JMG Exploration, Inc.
Notes to Consolidated Financial Statements
1. INCORPORATION, NATURE OF OPERATIONS, AND GOING CONCERN
JMG Exploration, Inc. (“JMG” or the “Company”) is an independent energy company that explores for, develops and produces natural gas, crude oil and natural gas liquids in Canada and the United States. Currently, all of the Company’s proved reserves are located in the United States.
JMG was incorporated with nominal share capital under the laws of the State of Nevada on July 16, 2004 and commenced operations in August 2004.
The Company’s future financial condition and results of operations will depend upon prices received for its oil and natural gas production and the costs of finding, acquiring, developing and producing reserves. Prices for oil and natural gas are subject to fluctuations in response to change in supply, market uncertainty and a variety of other factors beyond the Company’s control. These factors include worldwide political instability, the foreign supply of oil and natural gas, the price of foreign imports, the level of consumer demand, and the price and availability of alternative fuels.
In the event sufficient capital is not available to fund development and exploratory drilling opportunities the Company will explore a range of strategic alternatives, including a possible sale of the Company or a merger with another party. On April 27, 2007, JMG entered into a non-binding Letter of Intent with Iris Computers Ltd., a distributor of computer hardware and software in India, regarding a potential business combination. The transaction is subject to a 60 day due diligence period and provides for a No-Shop Period until June 26, 2007, during which period the parties have agreed not to enter into an agreement or consummate a transaction with any other party, which would preclude the consummation of the transaction. The due diligence period and No-Shop period were subsequently extended to August 15, 2007. Although no assurance can be given that the parties can reach agreement and proceed to a closing, if the proposed business combination is completed, the current JMG shareholders, immediately post-closing, would own approximately 37.5% of the combined entities, without giving effect to JMG’s outstanding options and warrants. JMG’s oil and gas assets will not be included in this transaction and will be sold or merged separately for the benefit of shareholders of a future record date.
JMG has not realized a profit from operations since its incorporation on July 16, 2004. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. The recovery of the Company’s assets and its ability to continue operations is dependent on successful production of economic quantities of hydrocarbons, or obtaining additional financing to fund its exploration activity. The sale of certain properties on January 30, 2007 provided additional cash flow towards the Company’s ongoing operations, however, as of June 30, 2007, we had an accumulated deficit of $20,077,680, and have insufficient working capital to fund development and exploratory drilling opportunities. These financial statements do not include any adjustments related to the recoverability and classification of assets or the amounts and classification of liabilities that may be necessary should the Company be unable to continue as a going concern.
2. RESTATEMENT OF 2006 INTERIM FINANCIAL STATEMENTS
The unaudited financial statements for the first three quarters of 2006 have been restated due to changes to depletion and impairment calculations. The Company’s calculation of depreciation, depletion and amortization was incorrect because of a clerical error which resulted in depletion being calculated with respect to proved and probable reserves instead of proved reserves.
The unaudited financial statement for the first three quarters of 2006 have also been restated to reflect deemed dividends resulting from the extension of warrant expiration dates. On February 24, 2006 the Company extended the expiration dates of its outstanding warrants to January 15, 2007. A total of 375,187 $6.00 warrants and 1,739,500 $4.25 warrants were to expire on December 31, 2006, and 1,854,235 $5.00 warrants were to expire on August 24, 2006. A deemed dividend of $552,846 for this extension of the
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warrant expiration dates was calculated using the Black-Scholes option-pricing model and was not reflected in the 2006 unaudited quarterly financial statements.
The effects of the depletion restatement of $650,604 and $1,452,000 and the warrant deemed dividend of $0 and $552,846 on expenses, net loss for the period, net loss applicable to common shareholders, and basic and diluted earnings per share for the three and six month periods ended June 30, 2006, respectively, are as follows:
| | For the three month period ended
June 30, 2006 | | For the six month period ended
June 30, 2006 | |
| | As Originally
Reported | | Restatement
Adjustments | | As Restated | | As Originally
Reported | | Restatement
Adjustments | | As Restated | |
| | (unaudited) | | (unaudited) | | (unaudited) | | (unaudited) | | (unaudited) | | (unaudited) | |
Expenses | | $ | 675,731 | | $ | 650,604 | | $ | 1,326,335 | | $ | 1,336,423 | | $ | 1,452,000 | | $ | 2,788,423 | |
Net loss for the period | | $ | (200,214 | ) | $ | (650,604 | ) | $ | (850,818 | ) | $ | (408,171 | ) | $ | (1,452,000 | ) | $ | (1,860,171 | ) |
Net loss applicable to common shareholders | | $ | (200,214 | ) | $ | (650,604 | ) | $ | (850,818 | ) | $ | (408,171 | ) | $ | (2,004,846 | ) | $ | (2,413,017 | ) |
Net loss for the period per share: basic and diluted | | $ | (0.04 | ) | $ | (0.14 | ) | $ | (0.17 | ) | $ | (0.08 | ) | $ | (0.39 | ) | $ | (0. 47) | |
The effects of the depletion and impairment restatement of $1,452,000, and the warrant deemed dividend of $552,846 on property and equipment, total assets, accumulated deficit and shareholders’ equity as of June 30, 2006 are as follows.
| | June 30, 2006 | |
| | As Originally
Reported | | Restatement
Adjustments | | As Restated | |
Property and equipment | | $ | 15,477,913 | | $ | (1,452,000 | ) | $ | 14,025,913 | |
Total assets | | $ | 19,036,883 | | $ | (1,452,000 | ) | $ | 17,584,883 | |
Accumulated deficit | | $ | (7,722,532 | ) | $ | (2,004,846 | ) | $ | (9,727,378 | ) |
Shareholders’ equity | | $ | 15,006,547 | | $ | (1,452,000 | ) | $ | 13,554,547 | |
3. SIGNIFICANT ACCOUNTING POLICIES
These interim consolidated financial statements have been prepared by the Company without audit pursuant to the rules and regulations of the Securities and Exchange Commission, and reflect all adjustments which, in the opinion of management, are necessary for a fair statement of the results for the interim periods, on a basis that is consistent with the annual audited financial statements. All such adjustments are of a normal recurring nature. Certain information, accounting policies, and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the audited financial statements and the summary of significant accounting policies and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2006.
Income (loss) per Common Share
Income (loss) per share (“EPS”) is computed based on weighted average number of common shares outstanding and excludes any potential dilution. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock, which would then share in the earnings of the Company. The
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shares issuable upon the exercise of stock options and warrants are excluded from the calculation of net loss per share for the three and six months ended June 30, 2007 and 2006 because their effect would be antidilutive in 2006 and 2007. The following shares were accordingly excluded from the net income/loss per share calculation.
| | Three month period ended
June 30, | | Six month period ended
June 30, | |
| | 2007 | | 2006 | | 2007 | | 2006 | |
| | (unaudited) | | (unaudited) | | (unaudited) | | (unaudited) | |
Stock warrants | | 4,062,551 | | 4,102,068 | | 4,062,551 | | 4,102,068 | |
Stock options | | 553,333 | | 392,500 | | 553,333 | | 392,500 | |
Total share excluded | | 4,615,884 | | 4,494,568 | | 4,615,884 | | 4,494,568 | |
Income Taxes. The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. No adjustments were required as a result of the adoption of FIN 48.
The Company files income tax returns in the U.S. federal jurisdiction and various states. There are currently no income tax examinations underway for these jurisdictions, although the tax years ended December 31, 2006, 2005 and 2004 are all still open for examination.
The Company provides for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS 109”). SFAS 109 requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of the assets and liabilities. Where it is more likely than not that a tax benefit will not be realized, a valuation allowance is recorded to reduce the deferred tax asset to its realizable value.
A valuation allowance has been provided against the Company’s net deferred tax assets as the Company believes that it is more likely than not that the net deferred tax assets will not be realized. As a result of this valuation allowance, the effective tax rate for the first quarter of 2007 and for the year ended December 31, 2006 is zero percent.
New Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). It became effective for the Company on January 1, 2007. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold that a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on measurement, classification, interim accounting and disclosure. We adopted FIN 48 effective January 1, 2007.
In September 2006, FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosure requirements regarding fair value measurement. Where applicable, this statement simplifies and codifies fair value related guidance previously issued within GAAP. Although this statement does not require any new fair value measurements, its application may, for some entities, change current practice. SFAS No. 157 will be effective for the Company beginning January 1, 2008. The adoption of SFAS No. 157 is not expected to have a material impact on our financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 applies to all
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entities and is effective for fiscal years beginning after November 15, 2007. Adoption of SFAS No. 159 is not required for these financial statements, and we are currently determining the impact, if any, that SFAS No. 159 will have on our future financial statements.
4. PROPERTY AND EQUIPMENT
Depletion and depreciation expense was $151,117 and $839,743 for the three months ended June 30, 2007 and 2006, and $387,010 and $1,847,208 for the six months ended June 30, 2007 and 2006. Undeveloped land and other assets not related to petroleum and natural gas properties were excluded from the depletion calculation.
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Oil and gas properties (accounted for under the successful efforts method of accounting)
| | June 30, 2007 | | December 31, 2006 | |
| | (unaudited) | | | |
Petroleum and natural gas properties | | $ | 6,117,224 | | $ | 5,961,987 | |
Undeveloped Properties | | 4,086,721 | | 4,086,722 | |
Accumulated depletion, depreciation and amortization | | (5,483,056 | ) | (5,120,316 | ) |
| | $ | 4,720,889 | | $ | 4,928,393 | |
Oil and gas properties held for resale (accounted for under the successful efforts method of accounting)
| | June 30, 2007 | | December 31, 2006 | |
| | (unaudited) | | | |
Petroleum and natural gas properties | | $ | — | | $ | 10,231,212 | |
Undeveloped Properties | | | | 2,174,170 | |
Accumulated depletion, depreciation and amortization | | | | (9,297,506 | ) |
| | $ | — | | $ | 3,107,876 | |
Other property and equipment
| | June 30, 2007 | | December 31, 2006 | |
| | (unaudited) | | | |
Property and Equipment | | $ | 73,403 | | $ | 119,227 | |
Accumulated depreciation | | (17,334 | ) | (17,048 | ) |
| | $ | 56,069 | | $ | 102,179 | |
5. PROMISSORY NOTE
On February 8, 2006 a promissory note was issued to an unrelated third party, for a total of $1,500,000. The terms of the agreement call for interest calculated at 12% per annum payable on a monthly basis. The promissory note was repayable on March 30, 2006, however, repayment was extended to December 31, 2006. All other terms of the original agreement remain the same. The note was paid in full in February 2007.
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6. RELATED PARTY TRANSACTIONS
JED Oil Inc.
On August 1, 2004 the Company entered into a technical services agreement with JED Oil Inc. (“JED”). Under the Agreement, JED provides all required personnel, office space and equipment, at standard industry rates for similar services. JED is considered an affiliate, because of its ownership interest in us and because two of our directors are directors of JED. This agreement was terminated on January 1, 2006; it was replaced by a joint services agreement, which operates to provide the above services on an as needed basis.
Pursuant to this agreement, the Company entered into the following transactions with JED:
JED paid on behalf of the Company a total of $16,852 for the three month period ended June 30, 2007 for capital related expenditures and production expenses.
During the three months ended June 30, 2007, the Company entered into the following transactions with JED:
JED paid on behalf of the Company a total of $14,587 and nil for the three month period ended June 30, 2007 and 2006 for operating costs and capital related expenditures. In consideration for the assignment of JED’s interest in certain oil and gas properties, JED charged the Company for drilling and other costs related to those properties for the three month period ended June 30, 2007 and 2006, in the amount of $2,265 and $1,249,917.
JED paid on behalf of the Company a total of $221,660 and nil for the six month period ended June 30, 2007 and 2006 for operating costs and capital related expenditures. JED also charged the Company $217,109 for payments to JMG’s partners paid by JED, and $4,333 in miscellaneous costs. In consideration for the assignment of JED’s interest in certain oil and gas properties, JED charged the Company for drilling and other costs related to those properties for the six month period ended June 30, 2007 and 2006, in the amount of $53,682 and $1,249,917.
In connection with these transactions the total amount payable to JED was $2,030,717 at June 30, 2007.
Skeehan & Company
Joseph Skeehan, the Chief Executive Officer, President and a director of JMG is also the owner of Skeehan & Company, a professional service corporation that engages in accounting, finance and consulting services to small to mid-sized companies and organizations primarily in Southern California since 1980. In conjunction with the maintenance of accounting records and the preparation of financial statements and regulatory filings, Skeehan & Company was paid a total of $77,489 and $80,527 during the three and six month periods ended June 30, 2007.
7. ASSET RETIREMENT OBLIGATION
As of June 30, 2007, the estimated present value of the Company’s asset retirement obligation was $69,969 based on estimated future cash requirements of $116,133, determined using a credit adjusted risk free interest rate of 8.5% over the economic life of the properties, an inflation rate of 2.0%, and an estimated life until repayment of 5-10 years. Accretion of $2,368 and $4,697 was recorded for the three and six month periods ending June 30, 2007.
Asset retirement obligations at December 31, 2006 | | $ | 111,096 | |
Liabilities incurred | | — | |
Liabilities settled | | (45,824 | ) |
Accretion expense | | 4,697 | |
Asset retirement obligations at June 30, 2007 | | $ | 69,969 | |
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of financial results as provided by the management of JMG Exploration, Inc. (“JMG”) should be read in conjunction with the unaudited consolidated financial statements and notes for the three and six month periods ended June 30, 2007, the audited financial statements and accompanying notes for the years ended December 31, 2006 and 2005 and the managements discussion and analysis for the years ended December 31, 2006 and 2005.
FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements. All statements other than statements of historical facts contained herein, including statements regarding our future financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “should,” “plan,” “expect” and similar expressions, as they relate to us, are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions as described in “Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2006.
Other sections of this report may include additional factors that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
Statements relating to “reserves” are deemed to be forward-looking statements, as they involve the implied assessment, based on certain estimates and assumptions, that the reserves described can be profitably produced in the future. Readers are cautioned that the foregoing lists of factors are not exhaustive. The forward-looking statements contained in this Form 10-Q are made as of the date hereof and the Company undertakes no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except in accordance with applicable securities laws. The forward-looking statements contained in this Form 10-Q are expressly qualified by this cautionary statement.
In the presentation of the Form 10-Q, JMG uses terms that are universally applied in analyzing corporate performance within the oil and gas industry for which regulators require that we provide disclaimers.
Barrel of Oil Equivalent (BOE) — The oil and gas industry commonly expresses production volumes and reserves on a “barrel of oil equivalent” basis (“BOE”) whereby natural gas volumes are converted at the ratio of six thousand cubic feet to one barrel of oil. The intention is to sum oil and natural gas measurement units into one basis for improved analysis of results and comparisons with other industry participants. Throughout this Form 10-Q, JMG has used the 6:1 BOE measure which is the approximate energy equivalency of the two commodities at the burner tip. BOE does not represent a value equivalency at the plant gate, which is where JMG sells its production volumes, and therefore may be a misleading measure if used in isolation.
Overview
In August 2004, we completed two private placements totaling $8.8 million, issuing 250,000 shares of common stock and 1,950,000 shares of convertible preferred stock, and commenced exploration activities. Upon the closing of the initial public offering on August 3, 2005, the Company issued 2,185,000 shares of common stock at a price of $5.00 and 2,185,000 warrants at a price of $0.10 for gross proceeds of $11,143,500. The warrants associated with the initial public offering are exercisable at $5.00, until one year from the statement of registration, and have been extended through January 15, 2008. The Company trades on the Archipelago Exchange under the symbols JMG (common stock) and JMG+ (stock warrants).
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During 2005, we made direct property acquisitions and commenced developing the oil and natural gas properties of others under arrangements in which we financed the cost of exploration drilling in exchange for interests in the oil or natural gas revenue generated by the properties. Such arrangements are commonly referred to as farm-ins to us, or farm-outs by the property owners to us.
In 2006 we continued drilling for oil and natural gas. We drilled eight horizontal oil wells in the Midale in North Dakota and four vertical gas wells in the Pinedale area of Wyoming.
On January 30, 2007, JMG completed the first closing of the sale of its oil and gas assets in North Dakota where it has been targeting the Bakken zone, for consideration of $5,454,437, subject to adjustment, to Samson Resources Company pursuant to a Purchase and Sale Agreement effective as of December 20, 2006, among JMG, JED Oil (USA) Inc. and Samson. The sales exclude the North Dakota lands where JMG has been developing its Midale play.
Results of operations
Revenue. Our revenue is dependent upon success in finding and developing oil and natural gas reserves. Our ownership interest in the production from these properties is measured in BOE per day, a term that encompasses both oil and natural gas production. Revenues were $167,551 and $475,517 for the three month periods ended June 30, 2007 and 2006, and $299,270 and $928,252 for the six month periods ended June 30, 2007 and 2006, respectively. The decrease in revenue was principally due to the sale of oil and gas assets in North Dakota.
Critical to our revenue stream is the market price for crude oil. Commodity benchmark prices for crude oil is as follows:
| | June 30, | |
| | 2007 | | 2006 | |
| | (unaudited) | | (unaudited) | |
West Texas Intermediate grade crude oil, per barrel | | $ | 67.48 | | $ | 70.96 | |
| | | | | | | |
We may use derivative financial instruments when we deem them appropriate to hedge exposure to changes in the price of crude oil, fluctuations in interest rates and foreign currency exchange rates. JMG currently does not have any financial derivative contracts or fixed price contracts in place.
General and administrative expense. General and administrative expense relates to compensation and overhead for executive officers and fees for general operational and administrative services. We have contracted out all field personnel and equipment necessary for exploration activities, and for related administrative functions. General and administrative expenses were $404,323 and $338,494 for the three month periods ended June 30, 2007 and 2006, and $694,579 and $631,857 for the six month periods ended June 30, 2007 and 2006, respectively. Expenses consist principally of salaries, consulting fees and office costs. The increase in general and administrative expense of $65,829 and $62,722 for the three and six month periods ended June 30, 2007 from the corresponding periods in the previous year was principally due to stock based compensation expense.
The Company has a stock option plan under which employees, directors and consultants are eligible to receive grants. The Corporation accounts for the stock option granted to consultants using the fair value recognition provisions of SFAS No. 123. Stock based compensation for the three and six month periods ended June 30, 2007 was $62,443 and $124,886. Stock based compensation expense for the three and six month periods ended June 30, 2006 was $25,144 and $50,012. The Company has adopted Statement 123(R) using the modified-prospective method, therefore for the three and six month periods ended June 30, 2006 the share-based payment was a result of expensing the stock options for employees as well as consultants on a straight line basis using the Black-Scholes option pricing model.
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Production expense. Production costs include operating costs associated with field activities and geophysical and geological expense. Under the successful-efforts method, costs such as geological and geophysical, exploratory dry holes and delay rentals are expensed as incurred. Production expenses were $74,590 and $56,186 for the three month period ended June 30, 2007 and 2006, and $138,399 and $191,648 for the six month period ended June 30, 2007 and 2006, respectively. The increase in production expense of $18,404 and decrease of $53,249 for the three and six month periods ended June 30, 2007 from the corresponding periods in the previous year was principally due to the sale of oil and gas assets in North Dakota.
Depletion, depreciation and impairment expense. Depletion, depreciation and impairment expense were $151,117 and $839,743 for the three month period ended June 30, 2007 and 2006, and $387,010 and $1,847,208 for the six month period ended June 30, 2007 and 2006, respectively. This decrease was due to impairment charges of $4,863,820 recorded in the year ended December 31, 2006 that reduced the depletable cost basis, and the sale of oil and gas assets in North Dakota effective January 2007.
Accretion expense. As of June 30, 2007, the estimated present value of the Company’s asset retirement obligation was $69,969 based on estimated future cash requirements of $116,133, determined using a credit adjusted risk free interest rate of 8.5% over the economic life of the properties, an inflation rate of 2.0%, and an estimated life until repayment of 5-10 years. Accretion expense of $2,368 and $4,697 was recorded for the three and six month periods ending June 30, 2007.
As of June 30, 2006, the estimated present value of the Company’s asset retirement obligation was $82,020 based on estimated future cash requirements of $216,000, determined using a credit adjusted risk free interest rate of 8.5% over the economic life of the properties, an inflation rate of 2.0%, and an estimated life until repayment of 5-10 years. Accretion of $1,937 and $3,838 was recorded for the three and six month periods ending June 30, 2006.
Gain on sale of oil and gas properties. On November 3, 2006, JMG signed an Offer Letter to sell its working interests in the Bakken lands and wells in North Dakota to an arms length party for approximately $5,454,437, subject to adjustment. The transaction was effective October 1, 2006 and closing of the transaction, following normal title and environmental due diligence, occurred January 30, 2007. The properties included in this sale are classified as “Oil and gas properties held for resale” on the balance sheet as of December 31, 2006.
Interest income. Interest income was $31,014 and $0 for the three month period ending June 30, 2007 and 2006, and $47,979 and $0 for the six month period ending June 30, 2007 and 2006, respectively, and increased due to greater cash balances on hand in the current year.
Interest expense. Interest expense was nil and $89,975 for the three month period ending June 30, 2007 and 2006, and was $19,444 and $113,872 for the six month period ending June 30, 2007 and 2006, respectively. Interest expense decreased due to the repayment of the promissory note and interest by an unrelated industry partner on June 28, 2005.
Deemed dividend on warrant extension. On February 24, 2006 the Company extended the expiration dates of its outstanding warrants to January 15, 2007. A total of 375,187 $6.00 warrants and 1,739,500 $4.25 warrants were to expire on December 31, 2006, and 1,854,235 $5.00 warrants were to expire on August 24, 2006. A deemed dividend of $552,846 for this extension of the warrant expiration dates was calculated using the Black-Scholes option-pricing model.
Income taxes. The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. No adjustments were required as a result of the adoption of FIN 48.
The Company files income tax returns in the U.S. federal jurisdiction and various states. There are currently no income tax examinations underway for these jurisdictions, although the tax years ended December 31, 2006, 2005 and 2004 are all still open for examination.
The Company provides for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS 109”). SFAS 109 requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the
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financial statement carrying amounts and the tax basis of the assets and liabilities. Where it is more likely than not that a tax benefit will not be realized, a valuation allowance is recorded to reduce the deferred tax asset to its realizable value.
A valuation allowance has been provided against the Company’s net deferred tax assets as the Company believes that it is more likely than not that the net deferred tax assets will not be realized. As a result of this valuation allowance, the effective tax rate for the first quarter of 2007 and for the year ended December 31, 2006 is zero percent.
Liquidity and capital resources
At June 30, 2007, we had $4,263,283 in cash and cash equivalents. Since our incorporation, we have financed our operating cash flow needs through private and public offerings of equity securities.
We have no plans for any future issues of equity securities other than in conjunction with the exercise of outstanding warrants, and pursuant to our employee equity compensation plan. Any additional exploration activities are dependent upon the exercise of our outstanding warrants, which are summarized in the table below. In the event funds from the exercise of warrants are unavailable, we will delay our exploration activities until alternative sources of capital such as production revenue and farm out agreements on our properties or sale of our properties.
Warrant summary
| | Number
of warrants
outstanding | | Exercise
price | | Maximum
proceeds | | Expiration
Date | |
Warrants issued in the preferred stock private placement | | 369,249 | | $ | 6.00 | | 2,215,494 | | 01/15/2008 | |
Warrants issued upon conversion of preferred stock | | 1,739,500 | | $ | 4.25 | | 7,392,875 | | 01/15/2008 | |
Warrants issued our initial public offering | | 1,763,802 | | $ | 5.00 | | 8,819,010 | | 01/15/2008 | |
Warrants issued to our underwriters | | 190,000 | | $ | 7.00 | | 1,330,000 | | 08/03/2010 | |
Total | | 4,062,551 | | various | | 19,757,379 | | various | |
As of June 30, 2007, we had an accumulated deficit of $20,077,680 and have insufficient working capital to fund development and exploratory drilling opportunities. We have operating and liquidity concerns due to our significant net losses and negative cash flows from operations. As a result of these and other factors there is substantial doubt about our ability to continue as a going concern. JMG is presently exploring a range of strategic alternatives, including the possible sale or merger with another party.
On April 27, 2007, we entered into a non-binding Letter of Intent with Iris Computers Ltd., a distributor of computer hardware and software in India, regarding a potential business combination. The transaction is subject to a 60 day due diligence period and provides for a No-Shop Period until June 26, 2007, during which period the parties have agreed not to enter into an agreement or consummate a transaction with any other party, which would preclude the consummation of the transaction. The due diligence period and No-Shop period were subsequently extended to August 15, 2007. Although no assurance can be given that the parties can reach agreement and proceed to a closing, if the proposed business combination is completed, the current JMG shareholders, immediately post-closing, would own approximately 37.5% of the combined entities, without giving effect to JMG’s outstanding options and warrants. JMG’s oil and gas assets will not be included in this transaction and will be sold or merged separately for the benefit of shareholders of a future record date.
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Cash flow used in operations. Cash provided (utilized) by operating activities was $27,220 and $(174,933) for the three months ended June 30, 2007 and 2006, and was $(65,815) and $(1,476,639) for the six months ended June 30, 2007 and 2006.
The use of cash for the three months ended June 30, 2007 was principally attributable to net loss of $433,833 which was decreased by the cash requirements related to the decrease in accounts payable of $60,575. These cash requirements were offset by a decrease in accounts receivable of $187,836 which provided cash and depletion, depreciation and accretion expense of $153,486, an increase in due to JED Oil of $133,760 and a increase in prepaid expenses of $15,894 which did not utilize cash.
The use of cash for the six months ended June 30, 2007 was principally attributable to net income of $1,487,035 which was decreased by the gain on sale of property and equipment of $2,370,546 and the cash requirements related to the decrease in accounts payable of $910,489. These cash requirements were offset by a decrease in accounts receivable of $656,434 which provided cash and depletion, depreciation and accretion expense of $391,708, an increase in due to JED Oil of $604,268 and a increase in prepaid expenses of $5,614 which did not utilize cash.
The use of cash in for the three months ended June 30, 2006 was principally attributable to the net loss of $850,818 which was reduced by a decrease in accounts payable of $2,975,813, depletion, depreciation and accretion expense of $841,680 and stock-based compensation of $25,144 which did not utilize cash. These cash requirements were offset by a increase in accounts receivable of $1,117,844 which did not provide cash and a decrease in Due to JED Oil Inc. of $1,970,730 which utilized cash.
The use of cash in for the six months ended June 30, 2006 was principally attributable to the net loss of $1,860,171 which was reduced by a decrease in accounts payable of $1,131,424, depletion, depreciation and accretion expense of $1,851,046 and stock-based compensation of $50,012 which did not utilize cash. These cash requirements were offset by a increase in accounts receivable of $326,755 which did not provide cash and a decrease in Due to JED Oil Inc. of $2,117,079 which utilized cash.
Cash flow used in investing activities. Cash provided (utilized) by investing activities was nil and $255,844 for the three months ended June 30, 2007 and 2006, and was $5,299,560 and $(841,162) for the six months ended June 30, 2007 and 2006, respectively.
Cash provided by investing activities for the six months ended June 30, 2007 was principally attributable to proceeds of $5,454,437 from the sale of oil and gas property, offset by equipment required for ongoing production activities of $155,236. Cash utilized by investing activities in 2006 was entirely attributable to equipment requirements for drilling and development of oil and gas properties.
Cash flow used in financing activities. Cash provided (utilized) by financing activities was nil and $60,431 for the three months ended June 30, 2007 and 2006, and $1,500,000 and $1,978,304 for the six months ended June 30, 2007 and 2006, respectively.
The cash utilized for the six months ended June 30, 2007 was due to the repayment of a $1,500,000 promissory note that originated in the same period in 2006.
The cash provided for the three months ended June 30, 2006 was due to $60,431 in proceeds from warrants that were exercised during the period. The cash provided for the six months ended June 30, 2006 was due to $1,500,000 proceeds from a promissory note and $417,873 in proceeds from warrants that were exercised during the period.
Changes in critical accounting estimates
Stock-based compensation
Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB Statement No. 123(R), Share-Based Payment, using the modified-prospective-transition method. Under that transition
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method, compensation cost recognized effective January 1, 2006 includes: (a) compensation cost for share-based options granted to employees and directors prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of Statement 123(R). Results for prior periods have not been restated.
Prior to January 1, 2006, the Company accounted for the stock options granted to employees and directors under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation and for the stock options granted to consultants under the recognition and measurement provisions of FASB Statement No. 123. No stock-based employee and directors compensation cost was recognized in the Statement of Operations and Deficit for the year ended December 31, 2005 nor for the period from the date of incorporation on July 16, 2004 to December 31, 2004, as all options granted to employees and directors under that plan had an exercise price equal to the market value of the Company’s common stock on the date of grant.
Contingencies
In the future, we may be subject to adverse proceedings, lawsuits and other claims related to environmental, labor, product and other matters. We will be required to assess the likelihood of any adverse judgments or outcomes of these matters as well as potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies is made after careful analysis of each individual issue. The required reserves may change in the future due to developments in each matter or changes in approach such as a change in settlement strategy in dealing with these potential matters.
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Contractual obligations and commitments
Our exploration prospects have several phases of possible development. Costs cannot be estimated at this time, as they are dependent upon the results of the exploration activities. In the event the results of the initial exploration are positive, our investment in subsequent exploration phases could be substantial. In the event the results of the initial exploration are not positive, there may be no further expenditures on the prospect.
Related Party Transactions
JED Oil Inc. On August 1, 2004 the Company entered into a technical services agreement with JED Oil Inc. (“JED”). Under the Agreement, JED provides all required personnel, office space and equipment, at standard industry rates for similar services. JED is considered an affiliate, because of its ownership interest in us and because two of our directors are directors of JED. This agreement was terminated on January 1, 2006; it was replaced by a joint services agreement, which operates to provide the above services on an as needed basis.
During the three months ended June 30, 2007, the Company entered into the following transactions with JED:
JED paid on behalf of the Company a total of $14,587 and nil for the three month period ended June 30, 2007 and 2006 for operating costs and capital related expenditures. In consideration for the assignment of JED’s interest in certain oil and gas properties, JED charged the Company for drilling and other costs related to those properties for the three month period ended June 30, 2007 and 2006, in the amount of $2,265 and $1,249,917.
JED paid on behalf of the Company a total of $221,660 and nil for the six month period ended June 30, 2007 and 2006 for operating costs and capital related expenditures. JED also charged the Company $217,109 for payments to JMG’s partners paid by JED, and $4,333 in miscellaneous costs. In consideration for the assignment of JED’s interest in certain oil and gas properties, JED charged the Company for drilling and other costs related to those properties for the six month period ended June 30, 2007 and 2006, in the amount of $53,682 and $1,249,917.
In connection with these transactions the total amount payable to JED was $2,030,717 at June 30, 2007.
Skeehan & Company. Joseph Skeehan, the Chief Executive Officer, President and a director of JMG is also the owner of Skeehan & Company, a professional service corporation that engages in accounting, finance and consulting services to small to mid-sized companies and organizations primarily in Southern California since 1980. In conjunction with the maintenance of accounting records and the preparation of financial statements and regulatory filings, Skeehan & Company was paid a total of $77,489 and $80,527 during the three and six month periods ended June 30, 2007.
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Outlook and Proposed Transactions
As of June 30, 2007, we had an accumulated deficit of $20,077,680 and have insufficient working capital to fund development and exploratory drilling opportunities. We have operating and liquidity concerns due to our significant net losses and negative cash flows from operations. As a result of these and other factors there is substantial doubt about our ability to continue as a going concern. JMG is presently exploring a range of strategic alternatives, including a possible sale or merger with another party.
On April 27, 2007, we entered into a non-binding Letter of Intent with Iris Computers Ltd., a distributor of computer hardware and software in India, regarding a potential business combination. The transaction is subject to a 60 day due diligence period and provides for a No-Shop Period until June 26, 2007, during which period the parties have agreed not to enter into an agreement or consummate a transaction with any other party, which would preclude the consummation of the transaction. The due diligence period and No-Shop period were subsequently extended to August 15, 2007. Although no assurance can be given that the parties can reach agreement and proceed to a closing, if the proposed business combination is completed, the current JMG shareholders, immediately post-closing, would own approximately 37.5% of the combined entities, without giving effect to JMG’s outstanding options and warrants. JMG’s oil and gas assets will not be included in this transaction and will be sold or merged separately for the benefit of shareholders of a future record date.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to all of the normal market risks inherent within the oil and natural gas industry, including commodity price risk, foreign-currency rate risk, interest rate risk and credit risk. We plan to manage our operations in a manner intended to minimize our exposure to such market risks.
Credit Risk. Credit risk is the risk of loss resulting from non-performance of contractual obligations by a customer or joint venture partner. A substantial portion of our accounts receivable are expected to be with customers in the energy industry and are subject to normal industry credit risk. We intend to assess the financial strength of our customers and joint venture partners through regular credit reviews in order to minimize the risk of non-payment.
Market Risk. We are exposed to market risk from changes in currency exchange rates. As JED is based in Canada, we may be adversely affected by changes in the exchange rate between U.S. and Canadian dollars as most of our operating expenses, drilling expenses and general overhead expenses will be billed by JED in Canadian dollars. The price we will receive for oil and natural gas production from operations in Canada, if any, will be based on a benchmark expressed in U.S. dollars, which is the standard for the oil and natural gas industry worldwide. Changes to the exchange rate between U.S. and Canadian dollars can adversely affect us. When the value of the U.S. dollar increases, we will receive higher revenue from any Canadian prospects and when the value of the U.S. dollar declines, we will receive lower revenue from any Canadian prospects on the same amount of production sold at the same prices.
Interest Rate Risk. Interest rate risk will exist principally with respect to any future indebtedness that bears interest at floating rates. At June 30, 2007, we had no long-term indebtedness and do not contemplate utilizing indebtedness as a means of financing our exploration activities.
Item 4T. Controls and Procedures
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the specified time periods. Disclosure controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. As of June 30, 2007, management conducted an assessment of the effectiveness of the
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design and operation of the Company’s disclosure controls. Based on this assessment, management has determined that the Company’s disclosure controls as of June 30, 2007 were ineffective because of the material weakness discussed below.
The required certifications of our principal executive officer and principal financial officer are included as exhibits to this Quarterly Report. The disclosures set forth below contain information concerning the evaluation of our disclosure controls and procedures and changes in internal control over financial reporting referred to in those certifications. Those certifications should be read in conjunction with this section for a more complete understanding of the matters covered by the certifications.
A material weakness is a significant deficiency (within the meaning of Public Company Accounting Oversight Board Auditing Standard No. 2), or combination of significant deficiencies, that results in there being a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
A material weakness was identified during the audit of our December 31, 2006 financial statements and continues to exist. Our current auditors, Hein & Associates LLP, informed us of their concern that there was a lack of personnel with sufficient knowledge of US generally accepted accounting principles and SEC reporting requirements to ensure proper and timely evaluation of the Company’s activities and transactions. To mitigate this weakness, the Company engaged consultants to assist with the preparation of the financial statements and other accounting issues. The Company did not retain outside experts to review its disclosure controls and procedures or its internal controls and consequently, no reports or recommendations regarding our controls were requested or prepared.
By taking remedial actions through the hiring of consultants, management believes that the consolidated financial statements for all periods presented in this Form 10-Q present fairly, in all material respects, our financial condition, results of operations, and cash flows in conformity with U.S. generally accepted accounting principles.
Changes in Internal Control Over Financial Reporting
There was no change in JMG’s internal control over financial reporting during the six month period ended June 30, 2007 that has materially affected, or is reasonably likely to materially affect, JMG’s internal control over financial reporting.
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Part II. Other Information
Item 1. Legal Proceedings
There are no material outstanding or threatened legal claims by or against us.
Item 1A. Risk Factors
There have been no material changes to the information included in response to Item 1A. “Risk Factors” in our 2006 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
(a) Exhibits required by Item 601 of Regulation S-K are as follows:
Exhibit 31.1 — Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended
Exhibit 31.2 — Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended
Exhibit 32.1 — Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 — Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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