NEXTRACTION ENERGY CORP. (formerly Kruger Capital Corp.)

Transcription

1 MANAGEMENT S DISCUSSION AND ANALYSIS of NEXTRACTION ENERGY CORP. (formerly Kruger Capital Corp.) Office: TSXV: NE Suite 328 Phone: (604) Burrard Street Fax: (604) Vancouver, BC V6C 2B5 info@nextraction.com Canada

2 This ( MD&A ) provides managements comments on the financial condition and results of operations of Nextraction Energy Corp. (formerly Kruger Capital Corp.) for the year ended December 31, In this MD&A, Nextraction or the Company refers to Nextraction Energy Corp. and its subsidiaries. This MD&A should be read in conjunction with the Company s audited consolidated financial statements and related notes thereto, for the years ended December 31, 2009 and 2008, which are prepared in accordance with Canadian generally accepted accounting principles ( GAAP ). Unless otherwise stated, all amounts in this MD&A and our audited consolidated financial statements are expressed in Canadian dollars. Additional information about the Company is available on our website at and on the SEDAR website at DATE This is prepared as of April 21, COMPANY OVERVIEW Nextraction Energy Corp. (formerly Kruger Capital Corp.) ( Nextraction or the Company ) was incorporated in British Columbia, Canada, on February 14, 1984 and was previously engaged in the business of owning and operating commercial property in British Columbia. In January 2007, the Company sold its remaining commercial property to a third party. During 2008, the Company acquired a 25% interest in certain oil and gas properties from Dolar Energy, L.L.C. ( Dolar ), herein referred to as the North Pinedale project, and located in Sublette County, Wyoming, United States. The completion of the acquisition of the oil and gas properties represented a change of business for the Company under the policies of the TSX Venture Exchange. The transaction with Dolar was entered into as an arm s length transaction, though Dolar became a related party at the Company s Annual Special General Meeting held October 15, 2008 where Mark S. Dolar, the Managing Member of Dolar, was named President, Chief Executive Officer and Director of the Company. The Company is now focused on the acquisition, exploration and development of oil and gas properties in the United States and Canada, including properties in the Appalachian Basin (Kentucky and Tennessee) and in North Pinedale, Wyoming. The Company has not yet determined whether these properties contain oil and gas reserves that are economically recoverable. The recoverability of the amounts shown for oil and gas properties is dependent upon the existence of economically recoverable reserves, confirmation of the Company s interest in the underlying oil and gas reserves, the ability of the Company to obtain necessary financing to complete the development of those reserves and upon future profitable production and/or the proceeds from the disposition thereof. As of December 31, 2009, the Company has not earned any revenues from its properties. 2

3 Oil and Gas Properties The following paragraphs are a brief summary detailing the projects acquired by the Company: North Pinedale Project (Sublette County, Wyoming) The Company, through its subsidiary Nextraction Energy (US) Inc. ( Nextraction US ), owns an undivided 25% interest in an approximately 2,551 net acre leasehold interest (the area of mutual interest ) in the North Pinedale Project situated along the northern extent of the Pinedale Anticline located in Sublette County, Wyoming. Pursuant to the terms of the 2008 acquisition agreement with Dolar the Company is committed to pay its proportionate share of the cost of drilling and completing (or plugging and abandoning, as applicable) one oil and/or gas well on the North Pinedale Project. If the first well is capable of producing oil and/or gas in economic quantities, the Company will be further committed to drilling and completing (or plugging and abandoning, as applicable) a second well. In addition, if the first two wells drilled are completed as producing wells capable of producing in paying quantities, the Company shall pay Dolar an additional US$300,000 cash or 300,000 common shares of the Company, or a combination of both, at Dolar s option, after the Company has generated a 15% rate of return from its investment in the first two wells in the project. On October 6, 2009, and as later amended on November 11, 2009 and March 22, 2010, Nextraction entered into a farm-out agreement (the Amended Vantage Agreement ) with Vantage Energy Green River, LLC ( Vantage ) (owner of the remaining 75% interest in the area of mutual interest). Vantage is a United States exploration company with extensive expertise and experience in completing the over pressurized Tertiary, Lance and Mesaverde formations in the area of mutual interest. Under the terms of the Amended Vantage Agreement, the Company will drill an initial test well on the Pinedale Anticline field in Sublette County, Wyoming on the area of mutual interest. Under the terms of the Amended Vantage Agreement, Vantage serves as operator for the project under the direction of the Company. In addition, the Company has the option to fund 100% of two wells with an aggregate net revenue interest of approximately 81.15%. The drilling of the first option well commenced on December 29, To fund the drilling of the first well, on October 7, 2009, the Company deposited into escrow an initial US$330,000 for permitting and surface pad preparation, followed by another deposit on November 20, 2009 of US$2,795,100 for drilling expenditures, an additional deposit of US$539,900 for hole casing expenditures on December 15, 2009 and a final deposit on April 1, 2010 for well completion expenditures of US$2,907,800 for a total of US$6,572,800. On October 29, 2009, the Company, through its operating partner Vantage, received approval by the Wyoming Oil and Gas Conservation Commission to drill the Noble 6-24 well. The well plans included drilling directionally from a surface location of in the SENW of Section 6 with a bottomhole location in the SENE of Section 6, Township 33 North, Range 109 West, 6th PM. The well is permitted to the depth of 4,650 metres +/-. Upon receiving the approval of the application, the access road and well pad construction was completed. Total costs incurred on the Noble 6-24 well as at December 31, 2009 were $261,881. The Company completed drilling and set production casing in the Noble 6-24 well, which was drilled to the depth of 14,888 feet (4,652.5 meters) in mid-february, The well was drilled to test the overpressured Tertiary, Lance and Mesaverde formations and intersected over 5,400 feet (1,687.5 meters) of formation intervals. The Noble 6-24 well was successfully drilled with a 3,000 foot (937 meters) deviated program, ahead of schedule and on budget. Upon completion of the drilling program and review of the well log data the Company elected to set production casing. The Company estimates final drilling and casing costs will be US$3,483,744. 3

4 The Company is currently designing a completion program that will include multi-stage fracs in the productive intervals. Budgeted costs for completion of the well are estimated at US$3,083,200 to complete and place the well into production, as well as lay pipelines, and set production facilities on location. The total budgeted cost of the well is US$6,566,944. The well is scheduled to be completed later this year. In accordance with the Amended Vantage Agreement, upon the Company receiving payout revenue equal to 150% of drilling and completion costs, Vantage will have the option to participate as to a 26.25% working interest in the well. Should Vantage exercise its option to participate after 150% of payout is received, the Company will own 73.75% working interest in the well. Should the Company not fund the above expenditures under the Amended Vantage Agreement the parties will revert to their original working interests. Under the terms of the Amended Vantage Agreement, should the Company complete the initial test well and pay in full all costs to drill, complete and equip the initial test well, then it will have the option but not the obligation, to drill a second well by giving written notice to Vantage on or before September 30, 2010, under the same terms as the initial test well. For all subsequent wells, Vantage will participate as a 75% interest owner and the Company will participate as a 25% interest owner, as per their original working interests. Appalachian Basin (Whitley and McCreary Counties, Kentucky and Campbell County, Tennessee) Nextraction has entered into several farm-out and property lease agreements to explore approximately 71,000 acres in the Appalachian Basin for conventional gas reserves and an unconventional shale gas resource play. Under the agreements, Nextraction shall have the rights to earn a pre-payout working interest of 95%, with a % net revenue interest, in a thirty well drilling program. On May 28, 2009, Nextraction US signed a farm-out and joint venture agreement (the Vinland Agreement ) with Vinland Energy Eastern, LLC ( Vinland ) for the development of approximately 56,700 net/70,130 gross acres (the Project Area ) located in Whitley and McCreary Counties, Kentucky. Terms for the Vinland Agreement are outlined in detail in Nextraction s Press Release dated March 26, In addition, on May 26, 2009, Nextraction US signed a Farm-out and Joint Venture Agreement (the Trust Agreement ) with Trust Energy Company, LLC ( Trust ), a wholly owned subsidiary of Vanguard Natural Resources, LLC. Trust is a joint venture partner with Vinland in the Project Area and owns a partial interest in approximately 13,000 net acres (which is inclusive of the Project Area). Terms of the Trust Agreement are outlined in detail in the Company s Press Release dated June 9, Upon entering into the agreements with the landowners, Vinland, Trust and the Company commenced a detailed geological review of the Project Area under contract to evaluate the Chattanooga shale and several other conventional geological horizons, including the Little Lime, Big Lime, Ft Payne and Knifely formations. Nextraction also acquired a 50% working interest in the George Brown #3 well from MTARRI, Inc. ( MTARRI ) with an effective date of June 1, 2009, and on June 17, 2009 commenced coring the well for the purpose of evaluating the characteristics for potential of the Chattanooga shale gas formation. The well is located in Whitley County, Kentucky. MTARRI will retain a net revenue royalty of % proportionally reduced, in the well. 4

5 The coring of the George Brown #3 well fulfilled the obligation to core an initial test well as required in the Vinland and Trust Energy Agreements. The core penetrated the Ft Payne, Waverly and Chattanooga shale formations from the depths of 550 metres to 636 metres. The core was delivered to the office of TerraTek, Inc., a Schlumberger company, located in Salt Lake City, Utah for interpretation of rock porosity and permeability, bulk and grain density; and gas, liquid hydrocarbons and water saturation. A total of twelve canisters were recovered in the Chattanooga shale formation for testing which ranged between the depths of 581 metres and 635 metres. Along with the desorption-related parameters, all data will be used to design a completion technique to be applied to this particular shale-gas formation. The results of the core confirmed the shale has potential for production and the Company can now move forward with plans to drill the additional wells. The core contains several natural and induced fractures which will supplement the rock's inherent permeability, and the matrix of the Chattanooga shale contains adequate gas-filled porosity and matrix permeability as well as low water saturations, all of which are positive characteristics for potential gas production. George Brown #3 well costs incurred to date include drilling costs of $56,242, coring and core analysis costs of $116,291, contract operator fee of $16,620 and roadwork and water hauling costs of $11,305. On September 29, 2009, Nextraction entered into an Amendment to the Vinland Agreement (the Amended JV Agreement ) with South Fork Energy Company, LLC ( South Fork ) and Vinland. The Amended JV Agreement amends the original Vinland Agreement, whereby South Fork assumes one-half of the interest owned by Vinland in and to 17,500 acres contained within the Project Area. In addition, under the terms of the Amended JV Agreement, South Fork will acquire a 5% interest in all wells drilled in the Project Area and the Company s 100% interest will be reduced to 95%. As consideration for the 5% interest, South Fork is to reimburse the Company for certain expenditures related to the Project Area. As at December 31, 2009, South Fork s 5% of certain costs totaled US$19,588. South Fork will then participate in the development of the future drilling program as a net 5% interest owner. On October 27, 2009, a property lease agreement, for acres, was entered into by Vinland with third party owners and has been added to the original Vinland Agreement. Terms of the lease agreement provide for the rights to explore and develop the properties over an initial term of three years, which then may be extended depending on the Company s continued development of the properties. In addition, the landowners retain a 12.5% net revenue interest in any oil and gas produced from the properties. The total lease payments issued to property owners was US$3,850. On January 10, 2010, a property lease agreement was entered into by the Company with Mountain Minerals, LLC, (the Landowner ) and has been added to the Vinland Agreement. Terms of the property lease agreement provide for the right to explore and develop the properties over an initial term of five years, which then may be extended depending on the Company s continued development of the properties. In addition, the Landowner retains an 18.75% net revenue interest in any oil and gas produced from the properties. In order to keep the lease in full force and effect, the Company is required to drill two wells in the first year of the lease, two wells in the second year of the lease, and one well in each of the third, fourth and fifth years of the leases; the Company will be assigned 40 acre spacing units for gas wells and 10 acre spacing units for oil wells. The anticipated costs of drilling these wells are approximately US$2,000,000. Failure to timely drill the required wells will lead to termination of that portion of the property covered by lease not drilled. The cumulative payment issued to the Landowner was US$20,750. 5

6 In March, 2010, the Company, through its operator, Vinland Energy Operating, LLC, commenced the Mountain Minerals #5 well, drilled to a total depth of 792 metres, and set production casing to the total depth drilled. The well appears to have gas in the conventional Big Lime, Knifely and Ft Payne formations, as well the unconventional gas resources formation know regionally as the Chattanooga (Devonian) shale. The Mountain Minerals #5 was successfully drilled on time and was on budget. The Company estimates final drilling and casing costs are US$181,034 The Company is currently designing a completion program that will include 3-5 multi-stage fracs in 3-4 prospective zones. Budgeted costs for completion, connecting to existing pipelines and production facilities are estimated at US$142,955. The well is scheduled to be completed and producing by June Natural gas in the Appalachian Basin is sold into the New York Mercantile Exchange (the NYMEX ) market, the highest commodity market place in the United States. In addition, the high Btu content of the gas (1,390 Btu) sells into the NYMEX market place at a premium. SUBSEQUENT EVENTS Events occurring subsequent to the end of the period regarding the development of the North Pinedale and Appalachian Basin projects are discussed above in Oil and Gas Properties. Stock Options Granted On February 19, 2010, pursuant to the Company s 2008 incentive stock option plan, the Company granted incentive stock options to certain consultants allowing them to purchase up to 30,000 common shares in the capital stock of the Company. The options are exercisable at an option price of $1.06 for a period of five years ending February 19, Amalgamation and Sale of Great Canadian Capital Corp. and Great Canadian Funding Corp. On March 1, 2010, the Company s two inactive subsidiaries, Great Canadian Capital Corp. and Great Canadian Funding Corp. were amalgamated and then sold on March 1, 2010 to Anthem Acquisition Ltd., a company related by virtue of a common director, for a nominal amount. This transaction has no impact on the Company s financial position or results of operations. Investor Relations Services On March 23, 2010, the Company retained a third party investor relations firm to provide investor relations services. The third party will receive a monthly retainer of $6,000 for a 5-month term after which the monthly retainer will be reduced to $2,500. The contract can be terminated by either party by giving 30 days written notice. The Company will also issue, as compensation to the third party, an option to purchase 100,000 common shares pursuant to the Companies stock option plan. The options are exercisable at a price of $1.19 per share and will expire 30 days after the termination of the contract. The options are subject to regulatory and shareholder approval. Non-brokered Private Placement On March 29, 2010, the Company completed a private placement of 4,240,000 units, consisting of one common share and one-half of one common share purchase warrant, at a price of $1.00 per unit for gross proceeds of $4,240,000. Each full warrant will entitle the holder to purchase one additional common share at a price of $1.25 per share until March 29, The securities issued under the private placement are subject to a four-month hold period under applicable securities law. The Company paid finder s fees of $141,180. The proceeds from the private placement will be used primarily to finance the completion of the Company s Noble 6-24 well in the Pinedale Anticline field in Sublette County, Wyoming as discussed in Oil and Gas Properties above. 6

7 Warrants Exercised For the period of January 1, 2010 to April 21, 2010, 585,200 warrants were exercised at $0.65 for one common share for gross proceeds of $380,380. SELECTED ANNUAL INFORMATION The following table shows selected consolidated financial information for the years ended December 31, 2009, 2008 and $ $ $ Interest income 8,686 39, ,720 Expenses 1,030, , ,152 Loss before discontinued operations (1,021,496) (357,770) (27,432) Net income from discontinued operations - - 3,273,147 Net income (loss) (1,021,496) (357,770) 3,246,147 Basic and diluted loss per share Oil and gas properties 1,013, ,215 - Total assets 5,579,610 3,291,792 1,746,326 Total liabilities 390, , ,698 Working capital 366,022 2,643,050 1,320,628 Shareholders equity 5,189,414 3,018,265 1,320,628 Interest income tends to fluctuate based on available cash balances and prevailing interest rates. Expenses incurred tend to vary due to the level of activity regarding the acquisition and exploration of oil and gas properties and primarily consist of management and consulting fees, professional fees and such overhead costs such as rent and administration fees. RESULTS OF OPERATIONS and 2008, the Company reported a net loss of $1,021,496 or $0.13 per share basic and diluted (2008 net loss of $357,770 or $0.11 per share basic and diluted). Interest income for the year was $8,686 (2008 $39,651) and was lower due to lower interest rates and lower cash balances throughout 2009 compared to Total expenses for the year ended December 31, 2009 were $1,030,182 (2008 $410,594) due to significantly higher activity levels related to the Company s focus on the oil and gas business. Specifically, management and consulting fees were $260,062 (2008 $146,584) and stock-based compensation expense was $481,116 (2008 $31,313) for the year. This increase is primarily due to compensation of $198,344 paid or accrued to an officer and director of the Company for the full year compared to $80,584 in 2008 for four and a half months. In 2009, stock-based compensation expense of $217,174 (2008 $31,313) related to the options granted to 2008 was recorded in addition to stockbased compensation expense of $263,942 for options granted in Professional fees of $112,385 (2008 $126,442) and filing and transfer agent fees of $18,138 (2008 $31,873) were lower due to legal, accounting and filing fees relating to the Company s change of business in Travel costs of $32,882 (2008 $13,260) and other costs of $21,110 (2008 $10,698) were higher due to the Company s change in business and change of company name. Property investigation costs of $8,101 (2008 $13,996) were lower as less time was spent investigating potential properties in The Company had a foreign 7

8 exchange loss of $66,388 for the year (2008 $3,944) due to the decline of the US dollar against the Canadian dollar during SUMMARY OF QUARTERLY RESULTS The following table is a summary of the most recently completed eight quarters. Figures are in thousands of dollars, except for per share amounts Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Revenue $ - $ 1 $ 2 $ 6 $ 13 $ 6 $ 8 $ 12 Net loss $ (514) $ (156) $ (205) $ (147) $ (139) $ (96) $ (96) $ (27) Net loss per common share - basic and diluted $ (0.06) $ (0.02) $ (0.03) $ (0.02) $ (0.02) $ (0.04) $ (0.04) $ (0.01) Since its change of business in 2008, revenue has been made up of interest earned on cash balances and will fluctuate based on the amount of cash on hand and interest rates in effect each quarter. Until the Company has oil and gas revenue from its properties, interest income will be its primary source of revenue. Until the Company s oil and gas properties become revenue producing, it will continue to incur losses due to increased expenses for management and consulting fees, professional fees, travel and other costs related to its change of business. LIQUIDITY As of December 31, 2009, the Company had current assets amounting to $4,565,731 consisting of a cash balance of $740,626, a restricted cash balance of $3,809,513 and accounts receivable and prepaid expenses of $15,592. During the year ended December 31, 2009, the Company capitalized $290,805 of acquisition and exploration costs related to the North Pinedale Project located in Sublette County, Wyoming. In addition, $347,859 relating to acquisition and exploration costs was capitalized for the Appalachian Basin Project in Whitley and McCreary Counties, Kentucky and Campbell County, Tennessee. Current liabilities amounted to $390,196. The Company completed one private placement during the year on November 19, 2009 for gross proceeds of $2,821,500. Another private placement was completed on March 29, 2010 for gross proceeds of $4,240,000. The Company has sufficient funds to meet its obligated drilling program commitments and operating requirements to the end of CAPITAL RESOURCES As of April 21, 2010 the Company has no reserves and no producing oil and gas wells. The Company may make further oil and gas expenditures on existing and new properties as economics and finances permit. As of December 31, 2009, the Company had cash and cash equivalents on hand of $740,626 (December 31, 2008 $2,905,718) and restricted cash of $3,809,513 for the North Pinedale Noble 6-24 well. The Company completed a private placement on March 29, 2010 for aggregate gross proceeds of $4,240,000 which will allow the Company to fund its currently proposed activities and obligations to the end of

9 COMMITMENTS Effective July 1, 2008, the Company entered into a three year agreement with Mark S. Dolar, the President, Chief Executive Officer and Director of the Company, for a fee of US$170,000 per year. In the event that the contract is terminated by the Company within the three year period, Mr. Dolar shall be entitled, on a going forward basis, to a 0.5% overriding royalty interest in the properties acquired in the North Pinedale project. Under the terms of the Acquisition as outlined in the Change of Business section above, the Company is obligated under the terms of its Wyoming property purchase agreement to pay an additional US$300,000 cash, or 300,000 shares of the Company, or a combination of both, at Dolar Energy, L.L.C. s option, which will be due when the Company has generated a 15% rate of return from its investment in the first two wells of the Wyoming project. Under the terms of the Wyoming property purchase agreement, the Company is committed to fund its proportion of the costs of drilling two wells on the Wyoming property as described in Oil and Gas Properties above. In December 2009, the Company began work on the initial test well and estimates final drilling and casing costs will be US$3,483,744, which the Company has already placed into an escrow account. The well is scheduled to be completed later this year and the estimated cost to complete and place the well into production, lay pipelines, and set production facilities on location is US$3,083,200. Pursuant to the Appalachian Basin project agreements, referenced in Oil and Gas Properties above, Nextraction has elected to drill an additional four wells and is in the process of mobilizing drilling activities for this project. Under the terms of the Vinland Agreement, if the Company does not complete the four wells by May 30, 2010 the only consequence will be the cancellation of the agreements. The total cost to drill these four wells is estimated between US$600,000 to US$1,100,000. The first well, the Mountain Minerals #5 well, was drilled in March 2010, with completing operations scheduled for the end of April Due to inclement weather conditions during the first quarter of 2010, the Company was unable to access other locations for drilling. The Company is in negotiations to extend the commencement of drilling the three additional wells to a date later in the year. The Company expects to fund these property expenditures by raising additional capital in OFF-BALANCE SHEET ARRANGEMENTS The Company does not have any off-balance sheet arrangements. 9

10 RELATED PARTY TRANSACTIONS For the years ended December 31, 2009 and 2008, amounts paid to directors, officers and companies related by virtue of directors in common were as follows: Year Ended December 31, 2009 December 31, 2008 Oil and gas properties Geological consulting $ 15,198 $ 1,964 $ 15,198 $ 1,964 Expenses Administration fees $ 18,000 $ 18,000 Management and consulting fees 222, ,593 Rent 12,000 12,000 Property investigation costs 3,271 - $ 255,686 $ 169,593, the Company paid or accrued $18,469 (December 31, 2008 $1,964) for geological consulting to MTARRI, Inc. (MTARRI), a company related by virtue of a common director. Of these costs $15,198 (2008 $1,964) were capitalized to oil and gas properties and $3,271 expensed to property investigation costs. With an effective date of June 1, 2009 MTARRI assigned a wellbore interest of a 50% working interest in the George Brown #3 well located in Whitley County, Kentucky to the Company. MTARRI is a private wholly-owned company of Dr. Paul B. Trost. Dr. Trost, who is also a director of Nextraction, agreed to the conveyance of the MTARRI interest in the core well for $1.00. The interest being conveyed does not have a significant market value. Dr. Trost will retain a previously retained net revenue royalty of %, proportionately reduced, in the well., the Company paid or accrued $18,000 (2008 $18,000) for administration fees, $41,000 (2008 $66,000) for management fees and $12,000 (2008 $12,000) for rent to Anthem Properties Group Ltd., a company related by virtue of a common director and officer., the Company also paid or accrued $181,415 (2008 $73,593) for consulting fees to Mark S. Dolar, who is an officer and director of Company, and Dolar Energy, L.L.C., of which Mr. Dolar is the managing member. These transactions are in the normal course of operations and are measured at the exchange amount, which is the amount of consideration established and agreed to by the related parties. FOURTH QUARTER For the three months ended December 31, 2009, the Company incurred a net loss of $514,008 or $0.06 per share basic and diluted (2008 net loss of $138,635 or $0.02 per share basic and diluted). Interest income for the fourth quarter of 2009 was $44 (2008 $13,027) and was lower due to lower interest rates during the fourth quarter of 2009 compared to the fourth quarter of

11 Total expenses for the three months ended December 31, 2009 were $514,052 (2008 $155,944) due to significantly higher activity levels related to the Company s focus on the oil and business. Specifically, management and consulting fees were $77,482 (2008 $55,592) and stock-based compensation expense was $328,467 (2008 $31,313) for the quarter. Consulting fees increased by $20,719 primarily due to searching and hiring of additional staff. In the fourth quarter of 2009, stock-based compensation expense of $64,525 (2008 $31,313) related to the options granted in 2008 was recorded in addition to stock-based compensation expense of $263,942 for options granted in The Company had a foreign exchange loss of $59,412 for the quarter (2008 $4,183) due to the decline of the US dollar against the Canadian dollar during PROPOSED TRANSACTIONS In the normal course of business, as an ongoing part of the exploration process, the Company investigates oil and gas properties which are submitted to the Board of Directors for consideration. CRITICAL ACCOUNTING ESTIMATES The Company is a venture issuer on the TSX Venture Exchange therefore this section is not applicable. CHANGES IN ACCOUNTING POLICIES For a detailed summary of the Company s significant accounting policies, the reader is directed to Note 2 of the Notes to the December 31, 2009 audited consolidated financial statements. Adoption of new accounting pronouncements Effective January 1, 2009, the Company adopted CICA Handbook Section 3064, Goodwill and Intangible Assets, replacing CICA 3062, Goodwill and Other Intangible Assets, and CICA 3450, Research and Development Costs. The new pronouncement established standards for the recognition, measurement, presentation, and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profit-oriented enterprises. Standards concerning goodwill are unchanged from the standards included in the previous Section The Company adopted these changes with no impact on its consolidated financial statements. In January 2009, the Emerging Issues Committee issued EIC-173, Credit Risk and the Fair Value of Financial Assets and Financial Liabilities which clarifies that an entity s own credit risk and the credit risk of the counterparty should be taken into account in determining the fair value of financial assets and liabilities, including derivative instruments. This guidance was effective for fiscal years ending on or before January 12, This new standard did not impact the Company s financial results. Effective December 31, 2009, the Company adopted the amendments to the CICA Handbook Section 3862, Financial Instruments Disclosures. These amendments require the Company to present information about financial instruments measured at fair value in accordance with a three level hierarchy. The hierarchy groups financial assets and liabilities into three levels based on the significance of inputs used in measuring the fair value of the financial assets and liabilities. The fair value hierarchy has the following levels: Level 1 valuation based on quoted prices observed in active markets for identical assets or liabilities; Level 2 valuation techniques based on inputs that are quoted prices of similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; inputs other than quoted prices used in a valuation model that are observable for that instrument; and inputs that are derived principally from or corroborated by observable market data by correlation or other means; and 11

12 Level 3 valuation techniques with significant unobservable market inputs. The level within which financial asset or liability is classified is determined based on the lowest level of significant input to the fair value measurement. The Company has adopted these disclosure requirements in the consolidated financial statements for the year ended December 31, Recent Accounting Pronouncements Convergence with International Reporting Standards In February, 2008, the Canadian Accounting Standards Board (AcSB) confirmed the changeover to International Financial Reporting Standards (IFRS) from Canadian GAAP will be required for publicly accountable enterprises interim and annual financial statements for fiscal years beginning on or after January 1, The Company will adopt IFRS as the basis for preparing its consolidated financial statements effective January 1, The adoption date of January 1, 2011 will require the restatement for comparative purposes of all quarterly results reported by the Company for the year ended December 31, 2010 as well as an opening IFRS balance sheet as of January 1, The Company is in the process of completing a preliminary assessment of the impact of adopting IFRS and is developing plans for transition. The transition to IFRS is being managed by internal staff with outside consultants and consultation with the Company s auditors as required. To date the Company has identified the following areas as having the greatest potential impact to its reported financial position and results of operations: exploration and development expenditures property, plant and equipment stock-based compensation income taxes foreign currency transactions The Company expects to complete its preliminary assessment by the end of the second quarter of As the Company is still evaluating the accounting policy alternatives and has not finalized its accounting policy choices and it is therefore unable to quantify the impact of adopting IFRS on the financial statements. The Company does not anticipate any significant changes to its information technology, internal controls over financial reporting, disclosure controls and procedures or its business activities as a result of the adoption of IFRS. The AcSB has ongoing projects and intends to issue new accounting standards during the conversion period. Management will continue to review new standards, as well as the impact of new accounting standards, between now and the conversion date to ensure all relevant changes are addressed. 12

13 Business Combinations In January 2009, the CICA issued Handbook Sections 1582, Business Combinations (Section 1582), CICA 1601, Consolidated Financial Statements (Section 1601) and CICA 1602, Non-Controlling Interests (Section 1602) which replaces CICA Handbook Sections 1581, Business Combinations and CICA 1600 Consolidated Financial Statements. Section 1582 establishes standards for the accounting for business combinations that is equivalent to the business combination accounting standard under IFRS. Section 1582 is applicable for the Company s business combinations with acquisition dates on or after January 1, Section 1601 together with Section 1602 establishes standards for the preparation of consolidated financial statements. Sections 1601 and 1602 are applicable for the Company s interim and annual consolidated financial statements for its fiscal year beginning January 1, FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS The carrying values of the Company s financial instruments, consisting of cash and cash equivalents, accounts receivable and amounts payable, approximate their fair values due to the short-term maturity of such instruments. It is management s opinion that the Company is not exposed to significant interest, currency or credit risks arising from these financial instruments. Interest rate risk Interest rate risk is the risk that future cash flows will fluctuate as a result of changes in market interest rates. The Company is exposed to interest rate risk as its cash and cash equivalents earn interest income at variable rates. The Company is not exposed to significant interest rate risk due to the nature of their monetary assets and liabilities. Credit risk Credit risk is the risk of financial loss to the Company if a customer fails to meet its contractual obligations. Financial instruments that potentially subject the Company to concentrations of credit risks consist principally of cash and cash equivalents. To minimize its credit risk, the Company places these with a high credit quality financial institution. Foreign currency risk Foreign currency risk is the risk that the fair value of future cash flows or financial instruments will fluctuate as a result of changes in foreign exchange rates. The Company operates in Canada and the United States and is therefore exposed to foreign currency risk arising from transactions denominated in a foreign currency. Certain of the Company s cash and cash equivalents and accounts payable and accrued liabilities are held in US dollars. A 1% change in the exchange rate between the Canadian and United States dollar would have an effect on the loss before income taxes for the year ended December 31, 2009 of approximately $35,927 (December 31, 2008 $3,251). The Company monitors the exposure to foreign currency fluctuations and adjusts its cash held in US dollars accordingly. The following table lists the Canadian dollar equivalent of financial instruments denominated in US dollars as of December 31, 2009 and December 31, 2008, using an exchange rate of CAD $1.00 equal to US$0.95 (December 31, 2008 $0.82): Cash $ 3,862,108 $ 459,891 Accounts receivable and prepaids 10,540 - Accounts payable and accrued liabilities 279, ,734 13

14 Liquidity risk Liquidity risk is the risk that the Company will incur difficulties meeting its financial obligations as they become due. The Company manages this risk by ensuring its holding of cash and cash equivalent is sufficient to meet its short-term exploration and general and administrative expenditures. The Company has a contractual obligation to settle all accounts payable and accrued liabilities as they become due. As at December 31, 2009, the Company s contractual cash flows consists of accounts payable and accrued liabilities totalling $390,196 which are due during ADDITIONAL INFORMATION Disclosure of Outstanding Share Data The Company is authorized to issue an unlimited number of common shares without par value. As of April 21, 2010, the following common shares, warrants and stock options are outstanding: Number Exercise Price Remaining Life (years) Common shares 16,218,713 N/A N/A Warrants 8,177,803 $0.65 to $ to 1.0 Stock options 1,725,000 $0.42 to $ to 4.9 Diluted 26,121,516 N/A N/A Trend Information There are no identifiable trends, demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, the Company s liquidity either increasing or decreasing at present or in the foreseeable future. The Company will require sufficient capital in the future to meet its ongoing obligations. Risks and Uncertainties The Company is subject to a number of risk factors and uncertainties. While the Company strives to manage such risks to the extent possible and practical, there may be risk factors that cannot be predicted or foreseen. The following are the risk factors which the Company s management believes are most significant to the Company s business. Financing risks The Company has no revenue producing oil and gas properties and is therefore limited to the cash and cash equivalents on hand in funding the acquisition and exploration of oil and gas properties unless it raises additional capital. While the Company has been successful in the past at raising funds through equity financings there is no assurance that the Company will be able to obtain adequate financing in the future or that the terms of such financing will be favourable. Failure to obtain such additional financing could result in the delay or indefinite postponement of further development of its projects. 14

15 Oil and gas exploration, production and other risks The business of the exploration for and the production of oil and gas resources involves a high degree of risk. Oil and gas reserves may never be found, or if discovered, may not result in production at reasonable costs or profitability. Oil and gas activities are also capital intensive and, to the extent that cash flows from operating activities and external sources become limited or unavailable, the ability of the Company to meet its financial obligations which are necessary to maintain its interests in the underlying properties could be impaired, resulting in the loss of the interests. There is no assurance that the Company s oil and gas properties will result in economically viable operations and will be able to recover the costs associated with the acquisition, exploration and development of the property. In addition, the activities of the Company may be disrupted, curtailed or cancelled by a variety of risks and hazards which are beyond the control of the Company, including environmental hazards, industrial accidents, occupational and health hazards, technical failures, labour disputes, unusual or unexpected rock formations, flooding and extended interruptions due to inclement or hazardous weather conditions, mechanical difficulties, shortage or delays in the delivery of rigs and/or other equipment, compliance with governmental requirements, explosions and other accidents. Although numerous precautions are taken to avoid injury and risk, the oil and gas industry involves operating hazards including, but not limited to, blowouts, explosions, fires, pipeline ruptures as well as other environmental hazards and risks. The Company may become subject to liability for hazards which cannot be insured against or against which it may elect not to be insured because of high premium costs or other commercial reasons. The Company may incur liabilities to third parties (in excess of any insurance cover) arising from pollution or other damage or injury. There can be no assurance that the Company will be able to obtain insurance at reasonable rates or at all, or that any coverage it obtains will be adequate and available to cover such claims. The Company competes with other companies that have significantly greater financial resources for the acquisition of interests in oil and gas properties and in the exploration and development of such properties, as well as for the recruitment and retention of qualified employees. The Company s oil and gas properties are located in the United States and the Company must comply with all material regulations applicable to its exploration activities. The oil and gas industry is subject to federal, state and local environmental laws and regulations controlling the exploration for, and sale of, oil and gas and the possible effects of such activities on the environment. Present, as well as future environmental legislation, regulations and actions could cause additional expense, restrictions and delays in its activities, the extent of which cannot be predicted. A breach of such legislation may result in the imposition of fines or issuance of clean up orders in respect of the Company or its properties and the Company may have to curtail specific activities in some circumstances or subject itself to various governmental controls. In addition, government approvals and permits are generally required in the development and production of oil and gas properties and there can be no assurance that such permits can be obtained on a timely basis or at all. As well, changes in governmental regulations have the potential to increase compliance costs and reduce the profitability of operations. Title to oil and gas interests is often not capable of conclusive determination, without incurring substantial expense. In accordance with industry practice, the Company will conduct such title reviews in connection with its principal properties as it believes are commensurate with the value of such properties. While the Company has taken steps to verify title to the oil and gas properties in which it has an interest, there is no guarantee that title to the oil and gas properties will not be disputed. The Company s oil and gas activities are conducted with partners and it is dependent upon its operating partners for financial and technical support which they contribute to the oil and gas properties. If the Company s operating partners are unable to fulfill their own contractual obligations, the Company may be subject to project delays, additional costs and potential loss of the property interests. 15

16 The feasible development of oil and gas properties into producing operations will be highly dependent on oil and gas prices. A sustained and substantial decline in oil and gas prices could result in the termination of exploration and development work. In addition, the marketability of oil and gas discovered by the Company in the future, if any, will be affected by numerous factors beyond its control. The profitability of the Company s future operations, if any, will be dependent upon, among other things, the market price of natural gas and crude oil which has fluctuated in the past. Oil and gas prices are affected by numerous factors beyond the control of the Company, including international economic and political conditions, levels of supply and demand and currency exchange rates. Investor Relations The Company did not incur any investor relations expense for the year ended December 31, 2009 as management was primarily focused on the acquisition of oil and gas properties and financing. In January 2010 the Company hired a qualified employee to head up its investor and media relations. The Company will manage its investor relations as an internal function and the Company will actively seek to raise its profile with both retail and institutional investors. In March 2010, the Company also engaged a third party investor relations firm to assist the Company with its objectives. Agreed fees will be $6,000 per month for a five-month term after which the monthly retainer will be reduced to $2,500. Disclosure Controls and Procedures Management, including the President and the Acting Chief Financial Officer, has evaluated the effectiveness of the Company s disclosure controls and procedures as of December 31, Management does not expect that the Company s disclosure controls and procedures will prevent or detect all error and all fraud. The inherent limitations in all control systems are such that they can provide only reasonable, not absolute, assurance that all control issues and instances of fraud or error, if any, within the Company have been detected. Based on that evaluation, subject to the inherent limitations as noted, they have concluded that the Company s disclosure controls and procedures are effective in providing reasonable assurance that material information relating to the Company and its consolidated subsidiaries would be made known to them. CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS Certain statements made and information contained herein may contain forward-looking statements or forward-looking information within the meaning of applicable securities legislation. Such forward-looking statements or information include, with limitation, statements or information about the anticipated benefits resulting from the Farm-out and Joint Venture Agreement, our business strategy and goals, our future capital and other expenditures and requirements, project development schedules and results, results of exploration activities and dates by which certain areas may be developed or may come on-stream, our future financing and capital activities, contingent liabilities and environmental matters. Often, but not always, forward-looking statements or information can be identified by the use of words such as plans, expects or does not expect, is expected, budget, scheduled, estimates, forecasts, intends, anticipates or does not anticipate, or believes or variations of such words and phrases or words and phrases that state or indicate that certain actions, events or results may, could, would, might or will be taken, occur or be achieved. Although management believes that the assumptions made and the expectations represented by such statements or information are reasonable, there can be no assurance that a forward-looking statement or information herein will prove to be accurate. Forward-looking statements and information by their nature are based on assumptions and involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, amongst others, general economic conditions, industry conditions, volatility of commodity prices, stock market volatility, imprecision of reserve estimates, environmental risks, and the Company s ability to obtain sufficient capital from internal and external sources to fund its proposed drilling program. Should one or more of 16

17 these risks and uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may vary materially from those described in forward-looking statements and information. Although the Company has attempted to identify factors that may cause actual actions, events or results to differ materially from those described in forward-looking statements and information, there may be other factors that cause actual results, performances, achievements or events to not be as anticipated, estimated or intended. Also, many of the factors are beyond our control. As actual results and future events could differ materially from those anticipated in such statements and information, readers should not place undue reliance on forward-looking statements or information. Except as may be required by law, the Company undertakes no obligation to publicly update or revise any forward-looking statements or information, whether as a result of new information, future events or otherwise. List of Directors and Officers Directors: Officers: Mark S. Dolar Eric H. Carlson Paul B. Trost R. Michael Jones Frank R. Hallam Mark S. Dolar (President and Chief Executive Officer) David Ferguson (Secretary and Acting Chief Financial Officer) 17