UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: February 28, 2014
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _______ to _______
Commission file number: 000-54328
EFLO ENERGY, INC.
(Exact name of registrant as specified in its charter)
Nevada | 26-3062721 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
333 N. Sam Houston Parkway East, Suite 600, Houston, Texas 77060
(Address of principal executive offices)(Zip Code)
Registrant’s telephone number, including area code: (281) 260-1034
(Former name or former address if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
Large accelerated filer | o | Accelerated filer | o |
Non-accelerated filer | o | Smaller reporting company | þ |
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). Yes o No þ
As of April 14, 2014, the registrant had 19,587,540 outstanding shares of common stock.
FORWARD LOOKING STATEMENTS
The information contained in this Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties. Any statement which does not contain a historical fact may be deemed to be a forward-looking statement. In some cases, you can identify forward-looking statements by terminology such as "may", "will", "should", "expect", "plan", "intend", "anticipate", "believe", "estimate", "predict", "potential" or "continue", the negative of such terms or other comparable terminology. In evaluating forward looking statements, you should consider various factors outlined in our latest Form 10-K filed with U.S. Securities Exchange Commission (“SEC”) on November 29, 2013 and, from time to time, in other reports we file with the SEC. These factors may cause our actual results to differ materially from any forward-looking statement. We disclaim any obligation to publicly update these statements, or disclose any difference between our actual results and those reflected in these statements.
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PART 1 – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EFLO ENERGY, INC.
(An Exploration Stage Company)
CONSOLIDATED BALANCE SHEETS
February 28, | August 31, | |||||||
2014 | 2013 | |||||||
(Unaudited) | ||||||||
ASSETS | ||||||||
CURRENT ASSETS | ||||||||
Cash | $ | 927,965 | $ | 476,522 | ||||
Accounts receivable, Joint interest owners and other | 1,272,631 | 912,458 | ||||||
Prepaids | 65,123 | 41,565 | ||||||
Other | 34,742 | 19,429 | ||||||
Total current assets | 2,300,461 | 1,449,974 | ||||||
OIL AND GAS PROPERTIES, full cost method, unproven | 49,522,295 | 48,897,972 | ||||||
OTHER ASSETS - Goodwill | 1,194,365 | 1,194,365 | ||||||
Total assets | $ | 53,017,121 | $ | 51,542,311 | ||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
CURRENT LIABILITIES | ||||||||
Accounts payable and accrued liabilities | $ | 3,665,338 | $ | 3,117,627 | ||||
Asset retirement obligation - current | 80,000 | 80,000 | ||||||
Total current liabilities | 3,745,338 | 3,197,627 | ||||||
NONCURRENT LIABILITIES | ||||||||
Asset retirement obligations | 17,409,792 | 17,066,750 | ||||||
Convertible notes, net of $474,014 of unamortized discount at February 28, 2014 | 1,780,986 | - | ||||||
Deferred income taxes | 2,779,849 | 2,779,849 | ||||||
Total liabilities | 25,715,965 | 23,044,226 | ||||||
STOCKHOLDERS' EQUITY | ||||||||
Capital Stock | ||||||||
Authorized: | ||||||||
10,000,000 preferred shares, par value $0.001 per share | ||||||||
150,000,000 common shares, par value $0.001 per share | ||||||||
Issued and outstanding: | ||||||||
19,587,540 and 19,487,739 common shares at February 28, 2014 and | ||||||||
August 31, 2013, respectively | 19,588 | 19,488 | ||||||
Additional paid-in capital | 30,028,391 | 29,153,194 | ||||||
Accumulated other comprehensive loss | (76,572 | ) | (43,488 | ) | ||||
Accumulated deficit during the exploration stage | (2,670,251 | ) | (631,109 | ) | ||||
Total stockholders' equity | 27,301,156 | 28,498,085 | ||||||
Total liabilities and stockholders' equity | $ | 53,017,121 | $ | 51,542,311 |
The accompanying notes are an integral part of these unaudited consolidated financial statements.
3
(An Exploration Stage Company)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Cumulative results | ||||||||||||||||||||
Three Months Ended | Six Months Ended | from July 22, 2008 to | ||||||||||||||||||
February 28, 2014 | February 28, 2013 | February 28, 2014 | February 28, 2013 | February 28, 2014 | ||||||||||||||||
EXPENSES | ||||||||||||||||||||
Management and director's fees | 218,676 | 288,853 | 432,568 | 562,689 | 2,822,362 | |||||||||||||||
Stock-based compensation expense | 106,440 | 355,723 | 222,419 | 1,050,426 | 2,294,080 | |||||||||||||||
Consulting fees | 86,737 | 150,586 | 244,535 | 815,975 | 2,202,955 | |||||||||||||||
Professional fees | 112,752 | 139,854 | 245,905 | 408,999 | 1,255,815 | |||||||||||||||
Financing fees | - | - | 176,400 | - | 176,400 | |||||||||||||||
Office, travel and general | 145,474 | 118,632 | 237,353 | 261,645 | 1,007,100 | |||||||||||||||
Accretion of asset retirement obligations | 172,374 | 165,648 | 343,042 | 259,816 | 915,550 | |||||||||||||||
Oil and gas property impairment | - | - | - | - | 879,994 | |||||||||||||||
Total Expenses | 842,453 | 1,219,296 | 1,902,222 | 3,359,550 | 11,554,256 | |||||||||||||||
OPERATING LOSS | (842,453 | ) | (1,219,296 | ) | (1,902,222 | ) | (3,359,550 | ) | (11,554,256 | ) | ||||||||||
OTHER INCOME (EXPENSE) | ||||||||||||||||||||
Interest Expense | (101,794 | ) | - | (136,920 | ) | - | (136,920 | ) | ||||||||||||
Gain on acquisition of assets | - | - | - | 11,766,887 | 11,766,787 | |||||||||||||||
Gain on forgiveness of accounts payable | - | - | - | - | 33,987 | |||||||||||||||
NET INCOME (LOSS) before taxes | (944,247 | ) | (1,219,296 | ) | (2,039,142 | ) | 8,407,337 | 109,598 | ||||||||||||
Provision for income tax | - | - | - | (3,164,790 | ) | (2,779,849 | ) | |||||||||||||
NET INCOME (LOSS) | $ | (944,247 | ) | $ | (1,219,296 | ) | $ | (2,039,142 | ) | $ | 5,242,547 | $ | (2,670,251 | ) | ||||||
Foreign currency translation | (39,185 | ) | (42,086 | ) | (33,084 | ) | (32,814 | ) | (76,572 | ) | ||||||||||
COMPREHENSIVE INCOME (LOSS) | $ | (983,432 | ) | $ | (1,261,382 | ) | $ | (2,072,226 | ) | $ | 5,209,733 | $ | (2,746,823 | ) | ||||||
EARNINGS (LOSS) PER SHARE | ||||||||||||||||||||
Basic | $ | (0.05 | ) | $ | (0.06 | ) | $ | (0.10 | ) | $ | 0.28 | |||||||||
Diluted | $ | (0.05 | ) | $ | (0.06 | ) | $ | (0.10 | ) | $ | 0.26 | |||||||||
WEIGHTED AVERAGE SHARES OUTSTANDING | ||||||||||||||||||||
Basic | 19,539,191 | 19,192,249 | 19,513,604 | 18,674,988 | ||||||||||||||||
Diluted | 19,539,191 | 19,192,249 | 19,513,604 | 19,887,518 |
The accompanying notes are an integral part of these unaudited consolidated financial statements.
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EFLO ENERGY, INC.
(An Exploration Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Cumulative results | ||||||||||||
Six Months Ended | from July 22, 2008 to | |||||||||||
February 28, 2014 | February 28, 2013 | February 28, 2014 | ||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||||
Net income (loss) | $ | (2,039,142 | ) | $ | 5,242,547 | $ | (2,670,251 | ) | ||||
Adjustments to reconcile net income (loss) to net cash used in operating activities: | ||||||||||||
Stock-based compensation and fee payments | 236,494 | 1,616,038 | 4,506,406 | |||||||||
Amortization of convertible note discount | 59,790 | - | 59,790 | |||||||||
Unrealized foreign exchange losses | (33,084 | ) | (32,814 | ) | (76,572 | ) | ||||||
Gain on forgiveness of accounts payable | - | - | (33,987 | ) | ||||||||
Gain on acquisition of Nahanni assets | - | (11,766,887 | ) | (11,766,787 | ) | |||||||
Accretion of asset retirement obligations | 343,042 | 259,816 | 915,550 | |||||||||
Oil and gas property impairment | - | - | 879,994 | |||||||||
Deferred income tax provision | - | 3,164,790 | 2,779,849 | |||||||||
Changes in working capital items - | ||||||||||||
Accounts receivable | (360,173 | ) | (556,440 | ) | (1,272,631 | ) | ||||||
Prepaids and other | (38,871 | ) | 76,601 | (99,865 | ) | |||||||
Accounts payable and accrued liabilities | 550,710 | 434,007 | 1,169,020 | |||||||||
Net cash used in operating activities | (1,281,234 | ) | (1,562,342 | ) | (5,609,484 | ) | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||||
Expenditures on oil and gas properties, net | (522,323 | ) | (380,616 | ) | (2,179,505 | ) | ||||||
Acquisition of oil and gas interests | - | (132,600 | ) | (421,895 | ) | |||||||
Net cash used in investing activities | (522,323 | ) | (513,216 | ) | (2,601,400 | ) | ||||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||||
Common stock sold for cash, net of fees | - | 2,177,812 | 6,779,612 | |||||||||
Common stock redeemed for cash | - | - | (100 | ) | ||||||||
Proceeds from notes payable | 2,255,000 | - | 2,809,500 | |||||||||
Repayments of notes payable | - | - | (484,500 | ) | ||||||||
Loans from related parties | - | - | 34,337 | |||||||||
Net cash provided by financing activities | 2,255,000 | 2,177,812 | 9,138,849 | |||||||||
INCREASE IN CASH | 451,443 | 102,254 | 927,965 | |||||||||
CASH, BEGINNING OF PERIOD | 476,522 | 2,206,347 | - | |||||||||
CASH, END OF PERIOD | $ | 927,965 | $ | 2,308,601 | $ | 927,965 | ||||||
SUPPLEMENTAL DISCLOSURE: | ||||||||||||
Cash paid for interest | $ | - | $ | - | $ | - | ||||||
Cash paid for income taxes | $ | - | $ | - | $ | - | ||||||
Forgiveness of debt | $ | - | $ | - | $ | 9,337 | ||||||
NON-CASH INVESTING ACTIVITIES: | ||||||||||||
Accrued expenditures on oil and gas properties | $ | 102,000 | $ | - | $ | 448,406 | ||||||
Asset retirement obligation incurred | $ | - | $ | - | $ | 80,000 | ||||||
Asset retirement obligation acquired in Devon Acquisition | $ | - | $ | - | $ | 7,057,716 | ||||||
Asset retirement obligation acquired in Nahanni acquisition | $ | - | $ | 9,436,526 | $ | 9,436,526 | ||||||
NON-CASH FINANCING ACTIVITIES | ||||||||||||
Common stock issued as repayment of note payable | $ | - | $ | - | $ | 95,000 | ||||||
Common stock issued for services | $ | 105,000 | $ | 70,000 | $ | 2,038,831 | ||||||
Common stock issued for Devon assets | $ | - | $ | - | $ | 15,950,000 | ||||||
Exchangeable shares granted for Nahanni assets | $ | - | $ | 4,190,643 | $ | 4,190,643 | ||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
5
EFLO ENERGY, INC.
(An Exploration Stage Company)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
Unaudited Interim Consolidated Financial Statements
The unaudited interim consolidated financial statements of EFLO Energy, Inc. (the “Company”), have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). They do not include all information and footnotes required by GAAP for complete financial statements. However, except as disclosed herein, there have been no material changes in the information disclosed in the notes to the consolidated financial statements for the year ended August 31, 2013 included in the Company’s Annual Report on Form 10-K filed with the SEC. The unaudited interim consolidated financial statements should be read in conjunction with those consolidated financial statements included in the Form 10-K. In the opinion of management, all adjustments considered necessary for fair presentation have been made. Operating results for the three and six month period ended February 28, 2014 are not necessarily indicative of the results that may be expected for the year ending August 31, 2014.
Recent Accounting Pronouncements
The Company has reviewed recently issued accounting pronouncements and plans to adopt those that are applicable to it. It does not expect the adoption of these pronouncements to have a material impact on its financial position, results of operations or cash flows.
2. OIL AND GAS PROPERTIES
Oil and Gas Acquisition – Kotaneelee Gas Project (the “KGP”)
On October 17, 2012, the Company completed a Share Purchase Agreement (the “Purchase Agreement”) with Nahanni Energy Inc., 1700665 Alberta Ltd., Apex Energy (2000), Inc. and Canada Southern Petroleum #1 L.P. (jointly “Nahanni”) for the acquisition of its entire right and interest (generally a working interest of 30.664%) in the KGP (the “Nahanni Assets”).
The KGP covers 30,542 gross acres in the Yukon Territory in Canada, and includes; a gas dehydration plant (capacity: 70 million cubic feet per day), one shut in gas well, one water disposal well (capacity: 6,000 barrels per day), and two suspended gas wells. The KGP has a fully developed gas gathering, sales and delivery infrastructure, airstrip, roads, flarestack, storage tanks, barge dock and permanent camp facilities.
As consideration for the Nahanni Assets, the Company paid Nahanni approximately $13,761,000. The consideration was comprised of approximately $133,000 in cash ($398,550 offset by $265,950 paid in connection with the acquisition of the Devon Assets in settlement of certain Nahanni indebtedness), 1,614,767 shares of one of the Company’s subsidiaries, which are exchangeable for 1,614,767 shares of the Company’s restricted common stock valued at approximately $4,191,000, and the absorption of approximately $9,437,000 in asset retirement obligations. The number of shares issued by the Company’s subsidiary was calculated by dividing the fair value of the exchangeable shares by the volume weighted average trading price of the Company’s stock for the ten (10) trading days prior to closing the Purchase Agreement. The fair value of the exchangeable shares has been recorded as additional paid in capital in the Company’s equity. The exchangeable shares enjoy no voting or revenue participation rights in the subsidiary.
On July 18, 2012, the Company completed an acquisition of Devon Canada’s (“Devon”) entire right and interest (generally a working interest of 22.989%, with a working interest of 69.337% in one shut in gas well) in the KGP. As consideration for Devon’s working interest in the KGP, (the “Devon Assets”), the Company paid approximately $23,298,000. The consideration was comprised of $290,000 in cash, 7,250,000 shares of the Company’s restricted common stock valued at $15,950,000, and the absorption of $7,058,000 in asset retirement obligations.
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As a result of its purchase of the Nahanni Assets and Devon Assets, the Company now generally owns a 53.65% working interest in the KGP, including a 100% working interest in one shut in gas well.
The Company is pursuing the acquisition of additional working interests in the KGP.
The Company records assets acquired and liabilities assumed at their estimated acquisition date fair values, while transaction and integration costs associated with the acquisitions are expensed as incurred. The Company uses relevant market assumptions to determine fair value and allocate purchase price, such as future commodity pricing for purchased hydrocarbons, market multiples for similar transactions and replacement value for certain equipment. Many of the assumptions are unobservable. The Company’s preliminary assessment of the fair value of the Nahanni Assets resulted in a valuation of $25,526,554. As a result of incorporating this information into the purchase price allocation, a gain on bargain purchase of $11,766,787 was recognized in the accompanying consolidated statement of operations. The gain on bargain purchase was primarily attributable to the strategic nature of the divestiture by the motivated seller, coupled with a confluence of certain favorable economic trends in the industry and the geographic region in which the Nahanni Assets are located.
The Company allocated the consideration paid for the Nahanni Assets and Devon assets based upon its assessment of their fair value at the dates of purchase, as follows:
Fair Value of Assets Acquired | ||||||||||||
Nahanni Assets | Devon Assets | Total | ||||||||||
Asset Description | ||||||||||||
Unproven Properties | ||||||||||||
Unproved leasehold costs | $ | 14,548,787 | $ | 13,827,001 | $ | 28,375,788 | ||||||
Plant and equipment | 8,594,362 | 6,484,001 | 15,078,363 | |||||||||
Gathering systems | 2,383,405 | 1,788,001 | 4,171,406 | |||||||||
Vehicles | – | 4,527 | 4,527 | |||||||||
25,526,554 | 22,103,530 | 47,630,084 | ||||||||||
Goodwill | – | 1,194,365 | 1,194,365 | |||||||||
Total Assets Acquired - KGP | $ | 25,526,554 | $ | 23,297,895 | $ | 48,824,449 |
Oil and natural gas revenues and lease operating expenses related to unproved oil and gas properties that are being evaluated for economic viability are offset against the full cost pool until proved reserves are established, or determination is made that the unproved properties are impaired. During the three and six month periods ended February 28, 2014, the Company capitalized $311,657 and $548,495, respectively of lease operating expense, net of oil and gas revenue, into the full cost pool related to its unproven interests.
3. ASSET RETIREMENT OBLIGATIONS
In connection with its acquisition of the Nahanni Assets and the Devon Assets, the Company acquired $9,436,526 and $7,057,716 in asset retirement obligations, respectively, relating with its portion of the abandonment, reclamation and environmental liabilities associated with the KGP.
On March 31, 2011, the Company initiated oil and gas operations by entry into a Farmout and Participation Agreement which provided for its acquisition of a net working interest ranging from 21.25% to 42.5%, in a 2,629 acre oil and gas lease, insofar as that lease covers from the surface to the base of the San Miguel formation (the “San Miguel Lease”). The San Miguel Lease, which is located in Zavala County, Texas, is unproven and has no current production. The Company recorded $80,000 in asset retirement obligations related to the future plugging and abandonment of a test well on the San Miguel Lease. At February 28, 2014, the Company’s interest in the San Miguel lease was impaired and expensed to the extent of its carrying value, which included the full amount of the associated asset retirement obligation. The entire asset retirement obligation relating to the San Miguel Lease has been classified as a current liability.
The Company has no assets that are legally restricted for purposes of settling asset retirement obligations. As part of the Company’s acquisition of the Devon Assets, it provided Devon a corporate guarantee (the “Guarantee”) in the amount of CAD$10,000,000 (USD$9,439,000) and delivered a letter of credit in the amount of CAD$4,380,000 (USD$4,134,000) to Devon (the “Devon LOC”). The Company also delivered a letter of credit in the amount of CAD$625,000 (USD$590,000) to the government of the Yukon Territory (the “Yukon LOC”). The amounts of the Devon LOC and Yukon LOC reduce the amount of the Guarantee on a dollar-for-dollar basis. The Company is primarily responsible for payment of all asset retirement obligations. The Guarantee, Devon LOC and Yukon LOC are only available to Devon in the event the Company defaults upon its asset retirement obligations relating to the Devon Assets.
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The following table summarizes amounts comprising the Company’s asset retirement obligations as of February 28, 2014:
Asset Retirement Obligations | ||||
Balance, August 31, 2012 | $ | 7,137,716 | ||
Liabilities incurred (acquired) | 9,436,526 | |||
Accretion expense | 572,508 | |||
Liabilities (settled) | –– | |||
Changes in asset retirement obligations | –– | |||
Balance, August 31, 2013 | 17,146,750 | |||
Liabilities incurred (acquired) | –– | |||
Accretion expense | 343,042 | |||
Liabilities (settled) | –– | |||
Changes in asset retirement obligations | –– | |||
Total Balance, February 28, 2014 | $ | 17,489,792 | ||
Total Balance, February 28, 2014 – Current | $ | 80,000 | ||
Total Balance, February 28, 2014 – Long Term | $ | 17,409,792 |
4. CONVERTIBLE NOTES PAYABLE
On October 30, 2013 the Company sold convertible notes having an aggregate principal amount of $2,255,000 (the “Convertible Notes”), to 22 accredited investors, under the following general terms (the "Convertible Note Offering"):
A. | The maturity date of the Convertible Notes is eighteen months from the date of issuance (April 30, 2015). |
B. | The principal amount of the Convertible Notes is convertible into shares of the Company’s common stock at a price of $1.00 per share. |
C. | The Convertible Notes bear interest at 10% per annum payable, at the Company’s election, in cash or shares of its common stock at a rate of $1.25 per share. |
D. | The interest rate payable on the Convertible Notes will escalation to 12.5% or 15.0% per annum for the entire period during which the Convertible Notes are outstanding, in the event the Company does not complete its migration to a senior stock exchange within 9 or 12 months, respectively, from date of issuance. |
E. | The Company also issued stock purchase warrants in connection with the Convertible Note Offering providing for the purchase of up to 1,127,500 shares of its common stock (1 full share for each $2.00 invested in the Convertible Notes”) at an exercise price of $1.25 per share for a period of three years (the "Stock Purchase Warrants”). |
The Company applied the Black-Scholes option pricing model to determine the fair market value of the stock purchase warrants issued in connection with the Convertible Note Offering. In applying the model, the Company used the following parameters: contractual lives of 3 years, historical stock price volatility of 73%, a risk-free rate of 4.5% and an annual dividend rate of 0%. As a result, the Company determined that the total fair market value of the stock purchase warrants was $533,803, and that amount was recognized as a discount against the principal of Convertible Notes. During the three and six month periods ended February 28, 2014, $15,306 and $59,790, respectively, of the Convertible Note discount was amortized to interest expense. At February 28, 2014, the principal balance on the Convertible Notes, net of discount was $1,780,986, all of which is considered long term.
During the six months ended February 28, 2014, the Company also paid $176,400 in finder’s fees and recognized $75,773 in interest expense relating to the Convertible Notes. During the three months ended February 28, 2014, the Company recognized $56,374 in interest expense relating to the Convertible Notes.
8
5. CAPITAL STOCK AND STOCK-BASED COMPENSATION
Sales of Common Stock
During the three and six months ended February 28, 2014 fees totaling $52,500 and $105,000, were paid using 48,892 and 99,801 shares of the Company’s restricted common stock, at a weighted average prices of $1.074 and $1.052 per share, respectively.
During the three and six months ended February 28, 2013, fees totaling $37,500 and $70,000 were paid using 33,411 and 20,596 shares of the Company’s restricted common stock at a weighted average price of $2.10 and $1.82 per share, respectively.
Sale of Convertible Notes
On October 30, 2013 the Company sold Convertible Notes having an aggregate principal amount of $2,255,000. The Company also issued stock purchase warrants in connection with the Convertible Note Offering providing for the purchase of up to 1,127,500 shares of its common stock (1 full share for each $2.00 invested in the Convertible Notes”) at an exercise price of $1.25 per share for a period of three years (see Note 4).
In aggregate, 3,382,500 shares of the Company’s common stock (comprised of 2,255,000 shares issuable on conversion of the principal of the Convertible Notes and 1,127,500 shares issuable on exercise of the Stock Purchase Warrants), or such greater number of shares as may be issuable upon election of the interest repayment in common stock under the terms of the Convertible Notes, have been reserved for issuance upon conversion of the Convertible Notes or exercise of the Stock Purchase Warrants in accordance with their terms.
The Company paid $176,400 in finder’s fees in connection with the Convertible Note Offering.
Stock-Based Compensation
During the three and six months ended February 28, 2014, the Company recognized $113,477 and $236,494, respectively, of non-cash expense related to stock-based compensation under its 2012 Non-Qualified Stock Option Plan (the “Option Plan”). As of February 28, 2014, $247,412 of total unrecognized compensation cost remains under the Option Plan. Of this amount, $200,614 and $46,798 are expected to be recognized during fiscal 2014, and fiscal 2015, respectively.
During the three and six months ended February 28, 2013, the Company recognized $193,947 and $468,632 respectively, of non-cash expense related to stock-based compensation under the Option Plan. On January 15, 2013, the Company also authorized the issuance of 50,000 bonus shares of its common stock to its new Chief Operating Officer pursuant to the 2012 Stock Bonus Plan. The fair market value of these bonus shares was $97,000 or $1.94 per share at that date. Stock-based compensation recognized during the six months ended February 28, 2013 also includes $516,919 earned by a company controlled by the Company’s Chief Executive Officer, and its Chief Financial Officer, under the terms of the Finders Fees Agreement (see Note 6).
6. RELATED PARTY TRANSACTIONS
Effective January 20, 2011, a company controlled by the Company’s Chief Executive Officer, its Chief Financial Officer, and an unrelated consultant (the “Finders”) entered into an agreement with the Company providing for the payment of finder’s compensation ranging from 5% (on transaction values greater than $1,000,000) to 10% (on transactions valued up to $300,000) on transactions introduced to the Company by or through the Finders for a period of two years (the “Finder’s Fee Agreement”). Under the Finder’s Fee Agreement, compensation is divided between the Finders and the Finders may elect whether the finder’s compensation is payable in cash, or shares of the Company’s restricted common stock. If the Finders elect to receive payment in stock, the shares into which finder’s compensation will be converted will be calculated using the average closing price of the Company’s common stock for the ten trading days preceding the closing date of the transaction to which the compensation relates. The Finder’s Fee Agreement specifically recognizes that the KGP has been presented to the Company by the Finders. During the six months ended February 28, 2013, finder’s compensation of $755,399 was accrued under the Finder’s Fee Agreement in connection with the Company’s acquisition of the Nahanni Assets. No such fees were incurred during six months ended February 28, 2014.
Effective September 1, 2013, the Company executed an administrative services agreement with its largest shareholder, Holloman Corporation. Under this agreement, fees of $5,000 per month are payable to Holloman Corporation covering; office and meeting space, supplies, utilities, office equipment, network access and other administrative facilities costs. These fees are payable quarterly in shares of the Company’s restricted common stock at the closing price of the stock on the last trading-day of the applicable monthly billing period. This administrative services agreement can be terminated by either party with 30-day notice. Proceeds from this administrative service agreement have been assigned to a wholly owned subsidiary of Holloman Corporation.
Of the fees paid in stock during the three and six month periods ended February 28, 2014 (see Note 5) consulting fees in the amount of $30,000 and $60,000, respectively, were earned by an entity controlled by the Company’s Chief Executive Officer, and fees in the amounts of $15,000 and $30,000, respectively, were paid to a subsidiary of the Company’s largest shareholder under the terms an administrative services agreement.
Of the fees paid in stock during the three and six month periods ended February 28, 2013, consulting fees in the amounts of $30,000 and $60,000, respectively, were earned by an entity controlled by the Company’s Chief Executive Officer.
The Company’s Chief Executive Officer and President purchased $50,000 in Convertible Notes (25,000 Stock Purchase Warrants) and $150,000 in Convertible Notes (75,000 Stock Purchase Warrants), respectively, in the Convertible Note Offering (See Note 4).
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
EFLO Energy, Inc. (formerly, EFL Overseas, Inc.) is an exploration stage company incorporated in the State of Nevada on July 22, 2008. We are engaged in the acquisition, exploration and development of oil and gas properties in the United States and Canada.
During the period from July 18, 2012 through October 17, 2012, we acquired working interests totaling 53.65% (including a 100% working interest in one shut in gas well) in the Kotaneelee Gas Project (“KGP”) located in the Yukon Territory in Canada. We believe the KGP has significant conventional and shale gas potential and is supported by an environment of growing investment in gas processing and export in the Pacific Northwest.
Our acquisition of an initial working interest of 22.989% (including a 69.337% working interest in one shut in gas well) in the KGP was completed on July 18, 2012, with an effective date of July 1, 2012. Since that date, we have been responsible for the operations of the KGP. Prior to this initial working interest acquisition in the KGP, we had generated no revenues and had no proven reserves. Following our acquisition of the KGP we have generated limited revenue which reduced the unamortized cost pool related to our unproven interests while their economic viability is being evaluated.
During March 2011, we initiated oil and gas operations by entry into the Eagleford Agreement which provided for our acquisition of a net working interest, ranging from 21.25% to 42.5%, in a 2,629 acre oil and gas lease, insofar as that lease covers from the surface to the base of the San Miguel formation (the “San Miguel Lease”). The San Miguel Lease is located in Zavala County, Texas, and has no current production or proven reserves.
The Kotaneelee Gas Project (“KGP”) – Yukon Territory, Canada
Working Interest Acquisitions
On October 17, 2012, we completed a Share Purchase Agreement (the “Purchase Agreement”) with Nahanni Energy Inc., 1700665 Alberta Ltd., Apex Energy (2000), Inc. and Canada Southern Petroleum #1 L.P. (jointly “Nahanni”) for the acquisition of its entire right and interest (generally a working interest of 30.664%) in the KGP (the “Nahanni Assets”).
The KGP covers 30,542 gross acres in the Yukon Territory in Canada, and includes; a gas dehydration plant (capacity: 70 million cubic feet per day), one shut in gas well, one water disposal well (capacity: 6,000 barrels per day), and two suspended gas wells. The KGP has a fully developed gas gathering, sales and delivery infrastructure, airstrip, roads, flarestack, storage tanks, barge dock and permanent camp facilities.
As consideration for the Nahanni Assets, we paid Nahanni approximately $13,761,000. The consideration was comprised of approximately $133,000 in cash ($398,550 offset by $265,950 paid in connection with the acquisition of the Devon Assets in settlement of certain Nahanni indebtedness), 1,614,767 shares of one of our subsidiaries, which are exchangeable, under certain terms and circumstances, for 1,614,767 shares of our restricted common stock valued at approximately $4,191,000, and the absorption of approximately $9,437,000 in asset retirement obligations. The number of shares issued by our subsidiary was calculated by dividing the fair value of the exchangeable shares by the volume weighted average trading price of our stock for the ten (10) trading days prior to closing the Purchase Agreement. Both the cash paid and stock issued for the Nahanni Assets are subject to certain holdbacks for asset related liabilities or breach of representations and warranties.
On July 18, 2012, we completed an acquisition of Devon Canada’s (“Devon”) entire right and interest (generally a working interest of 22.989%, with a working interest of 69.337% in one shut in gas well) in the KGP. As consideration for Devon’s working interest in the KGP, (the “Devon Assets”), we paid approximately $23,298,000. The consideration was comprised of $290,000 in cash, 7,250,000 shares of our restricted common stock valued at $15,950,000, and the absorption of approximately $7,058,000 in asset retirement obligations.
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As a result of our purchase of the Nahanni Assets and Devon Assets, we now generally own a 53.65% interest in the KGP, including a 100% interest in one gas well which has been shut in while economic viability is being evaluated.
We are also pursuing the acquisition of additional working interests in the KGP.
We record assets acquired and liabilities assumed at their estimated acquisition date fair values, while transaction and integration costs associated with the acquisitions are expensed as incurred. We use relevant market assumptions to determine fair value and allocate purchase price, such as market multiples for similar transactions and replacement value for certain equipment. Many of the assumptions are unobservable. Our preliminary assessment of the fair value of the Nahanni Assets and the Devon Assets resulted in a valuation of $25,526,554 and $22,103,530, respectively. As a result of our purchase price allocation, a gain on bargain purchase of $11,766,787 was recognized on the Nahanni Assets. The gain on bargain purchase was primarily attributable to the strategic nature of the divestiture by the motivated seller, coupled with a confluence of certain favorable economic trends in the industry and the geographic region in which the Nahanni Assets are located. The excess of the consideration paid over the estimated fair value of the Devon Assets was $1,194,365. This amount has been recognized as goodwill.
Fair Value of Assets Acquired | ||||||||||||
Nahanni Assets | Devon Assets | Total | ||||||||||
Asset Description | ||||||||||||
Unproven Properties | ||||||||||||
Unproved leasehold costs | $ | 14,548,787 | $ | 13,827,001 | $ | 28,375,788 | ||||||
Plant and equipment | 8,594,362 | 6,484,001 | 15,078,363 | |||||||||
Gathering systems | 2,383,405 | 1,788,001 | 4,171,406 | |||||||||
Vehicles | – | 4,527 | 4,527 | |||||||||
25,526,554 | 22,103,530 | 47,630,084 | ||||||||||
Goodwill | – | 1,194,365 | 1,194,365 | |||||||||
Total Assets Acquired - KGP | $ | 25,526,554 | $ | 23,297,895 | $ | 48,824,449 |
Our proven oil and gas properties have been reclassified as unproven.
Future Development and Exploration
Our long term exploration plan for the KGP involves the exploitation of both conventional and unconventional (shale) gas resources. Phase one of that plan includes the rework or recompletion of up to three wells, and the drilling, completion and equipping of up to two new wells. These efforts will focus on previously identified or tested conventional gas zones. During phase one, we intend to explore lower cost development and exploration targets with the potential to create positive cash flows and long term sustainability for the KGP. During this period we also plan to carry out feasibility studies to investigate the potential of developing a modular LNG scheme to supply LNG to the Yukon and other areas of northwestern Canada. Early estimates indicate the cost of phase one may range from $20,000,000 to $25,000,000 on a net basis. We expect that approximately $10,000,000 to 15,000,000 in costs associated with phase one exploration to be incurred during the twelve month period ending April 15, 2015.
Phases two and three of our exploration plan anticipate further development of conventional reservoirs and testing and development of shale resources.
Financial Condition and Results of Operations
KGP
Oil and natural gas revenues and lease operating expenses related to unproved oil and gas properties that are being evaluated for commercial viability are offset against the unamortized cost pool until proved reserves are established, or determination is made that the unproved properties are impaired. During the three and six month periods ended February 28, 2014, we offset $311,657 and $548,495, respectively of lease operating expense, net of oil and gas revenue, into the full cost pool related to our unproven interests. During the three and six month periods ended February 28, 2013, we offset $235,522 and $380,616, respectively, of oil and gas revenue, net of lease operating expense, into the full cost pool related to our unproven interests.
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The San Miguel Lease
Under the Eagleford Agreement, to earn our initial 21.25% working interest (net revenue interest 15.94%), we were obligated to drill and complete a vertical Test Well in the San Miguel shale formation. We were also obligated to perform an injection operation on the Test Well. If the Test Well was prospective for production in commercial quantities, we were required to equip the Test Well and place it on production. If we determined that the Test Well is not prospective for production in commercial quantities, we were responsible for the abandonment of the Test Well.
During April and May 2011, we drilled and completed the Test Well, performed injection operations and earned our initial interest in the San Miguel Lease. The Test Well was drilled into the San Miguel heavy oil zone to a depth of 3,168 feet. The well encountered oil and was completed as a producer. After completion, it was determined that the oil was subject to significant viscosity changes related to temperature reductions from formation to recovery at surface. The Test Well was stimulated with nitrified hydrochloric acid and placed on production. To date, however, oil viscosity has prohibited economic operation. We have no current plans to spend the funds necessary to earn an additional interest in the San Miguel Lease. In the event we are unable to substantially improve production, we intend to abandon the Test Well, or actively pursue the sale of our interest in the San Miguel Lease.
As a result of the application of the full cost pool "ceiling test", we determined that the book value of the San Miguel Lease was impaired to the extent of its carrying value. Accordingly, during the years ended August 31, 2012 and 2011, we recognized losses on the impairment of oil and gas assets of $44,335 and $835,659, respectively. The carrying value of oil and gas properties was likewise reduced to reflect the impairment of the Lease. We have made no additional expenditures on the San Miguel Lease since November 30, 2011.
Other
The excess of the estimated fair value of the Nahanni Assets over the consideration paid was $11,766,787. This amount has been recognized as a gain on the acquisition of assets during the six months ended February 28, 2013. The tax impact of $3,164,790 relating to this gain has been recorded as a deferred tax obligation during the same period. The excess of the consideration paid over the estimated fair value of the Devon Assets was $1,194,365. This amount has been recognized as goodwill during fiscal 2012.
Our operating loss for the three and six month periods ended February 28, 2014, decreased by approximately $275,000 or 23% (from $1,219,296 to $901,821) and $1,457,000 or 42% (from $3,359,550 to $1,902,222), respectively, when compared to the three and six month periods ended February 28, 2013. These decreased losses resulted from materially lower costs incurred in a number of categories, including:
1. | Decreases of approximately $70,000 or 24% (from $288,853 to $218,676) and $130,000 or 23% (from $562,689 to $432,568) in management and directors fees relating, in largest part, to our discontinuation of directors’ fees effective September 1, 2013, partially offset by an increase in fees payable to our Chief Operating Officer; |
2. | Decreases of approximately $249,000 or 70% (from $355,723 to $106,440) and $828,000 or 79% (from $1,050,426 to $222,419), respectively, in stock based compensation. For the comparative three month periods, the decrease consisted primarily of: a $145,000 decrease in expense relating to our 2012 Stock Option Plan and a $97,000 decrease in expense relating to our 2012 Stock Bonus Plan. For the comparative six month periods, the decrease consisted primarily of: a $213,000 decrease in expense relating to our 2012 Stock Option Plan, a $97,000 decrease in expense relating to our 2012 Stock Bonus Plan, and a decrease of $259,000 (100,583 shares) payable to our Chief Executive Officer, and $259,000 (100,553 shares) payable to our Chief Financial Officer, during fiscal 2013 in connection with our acquisition of the KGP. |
3. | Decreases of approximately $64,000 or 42% (from $150,586 to $86,737) and $571,000 or 70% (from $815,975 to $244,535), respectively, in consulting fees. For the comparative three month periods, the decrease related primarily to a reduction in fees expensed in connection with our acquisition of the KGP. For the comparative six month periods, the decrease consisted primarily of: a $230,100 decrease in payables in connection with investor relations services (payable to a consultant in 90,000 shares of our restricted common stock), and a $259,000 decrease in finder’s fees incurred in connection with the acquisition of the KGP during fiscal 2013 (payable to a consultant in 100,553 shares of our restricted common stock). |
4. | A decrease of approximately $163,000 or 40% (from $408,999 to $245,905), in professional fees incurred during the six month period ended February 28, 2014 which resulted from lower current period regulatory compliance and legal fees associated with asset acquisitions. |
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We did, however, incur current period increases in certain categories of expense including:
1. | An increase of $176,400 during the six months ended February 28, 2014 in financing costs consisting entirely of finders’ fees incurred in connection with our Convertible Note financing completed on October 30, 2013. Finders’ fees incurred in fundraising during the six month period ended February 28, 2013 related to private placements of our common stock and were recognized as reductions in paid in capital; |
2. | Increases in interest expense of $101,794 and $136,920, respectively, for the three and six month periods ended February 28, 2014 incurred almost entirely in connection with our Convertible Note financing completed on October 30, 2013. |
3. | An increase of approximately $83,000 or 32% (from $259,816 to $343,042) in accretion of asset retirement obligations generated during the six months ended February 28, 2014 resulting from a full, rather that partial, period’s accretion during that period. |
During the period from September 2012 through February 2014 fuel gas has been used from the Spectra pipeline system in order to maintain operations at the Kotaneelee site. This fuel gas was to be delivered back into the Spectra pipeline once production was re-established. In March 2014, we agreed to purchase the required monthly fuel gas from Spectra (approximately 10,075 GJs) at current spot price for cash each month until production commences from the Kotaneelee field. After production in the field comes back on line, the historical volume of gas used for fuel from September 2012 through February 2014 will be returned to Spectra in kind (approximately 174,000 GJs at an estimated net cost to us of approximately $575,000).
We have initiated cost savings measures, including the termination of directors fees effective September 1, 2013, and intend to decrease our administrative costs further during the upcoming fiscal quarter.
Liquidity and Capital Resources
The oil and gas industry is cyclical in nature and tends to reflect general economic conditions. The pattern of historic fluctuations in gas prices has resulted in additional uncertainty in capital markets. Our access to capital, as well as that of our partners and contractors, has been limited due to lower gas prices and tightened credit markets. These limitations may inhibit the size, and timing of exploration ventures.
We plan to generate profits by drilling productive gas wells or improving the production of existing wells. We will, however, need to raise the funds we require through the sale of our securities, from loans from third parties or by joint venturing operations with industry partners which will pay a portion of the costs required to explore for gas in the area covered by our leases. Any wells which we may drill may not produce gas in commercial quantities. We will report losses from our operations until such time, if ever, that we begin to generate significant revenue from gas sales.
We intend to migrate the trading of our common stock to a senior stock exchange. If successful, we believe those efforts could result in higher liquidity, enhanced potential for capital formation, and a more orderly market for our shares.
To secure our indemnity of the asset retirement obligations associated with the Devon Assets, we provided Devon a corporate guarantee (the “Guarantee”) in the amount of CAD$10,000,000 (USD$10,981,000) and delivered a letter of credit in the amount of CAD$4,380,000 (USD$4,809,000) to Devon (the “Devon LOC”). We also delivered a letter of credit in the amount of CAD$625,000 (USD$686,000) to the government of the Yukon Territory (the “Yukon LOC”). The amounts of the Devon LOC and Yukon LOC reduce the amount of the Guarantee on a dollar-for-dollar basis. We intend to actively develop and explore the KGP which will defer potential abandonment and reclamation liabilities into the longer term.
The Guarantee was provided to Devon by our largest shareholder, Holloman Corporation, in exchange for 3,250,000 shares of our restricted common stock. The Devon LOC was provided to Devon by Pacific LNG Operations Ltd. (“PLNG”). PLNG also provided the Yukon LOC. In exchange for the Devon LOC and Yukon LOC we issued PLNG 4,000,000 shares of our restricted common stock. Our directors, James Ebeling and Eric Prim are officers of Holloman Corporation, and Henry Aldorf, the Chairman of our Board of Directors, is a director of PLNG.
We anticipate that our acquisition of the KGP will generate significant capital requirements. During the twelve month period ending January 15, 2015, early estimates indicate that investment in the KGP, including operating costs, the acquisition of additional working interests, and phase one exploration costs may range from $10,000,000 to $15,000,000. We are attempting to raise the capital needed to implement our business plan.
Effective September 1, 2013, we executed an administrative services agreement with our largest shareholder, Holloman Corporation. Under this agreement, fees of $5,000 per month are payable to Holloman Corporation covering; office and meeting space, supplies, utilities, office equipment, network access and other administrative facilities costs. These fees are payable quarterly in shares of our restricted common stock at the closing price of the stock on the last trading-day of the applicable monthly billing period. This administrative services agreement can be terminated by either party with 30-day notice. Proceeds from this administrative service agreement have been assigned to a wholly owned subsidiary of Holloman Corporation.
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Effective January 20, 2011, a company controlled by our Chief Executive Officer, our Chief Financial Officer, and an unrelated consultant (the “Finders”) entered into an agreement with us providing for the payment of finder’s compensation ranging from 5% (on transaction values greater than $1,000,000) to 10% (on transactions valued up to $300,000) on transactions introduced to us by or through the Finders for a period of two years (the “Finder’s Fee Agreement”). Under the Finder’s Fee Agreement, compensation is divided between the Finders and the Finders may elect whether the finder’s compensation is payable in cash, or shares of our restricted common stock. If the Finders elect to receive payment in stock, the shares into which finder’s compensation will be converted will be calculated using the average closing price of our common stock for the ten trading days preceding the closing date of the transaction to which the compensation relates. The Finder’s Fee Agreement specifically recognizes that the KGP has been presented to us by the Finders. As of February 28, 2014, finder’s compensation of $1,599,682 has been accrued under the Finder’s Fee Agreement in connection with our acquisition of the Devon Assets and the Nahanni Assets.
Other than the obligations associated with the acquisition and exploration of our oil and gas leases disclosed elsewhere in this report, our only material future contractual obligation as of February 28, 2014 consisted of convertible notes having an aggregate principal amount of $2,255,000 (the “Convertible Notes”), sold on October 30, 2013 to 22 accredited investors under the following general terms (the "Convertible Note Offering"):
a) | The maturity date of the Convertible Notes is eighteen months from the date of issuance (April 30, 2015). |
b) | The principal amount of the Convertible Notes is convertible into shares of our common stock at a price of $1.00 per share. |
c) | The Convertible Notes bear interest at 10% per annum payable, at our election, in cash or shares of our common stock at a rate of $1.25 per share. |
d) | The interest rate payable on the Convertible Notes will escalate to 12.5% or to 15.0% per annum for the entire period during which the Convertible Notes are outstanding, in the event we do not complete our migration to a senior stock exchange within 9 or 12 months, respectively, from date of issuance. |
e) | We also issued stock purchase warrants in connection with the Convertible Note Offering providing for the purchase of up to 1,127,500 shares of our common stock (1 full share for each $2.00 invested in the Convertible Notes”) at an exercise price of $1.25 per share for a period of three years (the "Stock Purchase Warrants”). |
We anticipate that we will complete a dual listing of our common stock on a senior stock exchange within the period allotted by the Convertible Notes and that no escalation of the interest rate payable on the Convertible Notes will be incurred.
Our Chief Executive Officer and President purchased $50,000 in Convertible Notes (25,000 Stock Purchase Warrants) and $150,000 in Convertible Notes (75,000 Stock Purchase Warrants), respectively, in the Convertible Note Offering.
In aggregate, 3,382,500 shares of our common stock (comprised of 2,255,000 shares issuable on conversion of the principal of the Convertible Notes and 1,127,500 shares issuable on exercise of the Stock Purchase Warrants), or such greater number of shares as may be issuable upon election of the interest repayment in common stock under the terms of the Convertible Notes, have been reserved for issuance upon conversion of the Convertible Notes or exercise of the Stock Purchase Warrants in accordance with their terms.
During the period from June 2012 through February 2013, we sold 4,405,667 shares of our common stock to twenty eight accredited investors at a price of $1.20 per share. Gross proceeds from these private placements totaled $5,286,800. We paid $164,038 in finder’s fees in connection with the sale of these shares.
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We believe our plan of operation, exclusive of costs associated with the KGP or other acquired assets, will require from $1,500,000 to $2,000,000 in financing over the twelve-month period ending April 15, 2015 to cover general, administrative, and other costs.
If we are unable to raise the financing we need, our business plan may fail and our stockholders could lose their investment. There can be no assurance that we will be successful in raising the capital we require, or that if the capital is offered, it will be subject to terms we consider acceptable. Investors should be aware that even if we are able to raise the funds we require, there can be no assurance that we will succeed in our acquisition, exploration or production plans and we may never be profitable.
As of April 14, 2014, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, results of operations, liquidity or capital resources.
Critical Accounting Policies and Estimates
Measurement Uncertainty
The preparation of consolidated financial statements in conformity with US GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We regularly evaluate estimates and assumptions. We base our estimates and assumptions on current facts, historical experience and various other factors we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected. The most significant estimates with regard to our consolidated financial statements relate to carrying values of oil and gas properties, asset retirement obligations, the valuation of goodwill, determination of fair values of stock-based transactions, deferred income tax rates, and environmental risks and exposures.
Petroleum and Natural Gas Properties
We utilize the full cost method to account for our investment in oil and gas properties. Accordingly, all costs associated with acquisition, exploration and development of oil and gas reserves, including such costs as leasehold acquisition costs relating to unproved properties, geological expenditures, tangible and intangible development costs including direct internal costs are capitalized to the full cost pool. When we commence production from established proven oil and gas reserves, capitalized costs, including estimated future costs to develop the reserves and estimated abandonment costs, net of salvage, will be depleted on the units-of-production method using estimates of proved reserves. Costs of unproved properties are not amortized until the proved reserves associated with the projects can be determined or until impairment occurs. If an assessment of such properties indicates that properties are impaired, the amount of impairment is added to the capitalized cost base to be amortized.
Depletion, depreciation and amortization (DD&A) of proved oil and gas properties is calculated quarterly, using the Units of Production Method (UOP). The UOP calculation, in simplest terms, matches the percentage of estimated proved reserves produced each quarter with the costs of those reserves. The result is to recognize expense at the same pace that the reservoirs are actually depleting. The amortization base in the UOP calculation includes the sum of proved property costs net of accumulated DD&A, estimated future development costs (future costs to access and develop reserves) and asset retirement costs which are not already included in oil and gas properties, less related salvage value.
The capitalized costs included in the full cost pool are subject to a "ceiling test" (based on the average of the first-day-of-the-month prices during the twelve-month period prior to February 28, 2014 pursuant to the SEC’s “Modernization of Oil and Gas Reporting” rule), which limits such costs to the aggregate of the (i) estimated present value, using a ten percent discount rate, of the future net revenues from proved reserves, based on current economic and operating conditions, (ii) the lower of cost or estimated fair value of unproven properties included in the costs being amortized, (iii) the cost of properties not being amortized, less (iv) income tax effects related to differences between the book and tax basis of the cost of properties not being amortized and the cost or estimated fair value of unproved properties included in the costs being amortized. If net capitalized costs exceed this limit, the excess is charged to expense in the current period. At February 28, 2014, all of our oil and gas interests were unproven.
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Sales of proved and unproved properties are accounted for as adjustments of capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas, in which case the gain or loss is recognized in the statement of operations.
Oil and Gas Acquisitions
We account for all property acquisitions that include working interests in proved leaseholds, both operated and non-operated, that would generate more than an immaterial balance of goodwill as business combinations. We do not apply acquisition accounting to the purchase of oil and gas properties entirely comprised of unproved leaseholds. In accordance with this guidance, we have recognized the fair value of all the assets acquired and liabilities assumed in connection with our KGP working interest acquisition from Devon and Nahanni effective July 18, 2012 and October 17, 2012, respectively.
On an ongoing basis, we conduct assessments of net assets acquired to determine if acquisition accounting is appropriate. When we determine a "business" has been acquired under the requirements of ASC Topic 805, we record assets acquired and liabilities assumed at their estimated acquisition date fair values, while transaction and integration costs associated with the acquisitions are expensed as incurred. We use relevant market assumptions to determine fair value and allocate purchase price, such as future commodity pricing for purchased hydrocarbons, market multiples for similar transactions and replacement value for certain equipment. Many of the assumptions are unobservable.
Asset Retirement Obligations
We record asset retirement obligations based on guidance set forth in ASC Topic 410, as a liability in the period in which we incur an obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal use of the assets. The estimated balance of the asset retirement obligation is based on the current cost escalated at an inflation rate and discounted at a credit adjusted risk-free rate. This liability is capitalized as part of the cost of the related asset and amortized over its useful life.
Fair Value Measurements
Our valuation techniques are generally classified into three categories: the market approach; the income approach; and the cost approach. The selection and application of one or more of these techniques requires significant judgment and is primarily dependent upon the characteristics of the asset or liability, the principal (or most advantageous) market in which participants would transact for the asset or liability and the quality and availability of inputs. Inputs to valuation techniques are classified as either observable or unobservable within the following hierarchy:
● | Level 1 — quoted prices in active markets for identical assets or liabilities. |
● | Level 2 — inputs other than quoted prices that are observable for an asset or liability. These include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market-corroborated inputs). |
● | Level 3 — unobservable inputs that reflect our own expectations about the assumptions that market participants would use in measuring the fair value of an asset or liability. |
We consider all highly liquid instruments with an original maturity of three months or less at the time of issuance to be cash equivalents. Cash and cash equivalents totaled $927,965 and $476,522 at February 28, 2014 and August 31, 2013, respectively. We are exposed to a concentration of credit risk with respect to our cash deposits. We place cash deposits with highly rated financial institutions in the United States and Canada. At times, cash balances held in financial institutions may be in excess of insured limits. We believe the financial institutions are financially strong and the risk of loss is minimal. We have not experienced any losses with respect to the related risks and do not believe our exposure to such risks is more than normal.
The estimated fair values for financial instruments are determined at discrete points in time based on relevant market information. These estimates involve uncertainties and cannot be determined with precision. The estimated fair value of cash, other receivables, accounts payable, accrued liabilities and demand notes payable approximates their carrying value due to their short-term nature.
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Revenue Recognition
We recognize natural gas revenue under the sales method of accounting for our interests in producing wells as natural gas is produced and sold from those wells. We recognize revenue upon transfer of ownership of the product to the customer which occurs when (i) the product is physically received by the customer, (ii) an invoice is generated which evidences an arrangement between the customer and us, (iii) a fixed sales price has been included in such invoice and (iv) collection from such customer is reasonably assured. Gas sales are reported net of applicable production taxes.
Oil and natural gas revenues and lease operating expenses related to unproved oil and gas properties that are being evaluated for commercial viability are offset against the unamortized cost pool until proved reserves are established, or determination is made that the unproved properties are impaired. During the three and six month periods ended February 28, 2014, we offset $311,657 and $548,495, respectively of lease operating expense, net of oil and gas revenue, into the full cost pool related to our unproven interests. During the three and six month periods ended February 28, 2013, we offset $235,522 and $380,616, respectively, of oil and gas revenue, net of lease operating expense, into the full cost pool related to our unproven interests.
Stock-Based Compensation
We record compensation expense in the financial statements for stock-based payments using the fair value method. The fair value of stock options granted to directors and employees is determined using the Black-Scholes option valuation model at the time of grant. Fair value for common shares issued for goods or services rendered by non-employees are measured based on the fair value of the goods and services received. Stock-based compensation is expensed as earned with a corresponding increase to share capital.
Foreign Currency Gains and Losses
Our functional and reporting currency is the United States dollar. The functional currency of our Canadian subsidiaries is the Canadian dollar. Financial statements of our Canadian subsidiaries are translated to United States dollars using period-end rates of exchange for assets and liabilities, and average rates of exchange for the period for revenues and expenses. Translation gains (losses) are recorded in accumulated other comprehensive income as a component of stockholders’ equity. Transaction gains and losses are included in the determination of income. Foreign currency transactions are primarily undertaken in Canadian dollars. As of February 28, 2014, we have not entered into derivative instruments to offset the impact of foreign currency fluctuations.
Income Taxes
We follow the asset and liability method of accounting for future income taxes. Under this method, future income tax assets and liabilities are recorded based on temporary differences between the carrying amount of balance sheet items and their corresponding tax bases. In addition, the future benefits of income tax assets, including unused tax losses, are recognized, subject to a valuation allowance, to the extent that it is more likely than not that such future benefits will ultimately be realized. Future income tax assets and liabilities are measured using enacted tax rates and laws expected to apply when the tax liabilities or assets are to be either settled or realized.
Earnings per share
We present both basic and diluted earnings (loss) per share (EPS) on the face of the consolidated statements of operations. Basic EPS is computed by dividing net earnings (loss) available to common shareholders by the weighted average number of shares outstanding during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period including convertible debt, and stock options and warrants using the treasury stock method. Diluted EPS excludes all dilutive potential shares unless their effect is anti-dilutive. Our Diluted EPS amounts did not differ from Basic EPS during the three and six month periods ended February 28, 2014, or for the three month period ended February 28, 2013, as we generated a net loss during those periods. Our Diluted EPS amounts differ from Basic EPS for the six months ended February 28, 2013 as we have adjusted the weighted average number of shares outstanding by a) 8,145 shares resulting from in-the-money stock options, and b) 1,204,384 shares of one of our subsidiaries issued in connection with our acquisition of the Nahanni Assets, which are exchangeable for shares of the our restricted common stock.
See Note 1 to the Financial Statements included as part of this report for a discussion of recent accounting pronouncements.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was carried out under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report on Form 10-Q. Disclosure controls and procedures are procedures designed with the objective of ensuring that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, such as this Form 10-Q, is recorded, processed, summarized and reported, within the time period specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and is communicated to our management, including our Principal Executive Officer and Principal Financial Officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based on that evaluation, our management concluded that, as of February 28, 2014, our disclosure controls and procedures were effective.
Change in Internal Control over Financial Reporting
Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles in the United States. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives.
There were no changes in our internal control over financial reporting that occurred during the fiscal quarter covered by this report that materially affected or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS.
During the three months ended February 28, 2014, we accrued fees payable in stock totaling $52,500 under the terms of three agreements. Under one of these agreements, consulting fees in the amount of $30,000 were earned by an entity controlled by our Chief Executive Officer. Under another one of these agreements administrative fees in the amount of $15,000 were earned by our largest shareholder. Effective February 28, 2014, we issued 48,892 shares of our restricted common stock, at a weighted average price of $1.074 per share, in satisfaction of these obligations.
We relied upon the exemption provided by Section 4(2) of the Securities Act of 1933 in connection with the issuance of these shares. The certificates representing the shares of common stock bear a restricted legend providing that they cannot be sold unless pursuant to an effective registration statement or an exemption from registration. We did not pay any underwriting discounts or sales commissions in connection with the issuance of these shares.
ITEM 6. EXHIBITS
(b) | Exhibits |
3.1.1 | Articles of Incorporation(1) |
3.1.2 | Amendment to Articles of Incorporation(2) |
3.2 | Bylaws(3) |
4.0 | Form of Convertible Note – October 30, 2013(5) |
10.1 | Agreement of Purchase and Sale between Devon Canada and EFL Overseas, Inc.(4) |
10.2 | Share Purchase Agreement between Nahanni Energy et.al and EFL Overseas, Inc. (4) |
10.3 | Kotaneelee Closing Agreement between Devon Canada and EFL Overseas, Inc. (4) |
14.1 | Code of Ethics for Principal Executive and Senior Financial Officers(4)) |
21.1 | As of February 28, 2014, we had four consolidated subsidiaries; EFLO Energy Yukon Ltd., a Canadian Corporation (100% owned) 1693730 Alberta Ltd, a Canadian Corporation (voting stock 100% owned) 1693731 Alberta Ltd, a Canadian Corporation (100% owned) 1700665 Alberta Ltd, a Canadian Corporation (100% owned by 1693730 Alberta Ltd) |
31.1 | Rule 13a-14(a) Certifications |
31.2 | Rule 13a-14(a) Certifications |
32 | Section 1350 Certifications |
99.1 | EFL Overseas Inc. – Audit Committee Charter(4) |
101.INS | - XBRL Instance Document |
101.SCH | - XBRL Taxonomy Extension Schema Document |
101.CAL | - XBRL Taxonomy Extension Calculation Linkbase Document |
101.DEF | - XBRL Taxonomy Extension Definition Linkbase Document |
101.LAB | - XBRL Taxonomy Extension Label Linkbase Document |
101.PRE | - XBRL Taxonomy Extension Presentation Linkbase Document |
__________________________
(1) | Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 dated November 12, 2008. |
(2) | Incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K report dated April 28, 2010. |
(3) | Incorporated by reference to Exhibit 3.2 to the Company’s Form 8-K report dated April 28, 2010. |
(4) | Incorporated by reference to the Company’s Form10-K report for the year ended August 31, 2012, filed November 29, 2012. |
(5) | Incorporated by reference to the Company’s Form 10-Q report for the quarter ended November 30, 2013, filed January 14, 2014. |
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SIGNATURES
Pursuant to the requirements of the Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
EFLO ENERGY, INC. | |||
Dated: April 14, 2014 | BY: | /s/ Keith Macdonald | |
Keith Macdonald, | |||
Principal Executive Officer | |||
BY: | /s/ Robert Wesolek | ||
Robert Wesolek, | |||
Principal Financial and Accounting Officer |
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