UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: DECEMBER 31, 2006
[ ] TRANSITION REPORT PURSUANT TO 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
(Exact name of registrant 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)
Registrant's telephone number: (303) 572-8900
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 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 [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of
the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act) Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
222,928,734 SHARES OF COMMON STOCK, $.001 PAR VALUE, AS OF
JANUARY 31, 2007
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT COMPANY)
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31 SEPTEMBER 30
2006 2006
(UNAUDITED) (UNAUDITED)
-------------------- -------------------
Current Assets
Cash and cash equivalents $ 2,308,442 $ 10,631,776
Oil and gas receivables - related party 499,802 35,656
Other receivables 34,024 22,290
Due from related parties 228,173 921,344
Prepaid expenses and other assets 64,430 30,960
Subscriptions receivable - related party 300,000 -
-------------------- -------------------
TOTAL CURRENT ASSETS 3,434,871 11,642,026
-------------------- -------------------
PROPERTY AND EQUIPMENT, AT COST
Oil and gas properties under full cost, net 67,193,993 45,972,784
Furniture and equipment, net 635,862 550,213
-------------------- -------------------
67,829,855 46,522,997
-------------------- -------------------
OTHER ASSETS
Restricted cash 1,601,793 1,076,793
Deferred financing costs 29,617 -
-------------------- -------------------
TOTAL ASSETS $ 72,896,136 $ 59,241,816
==================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 16,207,549 $ 9,644,236
Accrued interest payable 62,342 124,474
Due to shareholder 545,467 197,785
Royalties payable 121,859 -
Contracts payable - oil and gas properties 2,900,000 -
Convertible notes payable - in default 200,000 -
Convertible notes payable 1,705,000 400,000
-------------------- -------------------
TOTAL CURRENT LIABILITIES 21,742,217 10,366,495
-------------------- -------------------
ASSET RETIREMENT OBLIGATION 528,268 522,054
-------------------- -------------------
TOTAL LIABILITIES 22,270,485 10,888,549
-------------------- -------------------
COMMON STOCK SUBSCRIBED 1,887,500 -
-------------------- -------------------
COMMITMENTS AND CONTINGENCIES (NOTES 3,4,6 AND 9)
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 shares 219,929 219,929
Capital in excess of par value 72,505,304 70,944,172
Common stock issuable 4,127,770 -
Deficit accumulated during the development stage (28,114,852) (22,810,834)
-------------------- -------------------
TOTAL STOCKHOLDERS' EQUITY 48,738,151 48,353,267
-------------------- -------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 72,896,136 $ 59,241,816
==================== ===================
The accompanying notes are an integral part of the consolidated
financial statements.
2
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
CUMULATIVE FROM
INCEPTION
THREE THREE (JUNE 20, 2005)
MONTHS ENDED MONTHS ENDED TO
DECEMBER 31 DECEMBER 31 DECEMBER 31
2006 2005 2006
(UNAUDITED) (UNAUDITED) (UNAUDITED)
----------------- ----------------- -------------------
REVENUES
Oil and gas revenues $ 448,876 $ - $ 484,532
----------------- ----------------- -------------------
COSTS AND EXPENSES
Lease operating expenses 161,800 - 165,472
General and administrative 3,670,998 711,254 18,544,590
Property development - related 1,815,000 700,000 7,205,000
Depreciation, depletion, amortization and accretion 86,137 - 159,274
----------------- ----------------- -------------------
TOTAL OPERATING EXPENSES 5,733,935 1,411,254 26,074,336
----------------- ----------------- -------------------
OTHER INCOME (EXPENSE)
Interest income 8,059 - 10,692
Interest expense (27,018) (187,434) (2,535,740)
----------------- ----------------- -------------------
TOTAL OTHER INCOME (EXPENSE) (18,959) (187,434) (2,525,048)
----------------- ----------------- -------------------
----------------- ----------------- -------------------
NET LOSS $ (5,304,018) $ (1,598,688) $ (28,114,852)
================= ================= ===================
NET LOSS PER COMMON SHARE -
BASIC AND DILUTED $ (0.02) $ (0.02)
================= =================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING - BASIC AND DILUTED 219,928,734 100,000,000
================= =================
The accompanying notes are an integral part of the
consolidated financial statements.
3
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
CUMULATIVE FROM
INCEPTION
THREE THREE (JUNE 20, 2005)
MONTHS ENDED MONTHS ENDED TO
DECEMBER 31 DECEMBER 31 DECEMBER 31
2006 2005 2006
(UNAUDITED) (UNAUDITED) (UNAUDITED)
----------------- ----------------- -----------------
Cash flows used in operating activities
Net loss $ (5,304,018) $ (1,598,688) $ (28,114,852)
Adjustments to reconcile net loss to
net cash (used) in operating activities
Stock for expenditures advanced - - 100,000
Stock based compensation 1,561,133 205,678 11,573,177
Depreciation, depletion, amotization and accretion 86,137 5,247 159,274
Stock for financing costs - - 1,422,701
Changes in assets and liabilities
Accounts receivable (475,880) - (533,826)
Due from related party 785,793 - (135,551)
Prepaids and other (33,470) (4,600) (42,421)
Accounts payable and accrued expenses (50,662) 172,082 1,329,125
Due to shareholder 347,682 (43,363) 545,467
Royalties payable 121,859 - 121,859
----------------- ----------------- -----------------
NET CASH USED IN OPERATING ACTIVITIES (2,961,426) (1,263,644) (13,575,047)
----------------- ----------------- -----------------
CASH FLOWS USED IN INVESTING ACTIVITIES
Additions to oil and gas properties (7,866,635) (4,189,761) (40,647,976)
Property and equipment (33,156) (3,774) (586,367)
Restricted cash (525,000) - (1,601,793)
----------------- ----------------- -----------------
NET CASH USED IN INVESTING ACTIVITIES (8,424,791) (4,193,535) (42,836,136)
----------------- ----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from the sale of common stock - - 35,442,500
Proceeds from common stock subscribed 1,587,500 - 1,587,500
Proceeds from the exercise of warrants - - 1,000,000
Cash received upon recapitalization and merger - - 20,949
Proceeds from issuance of convertible notes 1,505,000 4,310,000 22,336,667
Offering and financing costs (29,617) (10,424) (1,667,991)
----------------- ----------------- -----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 3,062,883 4,299,576 58,719,625
----------------- ----------------- -----------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (8,323,334) (1,157,603) 2,308,442
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 10,631,776 1,250,242 -
----------------- ----------------- -----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,308,442 $ 92,639 $ 2,308,442
================= ================= =================
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Cash paid for interest $ - $ - $ 1,028,353
================= ================= =================
Cash paid for income taxes $ - $ - $ -
================= ================= =================
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Stock issued for expenditures advanced $ - $ - $ 100,000
================= ================= =================
Contracts for oil and gas properties $ 2,900,000 $ 7,762,500 $ 14,673,960
================= ================= =================
Common stock issued for debt conversion $ - $ - $ 22,031,667
================= ================= =================
Common stock issued for commissions on offerings $ - $ - $ 2,900,201
================= ================= =================
Common stock issued for property and finders fee on property $ - $ - $ 2,200,000
================= ================= =================
Convertible debt issued for property $ - $ - $ 1,200,000
================= ================= =================
Common stock issuable $ 4,127,770 $ - $ 4,127,770
================= ================= =================
The accompanying notes are an integral part of the consolidated
financial statements.
4
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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. Effective September 30, 2006, PetroHunter
acquired 50% of the outstanding common shares of Sweetpea Corporation
Pty Ltd ("Sweetpea"), an Australian corporation; and effective January
1, 2007 acquired the remaining 50%. Sweetpea is the record owner of
four exploration permits issued by the Northern Territory of Australia.
On October 20, 2006, PetroHunter formed PetroHunter Energy NT Ltd.
("PetroHunter NT"), as a wholly owned subsidiary, 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".
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).
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The unaudited financial statements included herein were prepared from
the records of the Company in accordance with generally accepted
accounting principles in the United States applicable to interim
financial statements and reflect all adjustments which are, in the
opinion of management, necessary to provide a fair statement of the
results of operations and financial position for the interim periods.
Such financial statements conform to the presentation reflected in the
Company's Form 10-KSB filed with the Securities and Exchange Commission
for the year ended September 30, 2006. The current interim period
reported herein should be read in conjunction with the Company's Form
10-KSB for the year ended September 30, 2006. The results of operations
for the three months ended December 31, 2006 are not necessarily
indicative of the results that may be expected for the full fiscal year
ending September 30, 2007.
5
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 incurred a cumulative net
loss of $28,114,852 for the period from inception (June 20, 2005) to
December 31, 2006, has a working capital deficit of $18,307,346 at
December 31, 2006 and has significant capital expenditure commitments.
As of December 31, 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 $59.4 million of convertible notes and
common stock through December 31, 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 $955,000 (including $600,000 from
a related entity) subsequent to December 31, 2006 in two private
placements of common stock and convertible notes currently in process
and has received $7,000,000 from a private investor pursuant to a loan
commitment. (See Notes 6 and 7.)
BASIS OF PRESENTATION
The accompanying consolidated financial statements include PetroHunter
for the three months ended December 31, 2006. For the three months
ended December 31, 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.
6
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 December 31, 2006, the Company has no proved
reserves, has received 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 estimated 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.
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 may have an interest with other producers in certain
properties, in which case the Company uses the sales method to account
for gas imbalances. Under this method, revenue is recorded on the basis
of gas actually sold by the Company. In addition, the Company records
revenue for its share of gas sold by other owners that cannot be
volumetrically balanced in the future due to insufficient remaining
reserves. The Company also reduces revenue for other owners' gas sold
by the Company that cannot be volumetrically balanced in the future due
to insufficient remaining reserves. The Company's remaining over- and
under-produced gas balancing positions will be considered in the
Company's proved reserves. The Company has no gas balancing
arrangements in place at December 31, 2006. Oil and gas sold is not
significantly different from the Company's product entitlement.
7
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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
December 31, 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).
8
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 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 44,701,500 for the three months ended
December 31, 2006.
SHARE BASED COMPENSATION
The Company had 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, 2005, 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.
9
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SHARE BASED COMPENSATION (Continued)
As of December 31, 2006, options to purchase an aggregate of 32,295,000
shares of the Company's common stock were outstanding, of which
10,259,000 are exercisable. 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 $511,133 and stock-based non-employee compensation
costs of $1,050,000 before tax, were charged to operations as
compensation expense for the three months ended December 31, 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 December 31,
2006 consists of certificates of deposit underlying letters of credit
for exploration permits, state and local plugging and abandonment bonds
and guarantees to vendors.
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.
10
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
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"), as amended, 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 and 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 5% (the "Override"),
but the Override does not apply to the Company's Piceance II
properties, and does not apply to the extent that the Override
would cause the Company's net revenue interest under an oil and
gas lease to be less than 75%;
o MAB will receive 7% of the issued and outstanding shares of
PetroHunter Energy NT, Ltd. ("PetroHunter NT"), as of the date
that the Company receives PetroHunter NT shares in consideration
for the Company's assignment of its rights and obligations in the
Northern Territory (Australia) permits to PetroHunter NT.
The new agreement also 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.
11
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
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 October 1, 2006 to December 31, 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.
On November 28, 2006, MAB entered into an agreement with Maralex
Resources, Inc. and Adelante Oil & Gas, LLC (collectively, "Maralex")
for the acquisition and development of the Jack's Pocket Prospect in
Garfield County, Colorado (the "Maralex Agreement"). Under the terms of
the Maralex Agreement, an initial payment of $100,000 was made upon
execution and the balance of $2.9 million cash and issuance of
2,428,100 shares of the Company's common stock was due on January 15,
2007. The Company has recorded the $2.9 million obligation as a
contract payable at December 31, 2006 and the fair market value of the
shares to be issued of $4,127,770, based on the closing price of the
Company's common stock as of the date of the Maralex Agreement.
Effective January 12, 2007, the Maralex Agreement was amended to extend
the payment terms of the cash due through March 15, 2007, and increase
the shares to be issued to 3 million.
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 onshore 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, from
the date of the first closing under the Agreement (the "Closing").
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 from the Closing, 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 from the Closing. The Company is to assume Lakes Oil's position
as operator of the permits.
12
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE 4 - OIL AND GAS PROPERTIES (CONTINUED)
On December 29, 2006, the Company entered into an agreement ("PSA")
with Galaxy Energy Corporation ("Galaxy") and its wholly owned
subsidiary, Dolphin Energy Corporation ("Dolphin"), a related party,
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. The
controlling owner of PetroHunter's largest single shareholder (MAB
Resources LLC) is Marc A. Bruner. Mr. Bruner is a 14.3% beneficial
shareholder of Galaxy and the father of the President and Chief
Executive Officer of Galaxy. 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. As of
January 31, 2007, the Company has paid to Galaxy a $2 million earnest
money payment due under the terms of the agreement.
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
December 31, 2006, the Company had received revenues from initial
testing and production on certain of its projects.
NOTE 5 - 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.
13
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE 5 - ASSET RETIREMENT OBLIGATION (CONTINUED)
The following table summarizes activity related to the accounting for
asset retirement obligations for the three months ended December 31,
2006 and 2005:
2006 2005
-----------------------------
Asset retirement obligations, beginning of period $ 522,054 $ -
Liabilities incurred 170,230 -
Revisions to estimates (162,845) -
Liabilities settled - -
Accretion expense (1,171) -
------------ ----------
Asset retirement obligations, end of period $ 528,268 $ -
============ ==========
NOTE 6 - CONVERTIBLE NOTES
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 December 31, 2006 the Company
was in default on payment of an aggregate $200,000 of notes which
matured.
In December 2006, 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
December 31, 2006, $1,505,000 has been received from the offering.
NOTE 7 - STOCKHOLDERS' EQUITY
COMMON STOCK
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 December 31, 2006, the
Company has received subscriptions for $1,887,500 for the sale of units
pursuant to the Private Placement, of which cash of $1,587,500 has been
received. The subscription receivable at December 31, 2006 of $300,000
was received in January 2007. Of the total subscriptions, $1,400,000
was from a related party. In February 2007, the Board of Directors
determined that the composition of the units being offered would be
restructured, and those investors who had subscribed in the offering of
November 6, 2006 will be offered the opportunity to rescind their
subscriptions. Accordingly, the Company has recorded the proceeds and
outstanding subscriptions from the offering at December 31, 2006 as
"Common Stock Subscribed", and has not included these amounts as a
component of Stockholders' Equity.
14
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE 7 - STOCKHOLDERS' EQUITY (CONTINUED)
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 December
31, 2006, options to purchase 7,705,000 shares were available to be
granted pursuant to the stock option plan.
There were no options granted, forfeited or vested during the three
months ended December 31, 2006.
WARRANTS
The following stock purchase warrants were outstanding at December 31,
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, and no additional warrants were exercised
during the three months ended December 31, 2006.
NOTE 8 - RELATED PARTY TRANSACTIONS
During the three months ended December 31, 2006, the Company incurred
$1,815,000 in property development costs to MAB under the Development
Agreement between MAB and the Company (Note 3). At December 31, 2006,
MAB was owed $545,467 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. Marc A. Bruner, the 75% owner of the largest single
shareholder of the Company, is also the Chief Executive Officer and a
Director of Falcon. At December 31, 2006, Falcon owed the Company
$219,313, for Falcon's share of costs incurred pursuant to the
agreement.
Due from related parties at December 31, 2006 includes $8,860 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
January 2007.
15
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE 8 - RELATED PARTY TRANSACTIONS (CONTINUED)
At December 31, 2006, the Company is owed $499,802 from MAB for oil and
gas revenues for its share of initial production earned through
December 31, 2006 pursuant to the Development and EDA agreements with
MAB.
During the three months ended December 31, 2005, the Company incurred
consulting fees related to services provided by its officers in the
aggregate amount of $172,050; and incurred $700,000 in property
development costs to MAB under the Development Agreement between MAB
and the Company. At December 31, 2005, MAB was owed $605,058 by the
Company.
NOTE 9 - 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.
COMMITMENTS
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. Management estimates
that it will incur approximately $1.6 million under the five (5) year
term of the agreement between Paleo and Boxhill.
16
PETROHUNTER ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE - 10 SUBSEQUENT EVENTS
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 February 9, 2007, the Company has drawn down
$7,000,000 on the credit facility.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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-Q.
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 "Stock Exchange"). 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. Effective September 30, 2006, PetroHunter acquired 50% of the
outstanding common shares of Sweetpea Corporation Pty Ltd ("Sweetpea"), an
Australian corporation; and effective January 1, 2007 acquired the remaining
50%. Sweetpea is the record owner of four exploration permits issued by the
Northern Territory of Australia. 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".
As a result of the Stock Exchange, 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.
18
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.
MAB RESOURCES LLC
Effective January 1, 2007, we entered into an entered into an
Acquisition and Consulting Agreement (the "Consulting Agreement"), as amended,
with MAB Resources LLC ("MAB") which replaced in its entirety the Management and
Development Agreement (the "Development Agreement") entered into July 1, 2005,
and materially revised our relationship with MAB. MAB is a Delaware limited
liability company and our largest shareholder. MAB is in the business of oil and
gas exploration and development. Under the terms of the Consulting Agreement:
o Our working interest in all our oil and gas properties doubled
(from 50% undivided interest in the properties to 100%);
o Our prior obligation to carry MAB for its 50% portion of the
first $700 million in capital costs was eliminated;
o Our 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 5% (the
"Override"), but the Override does not apply to our Piceance
II properties, and does not apply to the extent that the
Override would cause our net revenue interest under an oil and
gas lease to be less than 75%;
o MAB will receive 7% of the issued and outstanding shares of
PetroHunter Energy NT, Ltd. ("PetroHunter NT"), as of the date
that we receive PetroHunter NT shares in consideration for our
assignment of our rights and obligations in the Northern
Territory (Australia) permits to PetroHunter NT.
The new agreement also provides for the issuance of 50 million shares
of our 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 our 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.
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 February 2007, will
be subject to such evaluation concluding that the consideration exchanged by the
parties reflects a fair and reasonable market value for us.
Commencing July 1, 2005 and continuing through December 31, 2006, we
and MAB operated pursuant to the Development Agreement, and a series of
individual property agreements (collectively, the "EDAs"). The Development
Agreement set forth: (a) MAB's obligation to assign to us a minimum 50%
undivided interest in any and all oil and gas assets which MAB acquired from
third parties in the future; and (b) our long-term relationship with MAB
regarding the ownership and operation of all
19
jointly-owned properties. Each of the Properties acquired was covered by a
property-specific EDA that was consistent with the terms of the Development
Agreement.
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 the controlling owner of 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.
As of January 31, 2007, we paid to Galaxy a $2 million earnest money
payment due under the terms of the agreement. 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.
20
PRODUCTION AND PRICES
The following table sets forth information regarding net production of
oil and natural gas, and certain price and cost information for quarter ended
December 31, 2006 and the fiscal year ended September 30, 2006. We did not have
any production during the fiscal year ended September 30, 2005.
--------------------------------------------------------------------------------------------------------
FOR THE QUARTER ENDED FOR THE FISCAL YEAR ENDED
DECEMBER 31, 2006 SEPTEMBER 30, 2006
--------------------------------------------------------------------------------------------------------
PRODUCTION DATA:
--------------------------------------------------------------------------------------------------------
Natural gas (Mcf) 85,922 5,822
--------------------------------------------------------------------------------------------------------
Oil (Bbls) 79 -0-
--------------------------------------------------------------------------------------------------------
AVERAGE PRICES:
--------------------------------------------------------------------------------------------------------
Natural gas (per Mcf) $5.17 $6.12
--------------------------------------------------------------------------------------------------------
Oil (per Bbl) $58.29 --
--------------------------------------------------------------------------------------------------------
PRODUCTIVE WELLS
The following table summarizes information at January 31, 2007,
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 -- 18 18 -- 5.2 5.2
------------------------------------------------------------------------------------------------
Utah -- -- -- -- -- --
------------------------------------------------------------------------------------------------
Montana 2 -- 2 2.0 -- 2.0
------------------------------------------------------------------------------------------------
Australia -- -- -- -- -- --
------------------------------------------------------------------------------------------------
TOTAL -- 18 20 2.0 5.2 7.2
------------------------------------------------------------------------------------------------
ACREAGE POSITIONS
As of January 31, 2007, we owned interests in the following developed
and undeveloped acreage positions. Undeveloped acreage refers to acreage that
has not been placed in producing units.
------------------------------------------------------------------------------------------------------------------
DEVELOPED UNDEVELOPED
------------------------------------------------------------------------------------------------------------------
LOCATION GROSS ACRES NET ACRES GROSS ACRES NET ACRES
------------------------------------------------------------------------------------------------------------------
Colorado 480.0 102.2 25,759.0 19,736.8
------------------------------------------------------------------------------------------------------------------
Utah 0 0 173,738.0 173,738.0
------------------------------------------------------------------------------------------------------------------
Montana 80.0 80.0 93,515.0 72,734.0
------------------------------------------------------------------------------------------------------------------
Australia 0 0 7,000,000.0 7,000,000.0
------------------------------------------------------------------------------------------------------------------
TOTAL 560.0 182.2 7,293,012.0 7,266,208.8
------------------------------------------------------------------------------------------------------------------
21
SUMMARY OF DEVELOPMENT AND EXPLORATION PROJECTS AND PLAN OF OPERATIONS
The following is an update of our production and exploration areas and
significant projects. While actively pursuing specific production and
exploration activities in each of the following areas, we continually review
additional acquisition opportunities in our core areas that meet our exploration
criteria.
HEAVY OIL PROPERTIES
GREAT SALT LAKE, UTAH. We have 173,738 net mineral acres under lease
(covered by approximately 78 leases) on two principal properties, the 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 may 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.
Pursuant to the terms of the acquisition agreement, we must commence
drilling of three wells within this project by April 30, 2007. We are currently
working to secure permits for planned drilling operations. The earliest
expiration for the project leasehold is June 2008. 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
wells.
FIDDLER CREEK, MONTANA. We have acquired an acreage position of 23,795
net acres on four anticlines on the northern portion of the Big Horn Basin,
which extends from north central Wyoming into southern Montana. These properties
encompass significant portions of Roscoe Dome, Dean Dome, Fiddler Creek and
MacKay Domes, which we believe have significant estimated in place oil reserves.
These structures 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 on the Fiddler Creek structure.
Additional wells have been selected for further testing on Roscoe Dome, the #4
George and the #6 George. Two horizontal tests are planned for the Roscoe and
Dean Dome this year as well as a stratigraphically deeper test on either the
MacKay Dome or the Fiddler Creek structure to test Paleozoic potential in
Phosphoria (Permian), Tensleep (Pennsylvanian), and Madison (Mississippian)
formations. A small 2D seismic program may be required to site the deeper test.
A portion of the acreage position in the Fiddler Creek Project area was
acquired for a purchase price of $11,250,000 (of which one-half has been paid
through January 31, 2007). We have the option to retain these leases by paying
the balance on or before December 31, 2007. 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.
22
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
petroleum potential is possible in Devonian Duperow and Nisku formations, and in
the Mississippian Madison Formation. 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 if the results of the investigation
support those wells.
We do not have any drilling commitments with respect to this property.
PLAN OF OPERATIONS. We anticipate that, over the next twelve months, we
will incur the following costs related to our heavy oil prospects in Montana and
Utah:
o $6,000,000 to $9,000,000 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 $15,000,000 to $20,000,000 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 in the near future, similar to the offering of
PetroHunter Energy NT described below.
PICEANCE BASIN, COLORADO PROPERTIES
BUCKSKIN MESA PROJECT. A 26-square mile 3D seismic survey has been
licensed, re-processed, and interpreted to focus initial drilling in areas of
thickest pay and enhanced fracturing. We have acquired approximately 20,000 net
acres of leasehold in Rio Blanco County, Colorado. We have applied for and
received six approved drilling permits to test targets in the Cretaceous
Mesaverde Group. We have drilled and cased our first well at Buckskin Mesa, the
Anderson 6-16, with a total depth of 10,785 feet. Log analysis indicates a gross
pay interval in excess of 3,500 feet, with a net pay of 600 feet. Gas shows
during drilling averaged 3,000 units with peaks as high as 20,000 units. Mud
weight had to be increased to control the well, which indicates a pressure
gradient in the Williams Fork of 0.56psi/foot. We are negotiating to enter into
a contract for a workover rig to begin completion and testing operations.
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 additional wells to test the Iles
Formation by November 30, 2007.
23
PICEANCE II PROJECT. We have acquired approximately 1,000 net acres of
leasehold contiguous to Parachute, Rulison, and Grand Valley fields in Garfield
County, Colorado. As of January 31, 2007, we had interests in 18 producing
wells, 13 wells waiting on completion, and 4 wells being drilled. Average daily
production net to us from these wells at January 31, 2007 (the most recent data
available) was 6,984 mcf/day. Initial production rates varied from 1,000 to
2,554 mcf/day.
Production is from frac-stimulated perforations in stacked sands of the
fluvial Williams Fork formation.
On November 28, 2006, we executed a purchase and sale agreement with
Maralex Resources, Inc. and Adelante Oil & Gas, LLC (collectively "Maralex") for
the acquisition and development of 2,000 net acres in the Jack's Pocket Prospect
in Garfield County, Colorado. Under the terms of the agreement, an initial
payment of $100,000 was made upon execution and the balance of $2.9 million cash
and issuance of 2,428,100 shares of our common stock was due on January 15,
2007. Effective January 12, 2007, the agreement was amended to extend the
payment terms of the cash due through March 15, 2007, and increase the shares to
be issued to 3 million. These shares have been issued as of January 31, 2007. We
are obligated to drill four wells on these leases during 2007.
PLAN OF OPERATIONS. We expect that the development of our Colorado
properties will include: (i) continued drilling of wells in the southern portion
of the Piceance Basin, where we expect to complete at least 12 wells for
additional gas production, (ii) design and construction of a two-mile low
pressure gathering system to connect these wells to market, and (iii) continued
exploration of our lease position near Buckskin Mesa/Powell Park discovery wells
in the northern Piceance Basin.
Associated with the development of our Colorado properties, we
anticipate that, over the next twelve to twenty-four months, we will incur the
following costs:
o $8,000,000 to $52,000,000 to add leasehold in the Piceance II
and Buckskin Mesa project areas
o $50,000,000 to $80,000,000 in connection with the Piceance II
project, to include drilling, completion and production
facilities; and
o $35,000,000 to $50,000,000 in connection with the Buckskin
Mesa project, to include drilling, completion and production
facilities.
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
24
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.
The prospective 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 sandstones (and perhaps the Bessie Creek sandstone
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.
The current seven 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. As part of the work
commitment plan submitted to the Northern Territory Department of Primary
Industry, Fisheries and Mines, 686 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 an eight 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. In the event of commercial production the exploration permits will
have to be converted to production licenses.
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
25
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.
PLAN OF OPERATIONS. In Australia we plan to explore and develop
portions of the 7,000,000 acres of the project area in the Northern Territory of
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 $45,000,000 to $60,000,000 in costs related to drilling,
well completion and a potential delineation seismic program.
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).
CURRENT FINANCING ACTIVITIES
To fund the planned operations described above and our fixed
commitments for operating leases, delay rentals, property development fees and
consulting fees and note payments to MAB totaling approximately $2,700,000 for
the fiscal year ended September 30, 2007, 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 consisted
of one share of our common stock and one-half common stock purchase warrant. A
whole common stock purchase warrant entitled 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 $1,917,500 from the sale
of units pursuant to the private placement. In February 2007, our board of
directors determined that the composition of the units being offered would be
restructured, and those investors who had subscribed in the offering will be
offered the opportunity to rescind their subscriptions.
In November 2006, PetroHunter Energy NT Ltd. commenced 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 Energy NT
common stock for each $0.50 of debt. As of December 31, 2006, $1,505,000 has
been received from this offering.
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
26
shareholder, Christian Russenberger, were shareholders of the Company prior to
the Credit Agreement. As February 7, 2007, we had drawn down $7,000,000 on the
credit facility.
LIQUIDITY AND CAPITAL RESOURCES
We had not commenced principal operations or earned significant revenue
as of December 31, 2006, and are considered a development stage company. During
the period from inception to December 31, 2006, we incurred a cumulative net
loss of $28,114,852 and at December 31, 2006 have a working capital deficit of
$18,307,346. In order to fund our planned exploration and development of oil and
gas properties, we will require significant additional funding. We have sold
approximately $59.4 million of convertible notes and common stock through
December 31, 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.
The Company at December 31, 2006 is vastly different from its existence
at December 31, 2005. At December 31, 2005, we had been operating for
approximately six 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 8,800,000 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 an oil and gas prospect. At December 31, 2006, we had a
working capital deficit of $18,307,346 and cash of $2,308,442. In addition, 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 31, 2007, we were in default on payment of an aggregate of $200,000 of
notes.
CASH USED IN OPERATING ACTIVITIES. Primarily as a result of our net
loss of $5,304,018, we used cash of $2,961,426 for three months ended December
31, 2006. See "Results of Operations" below for the discussion of our operating
expenses. The principal adjustment to reconcile the net loss to net cash used in
operating activities was stock based compensation of $1,561,133, as a result of
stock options issued to employees and consultants. In comparison, we used
$1,263,644 of cash in operations for the three months ended December 31, 2005.
CASH USED IN INVESTING ACTIVITIES. We used cash of $8,424,791 in during
the three month ended December 31, 2006, primarily for our additions to our oil
and gas properties ($7,866,635). We also used $525,000 for restricted cash,
which are certificates of deposit underlying letters of credit for exploration
permits, state and local bonds and guarantees to vendors. During the three
months ended December 31, 2005, we used $4,189,761 for additions to oil and gas
properties.
27
We currently anticipate our capital budget will be approximately
between $165 and $260 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. Cash provided by financing
activities in 2006 consists of proceeds from convertible promissory notes sold
by PetroHunter Energy NT Ltd. and proceeds from the sale of 1,058,333 units in
our private placement shares for gross proceeds of $1,587,500. Total cash
provided by financing activities was $3,062,883, resulting in cash of $2,308,442
at December 31, 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 $165 and $260 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 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
increased significantly for the quarter ended December 31, 2006, since we had 12
producing wells as of December 31, 2006. We generated $448,876 of production
revenues for the three months ended December 31, 2006, as compared to none for
the three months ended December 31, 2005.
A total of 12 wells produced and sold 85,922 Mcf of natural gas and 79
Bbl of oil. The average prices received for gas and oil sold were $5.17 per Mcf
and $58.29 per Bbl. Lease operating expenses were $161,800 or $1.88/Mcf.
Depreciation, depletion and amortization expense ("DD&A"), based on information
currently available to the Company, is estimated at $86,137 or $1.00/Mcfe.
GENERAL AND ADMINISTRATIVE. Due to the substantially increased level of
activity during the three months ended December 31, 2006 as compared to the
three months ended December 31, 2005, general and administrative expenses
increased by $2,959,744 or 516%.
For the quarters ended December 31, 2006 and 2005, we recorded general
and administrative costs of $3,670,998 and $711,254, respectively, as summarized
below.
28
--------------------------------------------------------------------------------
THREE MONTHS ENDED DECEMBER 31
--------------------------------------------------------------------------------
2006 2005
--------------------------------------------------------------------------------
Consulting fees $ 235,774 $ 282,891
--------------------------------------------------------------------------------
Insurance 69,124 8,327
--------------------------------------------------------------------------------
Investor relations 280,447 33,865
--------------------------------------------------------------------------------
Legal 189,132 71,151
--------------------------------------------------------------------------------
Salaries 554,143 --
--------------------------------------------------------------------------------
Stock Based compensation 1,561,133 205,678
--------------------------------------------------------------------------------
Travel & entertainment 466,093 61,359
--------------------------------------------------------------------------------
Director fees 10,500 --
--------------------------------------------------------------------------------
Office lease and expenses 172,082 15,488
--------------------------------------------------------------------------------
Audit and accounting 62,621 30,000
--------------------------------------------------------------------------------
Other expenses 69,949 2,495
--------------------------------------------------------------------------------
$ 3,670,998 $ 711,254
--------------------------------------------------------------------------------
o Consulting fees decreased as officers became salaried employees in 2006.
o Insurance increased due to growth of the business.
o Investor relations increased upon the Company becoming a public company
through the Stock Exchange in May 2006.
o Legal expenses increased due to growth of the business and costs of public
company reporting and compliance.
o We had no employees at December 31, 2005. Amount for 2006 reflects
officers becoming salaried employees and growth of the business.
o Stock based compensation expenses in 2006 include the effect of grant
date fair value accounting of vested employee stock options in
accordance with SFAS 123R adopted by us effective October 1, 2005. The
2005 expense was calculated in accordance with the provisions of
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations.
o Increased travel and entertainment expenses reflect the growth of the
business.
o Increase in director fees reflects one outside director in 2006 versus
none in 2005.
o Increased office expenses reflect costs of our existing offices in Denver
and Salt Lake City in 2006 versus one smaller office in Denver in 2005.
o Increased accounting and audit fees reflect the growth of the business.
PROPERTY DEVELOPMENT - RELATED. We also incurred $1,815,000 in property
development costs to MAB in 2006, as compared to $700,000 in 2005. As a result
of the new Acquisition and Consulting Agreement with MAB, which is effective
January 1, 2007, we will no longer incur these property development costs.
OPERATING EXPENSES. Total operating expenses for 2006 were $5,733,935,
as compared to $1,411,254 in 2005.
INTEREST EXPENSE. We incurred interest expense of $27,018 for 2006, as
compared to $187,434 for 2005. We expect that interest expense will increase for
the remainder of the current 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.
29
NET LOSS. As a result of the expenses described above, we incurred a
loss of $5,304,018 for 2006, as compared to $1,598,688 for 2005, increasing the
loss accumulated since inception to $28,114,852.
GOING CONCERN
We have incurred a cumulative net loss $28,114,852 for the period from
inception to December 31, 2006 and at December 31, 2006 have a working capital
deficit of $18,307,346. 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 ability to obtain additional financing, in
order to fund our planned operations and ultimately, to achieve profitable
operations.
OFF-BALANCE SHEET ARRANGEMENTS
From time to time, we enter into off-balance sheet arrangements and
transactions that can give rise to off-balance sheet obligations. As of
December 31, 2006, the off-balance sheet arrangements and transactions that we
have entered into include operating lease agreements. We do not believe that
these arrangements are reasonably likely to materially affect our liquidity or
availability of, or requirements for, capital resources.
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.
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
December 31, 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 estimated 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
30
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 December 31, 2006, we had recorded an ARO of $528,268 for our
initial wells under progress.
SHARE BASED COMPENSATION. On October 1, 2005, 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.
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.
31
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk relates to changes in the pricing applicable to
the sales of gas production in the Piceance Basin in Colorado. This risk will
become more significant to us as our production increases in this area.
Although we are not using derivatives at this time to mitigate the risk of
adverse changes in commodity prices, we may consider using them in the future.
ITEM 4. 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.
32
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable.
ITEM 1A. RISK FACTORS
There were no material changes from the risk factors disclosed in our Form
10-KSB for the fiscal year ended September 30, 2006.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the three months ended December 31, 2006, a wholly-owned subsidiary of
the registrant, PetroHunter Energy NT Ltd., sold convertible notes in the
aggregate amount of $1,505,000 to one non-U.S. Person pursuant to Regulation S
and to one accredited investor pursuant to the exemption from registration
contained in Rule 506 of Regulation D. Finder's fees of $75,250 were paid.
The registrant sold 1,058,333 units, each unit consisting of one share of common
stock and one-half common stock purchase warrant, to three non-U.S. Persons
pursuant to Regulation S and one accredited investor pursuant to the exemption
from registration contained in Rule 506 of Regulation D. No underwriters were
used.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS
--------------------------------------------------------------------------------
REGULATION
S-K 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)
--------------------------------------------------------------------------------
33
--------------------------------------------------------------------------------
REGULATION
S-K NUMBER EXHIBIT
--------------------------------------------------------------------------------
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)
--------------------------------------------------------------------------------
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)
--------------------------------------------------------------------------------
34
--------------------------------------------------------------------------------
REGULATION
S-K NUMBER EXHIBIT
--------------------------------------------------------------------------------
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
February 9, 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)
--------------------------------------------------------------------------------
31.1 Rule 13a-14(a) Certification of Thomas Ahlbrandt
--------------------------------------------------------------------------------
31.2 Rule 13a-14(a) Certification of Carmen J. Lotito
--------------------------------------------------------------------------------
32.1 Certification of Thomas Ahlbrandt 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
--------------------------------------------------------------------------------
35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PETROHUNTER ENERGY CORPORATION
(REGISTRANT)
Date: February 14, 2007 By: /s/ CARMEN J. LOTITO
----------------------------------------
Carmen J. Lotito
Chief Financial Officer and Treasurer
(Principal Financial Officer and
Principal Accounting Officer)
36