of properties
and prospects than our financial or human resources permit. To the extent
competitors are able to pay more for properties than we are able to afford, we
will be at a competitive disadvantage. Further, many competitors may enjoy
technological advantages and may be able to implement new technologies more
rapidly. Our ability to explore for natural gas and oil prospects and to acquire
additional properties in the future will depend upon its ability to successfully
conduct operations, implement advanced technologies, evaluate and select
suitable properties and consummate transactions in this highly competitive
environment.
SHORTAGES OF RIGS, EQUIPMENT, SUPPLIES AND PERSONNEL COULD DELAY OR OTHERWISE
ADVERSELY AFFECT OUR COST OF OPERATIONS OR OUR ABILITY TO OPERATE ACCORDING TO
OUR BUSINESS PLANS.
In periods of increased drilling activity, shortage of drilling and
completion rigs, field equipment and qualified personnel could develop. From
time to time, these costs have sharply increased in various areas around the
world and could do so again. The demand for and wage rates of qualified drilling
rig crews generally rise in response to the increasing number of active rigs in
service and could increase sharply in the event of a shortage. Shortages of
drilling and completion rigs, field equipment or qualified personnel could
delay, restrict or curtail our exploration and development operations, which
could in turn harm its operating results.
TO THE EXTENT THAT WE ESTABLISH NATURAL GAS AND OIL RESERVES, WE WILL BE
REQUIRED TO REPLACE, MAINTAIN OR EXPAND OUR NATURAL GAS AND OIL RESERVES IN
ORDER TO PREVENT OUR RESERVES AND PRODUCTION FROM DECLINING, WHICH WOULD
ADVERSELY AFFECT CASH FLOWS AND INCOME.
In general, production from natural gas and oil properties declines
over time as reserves are depleted, with the rate of decline depending on
reservoir characteristics. If we establish reserves, of which there is no
assurance, and are not successful in our subsequent exploration and development
activities or in subsequently acquiring properties containing proved reserves,
our proved reserves will decline as reserves are produced. Our future natural
gas and oil production is highly dependent upon our ability to economically
find, develop or acquire reserves in commercial quantities.
To the extent cash flow from operations is reduced, either by a
decrease in prevailing prices for natural gas and oil or an increase in finding
and development costs, and external sources of capital become limited or
unavailable, our ability to make the necessary capital investment to maintain or
expand our asset base of natural gas and oil reserves would be impaired. Even
with sufficient available capital,
17
our future exploration and development activities may not result in additional
proved reserves, and we might not be able to drill productive wells at
acceptable costs.
ACCOUNTING RULES MAY REQUIRE WRITE-DOWNS.
Under full cost accounting rules, capitalized costs of proved oil and
gas properties may not exceed the present value of estimated future net revenues
from proved reserves, discounted at 10%. Application of the ceiling test
generally requires pricing future revenue at the unescalated prices in effect as
of the end of each fiscal quarter and requires a write-down for accounting
purposes if the ceiling is exceeded. If a write-down is required, it would
result in a charge to earnings, but would not impact cash flow from operating
activities. Once incurred, a write-down of oil and gas properties is not
reversible at a later date.
OUR INDUSTRY IS HEAVILY REGULATED.
Federal, state and local authorities extensively regulate the oil and
gas industry. Legislation and regulations affecting the industry are under
constant review for amendment or expansion, raising the possibility of changes
that may affect, among other things, the pricing or marketing of oil and gas
production. State and local authorities regulate various aspects of oil and gas
drilling and production activities, including the drilling of wells (through
permit and bonding requirements), the spacing of wells, the unitization or
pooling of oil and gas properties, environmental matters, safety standards, the
sharing of markets, production limitations, plugging and abandonment, and
restoration. The overall regulatory burden on the industry increases the cost of
doing business, which, in turn, decreases profitability.
OUR OPERATIONS MUST COMPLY WITH COMPLEX ENVIRONMENTAL REGULATIONS.
Our operations are subject to complex and constantly changing
environmental laws and regulations adopted by federal, state and local
governmental authorities. New laws or regulations, or changes to current
requirements, could have a material adverse effect on our business. We will
continue to be subject to uncertainty associated with new regulatory
interpretations and inconsistent interpretations between state and federal
agencies. We could face significant liabilities to the government and third
parties for discharges of oil, natural gas, produced water or other pollutants
into the air, soil or water, and we could have to spend substantial amounts on
investigations, litigation and remediation. We cannot be sure that existing
environmental laws or regulations, as currently interpreted or enforced, or as
they may be interpreted, enforced or altered in the future, will not have a
material adverse effect on our results of operations and financial condition.
RISKS RELATED TO OUR COMMON STOCK.
OUR COMMON STOCK MAY BE THINLY TRADED, AND THEREFORE, AN INVESTOR MAY NOT BE
ABLE TO EASILY LIQUIDATE HIS OR HER INVESTMENT.
Although our common stock is currently traded on the OTC Bulletin
Board, at any time, it may be thinly traded. To the extent that is true, an
investor may not be able to liquidate his or her investment without a
significant decrease in price - or at all.
EVEN IF THERE IS AN ACTIVE TRADING MARKET DEVELOPS, STOCK PRICES MAY BE
VOLATILE.
Even if the trading volume in our common stock is active, the price of
the common stock may be low or volatile. Many brokerage firms may not effect
transactions and may not deal with low priced securities as it may not be
economical for them to do so. This could have an adverse effect on developing
and
18
sustaining a market for our securities. In addition, there is no assurance
that an investor will be able to use our securities as collateral.
There is no assurance that our common stock will meet the criteria
necessary to qualify for listing on the AIM Stock Exchange, NASDAQ or the
American Stock Exchange. Even if our common stock does meet the criteria, there
is no assurance that our common stock would be accepted for listing on any of
these exchanges.
RAISING ADDITIONAL CAPITAL WOULD DILUTE EXISTING SHAREHOLDERS.
In order to pursue our business plans, we will need to continue to
raise additional capital. If we are able to obtain additional funding through
the sale of common stock, the financing would dilute the equity ownership of
existing stockholders.
WE HAVE NOT AND DO NOT ANTICIPATE PAYING DIVIDENDS ON OUR COMMON STOCK.
We have not paid any cash dividends to date with respect to our common
stock. We do not anticipate paying dividends on our common stock in the
foreseeable future since we will use all of our earnings, if any, to finance
expansion of our operations. However, we are authorized to issue preferred stock
and may in the future pay dividends on our preferred stock that may be issued.
ITEM 2. DESCRIPTION OF PROPERTY
Commencing effective July 1, 2005 and continuing through December 31,
2006, we entered into a Management and Development Agreement (the "Development
Agreement") and a series of property-specific Exploration and Development
Agreements (collectively, the "EDAs") pursuant to the Development Agreement with
MAB. Effective January 1, 2007, the Development Agreement and the EDAs were
replaced in their entirety by the Acquisition and Consulting Agreement with MAB
as discussed in Item 1 above.
The following description of our oil and gas property acquisitions for
the period from inception to September 30, 2006 is pursuant to the original
Development Agreement and related EDAs. All references to our obligations to pay
"project development costs" pertaining to the following properties mean the
specified amounts of capital expenditures (for each such property), which were
credited against our obligation to carry MAB for MAB's 50% portion of such
expenditures.
HEAVY OIL PROPERTIES
As conventional petroleum reservoirs become depleted other
unconventional energy sources must supply an increasing proportion of North
American energy requirements. We believe that heavy oil and oil sands provide
this vitally needed resource increasingly in North America, as evidenced by oil
sands development in Alberta, Canada. Potential in heavy oil and oil sands are
known to exist in the United States. In California, heavy oil fields in the San
Joaquin Valley have demonstrated consistent and large field (reserve) growth for
nearly a hundred years. Application of new technology there resulted in
significant reserve additions both to recoverable reserves and in place
estimates. Most recent heavy oil technology advances have been made in Canada
related to development of the Athabasca heavy oil/tar sands. Heavy oil
occurrences are extensively developed in Canada but little effort has been
directed to U.S. heavy oil reservoirs in the Rocky Mountain region. We have
identified three such properties: Great Salt Lake (West Rozel field and Gunnison
Wedge Prospect) in Utah, the Fiddler Creek Area in southern Montana, and the
Promised Land Prospect in north central Montana. We believe that the economic
19
development of each project requires innovative technology to develop these
large potential oil resource plays.
GREAT SALT LAKE -- UTAH. We have 173,851 net mineral acres under lease
(covered by approximately 78 leases) on two principal properties, West Rozel
Field and Gunnison Wedge prospect in the Great Salt Lake of Utah. Recent
developments are mapping of seismic data and recommendation of three drill sites
on the West Rozel field. Three vertical pairs of wells have been sited to test
the productivity of the field using a dual well strategy. This strategy involves
paired wells with one well being a production well and the other a water
injection (disposal) well. Seismic and geologic maps have been completed and the
permit process has been started for the proposed locations. We anticipate
gathering additional seismic data to test the Gunnison Wedge prospect in the
northwestern portion of the Great Salt Lake. A significant production component
of producing these heavy oils is maintenance of an appropriate gas oil ratio
within the reservoir. We have recently identified a new potential gas sand, up
to 60 feet in thickness at a depth of about 1500 feet, i.e. about 900 feet above
the target reservoir depth, at West Rozel field, which will help to provide in
situ gas and increase the economic viability of the project. The gas horizon
seems to occur over much of the West Rozel acreage.
Effective November 21, 2005, we entered into an EDA with MAB for the
West Rozel Project, under which we have paid $1,250,000 to the assignor and paid
reimbursement of estimated costs incurred by the assignor of approximately
$180,000 through September 30, 2006. We were obligated to pay MAB monthly
project development costs in the amount of $200,000, commencing June 1, 2005,
and the first $50 million of project costs.
Pursuant to the terms of each of the leases, we must complete
permitting on this project during 2007. One well must be drilled prior to the
expiration date of the primary term under each lease. The primary terms of two
of the leases where we intend to commence operations end in June 2008, and the
primary term of the third lease where we intend to commence operations ends in
May 2009. We plan to drill at least one test well on each of the leases prior to
the end of each respective primary term. Subsequent drilling and development, as
well as any applications to extend the term of one or more of the leases, will
be determined as we evaluate the results of the first test well and as we
further analyze the results of the seismic surveys.
FIDDLER CREEK, MONTANA. We have acquired a significant acreage position
of 20,436 net acres on three anticlines on the northern portion of the Big Horn
Basin, which extends from north central Wyoming into southern Montana. These
three properties encompass significant portions of Roscoe Dome, Dean Dome and
Fiddler Creek structures, which we believe have significant estimated in place
oil reserves. These anticlines are large asymmetric anticlines with proven
production from several Cretaceous horizons; i.e. the Upper Greybull Sandstone,
the Lower Greybull Sandstone and the Pryor Sandstone. There is both oil and gas
potential in these sandstones and new technology and techniques have commenced
to improve recovery of oil from two previously drilled wells. We have re-entered
two wells, the Bar B #1 on Dean Dome and the #1 Eggen well on the Fiddler Creek
structure. Additional wells have been selected for additional testing as well on
Roscoe Dome, the #4 George and the #6 George wells and the #3 Keller on Dean
Dome. Three horizontal tests are planned for the Roscoe and Dean Dome this year
as well as a stratigraphically deeper test on the Fiddler Creek structure to
test Paleozoic potential in Phosphoria (Permian), Tensleep (Pennsylvanian), and
Madison (Mississippian) formations. A small 2-D seismic will be required to site
the deeper test.
Effective July 16, 2006, we entered into an EDA with MAB for the
Fiddler Creek (Montana) Project, under which we paid $2,000,000 through
September 30, 2006, consisting of $300,000 cash to the assignor and the issuance
of $1.7 million (3.4 million shares at $0.50 per share) of our common stock as a
20
finders fee to a third party. We were obligated to pay MAB monthly project
development costs of $20,000 per month, commencing April 1, 2006, and the first
$100 million of project costs.
Subsequently, we acquired additional acreage in the Fiddler Creek
Project area for a purchase price of $11,250,000 (of which $6,039,599 has been
paid through September 30, 2006). We have the option to pay said remaining
amount of approximately $5.2 million. In the event we elect not to make such
payment, we would be required to reassign the properties to the seller, and
there would be no other cost or penalty. We were obligated to pay MAB monthly
project development costs of $100,000, commencing August 1, 2006, and to pay the
first $50 million of project costs on these additional properties.
We are obligated to perform our due diligence investigation on this
property before the final payment is due December 31, 2007.
PROMISED LAND, MONTANA. We have acquired 49,120 net acres in a resource
play evaluating heavy oil reservoirs in Jurassic Swift Formation and Lower
Cretaceous Bow Island and Sunburst sandstone reservoirs in north central
Montana. The Swift reservoirs were deposited in a shallow marine to estuarine
depositional setting. The Swift sandstones are commonly oil saturated in the
area, and most well tests report oil shows in the Swift. The reservoirs are up
to 60 feet thick and composed of high quality sandstone, averaging about 20
percent porosity and permeabilities range up to one darcy. The oil gravities
range from 10(degree) to 22(degree)API with viscosities of 1500 centipoise to
greater than 50,000 centipoise at 125(degree)F. Additional conventional
potential is possible in Devonian Duperow grainstones, Nisku, and Madison
formations. Following some detailed geologic and geophysical investigations to
determine the depositional environment and geometry of the Swift sandstone
reservoirs, we anticipate drilling three vertical tests in the coming year
offsetting previously drilled wells that encountered oil saturated Swift
reservoirs.
Effective May 15, 2006, we entered into an EDA with MAB for the
Promised Land Project, under which we have paid $194,250 through September 30,
2006 to the assignor for leases acquired by the assignor. We were obligated to
pay MAB monthly project development costs of $50,000, commencing May 1, 2006,
and to pay the first $50 million of project costs.
We do not have any drilling commitments with respect to this property.
PICEANCE BASIN, COLORADO PROPERTIES
The Cretaceous Mesaverde Group, which includes the Williams Fork and
Iles formations, has long been known to hold vast reserves of natural gas. The
gas is sourced primarily from thick coals in the lower Williams Fork formation,
with additional contribution from thinner coals in portions of the Iles
formation. While the coals hold large volumes of gas, attempts at completions in
the coal have not proven economic. The sandstone reservoirs have been charged by
the coals and account for virtually all the gas being produced from the
Mesaverde Group.
Early attempts to complete wells resulted in low rates with no
noticeable decline. With the advent of advanced artificial fracturing techniques
and completion fluids in the late 1990s, operators began economic exploitation
of the play. Based on publicly-available data (IHS Energy PI/Dwights PLUS(R)
Well Data, July 2006), approximately 3,500 producing wells have been completed
to date. Total production from the play is 947 mmcf/day and 95 mbo/day, with
cumulative volumes produced from the play of over 1,534 bcf and 4.8 mmbo. The
play is active in Garfield, Mesa, and Rio Blanco counties in Colorado, with
approximately 50 to 60 rigs drilling at any given time (Rocky Mountain Oil
Journal, v. 86 no. 52).
21
BUCKSKIN MESA PROJECT. We have leased approximately 20,000 net acres in
Rio Blanco County, Colorado. Effective September 17, 2005, we entered into an
EDA with MAB for the Buckskin Mesa Project, under which we have paid, through
September 30, 2006, $5,362,500 to the assignor and $1,961,460 in Federal lease
payments for Federal leases acquired by the assignor on November 10, 2005. As
consideration for extending the final payment due on closing, we agreed to pay a
monthly extension fee of $200,000 for each 30-day period commencing January 6,
2006 of which all were paid as of June 30, 2006. We were obligated to pay MAB
monthly project development costs of $20,000, commencing July 1, 2005, and the
first $50 million of project costs. We charged all property development costs
incurred to MAB under the related EDAs to operations.
Effective July 18, 2006, we entered into an EDA with MAB related to the
Buckskin Mesa Project in the Piceance Basin, Colorado, under which we received
an undivided 50% working interest in the properties for $765,000. If we elect to
accept certain leases which are subject to additional title curative work, we
will pay up to a maximum of an additional $1.1 million payable to a third party
for bonus payments related to such properties. We were obligated to pay MAB
monthly project development costs of $20,000, commencing August 1, 2006 and to
pay the first $50 million of project costs.
We have applied for and received six approved drilling permits to test
targets in the Cretaceous Mesaverde Group. A 26-square mile 3-D seismic survey
has been licensed, re-processed, and interpreted to focus initial drilling in
areas of thickest pay and enhanced fracturing. We have spudded our first well at
Buckskin Mesa, the Anderson 6-16. As of January 9, 2007, the Bronco #4 rig was
drilling ahead at 6900 feet in the Williams Fork Formation. Planned total depth
of the well is 10,270 feet. The well is on prognosis with seismic
interpretations, and gas shows have been noted. If results from this well are
favorable, we plan to initiate a multi-well production program. Depending on
observed reservoir drainage of the wells, we believe there is potential for
1,000 to 2,000 additional well locations.
We are obligated to drill four wells to test the Rawlings Formation by
November 30, 2007, in addition to the one well being drilled as described above.
PICEANCE II PROJECT. We have leased approximately 1,000 net acres
contiguous to Parachute, Rulison, and Grand Valley fields in Garfield County,
Colorado. Effective December 29, 2005, we entered into an EDA with MAB for the
Piceance II Project, under which we agreed to pay up to $4,000,000 to the
assignor (of which $3,898,793 has been paid through September 30, 2006) and
issued $1 million of our common stock (2,000,000 shares at $0.50 per share). We
were obligated to pay MAB monthly project development costs of $20,000 per
month, commencing November 1, 2005, and the first $50 million of project costs.
As of January 10, 2007, we had interests in 12 producing wells, 15
wells waiting on completion, and 4 wells being drilled. Average daily production
net to us from these wells for the week ending December 17, 2006 (the most
recent available) was 2,656 mcf/day (including MAB's share of production).
Initial production rates varied from 1,000 to 2,023 mcf/day.
Production is from frac-stimulated perforations in stacked sands of the
fluvial Williams Fork formation.
We have signed a purchase and sale agreement to purchase leases
covering approximately 2,000 additional net acres within close proximity or
contiguous to our other Piceance II properties. We are not certain whether
additional acreage will be obtained under this agreement.
We are obligated to drill eight wells on these leases during 2007.
22
AUSTRALIA PROPERTIES
BEETALOO BASIN. The Beetaloo Basin property in the Northern Territory
of Australia currently consists of approximately 7 million acres. We have
applied for permits covering an additional 1.5 million acres that is contiguous
to the currently-owned permits. Located about 600 kilometers south of Darwin,
the Beetaloo Basin is a large basin, comparable in size to the Williston Basin
in the U.S. or the entire southern North Sea basin. Structurally it has been
viewed as a relatively simple intracratonic, passive margin basin, with minor
extension (strike-slip), filled with sediments ranging from Cambrian to
Mesoproterozoic rocks. However, interpretation of new 2D seismic data acquired
by us in 2006 requires modification of the structural and tectonic history of
the basin. The broad, low relief structures previously recognized in the basin,
probably related to strike-slip movement, represent only a portion of its
history. Significant and possibly multiple compressional events are observed in
the basin. Ongoing geophysical evaluation has identified a more recent
compressional history along the western margin of the basin resulting in a
series of westerly verging, imbricate thrust faults in contrast to easterly
verging, thrust faults discovered in the central basin. All identified
structures are untested and prospective.
The Basin has many thousands of meters of sediments, but the reservoirs
of interest to us are within 4000 meters of the surface, most less than 3000
meters. The sedimentary rocks include thick (hundreds of meters), rich source
rocks, namely the Velkerri Shale with Total Organic Carbon ("TOC") contents as
high as 12%, and the Kyalla Shale with typical TOC contents of 2-3%. There is
also a number of sandstone reservoirs interbedded with the rich source rocks.
These formations, from stratigraphically youngest to oldest, include the
Cambrian Bukalara Sandstone, and the Neoproterozoic Jamison, Moroak, and Bessie
Creek sandstones. A number of even deeper sandstones are expected to be very
tight and were not prospective in the single well where they were tested east of
the Basin.
Three primary plays have been recognized within the basin. The first is
a conventional structural, shallow sweet oil play of 35(degree) API gravity. The
Bukalara, Jamison, and Moroak sands (and perhaps the Bessie Creek sand along the
western margin) have potential for oil accumulations in trapped and sealed
geometries. Most of the eleven previous wells drilled within the basin had oil
and gas shows, and the Jamison #1 well tested oil on a Drill Stem Test. Detailed
petrophysical analyses have been performed on all wells and have identified
significant potential in some of these tests.
The second play is an unconventional fractured shale play within the
Kyalla and Velkerri formations, not unlike the Barnett Shale play in Texas. It
is unknown whether the hydrocarbons will be gas or oil (or possibly both) for
this exploration target; however, the Barnett Shale model and algorithms in our
petrophysical analyses of these shales suggest they are viable targets.
Finally, the Moroak and Bessie Creek sandstones offer a Basin Centered
Gas Accumulation (BCGA) play at the center of the basin. It is an unconventional
resource play characterized by a lack of a gas/water contact. Petrophysical
analyses of several wells previously drilled in the basin demonstrate the
presence of a BCGA in the basin.
Effective March 17, 2006, we entered into an EDA with MAB for the
Beetaloo Project representing exploration permits in the Northern Territory,
Australia. Under the terms of the EDA, we have paid $1,000,000 to the assignor
and have funded the $3 million seismic work commitment. We were obligated to pay
monthly project development costs of $100,000 per month, commencing March 1,
2006, and the first $100 million of project costs.
The current 7 million acres are represented by four exploration
permits. Depending on the permit, we are in the second or third year of an
initial five-year exploration period that can be extended.
23
As part of the work commitment plan submitted to the Northern Territory
Department of Primary Industry, Fisheries and Mines, approximately 700
kilometers of 2D seismic data were acquired during 2006 to delineate the
previously defined exploration leads. The data are being processed, interpreted,
and mapped in anticipation of a five to ten well drilling program in 2007
including both shallow offset wells to potential bypassed wells and tests of the
undrilled structural features seen throughout the basin.
We are required to drill four wells by August 31, 2007.
GIPPSLAND AND OTWAY BASINS. On November 14, 2006, we entered into an
agreement with Lakes Oil N.L. ("Lakes Oil"), under which we will jointly develop
Lakes Oil's on-shore petroleum prospects (focusing on unconventional gas
resources) in the Gippsland and Otway basins in Victoria, Australia. The
arrangement is subject to various conditions precedent, including completion of
satisfactory due diligence, and the satisfactory processing of certain retention
lease applications. Under the agreement, we or our subsidiary company, Sweetpea
Petroleum Pty. Ltd., will initially farm into 33-1/3% of Lakes Oil's permits by
spending $7 million in Lakes Oil's permits. In addition, we will subscribe for
$3 million in new shares in Lakes Oil at 1.5 cents (Australian). We will also
have the right to increase our position in Lakes Oil's permits with two further
16-2/3% farm-in tranches of $10 million each, exercisable within 12 months and
24 months respectively. Under the agreement, we have the right to participate in
the same proportion in any permits which are non-contiguous to existing permits
acquired by Lakes Oil within two years, and any contiguous permits acquired by
Lakes Oil moving forward, and we have a first right of refusal in other permits
acquired by Lakes Oil within five years. We are to assume Lakes Oil's position
as operator of the permits.
PRODUCTION AND PRICES
During the fiscal year ended September 30, 2006, we received nominal
revenues of $35,656 from the 5,822 mcf of natural gas resulting from the initial
testing and production from our interest in eight gross wells. The average price
per mcf was $6.12. We did not have any production during the fiscal year ended
September 30, 2005.
PRODUCTIVE WELLS
The following table summarizes information at September 30, 2006,
relating to the productive wells in which we owned a working interest as of that
date. Productive wells consist of producing wells and wells capable of
production. Gross wells are the total number of producing wells in which we have
an interest, and net wells are the sum of our fractional working interests owned
in gross wells.
--------------------------------------------------------------------------------------------------------------------
GROSS NET
--------------------------------------------------------------------------------------------------------------------
LOCATION OIL GAS TOTAL OIL GAS TOTAL
--------------------------------------------------------------------------------------------------------------------
Colorado -- 7 7 -- 2.14 2.14
--------------------------------------------------------------------------------------------------------------------
Utah -- -- -- -- -- --
--------------------------------------------------------------------------------------------------------------------
Montana -- -- -- -- -- --
--------------------------------------------------------------------------------------------------------------------
Australia -- -- -- -- -- --
--------------------------------------------------------------------------------------------------------------------
TOTAL -- 7 7 -- 2.14 2.14
--------------------------------------------------------------------------------------------------------------------
OIL AND GAS DRILLING ACTIVITIES
During the fiscal year ended September 30, 2006, our drilling
activities were limited to Colorado. We drilled 2.14 net productive exploratory
wells and no dry exploratory wells. We did not drill any development wells. We
did not drill any wells during the fiscal year ended September 30, 2005.
24
OIL AND GAS INTERESTS
As of September 30, 2006, we owned interests in the following developed
and undeveloped acreage positions. The "Net Acres As Adjusted" columns give
effect to the new agreement with MAB, under which MAB relinquishes its working
interest in the leases, permits, and licenses that were previously owned 50/50.
Undeveloped acreage refers to acreage that has not been placed in producing
units.
-----------------------------------------------------------------------------------------------------------------------
DEVELOPED UNDEVELOPED
-----------------------------------------------------------------------------------------------------------------------
NET ACRES AS NET ACRES AS
LOCATION GROSS ACRES NET ACRES ADJUSTED GROSS ACRES NET ACRES ADJUSTED
-----------------------------------------------------------------------------------------------------------------------
Colorado 0 0 0 26,239.0 9,919.5 19,839.0
-----------------------------------------------------------------------------------------------------------------------
Utah 0 0 0 177,445.0 88,722.5 177,445.0
-----------------------------------------------------------------------------------------------------------------------
Montana 0 0 0 90,236.0 34,727.5 69,455.0
-----------------------------------------------------------------------------------------------------------------------
Australia 0 0 0 7,000,000.0 3,500,000.0 7,000,000.0
-----------------------------------------------------------------------------------------------------------------------
TOTAL 0 0 0 7,293,920.0 3,633,369.5 7,266,739.0
-----------------------------------------------------------------------------------------------------------------------
OFFICES
We lease approximately 13,595 square feet of office space at 1875
Lawrence Street, Suite 1400, Denver, Colorado, pursuant to the terms of a lease
that expires June 30, 2011. We share the offices with Falcon Oil & Gas Ltd., an
affiliate, and share the costs of the office space, cost of equipment,
furniture, office operating costs, administrative staff, and related expenses on
a 50/50 basis.
We also lease approximately 2,400 square feet of office space at 170
South Main Street, Suite 170, Salt Lake City, Utah, pursuant to the terms of a
lease that expires May 31, 2011.
ITEM 3. LEGAL PROCEEDINGS
There are no legal proceedings pending against us. To the best of our
knowledge, there are no legal proceedings threatened or contemplated against us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Holders of approximately 117,566,000 of the then outstanding
225,373,000 shares of common stock (approximately 52%) approved the following
actions by means of a written consent to action effective as of August 11, 2006:
o The election of Dr. Anthony K. Yeats, Kelly H. Nelson and
Carmen J. Lotito as directors of the Company;
o The change of our state of incorporation from Nevada to
Maryland;
o The approval of an amendment to our Articles of Incorporation
to change the name of the Company from "Digital Ecosystems
Corp." to "PetroHunter Energy Corporation"; and
o The adoption of our 2005 Stock Option Plan.
25
PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL
BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
MARKET INFORMATION
Our common stock commenced trading on the OTC bulletin board on April
20, 2005, under the symbol "DGEO," and has been trading under the symbol "PHUN"
since August 21, 2006. The following table sets forth the high and low bid
prices per share of our common stock, as reported on the OTC bulletin board for
the periods indicated. The following prices reflect inter-dealer prices, without
retail mark-up, mark-down or commission, and may not represent actual
transactions.
QUARTER ENDED HIGH LOW
June 30, 2005 $ 0.53 $ 0.06
September 30, 2005 1.50 0.06
December 31, 2005 1.79 0.05
March 31, 2006 3.36 1.10
June 30, 2006 4.23 1.45
September 30, 2006 2.98 1.31
December 31, 2006 2.30 1.50
We have neither declared nor paid any cash dividends on our capital
stock and do not anticipate paying cash dividends in the foreseeable future. Our
current policy is to retain any earnings in order to finance the expansion of
our operations. Our board of directors will determine future declaration and
payment of dividends, if any, in light of the then-current conditions they deem
relevant and in accordance with applicable corporate law.
On January 13, 2007, the last sale price for the common stock was
$1.72.
HOLDERS AND DIVIDENDS
As of December 31, 2006, there were 258 record holders of our common
stock. Since our inception, no cash dividends have been declared on our common
stock.
RECENT SALES OF UNREGISTERED SECURITIES
During the quarter ended September 30, 2006, we issued and sold
unregistered securities set forth in the table below.
------------------------------------------------------------------------------------------------------------------
DATE PERSONS OR CLASS OF PERSONS SECURITIES CONSIDERATION
------------------------------------------------------------------------------------------------------------------
9/15/06 Majedie Investments 1,000,000 shares of common $1,000,000 pursuant to warrant
stock exercise
------------------------------------------------------------------------------------------------------------------
26
No underwriters, placement agents or finders were used in the above
stock transactions. We relied upon Regulation S for sales made outside the
United States without registration under the Securities Act of 1933 or the
exemption from registration contained in Section 4(2) and/or Rule 506 under the
Securities Act of 1933 as to all of the transactions, as the investors with
either non-U.S. persons or deemed to be sophisticated with respect to the
investment in the securities due to their financial condition and involvement in
our business or accredited investors. Restrictive legends were placed on the
certificates evidencing the securities issued in all of the above transactions.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our Consolidated
Financial Statements and related notes appearing elsewhere in this Form 10-KSB.
BACKGROUND
As a result of the stock exchange transaction by which the stockholders
of what was then GSL Energy Corporation received more than 85% of the
outstanding stock of our Company, GSL, now known as PetroHunter Operating
Company, became a wholly owned subsidiary of our Company. Since this transaction
resulted in the former shareholders of GSL acquiring control of our Company, for
financial reporting purposes the business combination was accounted for as an
additional capitalization of the Company (a reverse acquisition with GSL as the
accounting acquirer). In accounting for this transaction:
i. GSL was deemed to be the purchaser and parent company for
financial reporting purposes. Accordingly, its net assets were
included in the consolidated balance sheet at their historical
book value; and
ii. Control of the net assets and business of the Company was
acquired effective May 12, 2006 for no consideration.
PetroHunter Operating Company (formerly GSL) was incorporated under the
laws of the State of Maryland on June 20, 2005 for the purpose of acquiring,
exploring and developing oil and gas properties. PetroHunter Operating Company
is considered a development stage company as defined by Statement of Financial
Accounting Standards ("SFAS") No. 7, and its principal activities since
inception have been raising capital through the sale of common stock and
convertible notes and the acquisition of oil and gas properties in the Western
United States and Australia.
LIQUIDITY AND CAPITAL RESOURCES
The Company at September 30, 2006 is vastly different from its
existence at September 30, 2005. At September 30, 2005, we had been operating
for only a few months, had no employees, and had acquired an interest in two
properties, West Rozel and Buckskin Mesa, aggregating approximately 12,400 net
mineral acres. During the 2006 fiscal year, we added 16 employees, moved to
offices in Denver, Colorado, and acquired an interest in properties aggregating
approximately 7,207,000 acres.
We funded the acquisition of these properties and the increased level
of activity primarily through the sale of debt and equity securities for cash.
We also issued 6,400,000 shares, valued at $0.50 per share, as partial
consideration for the acquisition of oil and properties and as consideration for
a finder's fee on
27
an oil and gas prospect. At September 30, 2006, we had working capital of
$1,275,531 and cash of $10,631,776, but we will need to raise additional funds
for our planned operations and acquisitions.
Prior to the acquisition of PetroHunter Operating Company in May 2006,
we entered into five separate loan agreements, aggregating $400,000, due one
year from issuance, commencing October 11, 2006. The loans bear interest at 12%
per annum, are unsecured, and are convertible, at the option of the lender at
any time during the term of the loan or upon maturity, at a price per share
equal to the closing price of our common stock on the OTC Bulletin Board on the
day preceding notice from the lender of its intent to convert the loan. As of
January 10, 2007, we were in default on payment of an aggregate of $200,000 of
notes, which matured October 11, 2006 as to $100,000 and December 5, 2006 as to
$100,000.
CASH USED IN OPERATING ACTIVITIES. Primarily as a result of our net
loss of $20,692,014, we used cash of $10,545,806 for fiscal 2006. See "Results
of Operations" below for the discussion of our operating expenses. The principal
adjustments to reconcile the net loss to net cash used in operating activities
were stock based compensation of $9,189,334, as a result of stock options issued
to employees and consultants, and $1,422,701 of financing costs, resulting from
finder's fees paid in common stock in connection with the private placement of
convertible promissory notes. In comparison, we used only $222,158 of cash for
operating activities in fiscal 2005.
CASH USED IN INVESTING ACTIVITIES. We used cash of $32,692,402 in
fiscal 2006, primarily for our additions to our oil and gas properties
($31,062,398). We also used $553,211 for property and equipment and $1,076,793
for restricted cash, which are certificates of deposit underlying letters of
credit for exploration permits, state and local bonds and guarantees to vendors.
During fiscal 2005, we used only $1,564,600 for additions to oil and gas
properties.
We currently anticipate our capital budget will be approximately
between $107 and $175.5 million for the period ending December 31, 2007, which
we plan to use for a diverse portfolio of development and exploration wells in
our core areas of operation. If we are unable to obtain capital through the sale
of our securities or a credit facility or otherwise, our ability to execute our
development plans could be greatly limited. We may consider selling down a
portion of our interests in some of our exploration and development projects to
industry partners to generate additional funds to finance our 2007 capital
budget.
CASH PROVIDED BY FINANCING ACTIVITIES. We sold convertible promissory
notes in 2005 and 2006, raising a total of $20,831,667, of which $17,794,667 was
raised in fiscal 2006 and $3,037,000 was raised in fiscal 2005. Upon completion
of the share exchange between the Company and GSL, the notes were converted to
44,063,334 shares of common stock. We also sold 35,442,500 shares for gross
proceeds of $35,442,500. Total cash provided by financing activities was
$52,619,742, resulting in cash of $10,631,776 at September 30, 2006.
It is anticipated that the continuation and future development of our
business will require additional, substantial, capital expenditures. We have no
reliable source for additional funds for administration and operations to the
extent our existing funds have been utilized. In addition, our capital
expenditure budget for the period ending December 31, 2007 will depend on our
success in selling additional prospects for cash, the level of industry
participation in our exploration projects, the availability of debt or equity
financing, and the results of our activities. We anticipate spending
approximately between $107 and $175.5 million on exploration and development
activities during the period ending December 31, 2007. To limit capital
expenditures, we may form industry alliances and exchange an appropriate portion
of our interest for cash and/or a carried interest in our exploration
28
projects. We may need to raise additional funds to cover capital expenditures.
These funds may come from cash flow, equity or debt financings, a credit
facility, or sales of interests in our properties, although there is no
assurance additional funding will be available or that it will be available on
satisfactory terms.
RESULTS OF OPERATIONS
OIL AND GAS REVENUES. We generated our first revenues during the last
quarter of our fiscal year ending September 30, 2006 from initial testing and
production of natural gas wells in the Piceance Basin of Colorado. Revenues are
expected to increase significantly for the 2007 fiscal year, since we have 12
producing wells, 15 wells awaiting completion, and 4 wells being drilled in the
Piceance II Project as of January 15, 2007.
GENERAL AND ADMINISTRATIVE. Due to the substantially increased level of
activity during fiscal 2006 as compared to fiscal 2005, operating expenses
increased by $16,148,819 or 771%. The most significant increases occurred with
respect to general and administrative expenses, particularly with respect to
stock based compensation and salaries, consulting fees and services. We incurred
stock based compensation expenses of $9,189,334 in 2006, as compared to $822,710
in 2005, and expenses for salaries, consulting fees and services of $2,035,366
in 2006, as compared to $286,666 in 2005. We expect that we may continue to
incur stock based compensation expenses of this magnitude due to the
"mark-to-market" effect of SFAS No. 123(R), and that salaries, consulting fee
and services will likely remain at current levels or increase with our expected
increased level in activity. Other significant components of general and
administrative expenses were travel-related expenses ($759,261), investor
relations ($553,807), legal ($550,584), and directors' and officers' liability
insurance ($209,000).
PROPERTY DEVELOPMENT - RELATED. We also incurred $4,530,000 in property
development costs to MAB in 2006, as compared to $860,000 in 2005. As a result
of the new Acquisition and Consulting Agreement with MAB, which is effective
January 1, 2007, these property development costs will be reduced to $1,765,000
for the fiscal year ending September 30, 2007.
OPERATING EXPENSES. Total operating expenses for 2006 were $18,244,610,
as compared to $2,095,791 in 2005.
INTEREST EXPENSE. We incurred interest expense of $2,485,693 for 2006,
as compared to $23,029 for 2005. We expect that interest expense will increase
for the fiscal year ending September 30, 2007, due to the credit facility we
obtained in January 2007, which is described below in "Plan of Operations," and
due to the interest to be paid to MAB under the terms of the new Acquisition and
Consulting Agreement.
NET LOSS. As a result of the expenses described above, we incurred a
loss of $20,692,014 for 2006, as compared to $2,118,820 for 2005, increasing the
loss accumulated since inception to $22,810,834.
GOING CONCERN
The report of our independent registered public accounting firm on the
financial statements for the year ended September 30, 2006, includes an
explanatory paragraph relating to the uncertainty of our ability to continue as
a going concern. We have incurred a cumulative net loss $22,810,834 for the
period from inception to September 30, 2006. We require significant additional
funding to sustain our operations and satisfy our contractual obligations for
our planned oil and gas exploration and development operations. Our ability to
establish the Company as a going concern is dependent upon our
29
ability to obtain additional financing, in order to fund our planned operations
and ultimately, to achieve profitable operations.
PLAN OF OPERATION
COLORADO. We expect that the development of our Colorado properties
will include: (i) continued drilling of wells in our 1,000-acre holdings in
Piceance Basin, where we expect to complete approximately 15 to 18 wells and
have additional gas production and (ii) exploration of our 20,000-acre lease
near Buckskin Mesa/Powell Park discovery wells in the northern Piceance Basin.
We have applied for and received six approved permits to drill to an estimated
depth of 10,000 to 12,000 feet, to test the Williams Fork, Cameo, and Fort Union
formations.
Associated with the development of our Colorado properties, we
anticipate that, over the next twelve months, we will incur the following costs:
o $30,000,000 to $50,000,000 in connection with the Piceance II
project, to include seismic, drilling, completion and
production facilities; and
o $20,000,000 to $40,000,000 in connection with the Buckskin
Mesa project, to include seismic, and drilling.
To fund these costs and certain commitments totaling approximately
$2,700,000 for the fiscal year ended September 30, 2007 for operating leases,
delay rentals, property development fees and consulting fees and note payments
to MAB, we are engaging in financing activities. On November 6, 2006, we
commenced an offering of up to $125,000,000 pursuant to a private placement of
units at $1.50 per unit. Each unit consists of one share of our common stock and
one-half common stock purchase warrant. A whole common stock purchase warrant
entitles the purchaser to acquire one share of our common stock at an exercise
price of $1.88 per share through December 31, 2007. We may pay a commission of
up to 5% to a broker or agent in conjunction with the sale. As of January 12,
2007, we had received $1,887,500 from the sale of units pursuant to the private
placement.
In addition, on January 9, 2007, we entered into a Credit and Security
Agreement (the "Financing") with Global Project Finance AG, a Swiss company, for
mezzanine financing in the amount of $15 million. The loan provides for an
interest rate of 6.75% over prime, and is to be secured by a first perfected
lien on our assets, limited to the specific portion of the assets to which the
loan proceeds are applied by us. We plan to apply most of the proceeds of this
loan to our drilling and development operations in the Piceance Basin, Colorado.
The terms of the Financing also provide for the issuance of warrants to purchase
one million of our shares upon execution of the Credit Agreement, and warrants
to purchase up to an additional three million shares, tied on a pro rata basis
to each draw down of the credit facility up to $15 million - that is, warrants
for 600,000 shares for each $3 million advanced. The warrants will be
exercisable for five years after the date of the Credit Agreement. The exercise
price of the warrants will be equal to 120% of the weighted average price of our
stock for the 30 days immediately prior to each warrant issuance date. Global
Project Finance AG and its controlling shareholder, Christian Russenberger, were
shareholders of the Company prior to the Credit Agreement. As of January 10,
2007, we had drawn down $5,000,000 on the credit facility.
HEAVY OIL. The development of our heavy oil prospects in Montana and
Utah will include (i) the development of 15,000 acres of prime heavy oil acreage
in Montana and (ii) the development of 173,000 acres owned or under contract in
the Great Salt Lake. We anticipate that, over the next twelve months, we will
incur the following costs related to our heavy oil prospects in Montana and
Utah:
30
o $7,000,000 to $12,500,000 to add land in Montana in areas
where we have already completed acquisitions;
o $8,000,000 to $15,000,000 in connection with the Fiddler Creek
project, to include drilling, completion and production
facilities; and
o $12,000,000 to $18,000,000 in connection with the Great Salt
Lake project, to include project design, project equipment
procurement, site infrastructure development and initial
drilling.
We formed a subsidiary, PetroHunter Heavy Oil Ltd., in September 2006
("PetroHunter Heavy Oil"), for the purpose of holding and developing our heavy
oil assets. We anticipate that PetroHunter Heavy Oil will engage in a private
placement of debt securities, similar to the offering of PetroHunter Energy NT
described below in the near future.
AUSTRALIA. In Australia we plan to explore and develop portions of the
7,000,000 acres of the project area in northwestern Australia (Beetaloo Basin).
During 2007, we plan to drill a minimum of eight wells in the exploration permit
blocks. We anticipate that, over the next twelve months, we will incur
$30,000,000 to $40,000,000 in costs related to drilling and well completion.
Under the agreement with Lakes Oil, we or our subsidiary company,
Sweetpea Petroleum Pty. Ltd., will initially farm into 33-1/3% of Lakes Oil's
permits by spending $7 million in Lakes Oil's permits. In addition, we will
subscribe for $3 million in new shares in Lakes Oil at 1.5 cents (Australian).
DEVELOPMENT STAGE COMPANY. We had not commenced principal operations
nor earned significant revenue as of September 30, 2006, and are considered a
development stage company. During the period from inception to September 30,
2006, we incurred a cumulative net loss of $22,810,834. In order to fund our
planned exploration and development of oil and gas properties, we will require
significant additional funding. We have sold approximately $56.3 million of
convertible notes and common stock through September 30, 2006, and our
management believes that we will be successful in raising additional funding to
have sufficient capital to meet our obligations for our planned operations for
at least the next twelve months.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our Financial
Statements.
OIL AND GAS PROPERTIES. We utilize the full cost method of accounting
for oil and gas activities. Under this method, subject to a limitation based on
estimated value, all costs associated with property acquisition, exploration and
development, including costs of unsuccessful exploration, are capitalized within
a cost center. No gain or loss is recognized upon the sale or abandonment of
undeveloped or producing oil and gas properties unless the sale represents a
significant portion of oil and gas properties and the gain significantly alters
the relationship between capitalized costs and proved oil and gas reserves of
the cost center. Depreciation, depletion and amortization of oil and gas
properties is computed on the units of production method based on proved
reserves. Amortizable costs include estimates of future development costs of
proved undeveloped reserves.
31
Capitalized costs of oil and gas properties may not exceed an amount
equal to the present value, discounted at 10%, of the estimated future net cash
flows from proved oil and gas reserves plus the cost, or estimated fair market
value, if lower, of unproved properties. Should capitalized costs exceed this
ceiling, an impairment is recognized. The present value of estimated future net
cash flows is computed by applying year end prices of oil and natural gas to
estimated future production of proved oil and gas reserves as of year end, less
estimated future expenditures to be incurred in developing and producing the
proved reserves and assuming continuation of existing economic conditions. As of
September 30, 2006, the Company has no proved reserves and all oil and gas
property costs are considered to be unevaluated and are recorded at the lower of
cost or fair market value.
ASSET RETIREMENT OBLIGATION. We apply SFAS 143, "Accounting for Asset
Retirement Obligations," which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. This statement requires companies to record
the present value of obligations associated with the retirement of tangible
long-lived assets in the period in which it is incurred. The liability is
capitalized as part of the related long-lived asset's carrying amount. Over
time, accretion of the liability is recognized as an operating expense and the
capitalized cost is depreciated over the expected useful life of the related
asset. Asset retirement obligations ("ARO") relate primarily to the plugging,
dismantlement, removal, site reclamation and similar activities of its oil and
gas properties. At September 30, 2006, we had recorded an ARO of $522,054 for
our initial wells under progress.
SHARE BASED COMPENSATION. On October 1, 2006, we adopted SFAS 123(R),
"Accounting for Stock-Based Compensation," using the modified prospective
method, which results in the provisions of SFAS 123(R) being applied to the
consolidated financial statements on a going-forward basis. Prior periods have
not been restated. SFAS 123(R) requires companies to recognize share-based
payments to employees as compensation expense on a fair value method. Under the
fair value recognition provisions of SFAS 123(R), stock-based compensation cost
is measured at the grant date based on the fair value of the award and is
recognized as expense over the service period, which generally represents the
vesting period. The expense recognized over the service period is required to
include an estimate of the awards that will be forfeited. Previously, no such
forfeitures have occurred. We are assuming no forfeitures going forward based on
our historical forfeiture experience. The fair value of stock options is
calculated using the Black-Scholes option-pricing model.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 2006, the Financial Accounting Standards Board (FASB)
issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments-an
amendment of FASB Statements No. 133 and 140." SFAS No. 155 amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" and SFAS No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," and also resolves issues addressed in SFAS No.
133 Implementation Issue No. D1, "Application of Statement 133 to Beneficial
Interests in Securitized Financial Assets." SFAS No. 155 was issued to eliminate
the exemption from applying SFAS No. 133 to interests in securitized financial
assets so that similar instruments are accounted for in a similar fashion,
regardless of the instrument's form. The Company does not believe that its
financial position, results of operations or cash flows will be impacted by SFAS
No. 155 as the Company does not currently hold any hybrid financial instruments.
32
In June 2006, the FASB issued FASB Interpretation No. 48 (FIN 48),
"Accounting for Uncertainty in Income Taxes." The interpretation clarifies the
accounting for uncertainty in income taxes recognized in a company's financial
statements in accordance with Statement of Financial Accounting Standards No.
109, Accounting for Income Taxes. Specifically, the pronouncement prescribes a
recognition threshold and a measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. The interpretation also provides guidance on the related
derecognition, classification, interest and penalties, accounting for interim
periods, disclosure and transition of uncertain tax positions. The Company will
be required to adopt FIN 48 for the fiscal year ended September 30, 2008. The
Company is reviewing and evaluating the effect, if any, of adopting FIN 48 on
its financial position and results of operations.
ITEM 7. FINANCIAL STATEMENTS
The financial statements required by this Item begin on Page F-1 of
this Form 10-KSB.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On August 21, 2006, our Board of Directors approved the termination of
Telford Sadovnick, P.L.L.C. ("Telford") as our independent accountants and the
appointment of Hein & Associates LLP ("Hein") to serve as our independent
accountants for the year ending September 30, 2006. The change was effective
August 21, 2006.
Telford's reports on our financial statements for each of the years
ended March 31, 2006 and 2005 did not contain, with the exception of a going
concern disclaimer in each such report, an adverse opinion or disclaimer of
opinion, nor were such reports qualified or modified as to uncertainty, audit
scope, or accounting principles.
During the years ended March 31, 2006 and 2005, and the period ended
August 21, 2006, there were no disagreements with Telford on any matter of
accounting principle or practice, financial statement disclosure, or auditing
scope or procedure which, if not resolved to Telford's satisfaction, would have
caused them to make reference to the subject matter of the disagreement in
connection with the audit reports on our financial statements for such years;
and there were no events as set forth in Item 304(a)(1)(iv) of Regulation S-B.
We provided Telford with a copy of the foregoing disclosures. We filed
as an exhibit to a report on Form 8-K a letter from Telford relating to the
disclosure included in the Form 8-K.
During the years ended March 31, 2006 and 2005 and through August 21,
2006, we did not consult Hein with respect to the application of accounting
principles to a specified transaction, either completed or proposed, or the type
of audit opinion that might be rendered on our consolidated financial
statements, or on any other matters or reportable events as set forth in Items
304(a)(2)(i) and (ii) of Regulation S-B. Hein was the independent accountants
for our subsidiary, PetroHunter Operating Company from its inception (June 2005)
until we acquired substantially all of its outstanding common stock (May 12,
2006).
33
ITEM 8A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report, our management
carried out an evaluation, under the supervision and with the participation of
our principal executive officer and principal financial officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act).
Based on this evaluation, our principal executive officer and principal
financial officer have concluded that our disclosure controls and procedures
lack adequate staff and procedures in order to be effective. Subsequent to the
end of the period covered by this report we have implemented procedures to
remediate this control deficiency by completing the implementation of an
accounting system designed for oil and gas producing companies and will be
hiring additional staff.
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING
In connection with the evaluation of our internal controls during our
last fiscal quarter, our principal executive officer and principal financial
officer have determined that there have been no changes to our internal controls
over financial reporting that has materially affected, or is reasonably likely
to materially affect, our internal controls over financial reporting.
ITEM 8B. OTHER INFORMATION
None.
34
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND
CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
EXECUTIVE OFFICERS AND DIRECTORS
Our executive officers and directors are:
NAME AGE POSITION
Kelly H. Nelson 50 Chairman and Chief Executive Officer
Carmen J. Lotito 62 Executive Vice President, Chief
Financial Officer, Treasurer,
Secretary and Director
Garry Lavold 61 President and Chief Operating Officer
Dr. Anthony K. Yeats 60 Director
Our shareholders elect our directors annually and our board of
directors appoints our officers annually. Vacancies in our board are filled by
the board itself. Set forth below are brief descriptions of the recent
employment and business experience of our executive officers and directors.
KELLY H. NELSON has been the Chairman and Chief Executive Officer of
the Company since May 2006, and President and Director of PetroHunter Operating
Company since its inception. Mr. Nelson is the cofounder of Equistar Capital,
LLC, a Merchant Banking firm with offices in Salt Lake City, Utah and Zurich,
Switzerland, and has served as Equistar's Managing Partner since its inception
in 1999. While with Equistar, Mr. Nelson has been actively involved in raising
investment capital and financing for Equistar's energy sector portfolio
companies. Since August 2003, Mr. Nelson has also served as chief financial
officer and director of BioComposites International, Inc., one of Equistar's
portfolio companies. Mr. Nelson also is a director for two non-profit
organizations, The Center for Ancient American Culture and the Utah Spiders,
Women's Professional Soccer League. Mr. Nelson earned his Bachelor's degree in
Business Administration from the University of Utah and has completed management
seminars and courses through the University of Southern California and Wharton
School of Business.
CARMEN J. LOTITO has been the Executive Vice President, Chief Financial
Officer, Treasurer, Secretary and a director of the Company since May 2006. Mr.
Lotito has also been the Executive Vice President, Chief Financial Officer,
Treasurer, Secretary and Director of PetroHunter Operating Company since its
inception. Mr. Lotito has been a director and chairman of the audit and
compensation committees of Gasco Energy, Inc. since April 2001, and a director
of Galaxy Energy Corporation from November 2002 to August 2006 He served as
chief financial officer and treasurer of Galaxy Energy Corporation from November
2002 to July 2005, and as executive vice president from August 2004 to July
2005. Both Gasco Energy and Galaxy Energy are subject to the reporting
requirements of the Securities Exchange Act of 1934. Mr. Lotito served as vice
president, chief financial officer, and director of Coriko Corporation, a
private business development company, from November 2000 to August 2002. Prior
to joining Coriko, Mr. Lotito was self-employed as a financial consultant. Mr.
Lotito holds a B.S. degree in accounting from the University of Southern
California.
GARRY LAVOLD has been the President and Chief Operating Officer of the
Company since June 2006. Mr. Lavold has also served as the Chief Operating
Officer of PetroHunter Operating Company since its inception. Mr. Lavold was the
chief operating officer of BioComposites International from January 2003 to July
2005, where he assisted in the development of biocomposite plants to produce
composite materials. From August 2001 until December 2002, Mr. Lavold was the
director of
35
engineering at Coach House, developing composite material projects. From October
2000 to July 2001, Mr. Lavold was chief operating officer of Alpha Fibre,
developing petroleum-based composite materials. Prior to working for Alpha
Fibre, Mr. Lavold worked for 18 years for Nova , an Alberta Corporation (and
affiliated companies), serving in the latter years as a vice president involved
in design, construction and project management of large diameter gas pipelines
for a Nova subsidiary, and from 1969 to 1974 was employed as a process engineer
involved in start up and operations of an 80,000 BPD refinery for Gulf Oil
Canada. Mr. Lavold composed a chapter in PROJECT MANAGEMENT HANDBOOK, eds.
David Cleland and William King, N.Y: Van Rostrand Reinhold, 1983. Mr. Lavold
received a B.S. in Chemical Engineering and an MBA from the University of
Alberta, and is a registered Professional Engineer in Alberta and Ontario,
Canada.
DR. ANTHONY K. YEATS has been a director of the Company since February
2006. Dr. Yeats has participated in the development of numerous exploration
ventures in oil and gas opportunities around the world as well as identifying
some mineral projects. His career has included the role of Chief Geologist,
Geophysicist and Team Leader for Royal Dutch Shell in the Middle East, Africa
and the Far East; Exploration Coordinator for BP's Global Basin Group, and Chief
Geologist for a number of regional acquisitions undertaken by British Petroleum
at a variety of locations throughout the Middle East, Africa, Canada and Europe.
Before joining the Company, in 1999 Dr. Yeats started Cambridge Earth Sciences
Limited, which provides private research and consulting services for companies
engaging in geology and exploration management, which Dr. Yeats continues to
run. In addition, Dr. Yeats has been active as both the Vice President of a
resource investment company in Canada with exploration interests in gravel,
titanium, and kimberlite. Prior to 1999, Dr. Yeats was Co-coordinator for World
Wide New Ventures for Total in Paris and finally Exploration Manager for Total
in the Former Soviet Union where he managed teams undertaking hydrocarbon
exploration in Kazakhstan, Azerbaijan, and Russia. In this post he was
responsible for the generation of new ventures, including the acquisition of
already existing discoveries. Over the years he has developed extensive contacts
with the financial community in Edinburgh and London, which specialize in the
raising of capital for oil and gas ventures particularly from UK, French,
Canadian and Middle East sources.
COMMITTEES OF THE BOARD OF DIRECTORS
We currently do not have an audit committee, compensation committee, or
nominating committee, primarily since we previously did not have any significant
operations. The entire Board of Directors is acting as the Company's audit
committee.
AUDIT COMMITTEE FINANCIAL EXPERT
The Board of Directors currently has not determined whether the company
has a designated audit committee financial expert, primarily since we previously
did not have any significant operations.
FAMILY RELATIONSHIPS
There is no family relationship between any director, executive or
person nominated or chosen by us to become a director or executive officer of
our Company. Please see Item 12. Certain Relationships and Related Transactions,
and Director Independence for a discussion of related party transactions.
CONFLICTS OF INTEREST
Members of our management are associated with other firms involved in a
range of business activities. Consequently, there are potential inherent
conflicts of interest in their acting as officers and directors of our company.
While the officers and directors are engaged in other business activities, we
36
anticipate that such activities will not interfere in any significant fashion
with the affairs of our business, in terms of having adequate time to devote to
the business of the Company.
Our officers and directors are now and may in the future become
shareholders, officers or directors of other companies, which may be formed for
the purpose of engaging in business activities similar to us. Accordingly,
additional direct conflicts of interest may arise in the future with respect to
such individuals acting on behalf of us or other entities. Moreover, additional
conflicts of interest may arise with respect to opportunities which come to the
attention of such individuals in the performance of their duties or otherwise.
Currently, we do not have a right of first refusal pertaining to opportunities
that come to their attention and may relate to our business operations.
Our officers and directors are, so long as they are our officers or
directors, subject to the restriction that all opportunities contemplated by our
plan of operation which come to their attention, either in the performance of
their duties or in any other manner, will be considered opportunities of, and be
made available to us and the companies that they are affiliated with on an equal
basis. A breach of this requirement will be a breach of the fiduciary duties of
the officer or director. If we or the companies with which the officers and
directors are affiliated both desire to take advantage of an opportunity, then
said officers and directors would abstain from negotiating and voting upon the
opportunity. However, all directors may still individually take advantage of
opportunities if we should decline to do so. Except as set forth above, we have
not adopted any other conflict of interest policy with respect to such
transactions.
CODE OF ETHICS
We have not yet adopted a code of ethics that applies to our principal
executive officers, principal financial officer, principal accounting officer or
controller, or persons performing similar functions, since we have been focusing
our efforts on obtaining financing for the Company. We expect to adopt a code by
the end of the current fiscal year.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Officers and directors, and persons who own more than 10% of a
registered class of our equity securities are required to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
pursuant to Section 16(a) of the Securities Exchange Act of 1934. The following
table sets forth reports that were not filed on a timely basis during the most
recently completed fiscal year:
--------------------------------------------------------------------------------------------------------------------
REPORTING PERSON DATE REPORT DUE DATE REPORT FILED
--------------------------------------------------------------------------------------------------------------------
Garry Lavold Form 3 due 06/12/06 06/15/06
--------------------------------------------------------------------------------------------------------------------
Marc A. Bruner Form 3 due 05/22/06 12/05/06
--------------------------------------------------------------------------------------------------------------------
Kelly H. Nelson Form 4 due 08/15/06 01/18/07
--------------------------------------------------------------------------------------------------------------------
Carmen J. Lotito Form 4 due 08/15/06 01/18/07
--------------------------------------------------------------------------------------------------------------------
Garry Lavold Form 4 due 08/15/06 01/18/07
--------------------------------------------------------------------------------------------------------------------
Anthony K. Yeats Form 4 due 08/15/06 01/19/07
--------------------------------------------------------------------------------------------------------------------
37
ITEM 10. EXECUTIVE COMPENSATION
The following table summarizes the annual compensation paid to our
Chief Executive Officer and two most highly compensated executive officers for
the two fiscal years ended September 30, 2006:
SUMMARY COMPENSATION TABLE
------------------------------------------------------------------------------------------------------------------------
LONG TERM COMPENSATION
-------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
-------------------------------------------------------------------------------
SALARY ($) BONUS OTHER SECURITIES
NAME AND ANNUAL RESTRICTED UNDERLYING
PRINCIPAL COMPENSA- STOCK OPTIONS/ LTIP ALL OTHER
POSITION YEAR SALARY ($) ($) TION AWARD(S) SARS(#) PAYOUTS COMPENSATION
------------------------------------------------------------------------------------------------------------------------
Kelly H. 2006 230,000 (1) -- -- -- 750,000 -- --
Nelson, CEO 2005 60,000 -- -- -- 2,000,000 -- --
------------------------------------------------------------------------------------------------------------------------
Carmen J. 2006 205,000 (2) -- -- -- 750,000 -- --
Lotito, CFO 2005 60,000 -- -- -- 2,000,000 -- --
------------------------------------------------------------------------------------------------------------------------
Garry 2006 339,650 (3) -- -- -- 750,000 -- --
Lavold, COO 2005 116,300 -- -- -- 2,000,000 -- --
------------------------------------------------------------------------------------------------------------------------
Gregory 2006 70,000 -- -- -- -- -- --
Leigh Lyons,
CEO (4)
------------------------------------------------------------------------------------------------------------------------
---------------
(1) Includes $155,000 paid in fiscal year 2006 and $60,000 paid in fiscal
year 2005 to Mr. Nelson under terms of a consulting agreement prior to
his employment with the Company.
(2) Includes $125,000 paid in fiscal year 2006 and $60,000 paid in fiscal
year 2005 to Mr. Lotito under terms of a consulting agreement prior to
his employment with the Company.
(3) Includes $211,650 paid in fiscal year 2006 and $116,300 paid in fiscal
year 2005 to Mr. Lavold under terms of a consulting agreement prior to
his employment with the Company. Also includes $38,000 paid in fiscal
year 2006 to Mr. Lavold as reimbursement for $30,000 in moving expenses
and $8,000 for lease of office space in Mr. Lavold's residence.
(4) Mr. Lyons was appointed as an officer of the Company on September 15,
2005. Mr. Lyons resigned from all of his officer positions with the
Company on May 12, 2006.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
----------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES % OF TOTAL
NDERLYING OPTIONS/SARS OPTIONS/SARS GRANTED
GRANTED (#) TO EMPLOYEES IN EXERCISE OR BASE
NAME GRANTED (#) FISCAL YEAR PRICE ($/SH) EXPIRATION DATE
----------------------------------------------------------------------------------------------------------------------
Kelly H. Nelson 750,000 5.64% $2.10 08/11/2011
----------------------------------------------------------------------------------------------------------------------
Carmen J. Lotito 750,000 5.64% $2.10 08/11/2011
----------------------------------------------------------------------------------------------------------------------
Garry Lavold 750,000 5.64% $2.10 08/11/2011
----------------------------------------------------------------------------------------------------------------------
Gregory Leigh Lyons -- -- -- --
----------------------------------------------------------------------------------------------------------------------
38
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
----------------------------------------------------------------------------------------------------------------------
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTIONS/SARS AT
FY-END (#) FY-END ($)
SHARES ACQUIRED ON EXERCISABLE/ EXERCISABLE/
NAME EXERCISE (#) VALUE REALIZED ($) UNEXERCISABLE UNEXERCISABLE
----------------------------------------------------------------------------------------------------------------------
Kelly H. Nelson -- -- 950,000/1,800,000 1,280,000/1,920,000
----------------------------------------------------------------------------------------------------------------------
Carmen J. Lotito -- -- 950,000/1,800,000 1,280,000/1,920,000
----------------------------------------------------------------------------------------------------------------------
Garry Lavold -- -- 950,000/1,800,000 1,280,000/1,920,000
----------------------------------------------------------------------------------------------------------------------
Gregory Leigh Lyons -- -- --
----------------------------------------------------------------------------------------------------------------------
LONG-TERM INCENTIVE PLAN AWARDS
No long-term incentive plan awards were granted in the fiscal year
ended September 30, 2006.
COMPENSATION OF DIRECTORS
The Company currently pays its non-employee directors compensation of
$2,500 per month. In addition, upon election, each director will be granted
options to purchase 100,000 shares of the Company's common stock annually, at
the rate of 25,000 options per quarter. Finally, the Company's independent
directors, who have not yet been elected, shall receive $1,000 per month for
each committee upon which they serve.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table provides certain information as to our officers and
directors individually and as a group, and the holders of more than 5% of our
common stock, as of November 30, 2006. As of November 30, 2006, there were
219,928,734 shares of common stock outstanding.
AMOUNT AND NATURE OF
NAME AND ADDRESS OF BENEFICIAL OWNER (1) BENEFICIAL OWNERSHIP (2) PERCENT OF CLASS (2)
-------------------------------------------- ----------------------------- ------------------------
Marc A. Bruner 75,200,000 (3) 33.4%
1875 Lawrence Street, #1400
Denver, Colorado 80202
Kelly H. Nelson 1,050,000 (4) *
170 South Main, Suite 1025
Salt Lake City, Utah 84101
Carmen J. Lotito 1,050,000 (5) *
1875 Lawrence Street, #1400
Denver, Colorado 80202
39
AMOUNT AND NATURE OF
NAME AND ADDRESS OF BENEFICIAL OWNER (1) BENEFICIAL OWNERSHIP (2) PERCENT OF CLASS (2)
-------------------------------------------- ----------------------------- ------------------------
Garry Lavold 950,000 (6) *
1875 Lawrence Street, #1400
Denver, Colorado 80202
Dr. Anthony K. Yeats 100,000 (7) *
The Moat House
Saffron Walden
Essex, UK CB11 4RU
All officers and directors as a group (4 persons) 3,150,000 1.4%
*Represents beneficial ownership of less than one percent (1%) of the
outstanding shares of our common stock.
---------------------
(1) To our knowledge, except as set forth in the footnotes to this table
and subject to applicable community property laws, each person named in
the table has sole voting and investment power with respect to the
shares set forth opposite such person's name.
(2) This table is based on 219,928,734 shares of common stock outstanding
as of November 30, 2006. If a person listed on this table has the right
to obtain additional shares of common stock within sixty (60) days from
November 30, 2006, the additional shares are deemed to be outstanding
for the purpose of computing the percentage of class owned by such
person, but are not deemed to be outstanding for the purpose of
computing the percentage of any other person.
(3) Consists of (i) 68,000,000 shares held by MAB Resources LLC, an entity
100% owned by Mr. Bruner and his family trust; (ii) 2,000,000 shares
held by MABio Materials Corporation, an entity 68.83% owned by Mr.
Bruner and over which Mr. Bruner has investment and voting control; and
(iii) an option to purchase 5,200,000 shares at an exercise price of
$0.50, which expires August 10, 2010.
(4) Consists of (i) 100,000 shares held by Mr. Nelson, (ii) an option to
acquire 800,000 shares at an exercise price of $0.50, which expires
August 10, 2010, and (iii) an option to acquire 150,000 shares at an
exercise price of $2.10, which expires August 11, 2011.
(5) Consists of (i) 100,000 shares held by Laura Melou Lotito, Mr. Lotito's
wife, (ii) an option to acquire 800,000 shares at an exercise price of
$0.50, which expires on August 10, 2010, and (iii) an option to acquire
150,000 shares at an exercise price of $2.10, which expires August 11,
2011.
(6) Consists of (i) an option to acquire 800,000 shares at an exercise
price of $0.50, which expires on August 10, 2010, and (ii) an option to
acquire 150,000 shares at an exercise price of $2.10, which expires
August 11, 2011.
(7) Consists of an option to acquire 100,000 shares at an exercise price of
$2.10, which expires August 11, 2011.
Marc A. Bruner may be deemed to be the "parent" of our company within
the meaning of the rules and regulations of the Securities and Exchange
Commission.
CHANGES IN CONTROL
There are no agreements known to management that may result in a change
of control of our company.
40
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth information as of the end of the most
recently completed fiscal year, September 30, 2006:
--------------------------------------------------------------------------------------------------------------------
Number of securities to be Weighted average exercise
issued upon exercise of price of outstanding Number of securities
outstanding options, options, warrants and remaining available for
Plan category warrants and rights rights future issuance
--------------------------------------------------------------------------------------------------------------------
Equity compensation plans 32,295,000 $1.16 7,705,000
approved by security holders
--------------------------------------------------------------------------------------------------------------------
Equity compensation plans not -- -- --
approved by security holders
--------------------------------------------------------------------------------------------------------------------
Total 32,295,000 $1.16 7,705,000
--------------------------------------------------------------------------------------------------------------------
STOCK OPTION PLAN
On August 11, 2006, our stockholders approved the terms of the 2005
Stock Option Plan of PetroHunter Operating Company (the "Plan"). Under the Plan,
we may grant certain employees both incentive and non-qualified options to
purchase shares of common stock. The Plan is authorized to grant options
covering up to 40,000,000 shares. When we acquired more than 85% of the
outstanding stock of PetroHunter Operating Company in May 2006, we agreed to
replace all existing stock options of PetroHunter Operating Company with stock
options to purchase shares of our common stock having the same terms as the
original grant. Accordingly in August 2006, we granted options to purchase an
aggregate of 19,000,000 shares of common stock to replace those that had been
granted by PetroHunter Operating Company in August 2005, including options to
purchase 13,000,000 shares to MAB Operating Company and options to purchase
2,000,000 shares each to Kelly Nelson, Carmen Lotito and Garry Lavold. Twenty
percent of each of the options granted is exercisable immediately, and twenty
percent of each option becomes exercisable on August 10th of 2006, 2007, 2008
and 2009. Each option has an exercise price of $0.50 per share, and each option
expires and terminates, if not exercised sooner, on August 10, 2010.
We granted additional options to purchase a total of 13,295,000 shares
under the Plan in August 2006 to employees and consultants, including options to
purchase 750,000 shares each to Kelly Nelson, Carmen Lotito, and Garry Lavold.
Twenty percent of each of the options granted is exercisable immediately and
twenty percent of each option becomes exercisable on August 10th of 2007, 2008,
2009, and 2010. Each option has an exercise price of $2.10 per share, and each
option expires and terminates, if not exercised sooner, on August 11, 2011.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Other than the transactions described below, none of our present
directors, officers or principal shareholders, nor any family member of the
foregoing, nor, to the best of our information and belief, any of our former
directors, officers or principal shareholders, nor any family member of such
former directors, officers or principal shareholders, has or had any material
interest, direct or indirect, in any transaction, or in any proposed transaction
which has materially affected or will materially affect us.
41
MAB RESOURCES LLC/MARC A. BRUNER
As described in Item 1. Description of Business above, we have several
agreements with MAB Resources LLC. Marc A. Bruner, the controlling owner of MAB,
is our largest beneficial owner of our outstanding common stock.
During 2006 and 2005, we incurred $4,530,000 and $860,000,
respectively, in property development costs to MAB under the Development
Agreement with MAB. During 2005, we recorded expenditures paid by MAB on behalf
of us of $222,000. At September 30, 2006 and 2005, we owed MAB $197,785 and
$648,421, respectively. At September 30, 2006, MAB owed us $35,656 for our share
of oil and gas revenues from initial production earned through that date,
pursuant to the terms of the Development Agreement and EDAs.
OFFICERS
During 2006, we incurred consulting fees related to services provided
by our officers in the aggregate amount of $491,650 as follows: Kelly H. Nelson
($155,000), Carmen J. Lotito ($125,000), and Garry Lavold ($211,650). During
2005, we incurred consulting fees related to services provided by our officers
in the aggregate amount of $236,300 and services provided by a related party in
the amount of $41,366, of which $11,966 is included in accounts payable at
September 30, 2005.
FALCON OIL & GAS LTD.
Falcon Oil & Gas Ltd. ("Falcon") is the lessee of approximately 13,595
square feet of office space at 1875 Lawrence Street, Suite 1400, Denver,
Colorado, pursuant to the terms of a lease that expires June 30, 2011. Effective
June 1, 2006, we began sharing the offices with Falcon, and sharing the costs of
the office space, cost of equipment, furniture, office operating costs,
administrative staff, and related expenses on a 50/50 basis. Several of the
consultants and employees of Falcon and the Company who work in the shared space
perform services for both companies pursuant to separate agreements - that is,
each consultant or employee who performs work for both companies does so
pursuant to separate agreements, which define the scope of work for each company
and which do not combine such work under one agreement. At September 30, 2006,
Falcon owed us $208,514 for Falcon's share of cost incurred pursuant to the
sharing arrangement.
Marc A. Bruner is the President, Chief Executive Officer, and Chairman
of the Board of Falcon. In addition, he owns or controls approximately 9.5% of
the issued and outstanding shares of Falcon.
GALAXY ENERGY CORPORATION
In July 2006, Galaxy Energy Corporation ("Galaxy") used a drilling rig
under contract to us. At September 30, 2006, Galaxy owed us $712,830 for
reimbursement for charges paid to a drilling company for Galaxy's use of the
rig. Galaxy paid us $703,970 during the quarter ended December 31, 2006 and the
remaining $8,860 in January 2007.
On December 29, 2006, we entered into a Purchase and Sale Agreement
(the "PSA") with Galaxy and its wholly owned subsidiary, Dolphin Energy
Corporation ("Dolphin"). Pursuant to the PSA, we agreed to purchase all of
Galaxy's and Dolphin's oil and gas interests in the Powder River Basin of
Wyoming and Montana (the "Powder River Basin Assets").
Marc A. Bruner, who is our largest shareholder, also is a 14.3%
beneficial shareholder of Galaxy. Marc A. Bruner is the father of Marc E.
Bruner, the President, Chief Executive Officer and director of
42
Galaxy. Marc E. Bruner is the stepson of Carmen J. Lotito, the Chief Financial
Officer and a director of the Company. Mr. Lotito was a director of Galaxy from
November 2002 to August 2006 and served as its chief financial officer and
treasurer from November 2002 to July 2005, and as its executive vice president
from August 2004 to July 2005.
The purchase price for Powder River Basin Assets is $45 million, with
$20 million to be paid in cash and $25 million to be paid in shares of our
common stock at the rate of $1.50 per share.
Closing of the transaction is subject to approval by Galaxy's secured
noteholders, approval of all matters in its discretion by our Board of
Directors, including the Company obtaining outside financing on terms acceptable
to its Board of Directors, and various other terms and conditions. Either party
may terminate the agreement if closing has not occurred by February 28, 2007.
Within ten (10) days of signing the PSA, we were required and did make
an initial earnest money payment of $1.4 million. On or before January 31, 2007,
we will make an additional earnest money payment of $600,000. In the event the
closing does not occur for any reason other than a material breach by us, the
deposit shall convert into a promissory note (the "Note"), payable to us, and
shall be an unsecured subordinated debt of both Galaxy and Dolphin, which is
payable only after repayment of Galaxy's and Dolphin's senior indebtedness.
We became the contract operator of the Powder River Basin Assets
beginning January 1, 2007. At closing, the operating expenses incurred by us as
the contract operator will be credited toward the purchase price, or if closing
does not occur, will be added to the principal amount of the Note.
MAB has orally agreed to guarantee the performance of Galaxy and
Dolphin under the PSA (including but not limited to all their obligations under
the Note), and has orally agreed to reimburse us for certain losses and damages
which might be incurred as a result of those parties entering into the PSA. A
written agreement will be entered into by the parties prior to closing.
GLOBAL PROJECT FINANCE AG
On January 9, 2007, we entered into a Credit and Security Agreement
with Global Project Finance AG, a Swiss company ("Global"). Under that
Agreement, Global has committed to advance up to $15,000,000 over the next 18
months. Interest accrues at 6.75% over the prime rate and will be payable
quarterly beginning March 31, 2007. We are to begin making principal payments on
the loan beginning at the end of the first quarter following the end of the
18-month funding period, with the maturity date of the loan being 30 months from
the date of the Agreement. The loan is secured by a first perfected security
interest on our assets, limited to the specific portion of the assets to which
the loan proceeds are applied by us. We plan to use the loan proceeds for its
drilling and development operations in the Piceance Basin, Colorado.
Global received warrants to purchase 1,000,000 shares of our common
stock upon execution of the Agreement and up to 3,000,000 warrants, tied on a
pro rata basis to each advance of the credit facility. The warrants will be
exercisable for five years from the date of the Agreement at a price equal to
the 120% of the volume-weighted average price of the stock for the 30 days
immediately preceding each warrant issuance date. In addition, upon each
advance, Global receives a fee equal to 1% of the amount of the advance.
Global and its controlling shareholder, Christian Russenberger, were
shareholders of the Company prior to entering into this Credit and Security
Agreement
43
FUTURE TRANSACTIONS
All future affiliated transactions will be made or entered into on
terms that are no less favorable to us than those that can be obtained from any
unaffiliated third party. A majority of the independent, disinterested members
of our board of directors will approve future affiliated transactions.
DIRECTOR INDEPENDENCE
Our common stock trades in the OTC Bulletin Board. As such, we are not
currently subject to corporate governance standards of listed companies, which
require, among other things, that the majority of the board of directors be
independent.
Since we are not currently subject to corporate governance standards
relating to the independence of our directors, we choose to define an
"independent" director in accordance with the NASDAQ Global Market's
requirements for independent directors (NASDAQ Marketplace Rule 4200). The
NASDAQ independence definition includes a series of objective tests, such as
that the director is not an employee of the company and has not engaged in
various types of business dealings with the company.
Anthony Yeats is considered an independent director under the above
definition. We do not list that definition on our Internet website.
We presently do not have an audit committee, compensation committee,
nominating committee, executive committee of our Board of Directors, stock plan
committee or any other committees.
ITEM 13. EXHIBITS
--------------------------------------------------------------------------------
REGULATION
S-B NUMBER EXHIBIT
--------------------------------------------------------------------------------
2.1 Stock Exchange Agreement dated February 10, 2006 by and among
Digital Ecosystems Corp., GSL Energy Corporation, MABio Materials
Corporation and MAB Resources LLC (incorporated by reference to
Exhibit 10.8 to the Company's quarterly report on Form 10-QSB for
the quarter ended December 31, 2005, filed February 16, 2006)
--------------------------------------------------------------------------------
2.2 Amendment No. 1 to Stock Exchange Agreement dated March 31, 2006
(incorporated by reference from Exhibit 10.1 to the Company's
current report on Form 8-K dated March 31, 2006, filed April 7,
2006)
--------------------------------------------------------------------------------
2.3 Amendment No. 5 to Stock Exchange Agreement dated May 12, 2006
(incorporated by reference from Exhibit 10.1 to the Company's
current report on Form 8-K dated May 12, 2006, filed May 15, 2006)
--------------------------------------------------------------------------------
2.4 Purchase and Sale Agreement dated December 29, 2006 between
Dolphin Energy Corporation and Galaxy Energy Corporation and
PetroHunter Operating Company and PetroHunter Energy Corporation
(incorporated by reference to Exhibit 2.1 to the Company's
current report on Form 8-K dated December 29, 2006, filed
January 4, 2007)
--------------------------------------------------------------------------------
3.1 Articles of Incorporation (incorporated by reference to Exhibit A
to the Information Statement filed July 17, 2006)
--------------------------------------------------------------------------------
3.2 Bylaws (incorporated by reference to Exhibit B to the Information
Statement filed July 17, 2006)
--------------------------------------------------------------------------------
44
--------------------------------------------------------------------------------
REGULATION
S-B NUMBER EXHIBIT
--------------------------------------------------------------------------------
10.1 Business Consultant Agreement dated October 1, 2005 (incorporated
by reference to Exhibit 10.1 to the Company's current report on
Form 8-K dated October 1, 2005, filed October 28, 2005)
--------------------------------------------------------------------------------
10.2 Marketing Management Contract dated October 15, 2005
(incorporated by reference to Exhibit 10.1 to the Company's
current report on Form 8-K dated October 1, 2005, filed
October 28, 2005)
--------------------------------------------------------------------------------
10.3 Loan Agreement with Carnavon Trust Reg. Dated for reference
October 11, 2005 (incorporated by reference to Exhibit 10.3 to the
Company's quarterly report on Form 10-QSB for the quarter ended
September 30, 2005, filed November 21, 2005)
--------------------------------------------------------------------------------
10.4 Loan Agreement with Carnavon Trust Reg. Dated for reference
December 5, 2005 (incorporated by reference to Exhibit 10.6 to the
Company's quarterly report on Form 10-QSB for the quarter ended
December 31, 2005, filed February 16, 2006)
--------------------------------------------------------------------------------
10.5 Loan Agreement with Carnavon Trust Reg. Dated for reference
February 2, 2006 (incorporated by reference to Exhibit 10.7 to the
Company's quarterly report on Form 10-QSB for the quarter ended
December 31, 2005, filed February 16, 2006)
--------------------------------------------------------------------------------
10.6 2005 Stock Option Plan (incorporated by reference from Exhibit 4.1
to the Company's annual report Form 10-KSB for the fiscal year
ending March 31, 2006, filed on July 14, 2006)
--------------------------------------------------------------------------------
10.7 Management and Development Agreement Between MAB Resources LLC and
GSL Energy Corporation (Amended and Restated) Effective July 1,
2005 (incorporated by reference from Exhibit 10.4 to the Company's
annual report Form 10-KSB for the fiscal year ending March 31,
2006, filed on July 14, 2006)
--------------------------------------------------------------------------------
10.8 Acquisition and Consulting Agreement between MAB Resources LLC and
PetroHunter Energy Corporation Effective January 1, 2007
(incorporated by reference to Exhibit 10.1 to the Company's
amended current report on Form 8-K dated January 9, 2007, filed
January 25, 2007)
--------------------------------------------------------------------------------
10.9 Credit and Security Agreement dated as of January 9, 2007 between
PetroHunter Energy Corporation and PetroHunter Operating Company
and Global Project Finance AG (incorporated by reference to
Exhibit 10.2 to the Company's current report on Form 8-K dated
January 9, 2007, filed January 11, 2007)
--------------------------------------------------------------------------------
14.1 Code of Ethics (incorporated by reference from Exhibit 14.1 to the
Company's annual report Form 10-KSB for the fiscal year ending
March 31, 2005, filed on July 13, 2005)
--------------------------------------------------------------------------------
16.1 Letter from Telford Sadovnick P.L.L.C. (incorporated by reference
to Exhibit 16.1 to the Company's amended current report on Form
8-K dated September 8, 2006, filed September 8, 2006)
--------------------------------------------------------------------------------
21.1 Subsidiaries
--------------------------------------------------------------------------------
31.1 Rule 13a-14(a) Certification of Kelly H. Nelson
--------------------------------------------------------------------------------
31.2 Rule 13a-14(a) Certification of Carmen J. Lotito
--------------------------------------------------------------------------------
32.1 Certification of Kelly H. Nelson Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
Of 2002
--------------------------------------------------------------------------------
32.2 Certification of Carmen J. Lotito Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
Of 2002
--------------------------------------------------------------------------------
45
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The fees billed for professional services rendered by our principal
accountant are as follows:
FISCAL AUDIT-RELATED
YEAR AUDIT FEES FEES TAX FEES ALL OTHER FEES
--------------------------------------------------------------------------------------------------------------------
2005 $ 37,558 $-0- $-0- $-0-
2006 $125,000 $-0- $-0- $-0-
PRE-APPROVAL POLICIES AND PROCEDURES
The Board of Directors must pre-approve any use of our independent
accountants for any non-audit services. All services of our auditors are
approved by our Board and are subject to review by our Board.
46
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
PETROHUNTER ENERGY CORPORATION
Date: January 26, 2007 By: /s/ KELLY H. NELSON
-------------------------------------------
Kelly H. Nelson
Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
SIGNATURE TITLE DATE
Chairman and Chief Executive Officer and
/s/ KELLY H. NELSON Director (Principal Executive Officer) January 26, 2007
------------------------------------
Kelly H. Nelson
Executive Vice President, Chief Financial
Officer, Treasurer, Secretary and Director
(Principal Financial Officer and Principal
/s/ CARMEN J. LOTITO Accounting Officer) January 26, 2007
------------------------------------
Carmen J. Lotito
/s/ ANTHONY K. YEATS Director January 26, 2007
------------------------------------
Anthony K. Yeats
47
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
PetroHunter Energy Corporation
Denver, CO
We have audited the consolidated balance sheet of PetroHunter Energy Corporation
and subsidiaries (the "Company"), a development stage company, as of September
30, 2006, and the related consolidated statements of operations, stockholders'
equity and cash flows for the year ended September 30, 2006 and for the periods
from inception (June 20, 2005) to September 30, 2005 and September 30, 2006.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provided a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of PetroHunter Energy
Corporation and subsidiaries as of September 30, 2006 and the results of their
operations and their cash flows for the year ended September 30, 2006 and for
the periods from inception (June 20, 2005) to September 30, 2005 and September
30, 2006 in conformity with U.S. generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has suffered recurring losses from operations
and has significant capital expenditure commitments. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 2. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ HEIN & ASSOCIATES LLP
Denver, Colorado
January 19, 2006
F-1
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT COMPANY)
CONSOLIDATED BALANCE SHEETS
ASSETS
SEPTEMBER 30 SEPTEMBER 30
2006 2005
------------------ -----------------
Current Assets
Cash and cash equivalents $ 10,631,776 $ 1,250,242
Oil and gas receivables - related party 35,656 -
Other receivables 22,290 -
Due from related parties 921,344 -
Prepaid expenses and other assets 30,960 7,699
------------------ -----------------
TOTAL CURRENT ASSETS 11,642,026 1,257,941
------------------ -----------------
PROPERTY AND EQUIPMENT, AT COST
Oil and gas properties under full cost, net 45,972,784 7,231,443
Furniture and equipment, net 550,213 -
------------------ -----------------
46,522,997 7,231,443
------------------ -----------------
OTHER ASSETS
Restricted cash 1,076,793 -
Deferred financing costs - 10,563
------------------ -----------------
TOTAL ASSETS $ 59,241,816 $ 8,499,947
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 9,644,236 $ 475,107
Accrued interest payable 124,474 23,029
Due to shareholder 197,785 648,421
Contracts payable - oil and gas properties - 5,512,500
Notes payable 400,000 -
Convertible notes payable - 3,037,000
------------------ -----------------
TOTAL CURRENT LIABILITIES 10,366,495 9,696,057
------------------ -----------------
ASSET RETIREMENT OBLIGATION 522,054 -
------------------ -----------------
TOTAL LIABILITIES 10,888,549 9,696,057
------------------ -----------------
COMMITMENTS AND CONTINGENCIES (NOTES 2, 3, 4, 9, 12 AND 13)
STOCKHOLDERS' EQUITY
Preferred stock, $.001 par value
Authorized - 1,000,000 shares, issued, none
Common stock, $.001 par value
Authorized - 500,000,000 shares
Issued and outstanding - 219,928,734 (2006)
and 100,000,000 (2005) shares 219,929 100,000
Capital in excess of par value 70,944,172 822,710
Deficit accumulated during the development stage (22,810,834) (2,118,820)
------------------ -----------------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) 48,353,267 (1,196,110)
------------------ -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 59,241,816 $ 8,499,947
================== =================
The accompanying notes are an integral part of the consolidated
financial statements.
F-2
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
PERIOD FROM CUMULATIVE FROM
INCEPTION INCEPTION
(JUNE 20, 2005) (JUNE 20, 2005)
YEAR ENDED TO TO
SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30
2006 2005 2006
----------------- ----------------- -------------------
REVENUES
Oil and gas revenues $ 35,656 $ - $ 35,656
----------------- ----------------- -------------------
COSTS AND EXPENSES
Lease operating expenses 3,672 - 3,672
General and administrative 13,637,801 1,235,791 14,873,592
Property development - related 4,530,000 860,000 5,390,000
Depreciation, depletion, amortization and accretion 73,137 - 73,137
----------------- ----------------- -------------------
TOTAL OPERATING EXPENSES 18,244,610 2,095,791 20,340,401
----------------- ----------------- -------------------
OTHER INCOME (EXPENSE)
Interest income 2,633 - 2,633
Interest expense (2,485,693) (23,029) (2,508,722)
----------------- ----------------- -------------------
TOTAL OTHER INCOME (EXPENSE) (2,483,060) (23,029) (2,506,089)
----------------- ----------------- -------------------
----------------- ----------------- -------------------
NET LOSS $ (20,692,014) $ (2,118,820) $ (22,810,834)
================= ================= ===================
NET LOSS PER COMMON SHARE -
BASIC AND DILUTED $ (0.14) $ (0.02)
================= =================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING - BASIC AND DILUTED 147,309,096 100,000,000
================= =================
The accompanying notes are an integral part of the
consolidated financial statements.
F-3
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT COMPANY)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Deficit
Accumulated
Common Stock Capital in During the Total
------------------------------- Excess of Par Development Stockholders'
Shares Amount Value Stage Equity
-------------- ------------- ------------- -------------- ----------------
Balance, June 20, 2005 (inception) - $ - $ - $ - $ -
Issuance of common shares to founder,
at $.001 per share 100,000,000 100,000 - - 100,000
Stock based compensation costs for
options granted to non-employees - - 822,710 - 822,710
NET LOSS - - - (2,118,820) (2,118,820)
-------------- ------------- ------------- -------------- ----------------
BALANCE, SEPTEMBER 30, 2005 100,000,000 100,000 822,710 (2,118,820) (1,196,110)
Issuance of common stock for property
interests at $.50 per share 3,000,000 3,000 1,497,000 - 1,500,000
Issuance of common stock for finders fee
on property at $.50 per share 3,400,000 3,400 1,696,600 - 1,700,000
Issuance of common shares upon conversion
of debt, at $.50 per share 44,063,334 44,063 21,987,604 - 22,031,667
Issuance of common shares for commission
on convertible debt at $.50 per share 2,845,400 2,846 1,419,855 - 1,422,701
Sale of common shares and warrants at
$1.00 per unit 35,442,500 35,442 35,407,058 - 35,442,500
Issuance of common shares for commission
on sale of units 1,477,500 1,478 1,476,023 - 1,477,501
Costs of stock offering
Cash - - (1,638,374) - (1,638,374)
Common shares for commission at $1.00 - - (1,477,500) - (1,477,500)
Exercise of common stock warrants 1,000,000 1,000 999,000 - 1,000,000
Recapitalizaton of shares issued upon merger 28,700,000 28,700 (435,138) - (406,438)
Stock based compensation - - 9,189,334 - 9,189,334
NET LOSS - - - (20,692,014) (20,692,014)
-------------- ------------- ------------- -------------- ----------------
BALANCE, SEPTEMBER 30, 2006 219,928,734 $ 219,929 $ 70,944,172 $ (22,810,834) $ 48,353,267
============== ============= ============= ============== ================
The accompanying notes are an integral part of the consolidated
financial statements.
F-4
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIOD FROM CUMULATIVE FROM
INCEPTION INCEPTION
(JUNE 20, 2005) (JUNE 20, 2005)
YEAR ENDED TO TO
SEPTEMBER 30 SEPTEMBER 30 SEPTEMBER 30
2006 2005 2006
------------------ ----------------- -----------------
Cash flows used in operating activities
Net loss $ (20,692,014) $ (2,118,820) $ (22,810,834)
Adjustments to reconcile net loss to
net cash (used) in operating activities
Stock for expenditures advanced - 100,000 100,000
Stock based compensation 9,189,334 822,710 10,012,044
Depreciation, depletion, amotization and accretion 73,137 - 73,137
Stock for financing costs 1,422,701 - 1,422,701
Changes in assets and liabilities
Accounts receivable (57,946) - (57,946)
Due from related party (921,344) - (921,344)
Prepaids and other 9,311 (18,262) (8,951)
Accounts payable and accrued expenses 881,651 343,793 1,379,787
Due to shareholder (450,636) 648,421 197,785
------------------ ----------------- -----------------
NET CASH USED IN OPERATING ACTIVITIES (10,545,806) (222,158) (10,613,621)
------------------ ----------------- -----------------
CASH FLOWS USED IN INVESTING ACTIVITIES
Additions to oil and gas properties (31,062,398) (1,564,600) (32,781,341)
Property and equipment (553,211) - (553,211)
Restricted cash (1,076,793) - (1,076,793)
------------------ ----------------- -----------------
NET CASH USED IN INVESTING ACTIVITIES (32,692,402) (1,564,600) (34,411,345)
------------------ ----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from the sale of common stock 35,442,500 - 35,442,500
Proceeds from the exercise of warrants 1,000,000 - 1,000,000
Cash received upon recapitalization and merger 20,949 - 20,949
Proceeds from issuance of convertible notes 17,794,667 3,037,000 20,831,667
Offering costs (1,638,374) - (1,638,374)
------------------ ----------------- -----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 52,619,742 3,037,000 55,656,742
------------------ ----------------- -----------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 9,381,534 1,250,242 10,631,776
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,250,242 - -
------------------ ----------------- -----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 10,631,776 $ 1,250,242 $ 10,631,776
================== ================= =================
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Cash paid for interest $ 1,028,353 $ - $ 1,028,353
================== ================= =================
Cash paid for income taxes $ - $ - $ -
================== ================= =================
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING
ACTIVITIES
Stock issued for expenditures advanced $ - $ 100,000 $ 100,000
================== ================= =================
Contracts for oil and gas properties $ 6,261,460 $ 5,512,500 $ 11,773,960
================== ================= =================
Common stock issued for debt conversion $ 22,031,667 $ - $ 22,031,667
================== ================= =================
Common stock issued for commissions on offerings $ 2,900,201 $ - $ 2,900,201
================== ================= =================
Common stock issued for finders fee on property $ 1,700,000 $ - $ 1,700,000
================== ================= =================
Convertible debt issued for property $ 1,200,000 $ - $ 1,200,000
================== ================= =================
Common stock issued for property $ 500,000 $ - $ 500,000
================== ================= =================
The accompanying notes are an integral part of the
consolidated financial statements.
F-5
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 1 -- ORGANIZATION AND BASIS OF PRESENTATION
PetroHunter Energy Corporation, formerly known as Digital Ecosystems Corp.,
("Digital") was incorporated on February 21, 2002 under the laws of the
State of Nevada. On February 10, 2006, Digital entered into a Share
Exchange Agreement (the "Agreement") with GSL Energy Corporation ("GSL")
and certain shareholders of GSL pursuant to which Digital acquired more
than 85% of the issued and outstanding shares of common stock of GSL, in
exchange for shares of Digital's common stock. On May 12, 2006, the parties
to the Agreement completed the share exchange, and Digital changed its
business to the business of GSL. Subsequent to the closing of the
Agreement, Digital acquired all the remaining outstanding stock of GSL, and
effective August 14, 2006, Digital changed its name from Digital Ecosystems
Corp. to PetroHunter Energy Corporation ("PetroHunter").
GSL was incorporated under the laws of the State of Maryland on June 20,
2005 for the purpose of acquiring, exploring and developing oil and gas
properties. GSL is considered a development stage company as defined by
Statement of Financial Accounting Standards ("SFAS") No. 7, and its
principal activities since inception have been raising capital through the
sale of common stock and convertible notes and the acquisition of oil and
gas properties in the Western United States and Australia. In October 2006,
GSL changed its name to PetroHunter Operating Company. On November 8, 2005,
GSL formed Paleotechnology, Inc. ("Paleo") as a wholly owned subsidiary for
the purpose of exploring and developing new products and processes using
by-products of petroleum extraction environments. On September 11, 2006,
PetroHunter formed PetroHunter Heavy Oil Ltd. ("Heavy Oil"), as a wholly
owned subsidiary for the purpose of holding and developing the Company's
heavy oil assets. (Unless otherwise specified, PetroHunter, GSL, Heavy Oil,
and Paleo are collectively referred to herein as the "Company").
As a result of the Agreement, GSL became a wholly owned subsidiary of
PetroHunter. Since this transaction resulted in the former shareholders of
GSL acquiring control of PetroHunter, for financial reporting purposes the
business combination was accounted for as an additional capitalization of
PetroHunter (a reverse acquisition with GSL as the accounting acquirer). In
accounting for this transaction:
i. GSL was deemed to be the purchaser and parent company for financial
reporting purposes. Accordingly, its net assets were included in the
consolidated balance sheet at their historical book value; and
ii. Control of the net assets and business of PetroHunter was acquired
effective May 12, 2006 for no consideration.
The fair value of the Digital assets acquired and liabilities assumed
pursuant to the transaction with GSL are as follows:
Net cash acquired $ 20,949
Current assets 22,009
Liabilities assumed (449,396)
------------
Value of 28,700,000 Digital Shares $ (406,438)
============
F-6
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING
The accompanying financial statements have been prepared on the basis of
accounting principles applicable to a going concern, which contemplates the
realization of assets and extinguishment of liabilities in the normal
course of business. As shown in the accompanying balance sheet the Company
has the Company has incurred a cumulative net loss of $22,810,834 for the
period from inception (June 20, 2005) to September 30, 2006, and has
significant capital expenditure commitments. As of September 30, 2006, the
Company has received oil and gas revenue from its initial wells, and will
require significant additional funding to sustain its operations and
satisfy its contractual obligations for its planned oil and gas exploration
and development operations. These factors, among others, may indicate that
the Company may be unable to continue in existence. The Company's financial
statements do not include any adjustments related to the realization of the
carrying value of assets or the amounts and classification of liabilities
that might be necessary should the Company be unable to continue in
existence. The Company's ability to establish itself as a going concern is
dependent upon its ability to obtain additional financing, in order to fund
its planned operations and ultimately, to achieve profitable operations.
Management believes that they can be successful in obtaining equity and/or
debt financing which will enable the Company to continue in existence and
establish itself as a going concern. The Company has sold approximately
$56.3 million of convertible notes and common stock through September 30,
2006, and management believes that the Company will be successful in
raising additional funding to have sufficient capital to meet its
obligations for its planned operations. The Company has raised an
additional $3,417,500 subsequent to September 30, 2006 in two private
placements of common stock currently in process and has received $5,000,000
from a private investor pursuant to a loan commitment (See Note 13).
BASIS OF PRESENTATION
The accompanying consolidated financial statements include PetroHunter for
the period from May 12, 2006 to September 30, 2006, and its wholly owned
subsidiary, GSL, for the twelve months ended September 30, 2006. For the
period ended September 30, 2005, the consolidated financial statements are
those of GSL. All significant intercompany transactions have been
eliminated upon consolidation.
OIL AND GAS PROPERTIES
The Company utilizes the full cost method of accounting for oil and gas
activities. Under this method, subject to a limitation based on estimated
value, all costs associated with property acquisition, exploration and
development, including costs of unsuccessful exploration, are capitalized
within a cost center on a country basis. No gain or loss is recognized upon
the sale or abandonment of undeveloped or producing oil and gas properties
unless the sale represents a significant portion of oil and gas properties
and the gain significantly alters the relationship between capitalized
costs and proved oil and gas reserves of the cost center. Depreciation,
depletion and amortization of oil and gas properties is computed on the
units of production method based on proved reserves. Amortizable costs
include estimates of future development costs of proved undeveloped
reserves.
F-7
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OIL AND GAS PROPERTIES (Continued)
Capitalized costs of oil and gas properties may not exceed an amount equal
to the present value, discounted at 10%, of the estimated future net cash
flows from proved oil and gas reserves plus the cost, or estimated fair
market value, if lower, of unproved properties. Should capitalized costs
exceed this ceiling, an impairment is recognized. The present value of
estimated future net cash flows is computed by applying year end prices of
oil and natural gas to estimated future production of proved oil and gas
reserves as of year end, less estimated future expenditures to be incurred
in developing and producing the proved reserves and assuming continuation
of existing economic conditions. As of September 30, 2006, the Company has
no proved reserves, has received nominal revenue from testing and
production on its initial wells, and all oil and gas property costs are
considered to be unevaluated and are recorded at the lower of cost or fair
market value.
ASSET RETIREMENT OBLIGATION
The Company applies SFAS 143, "Accounting for Asset Retirement
Obligations," which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets
and the associated asset retirement costs. This statement requires
companies to record the present value of obligations associated with the
retirement of tangible long-lived assets in the period in which it is
incurred. The liability is capitalized as part of the related long-lived
asset's carrying amount. Over time, accretion of the liability is
recognized as an operating expense and the capitalized cost is depreciated
over the expected useful life of the related asset. Asset retirement
obligations ("ARO") relate primarily to the plugging, dismantlement,
removal, site reclamation and similar activities of its oil and gas
properties. At September 30, 2006, the Company had recorded an ARO of
$522,054 for its initial wells.
PROPERTY AND EQUIPMENT
Furniture, equipment and computer software is recorded at cost.
Depreciation and amortization is recorded using the straight-line method
over the estimated useful lives of the related assets of three to seven
years. Expenditures for replacements, renewals, and betterments are
capitalized. Maintenance and repairs are charged to operations as incurred.
REVENUE RECOGNITION
The Company recognizes oil and gas revenues from its interests in producing
wells as oil and gas is produced and sold from these wells. The Company has
no gas balancing arrangements in place. Oil and gas sold is not
significantly different from the Company's product entitlement.
F-8
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
IMPAIRMENT
The Company applies SFAS 144, "Accounting for the Impairment and Disposal
of Long-Lived Assets," which requires that long-lived assets to be held and
used be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Oil
and gas properties accounted for using the full cost method of accounting,
the method utilized by the Company, are excluded from this requirement, but
will continue to be subject to the ceiling test limitations. The Company's
unproved properties are evaluated periodically for the possibility of
potential impairment. At September 30, 2006, there was no impairment charge
for unproved properties.
INCOME TAXES
The Company has adopted the provisions of SFAS 109, "Accounting for Income
Taxes." SFAS 109 requires recognition of deferred tax liabilities and
assets for the expected future tax consequences of events that have been
included in the financial statements or tax returns. Under this method,
deferred tax liabilities and assets are determined based on the difference
between the financial statement and tax basis of assets and liabilities
using enacted tax rates in effect for the year in which the differences are
expected to reverse.
Temporary differences between the time of reporting certain items for
financial and tax reporting purposes consist primarily of exploration and
development costs on oil and gas properties, and stock based compensation
of options granted.
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 and disclosure of contingent assets and
liabilities at the date of the financial statements and 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 oil and gas reserve quantities which are the basis for
the calculation of depreciation, depletion and impairment of oil and gas
properties, and timing and costs associated with its retirement
obligations.
The oil and gas industry is subject, by its nature, to environmental
hazards and clean-up costs. At this time, management knows of no
substantial costs from environmental accidents or events for which the
Company may be currently liable. In addition, the Company's oil and 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 be volatile in the future. By definition, proved reserves are based on
current oil and gas prices and estimated reserves. Price declines reduce
the estimated quantity of proved reserves and increase annual amortization
expense (which is based on proved reserves).
F-9
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOSS PER COMMON SHARE
Basic (loss) per share is based on the weighted average number of common
shares outstanding during the period. Diluted (loss) per share reflects the
potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock.
Convertible equity instruments such as stock options and convertible
debentures are excluded from the computation of diluted loss per share, as
the effect of the assumed exercises would be anti-dilutive. The dilutive
weighted average number of common shares outstanding excluded potential
common shares from stock options and warrants of approximately 25,309,000
for the fiscal year ending September 30, 2006.
SHARE BASED COMPENSATION
The Company has followed Accounting Principles Board ("APB") Opinion No.
25,"Accounting for Stock Issued to Employees", and related interpretations,
through September 30, 2005 which resulted in the accounting for grants of
awards to employees at their intrinsic value in the consolidated financial
statements. Additionally, the Company has recognized compensation expense
in the financial statements for awards granted to non-employees which must
be re-measured each period under the mark-to-market, as required under EITF
96-18, "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring or in Conjunction with Selling, Goods or Services".
The Company previously adopted the provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation", as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation --Transition and Disclosure", through disclosure
only.
Effective October 1, 2006, the Company adopted SFAS123(R), "Accounting for
Stock-Based Compensation," using the modified prospective method, which
results in the provisions of SFAS 123(R) being applied to the consolidated
financial statements on a going-forward basis. Prior periods have not been
restated. SFAS 123(R) requires companies to recognize share-based payments
to employees as compensation expense on a fair value method. Under the fair
value recognition provisions of SFAS 123(R), stock-based compensation cost
is measured at the grant date based on the fair value of the award and is
recognized as expense over the service period, which generally represents
the vesting period. The expense recognized over the service period is
required to include an estimate of the awards that will be forfeited.
Previously, no such forfeitures have occurred. The Company is assuming no
forfeitures going forward based on the Company's historical forfeiture
experience. The fair value of stock options is calculated using the
Black-Scholes option-pricing model. Had compensation cost for the Company's
stock-based compensation plans been determined based on the fair value at
the grant dates for awards under the plan consistent with the method
prescribed in SFAS 123(R) for the year ended September 30, 2006, the
Company's net loss and net loss per share for the period would have been
adjusted to the pro-forma amounts indicated below.
F-10
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SHARE BASED COMPENSATION (Continued)
2006 2005
----------------------------------
Net loss as reported $ (20,692,014) $ (2,118,820)
Add stock based compensation included in
Reported loss 9,189,334 822,710
Deduct stock based compensation expense
Determined under fair value method (9,189,334) (1,202,422)
--------------- --------------
Pro-forma net loss $ (20,692,014) $ (2,498,532)
=============== ==============
Net loss per share
As reported $(0.14) $(0.02)
Pro-forma $(0.14) $(0.02)
The estimated value of stock options granted following calculation methods
prescribed by SFAS 123R, uses the Black-Scholes stock options pricing model
with the following assumptions used:
2006 2005
--------------- --------------
Expected option term - years 4 5
Risk-free interest rate 4.6%-4.9% 4.13%
Dividend yield 0 0
Volatility 74% 74%
As of September 30, 2006, options to purchase an aggregate of 32,295,000
shares of the Company's common stock were outstanding. These options were
granted, to the Company's officers, directors and consultants in August of
2005 and 2006, vest 20% at grant date and 20% per year on the anniversary
of the grant date for the next four years. Each option has an exercise
price equal to the fair market value per share of the Company's common
stock at the date of grant and each option expires and terminates, if not
exercised sooner, five years from the grant date. Stock-based employee
compensation of $2,632,372 and stock-based non-employee compensation costs
of $6,556,962 before tax, were charged to operations as compensation
expense for the year ended September 30, 2006.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, the Company considers as cash
equivalents all highly liquid investments with a maturity of three months
or less at the time of purchase. Restricted cash at September 30, 2006
consists of certificates of deposit underlying letters of credit for
exploration permits, state and local bonds and guarantees to vendors.
F-11
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist of cash. The Company maintains cash
accounts at one financial institution. The Company periodically evaluates
the credit worthiness of financial institutions, and maintains cash
accounts only in large high quality financial institutions, thereby
minimizing exposure for deposits in excess of federally insured amounts. On
occasion, the Company may have cash in banks in excess of federally insured
amounts. The Company believes that credit risk associated with cash is
remote.
FAIR VALUE
The carrying amount reported in the balance sheet for cash, receivables,
prepaids, accounts payable and accrued liabilities approximates fair value
because of the immediate or short-term maturity of these financial
instruments.
Based upon the borrowing rates currently available to the Company for loans
with similar terms and average maturities, the fair value of convertible
notes approximates their carrying value.
OFF BALANCE SHEET ARRANGEMENTS
The Company has no off balance sheet arrangements.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 2006, the Financial Accounting Standards Board (FASB) issued
SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments-an
amendment of FASB Statements No. 133 and 140." SFAS No. 155 amends SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" and
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities," and also resolves issues addressed in
SFAS No. 133 Implementation Issue No. D1, "Application of Statement 133 to
Beneficial Interests in Securitized Financial Assets." SFAS No. 155 was
issued to eliminate the exemption from applying SFAS No. 133 to interests
in securitized financial assets so that similar instruments are accounted
for in a similar fashion, regardless of the instrument's form. The Company
does not believe that its financial position, results of operations or cash
flows will be impacted by SFAS No. 155 as the Company does not currently
hold any hybrid financial instruments.
F-12
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (Continued)
In June 2006, the FASB issued FASB Interpretation No. 48 (FIN 48),
Accounting for Uncertainty in Income Taxes. The interpretation clarifies
the accounting for uncertainty in income taxes recognized in a company's
financial statements in accordance with Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes. Specifically, the
pronouncement prescribes a recognition threshold and a measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. The interpretation
also provides guidance on the related derecognition, classification,
interest and penalties, accounting for interim periods, disclosure and
transition of uncertain tax positions. The Company will be required to
adopt FIN 48 for the fiscal year ended September 30, 2008. The Company is
reviewing and evaluating the effect, if any, of adopting FIN 48 on its
financial position and results of operations.
RECLASSIFICATION
Certain reclassifications have been made to the 2005 financial statements
to conform to 2006 presentation. Such reclassifications had no effect on
net loss.
NOTE 3 -- AGREEMENT WITH MAB RESOURCES LLC
Effective January 1, 2007, the Company and MAB Resources LLC ("MAB")
entered into an Acquisition and Consulting Agreement (the "Consulting
Agreement") which replaced in its entirety the Management and Development
Agreement (the "Development Agreement") entered into July 1, 2005, and
materially revised the relationship between MAB and the Company. MAB is a
Delaware limited liability company controlled by the largest shareholder of
the Company. MAB is in the business of oil and gas exploration and
development. Under the terms of the Consulting Agreement:
o The Company's working interest in all its oil and gas properties
doubled (from 50% undivided interest in the properties to 100%);
o The Company's prior obligation to carry MAB for its 50% portion of the
first $700 million in capital costs was eliminated;
o The Company's aggregate monthly payments to MAB related to the existing
properties were reduced from $600,000 to (i) $25,000 for consulting,
plus (ii) $225,000 for payments under a $13.5 million promissory note
as partial consideration for MAB's assignment of its previous undivided
50% working interest in the properties;
o MAB's 3% overriding royalty was increased to 10%, half of which
accrues but is deferred for three years.
F-13
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 3 -- AGREEMENT WITH MAB RESOURCES LLC (CONTINUED)
The new agreement provides for the issuance of 50 million shares of the
Company's common stock to MAB. MAB has the right and opportunity to receive
up to an additional 50 million shares, to be held in escrow and released
over a five-year period in specified numbers of shares that are tied to the
Company's performance in booking reserves. The entire Consulting Agreement,
including the monthly payments to MAB, terminates after five years, except
MAB's overriding royalty continues for the life of the properties.
Commencing July 1, 2005 and continuing through December 31, 2006, the
Company and MAB operated pursuant to the Development Agreement, and a
series of individual property agreements (collectively, the "EDAs").
The Development Agreement sets forth: (a) MAB's obligation to assign to the
Company a minimum 50% undivided interest in any and all oil and gas assets
which MAB acquires from third parties in the future; and (b) MAB's and the
Company's long-term relationship regarding the ownership and operation of
all jointly-owned properties. Each of the Properties acquired was covered
by a property-specific EDA that is consistent with the terms of the
Development Agreement.
Each EDA and the Development Agreement include the following material
terms:
1. OWNERSHIP: MAB and the Company each own an undivided 50% working
interest in all oil and gas leases, production facilities, and related
assets (collectively, the "Properties").
2. OPERATOR: The Company is named as Operator, and has appointed a
related controlled entity, MAB Operating Company LLC, as sub-operator.
The Company and MAB will sign a joint operating agreement, governing
all operations.
3. COSTS AND REVENUES: Each party pays its proportionate share of costs
and receives its proportionate share of revenues, subject to the
Company bearing the following burdens:
(a) MAB OVERRIDING ROYALTY INTEREST: Each assignment of Properties
from MAB to the Company reserves an overriding royalty
equivalent to 3% of 8/8ths (proportionately reduced to 1.5% of
the Company's undivided 50% working interest in the Properties)
(the "MAB Override"), payable out of production and sales.
(b) PROJECT COSTS: Each Acquisition Agreement provides that the
Company shall pay 100% of the cost of acquisitions and
operations ("Project Costs") up to a specified amount, after
which time each party shall pay its proportionate 50% share of
such costs. The maximum specified amount of Project Costs of
which the Company must pay 100%, under the Development Agreement
for Properties acquired in the future, is $100 million per
project. There is no "before payout" or "after payout" in the
traditional sense of a "carried interest" because the Company's
obligation to expend the specified amount of Project Costs and
MAB's receipt of its 50% share of revenues apply without regard
to whether "payout" has occurred. Therefore, the Company's
payment of all Project Costs up to such specified amount might
occur BEFORE actual payout, or might occur AFTER actual payout,
depending on each project and set of Properties.
F-14
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 3 -- AGREEMENT WITH MAB RESOURCES LLC (CONTINUED)
(c) PROJECT DEVELOPMENT COSTS: Under the Development Agreement,
the Company pays to MAB monthly Project Development Costs
representing a specified portion of MAB's "carried" Project
Costs. The total amount incurred to MAB by the Company will be
deducted from MAB's portion of the Project Costs carried by the
Company.
4. RIGHTS AND OBLIGATIONS: MAB conveys to the Company an undivided
50% working interest in all rights and benefits under each Acquisition
Agreement, and the Company assumes its share of all duties and
obligations under each Acquisition Agreement (such as drilling and
development obligations).
NOTE 4 -- OIL AND GAS PROPERTIES
Commencing effective July 1, 2005 and continuing through December 31, 2006,
the Company entered into a Management and Development Agreement (the
"Development Agreement") and a series of property-specific Exploration and
Development Agreements (collectively, the "EDAs") pursuant to the
Development Agreement with MAB. Effective January 1, 2007, the Development
Agreement and the EDA's were replaced in their entirety by the Consulting
Agreement with MAB as discussed in Note 3 above.
The following description of the Company's oil and gas property
acquisitions for the period from inception to September 30, 2006 is
pursuant to the original Development Agreement and related EDA's. All
references to the Company's obligations to pay "project development costs"
pertaining to the following properties means the specified amount of
capital expenditures (for each such property), which were credited against
the Company's obligation to carry MAB for MAB's 50% portion of such
expenditures.
WEST ROZEL PROJECT
Effective November 21, 2005, the Company entered into an EDA with MAB for
the West Rozel Project, under which the Company has paid $1,250,000 to the
assignor and paid reimbursement of estimated costs incurred by the assignor
of approximately $180,000. The Company is obligated to pay MAB monthly
project development costs in the amount of $200,000, commencing June 1,
2005, and the first $50 million of project costs.
BUCKSKIN MESA PROJECT
Effective September 17, 2005, the Company entered into an EDA with MAB for
the Buckskin Mesa Project, under which the Company has paid $5,362,500 to
the assignor and $1,961,460 in Federal Lease payments for Federal leases
acquired by the assignor on November 10, 2005. As consideration for
extending the final payment due on closing, the Company agreed to pay a
monthly extension fee of $200,000 for each 30-day period commencing January
6, 2006 of which all were paid as of June 30, 2006. The Company is
obligated to pay MAB monthly project development costs of $20,000,
commencing July 1, 2005, and the first $50 million of project costs. The
Company charges to operations all property development costs incurred to
MAB under the related EDA's.
F-15
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 4 -- OIL AND GAS PROPERTIES (CONTINUED)
PICEANCE II PROJECT
Effective December 29, 2005, the Company entered into an EDA with MAB for
the Piceance II Project, under which the Company will pay up to $4,000,000
to the assignor (of which $3,898,793 has been paid) and has issued $1
million (2.0 million shares at $0.50 per share) of the Company's Common
Stock. The Company is obligated to pay MAB monthly project development
costs of $20,000 per month, commencing November 1, 2005, and the first $50
million of project costs.
BEETALOO PROJECT
Effective March 17, 2006, the Company entered into an EDA with MAB for the
Beetaloo Project representing exploration permits in the Northern
Territory, Australia. Under the terms of the EDA, the Company has paid
$1,000,000 to the assignor and has funded the $3 million seismic work
commitment. The Company is obligated to pay monthly project development
costs of $100,000 per month, commencing March 1, 2006, and the first $100
million of project costs.
FIDDLER CREEK PROJECT
Effective July 16, 2006, the Company entered into an EDA with MAB for the
Fiddler Creek (Montana) Project, under which the Company paid $2,000,000,
consisting of $300,000 cash to the assignor and the issuance of $1.7
million (3.4 million shares at $0.50 per share) of the Company's Common
Stock as a finders fee to a third party. The Company is obligated to pay
MAB monthly project development costs of $20,000 per month, commencing
April 1, 2006, and the first $100 million of project costs.
Subsequently, the Company acquired additional acreage in the Fiddler Creek
Project area for a purchase price of $11,250,000 (of which $6,039,599 has
been paid). The Company also is obligated to pay MAB monthly project
development costs of $100,000, commencing August 1, 2006, and to pay the
first $50 million of project costs on these additional properties.
SOUTH BRONCO PROJECT
Effective July 17, 2006, the Company entered into an EDA with MAB related
to the South Bronco properties in the Piceance Basin, Colorado, under which
the Company receives an undivided 50% working interest in the properties
and commits to drill four exploration wells. The Company also is obligated
to pay MAB monthly project development costs of $20,000, commencing May 1,
2006, and to pay the first $50 million of project costs.
BEAR CREEK PROJECT
Effective May 15, 2006, the Company entered into an EDA with MAB related to
the Bear Creek prospect in Montana, under which the Company receives an
undivided 50% working interest in the properties. Under the terms of the
agreement, the Company issued to a third party as the purchase price, a
convertible note for $1.2 million, convertible to 2.4 million shares of the
Company's Common Stock at $0.50 per share of the Company's Common Stock.
The Company also is obligated to pay MAB monthly project development costs
of $50,000 commencing May 1, 2006, and to pay the first $50 million of
project costs.
F-16
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 4 -- OIL AND GAS PROPERTIES (CONTINUED)
BUCKSKIN MESA II PROJECT
Effective July 18, 2006, the Company entered into an EDA with MAB related
to the Buckskin Mesa Project in the Piceance Basin, Colorado, under which
the Company receives an undivided 50% working interest in the properties
for $765,000. If he Company elects to accept certain leases which are
subject to additional title curative work, it will pay up to a maximum of
an additional $1.1 million payable to a third party for bonus payments
related to such properties. The Company is also obligated to pay MAB
monthly project development costs of $20,000, commencing August 1, 2006 and
to pay the first $50 million of project costs.
PROMISED LAND PROJECT
Effective May 15, 2006, the Company entered into an EDA with MAB for the
Promised Land Project, under which the Company has paid $194,250 to the
assignor for leases acquired by the assignor. The Company also is obligated
to pay MAB monthly project development costs of $50,000, commencing May 1,
2006, and to pay the first $50 million of project costs.
GIBSON GULCH PROJECT
Effective September 18, 2006, the Company entered into an EDA with MAB for
the Gibson Gulch Project under which the Company has acquired an interest
to participate in four wells proposed to be drilled. The Company has paid
$850,000 for its share of costs associated with the AFE's submitted to
date. The Company also is obligated to pay MAB monthly project development
costs of $5,000, commencing August 1, 2006, and to pay the first $5 million
of project costs.
The Company's exploration projects continue to be evaluated, and management
believes that the carrying costs of these projects are recoverable. Should
the company be unsuccessful in its exploration activities, the carrying
cost of these prospects will be charged to operations. The Company charges
to operations all property development costs incurred to MAB under the
related EDA's. None of the Company's projects had production as of the date
of acquisition and, as of September 30, 2006, the Company had received only
nominal revenues from initial testing and production.
NOTE 5 - PROPERTY AND EQUIPMENT
Oil and Gas Properties - Oil and gas properties at September 30, 2006 and
2005 consisted of the following:
2006 2005
--------------------------
(In thousands)
Oil and gas properties, full cost method
Unevaluated costs, not subject to amortization
United States $ 39,906 $ 7,231
Australia 6,106 -
Evaluated costs - -
--------- -------
46,012 7,231
Less accumulated depreciation, depletion, amortization and impairment (39) -
--------- -------
$ 45,973 $ 7,231
========= =======
F-17
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 5 - PROPERTY AND EQUIPMENT (CONTINUED)
Property acquisition costs include costs incurred to purchase, lease, or
otherwise acquire a property. Exploration costs include the costs of
geological and geophysical activity, and drilling and equipping exploratory
wells. The Company reviews and determines the cost basis of drilling
prospects on a drilling location basis.
Depreciation, depletion, and amortization of oil and gas properties for the
years ended September 30, 2006 and 2005 was approximately $38,000 and $0,
respectively. Depreciation of assets recognized in accordance with the
Asset Retirement Obligation calculation is included in these amounts (see
below).
Information relating to the Company's costs incurred in its oil and gas
operations during the years ended September 30, 2006 and 2005 is summarized
as follows:
2006 2005
---------------------------
(In thousands)
Property acquisition costs $ 25,076 $ 7,066
Exploration costs 13,184 165
Development costs - -
--------- ---------
$ 38,260 $ 7,231
========= =========
Furniture and Equipment - Furniture and equipment at September 30, 2006 and
2005 consisted of the following:
2006 2005
---------------------------
(In thousands)
Furniture and equipment $ 582 $ -
Less accumulated depreciation (32) -
---------- ----------
$ 550 $ -
========== ==========
Depreciation expense associated with capitalized office furniture and
equipment during fiscal 2006 and 2005 was $32,000 and $0, respectively.
NOTE 6 - ASSET RETIREMENT OBLIGATION
SFAS 143, "Accounting for Asset Retirement Obligations addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. This
statement requires companies to record the present value of obligations
associated with the retirement of tangible long-lived assets in the period
in which it is incurred. The liability is capitalized as part of the
related long-lived asset's carrying amount. Over time, accretion of the
liability is recognized as an operating expense and the capitalized cost is
depreciated over the expected useful life of the related asset. The
Company's asset retirement obligations relate primarily to the plugging,
dismantlement, removal, site reclamation and similar activities of its oil
and gas properties.
F-18
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 6 - ASSET RETIREMENT OBLIGATION (CONTINUED)
The following table summarizes activity related to the accounting for asset
retirement obligations for the fiscal years ended September 30, 2006 and
September 30, 2005:
2006 2005
---------------------------
(In thousands)
Asset retirement obligations, beginning of fiscal year $ - $ -
Liabilities incurred 520 -
Liabilities settled - -
Accretion of asset retirement obligation including revision of estimates 2 -
-------- --------
Asset retirement obligations, end of fiscal year 522 -
Less current portion - -
-------- --------
Long-term portion $ 522 $ -
======== ========
NOTE 7 -- CONVERTIBLE NOTES
During the year ended September 30, 2006 the Company completed the sale of
$20,831,667 convertible promissory notes to accredited investors pursuant
to a private placement memorandum. The notes pay interest at the rate of
14% per annum and are due one year from closing of the placement. At the
option of a note holder, the principal may be converted into the Company's
common stock at a rate of one share for each $0.50 of debt (the "Conversion
Price"). Each Note may be converted by the Company, in its sole discretion,
into the Company's common stock at the Conversion Price anytime after the
earlier to occur of (i) the Company raising at least $5,000,000 in funds,
including the proceeds received under the Placement; or (ii) the
consummation of a consolidation of the Company with a reporting company
under the Securities Exchange Act of 1934, whose stock is publicly traded,
provided that the stockholders of the Company immediately prior to the
consolidation own at least 80% of the post-consolidation entity. Each Note
holder will receive at least 60 days' interest at 14% per annum so that if
this mandatory conversion occurs less than 60 days after the date of a
Convertible Note, the holder still will receive payment for a minimum of 60
days' interest. Upon completion of the share exchange between PetroHunter
and GSL, the notes were converted to 41,663,334 shares of common stock.
Prior to the merger with GSL on May 12, 2006, Digital entered into five
separate loan agreements, aggregating $400,000, due one year from issuance,
commencing October 11, 2006. The loans bear interest at 12% per annum, are
unsecured, and are convertible at the option of the lender, at any time
during the term of the loan or upon maturity, at a price per share equal to
the closing price of the Company's common shares on the OTC.BB market on
the day preceding notice from the lender of its intent to convert the loan.
As of January 10, 2007, the Company was in default on payment of an
aggregate $200,000 of notes which matured subsequent to September 30, 2006.
F-19
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 8 -- STOCKHOLDERS' EQUITY
COMMON STOCK
During the period from June 20, 2005 (inception) to September 30, 2005, the
Company issued 100,000,000 shares of its common stock, at $.001 per share,
to its founder for previous advances for expenditures made on behalf of the
Company in the amount of $100,000.
During the twelve months ended September 30, 2006, the Company issued
119,928,734 shares of its common stock as follows:
o 3,000,000 shares, valued at $.50 per share, as partial consideration
for the acquisition of oil and gas properties
o 3,400,000 shares, valued at $.50 per share, as consideration for a
finders' fee on an oil and gas prospect
o 2,845,400 shares valued at $.50 per share, as partial consideration
for finder's fees on the sale of convertible debt
o 44,063,334, shares at $.50 per share, for conversion of convertible
debt (Note 7)
o 28,700,000 shares pursuant to the share exchange agreement with GSL
(Note 1)
o 35,442,500 shares pursuant to the sale of units at $1.00 per unit to
accredited investors pursuant to a private placement memorandum. Each
unit consists of one share of common stock and a warrant to purchase
one share of common share for a period of 5 years at $1.00 per share.
o 1,477,500 shares valued at $1.00 per share, as partial consideration
for finder's fees on the sale of $1.00 units
o 1,000,000 shares for exercise of warrants at $1.00 per share
STOCK OPTION PLAN
The Company adopted the 2005 Stock Option Plan (the "Plan"), as amended.
Under the Plan, stock options may be granted at an exercise price not less
than the fair market value of the Company's common stock at the date of
grant. Options may be granted to key employees and other persons who
contribute to the success of the Company. The Company has reserved
40,000,000 shares of common stock for the plan. At September 30, 2006,
options to purchase 7,705,000 shares were available to be granted pursuant
to the stock option plan.
F-20
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 8 -- STOCKHOLDERS' EQUITY (CONTINUED)
A summary of option activity under the Plan as of September 30, 2006
and 2005 and changes during the years then ended is presented below:
Weighted
Weighted Average
Average Remaining
Exercise Contractual Aggregate
Number of Shares Price Term Intrinsic Value
Options outstanding - June 20, 2005 - $ -
Granted during period 19,000,000 $ 0.50
-----------------
Options outstanding - September 30, 2005 19,000,000 $ 0.50
Granted during period 13,295,000 $ 2.10
Exercised during period - -
Forfeited during period - -
Expired during period - -
-----------------
Options outstanding - September 30, 2006 32,295,000 $ 1.16 4.28 $ 41,213,419
================================================================
Exercisable at September 30, 2006 10,259,000 $ 0.91 4.12 $ 13,212,971
================================================================
There have been noThere have been no options exercised under the terms of
the Plan.
A summary of the status of the Company's nonvested options as of September
30, 2006 and 2005 and changes during the periods then ended is presented
below:
Weighted
Number of Average Fair
Shares Value
Inception - June 20, 2005 - -
Granted during period 19,000,000 $ 0.32
Exercised during period - -
Vested during period (3,800,000) $ 0.32
Forfeited during period - -
Expired during period - -
----------------
Nonvested - September 30, 2005 15,200,000 $ 0.32
Granted during period 13,295,000 1.23
Exercised during period - -
Vested during period (6,459,000) $ 1.28
Forfeited during period - -
Expired during period - -
----------------
Nonvested - September 30, 2006 22,036,000 $ 1.21
================
F-21
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 8 -- STOCKHOLDERS' EQUITY (CONTINUED)
As of September 30, 2006 there is $28,000,448 of total unrecognized
compensation cost related to nonvested share-based compensation
arrangements granted under the Plan. That cost is expected to be recognized
over a weighted-average period of 3.35 years. The total fair value of
shares vested during the year ended September 30, 2006 was $8,253,927.
WARRANTS
The following stock purchase warrants were outstanding at September 30,
2006:
NUMBER OF SHARES EXERCISE PRICE EXPIRY DATE
34,442,500 $1.00 2011
During 2006, the Company issued 35,442,500 stock purchase warrants in
conjunction with the unit sale of common stock. The warrants are
exercisable for a period of five years from date of issuance at an exercise
price of $1.00 per share. As of September 30, 2006, 1,000,000 warrants were
exercised.
NOTE 9 -- RELATED PARTY TRANSACTIONS
During 2006, the Company incurred consulting fees related to services
provided by its officers in the aggregate amount of $529,650, and
$4,530,000 in property development costs to MAB under the Development
Agreement between MAB and the Company (Note 3). At September 30, 2006, MAB
was owed $197,785 by the Company.
In June 2006, the Company entered into an Office Sharing Agreement with
Falcon Oil & Gas Ltd. ("Falcon") for office space in Denver, Colorado, of
which Falcon is the lessee. Under the terms of the agreement, Falcon and
the Company share, on a 50/50 cost basis, all costs related to the office
space, including rent, office operating costs, furniture and equipment and
any other expenses related to the operations of the corporate offices. The
largest single shareholder of the Company is also the Chief Executive
Officer and a Director of Falcon. At September 30, 2006, Falcon owed the
Company $208,514, for Falcon's share of costs incurred pursuant to the
agreement.
Due from related parties at September 30, 2006 includes $712,830 due to the
Company from Galaxy Energy Corporation ("Galaxy") for reimbursement for
charges paid to a drilling company for Galaxy's use of a drilling rig under
contract to the Company. This amount was paid to the Company subsequent to
September 30, 2006. The largest single shareholder of the Company is a
14.3% beneficial shareholder of Galaxy and the father of the President and
Chief Executive Officer of Galaxy.
At September 30, 2006, the Company is owed $35,656 from MAB for oil and gas
revenues for it's share of initial production earned through September 30,
2006 pursuant to the Development and EDA agreements with MAB.
F-22
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 9 -- RELATED PARTY TRANSACTIONS (CONTINUED)
During 2005, the Company incurred consulting fees related to services
provided by its officers in the aggregate amount of $236,300 and services
provided by a related party in the amount of $41,366, of which $11,966 is
included in accounts payable at September 30, 2005; and incurred $860,000
in property development costs to MAB under the Development Agreement
between MAB and the Company and recorded expenditures paid by MAB on behalf
of the Company of $222,000. At September 30, 2005, MAB was owed $648,421 by
the Company.
NOTE 10 - INCOME TAXES
Income tax expense (benefit) for the years ended September 30 consists of
the following:
2006 2005
---- ----
Current taxes $ - $ -
Deferred taxes (6,850,000) (835,000)
Less: valuation allowance 6,850,000 835,000
-------------- ------------
Net income tax provision (benefit) $ - $ -
============== ============
The effective income tax rate for the years ended September 30, 2006 and
2005 differs from the U.S. Federal statutory income tax rate due to the
following:
2006 2005
---- ----
Federal statutory income tax rate (35.0%) (35.0%)
State income taxes, net of Federal benefit (3.25%) (3.25%)
Permanent differences - disallowed interest on convertible debt 4.76% .07%
other .44% -
Increase in valuation allowance 33.05% 38.18%
Net income tax provision (benefit) - -
F-23
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 10 - INCOME TAXES (CONTINUED)
The components of the deferred tax assets and liabilities as of September
30, 2006 and 2005 are as follows:
2006 2005
---- ----
Deferred tax assets:
Federal and state net operating loss carryovers $ 6,640,000 $ 510,000
Asset retirement obligation 200,000 -
Oil and gas property
Stock compensation 3,830,000 325,000
----------------- ------------------
Deferred tax asset $ 10,670,000 $ 835,000
================= ==================
Deferred tax liabilities:
Intangible drilling costs and other exploration costs $ (2,982,000) $ -
capitalized for financial reporting purposes
Property and equipment (3,000) -
----------------- ------------------
Total deferred liabilities (2,985,000) -
Net deferred tax asset 7,685,000 835,000
Less: valuation allowance (7,685,000) (835,000)
----------------- ------------------
Deferred tax liability $ -0- $ -0-
================= ==================
The Company has a $17,360,000 net operating loss carryover as of September
30, 2006. The net operating losses may offset against taxable income
through the year ended September 2026. A portion of the net operating loss
carryovers begin expiring in 2025 and may be subject to U.S. Internal
Revenue Code Section 382 limitations.
The Company has provided a valuation allowance for the deferred tax asset
at September 30, 2006, as the likelihood of the realization of the tax
benefit of the net operating loss carry forward cannot be determined. The
valuation allowance increased by approximately $6,850,000 and $835,000 for
the years ended September 30, 2006 and 2005, respectively.
NOTE 11 - SEGMENT INFORMATION
Segment information has been prepared in accordance with SFAS 131,
"Disclosures About Segments of an Enterprise and Related Information." All
of the Company's operations are in the oil and gas industry with its
principal business activity being in the acquisition and development of oil
and gas properties. The Company has two geographic reporting segments for
its unevaluated oil and gas properties, the United States and Australia.
Corporate expenses are not allocated to the geographic segments. An
analysis of the Company's geographic areas is as follows:
F-24
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 11 - SEGMENT INFORMATION (CONTINUED)
UNITED STATES AUSTRALIA CORPORATE TOTAL
2006
Revenue for the year $ 35,656 $ - $ - $ 35,656
Operating costs 3,672 - - 3,672
Depreciation, depletion, 40,645 - 32,492 73,137
amortization and accretion
Corporate costs and expenses - - 20,650,861 20,650,861
Loss for the year 8,661 - 20,683,353 20,692,014
Capital assets 39,866,574 6,106,210 550,213 46,522,997
2005
Revenue for the year $ - $ - $ - $ -
Loss for the year - - 2,118,820 2,118,820
Capital assets 7,231,443 - - 7,231,443
NOTE 12 -- COMMITMENTS AND CONTINGENCIES
ENVIRONMENTAL
Oil and gas producing activities are subject to extensive environmental
laws and regulations. These laws, which are constantly changing, regulate
the discharge of materials into the environment and may require the Company
to remove or mitigate the environmental effects of the disposal or release
of petroleum or chemical substances at various sites. Environmental
expenditures are expensed or capitalized depending on their future economic
benefit. Expenditures that relate to an existing condition caused by past
operations and that have no future economic benefit are expensed.
Liabilities for expenditures of a noncapital nature are recorded when
environmental assessment and/or remediation is probable, and the costs can
be reasonably estimated.
CONTINGENCIES
The Company may from time to time be involved in various claims, lawsuits,
disputes with third parties, actions involving allegations of
discrimination, or breach of contract incidental to the operations of its
business. The Company is not currently involved in any such incidental
litigation which it believes could have a materially adverse effect on its
financial condition or results of operations.
F-25
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE 12 -- COMMITMENTS AND CONTINGENCIES (CONTINUED)
COMMITMENTS
OPERATING LEASES
In 2006, the Company has entered into lease agreements for office space in
Denver, Colorado and Salt Lake City, Utah. The Company is obligated to pay
the following minimum future rental commitments under the noncancelable
operating leases, including its obligation under the sublease agreement
with Falcon:
Year ended September 30, 2007 $183,521
2008 188,317
2009 194,281
2010 201,414
2011 153,705
Rent expense for the year ended September 30, 2006 was $81,225.
DELAY RENTALS
In conjunction with the Company's working interests in undeveloped oil and
gas prospects, the Company must pay approximately $224,000 in delay rentals
during the fiscal year ending September 30, 2007 to maintain the right to
explore these prospects. The Company continually evaluates its leasehold
interests, therefore certain leases may be abandoned by the Company in the
normal course of business.
AGREEMENTS WITH MAB
During the fiscal year ending September 30, 2007, the Company is obligated
to pay MAB property development fees of $1,765,000 for the period October
1, 2006 to December 31, 2006 under the EDAs; and $225,000 in consulting
fees and $2,025,000 as payments under a $13.5 million note, for the period
January 1, 2007 to September 30, 2007 under the Consulting Agreement (See
Note 3).
WORK COMMITMENTS
During 2007, the Company is obligated to perform the following work
commitments pursuant to the original EDA's and the January 1, 2007
Consulting Agreement with MAB:
o Drill eight wells on the Piceance II prospect
o Drill five wells on the Buckskin prospect
o Drill four wells on the Beetaloo prospect
o Complete permitting on the West Rozel Project
Additionally, the Company has contracted with two drilling rigs, each of
which has a stand-by day rate commitment of $24,000 per day, with one
obligated through May 2007 and one obligated through June 2007.
F-26
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE - 13 - SUBSEQUENT EVENTS (UNAUDITED)
(a) On November 6, 2006, the Company commenced the sale of a maximum
$125,000,000 pursuant to a Private Placement of Units at $1.50 per
unit. Each unit consists of one share of the Company's common
stock and one-half common stock purchase warrant. A whole common
stock purchase warrant entitles the purchaser to acquire one share
of the Company's common stock at an exercise price of $1.88 per
share through December 31, 2007. The Company may pay a commission
of up to 5% to a broker or agent in conjunction with the sale. As
of January 12, 2007, the Company has received $1,887,500 from the
sale of units pursuant to the Private Placement.
(b) In December 2006, the Company's newly formed wholly owned
subsidiary, PetroHunter Energy NT Ltd ("PetroHunter NT"),
commenced the sale, pursuant to a private placement, of up to
$50,000,000 of convertible notes. The notes bear interest at 12%
per annum, mature one year from date of issuance and are
convertible, at the option of the note holder, at the rate of one
share of PetroHunter NT common stock for each $.50 of debt. As of
January 12, 2007, $1,530,000 has been received from the offering.
(c) On November 14, 2006, the Company and Lakes Oil N.L. entered into
an agreement (the "Agreement") under which they will jointly
develop Lakes Oil's on-shore petroleum prospects (focusing on
unconventional gas resources) in the Gippsland and Otway basins in
Victoria, Australia. The arrangement is subject to various
conditions precedent, including completion of satisfactory due
diligence, and the satisfactory processing of certain retention
lease applications. Under the Agreement, the Company or its
subsidiary company Sweetpea will initially farm into 33-1/3% of
Lakes Oil's permits by spending $7 million in Lakes Oil's permits.
In addition, the Company will subscribe for $3 million in new
shares in Lakes Oil at 1.5 cents (Australian). PetroHunter will
also have the right to increase its position in Lakes Oil's
permits with two further 16-2/3% farm-in tranches of $10 million
each, exercisable within 12 months and 24 months respectively.
Under the Agreement, the Company has the right to participate in
the same proportion in any permits which are non-contiguous to
existing permits acquired by Lakes within 2 years, and any
contiguous permits acquired by Lakes moving forward, and the
Company has a first right of refusal in other permits acquired by
Lakes within 5 years. The Company is to assume Lakes Oil's
position as operator of the permits.
(d) On November 14, 2006, the Company, through its subsidiary, Paleo,
and the Box Hill Institute signed an agreement which commenced a
five-year research collaboration with the BioSkills Specialist
Centre for Biotechnology Training at the Box Hill Institute in
Melbourne, Australia. As part of the agreement, Paleo and the Box
Hill Institute share laboratory space and offer training
opportunities for Box Hill students. The team will target a broad
array of applications including energy/petrochemical,
environmental remediation, timber and plant resources,
agricultural and consumer products.
F-27
PETROHUNTER ENERGY CORPORATION
(FORMERLY DIGITAL ECOSYSTEMS CORP.)
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
NOTE - 13 - SUBSEQUENT EVENTS (CONTINUED)
(e) On December 29, 2006, the Company entered into an agreement
("PSA") with Galaxy and its wholly owned subsidiary, Dolphin
Energy Corporation ("Dolphin"), for the Company to purchase,
through its wholly owned subsidiary, PetroHunter Operating
Company, all of Galaxy's and Dolphin's oil and gas interests in
the Powder River Basin of Wyoming and Montana.
Dolphin owns an average 86% working interest in 197 oil and gas
wells in the Powder River Basin. Twenty-two wells are currently
selling gas at an average rate of 850,000 cubic feet a day. The
remaining wells are in various stages of dewatering, shut-in
waiting on pipeline, or waiting to be completed.
The PSA provides for the Company to pay $45 million to acquire all
of Galaxy's and Dolphin's oil and gas interests in Sheridan,
Johnson, Converse and Campbell Counties in Wyoming, and in Big
Horn, Custer, Powder River and Rosebud Counties in Montana. The
purchase price will be $20 million in cash and $25 million in
shares of the Company's common stock at the rate of $1.50 per
share. Closing of the transaction will be subject to approval by
Galaxy's senior lenders, approval in its discretion of all matters
by the Company's Board of Directors, including the Company
receiving financing on terms acceptable to it, and various other
terms and conditions. Either party may terminate the agreement if
the closing has not occurred by February 28, 2007. The agreement
calls for a $2 million earnest money payment to be made to Galaxy
in two installments by January 31, 2007, of which $1,400,000 has
been paid as of January 10, 2007.
(f) On January 9, 2007, the Company entered into a Credit and Security
Agreement (the "Financing") with Global Project Finance AG, a
Swiss company, for mezzanine financing in the amount of $15
million. The loan provides for an interest rate of 6.75% over
prime, and is to be secured by a first perfected lien on the
Company's assets, limited to the specific portion of the assets to
which the loan proceeds are applied by the Company. The Company
plans to apply most of the proceeds of this loan to its drilling
and development operations in the Piceance Basin, Colorado. The
terms of the Financing also provide for the issuance of one
million warrants of the Company's shares upon execution of the
Credit Agreement, and up to an additional three million warrants,
tied on a pro rata basis to each draw down of the credit facility
up to $15 million - that is, warrants for 600,000 shares for each
$3 million advanced. The warrants will be exercisable for five
years after the date of the Credit Agreement. The exercise price
of the warrants will be equal to 120% of the weighted average
price of the Company's stock for the 30 days immediately prior to
each warrant issuance date. Global Project Finance AG and its
controlling shareholder, Christian Russenberger, were shareholders
of the Company prior to the Credit Agreement. As of January 10,
2007, the Company has drawn down $5,000,000 on the credit
facility.
F-28