UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended February 28, 2007
[ ] 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 1-32682
GALAXY ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
COLORADO 98-0347827
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1331 - 17TH STREET, SUITE 1050, DENVER, COLORADO 80202
(Address of principal executive offices) (Zip Code)
(303) 293-2300
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [x]Yes [ ]No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer[ ] Accelerated filer[ ] Non-accelerated filer[x]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). [ ]Yes [X] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 83,681,968 SHARES OF COMMON
STOCK, $0.001 PAR VALUE, AS OF APRIL 10, 2007
GALAXY ENERGY CORPORATION
(A Development Stage Company)
CONSOLIDATED BALANCE SHEETS
February 28, 2007 November 30, 2006
Unaudited
ASSETS
Current assets
Cash and cash equivalents $ 916,948 $ 608,180
Accounts receivable, joint interest 14,465 60,475
Accounts receivable, joint interest, related party 133,616 923,172
Accounts receivable, other 111,660 102,800
Prepaid and other 169,950 107,236
-------------------- ---------------------
Total Current Assets 1,346,639 1,801,863
-------------------- ---------------------
Oil and gas properties, at cost, full cost method of accounting
Evaluated oil and gas properties 10,998,266 10,991,945
Unevaluated oil and gas properties 43,588,158 42,767,330
Less accumulated depletion, amortization and impairment (9,065,049) (8,966,135)
-------------------- ---------------------
45,521,375 44,793,140
-------------------- ---------------------
Furniture and equipment, net 103,604 121,945
-------------------- ---------------------
Other assets
Deferred financing costs, net 519,068 565,524
Restricted investments 459,783 459,783
Deferred selling costs 460,000 -
Other 18,003 18,003
-------------------- ---------------------
1,456,854 1,043,310
-------------------- ---------------------
TOTAL ASSETS $ 48,428,472 $ 47,760,258
==================== =====================
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Accounts payable and accrued expenses $ 1,688,647 $ 1,548,168
Accounts payable - related party 68,073 64,400
Notes payable - related party 2,049,728 2,049,728
Current portion convertible notes payable, net 9,211,809 10,019,996
Interest payable 2,990,108 2,488,451
Deposit received on oil and gas asset sale 2,000,000 -
-------------------- ---------------------
Total Current Liabilities 18,008,365 16,170,743
-------------------- ---------------------
Non-current obligations
Convertible notes payable, net 16,558,595 16,308,801
Notes payable - related party 6,900,000 5,500,000
Interest payable 832,397 572,466
Asset retirement obligation 1,314,359 1,288,337
-------------------- ---------------------
Total Non-current Obligations 25,605,351 23,669,604
-------------------- ---------------------
Stockholders' equity
Preferred stock, $.001 par value
Authorized - 25,000,000 shares
Issued - none - -
Common stock, $.001 par value
Authorized - 400,000,000 shares
Issued and outstanding - 83,661,968 shares
and 81,661,968 shares 83,662 81,662
Capital in excess of par value 72,254,502 71,537,766
Deficit accumulated during the development stage (67,523,408) (63,699,517)
-------------------- ---------------------
Total Stockholders' Equity 4,814,756 7,919,911
-------------------- ---------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 48,428,472 $ 47,760,258
==================== =====================
The accompanying notes are an integral part of these financial statements.
2
GALAXY ENERGY CORPORATION
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Cumulative
From Inception
Three Months Ended February 28, (June 18, 2002) to
2007 2006 February 28, 2007
Revenue
Natural gas sales $ 217,189 $ 425,675 $ 2,831,480
Gain on disposition of oil and gas property - - 197,676
Gain on disposition of oil and gas property
and other income, related party - - 122,946
-------------------------------------------------------
217,189 425,675 3,152,102
-------------------------------------------------------
Costs and expenses
Lease operating expense 163,291 294,308 1,968,742
General and administrative 1,059,402 1,154,718 18,145,305
Impairment of oil and gas properties - - 6,667,996
Depreciation depletion and amortization 143,277 176,344 2,886,872
-------------------------------------------------------
1,365,970 1,625,370 29,668,915
-------------------------------------------------------
Other income (expense)
Interest and other income 5,220 4,199 235,521
Interest expense and financing costs (2,680,329) (4,582,103) (41,242,116)
-------------------------------------------------------
(2,675,109) (4,577,904) (41,006,595)
-------------------------------------------------------
Net Loss $ (3,823,890) $ (5,777,599) $ (67,523,408)
=======================================================
Net loss per common share - basic and diluted $ (0.05) $ (0.08) $ (1.25)
=======================================================
Weighed average number of common
shares outstanding - basic and diluted 82,617,024 68,668,029 54,119,024
=======================================================
The accompanying notes are an integral part of these financial statements.
3
GALAXY ENERGY CORPORATION
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Cumulative
From Inception
Three Months Ended February 28, (June 18, 2002) to
2007 2006 February 28, 2007
Cash flows from operating activities
Net loss $ (3,823,890) $ (5,777,599) $ (67,523,408)
Adjustments to reconcile net loss to net
cash (used) by operating activities
Stock for interest - - 4,352,508
Stock for services - - 264,600
Stock for services - related party - - 90,000
Oil and gas properties for services - - 732,687
Stock for debt - related party - - 233,204
Amortization of discount and deferred financing costs
on convertible debt 1,363,064 3,478,271 19,271,626
Finance costs incurred for waiver of triggering event - - 3,457,101
Write-off of discount and deferred financing costs
upon conversion of convertible debt - - 2,979,404
Write-off of discount and deferred financing costs
upon extiguishment of convertible debt - - 2,162,597
Compensation expense on vested stock options 308,735 320,309 2,036,145
Depreciation, depletion and amortization
and accretion of ARO expense 143,277 176,344 2,881,871
Gain on disposition of oil and gas assets - - (270,389)
Impairment of oil and gas properties - - 6,667,996
Other - - 11,178
Changes in assets and liabilities
Accounts payable - trade, accruals, bank overdrafts 215,136 1,152,809 253,794
Accounts payable - related 3,673 (4,436) 68,073
Interest payable 761,589 750,955 3,822,506
Accounts receivable, prepaids and other
current assets 664,332 (671,994) (523,443)
Other - - (18,443)
---------------------------------------------------------
Net cash used by operating activities (364,084) (575,341) (19,049,393)
---------------------------------------------------------
Cash flows from investing activities
Additions to oil and gas properties (838,939) (767,345) (46,263,966)
Management fees earned on operated properties 11,791 - 1,707,621
Purchase of furniture and equipment - - (281,172)
Purchase surety bonds - - (459,783)
Proceeds from sale of oil and gas asset - - 340,000
Deposit on sale of oil and gas properties, net of
selling costs 1,975,000 1,975,000
Advance to affiliate - (60,000)
Cash received upon recapitalization and merger - 4,234
---------------------------------------------------------
Net cash provided by (used for) investing activities 1,147,852 (767,345) (43,038,066)
---------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
4
GALAXY ENERGY CORPORATION
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Cumulative
From Inception
Three Months Ended February 28, (June 18, 2002) to
2007 2006 February 28, 2007
Cash flows from financing activities
Proceeds from sale of common stock - - 17,905,300
Proceeds from sale of convertible notes payable - - 44,695,000
Proceeds from sale of convertible debentures - - 5,040,000
Proceed for sale of notes payable - related party 1,400,000 6,900,000
Proceeds from exercise of warrants - - 1,019,306
Debt and stock offering costs - - (3,980,569)
Payment of convertible notes payable (1,875,000) - (7,894,780)
Payment of note payable - related party - - (129,578)
Payment of note payable - (550,272)
Checks written against future deposits 190,062 0
---------------------------------------------------------
Net cash provided by (used for) financing activities (475,000) 190,062 63,004,407
---------------------------------------------------------
Net (decrease) increase in cash 308,768 (1,152,624) 916,948
Cash and cash equivalents, beginning of period 608,180 1,328,469 -
---------------------------------------------------------
Cash and cash equivalents, end of period $ 916,948 $ 175,845 $ 916,948
=========================================================
Supplemental schedule of cash flow information
Cash paid for interest $ 555,676 $ 352,877 $ 5,114,960
=========================================================
Supplemental disclosures of non-cash investing and
financing activities
Debt incurred for oil and gas properties $ - $ - $ 3,646,000
=========================================================
Debt incurred for finance costs $ - $ - $ 3,547,101
=========================================================
Stock issued for services $ - $ - $ 354,600
=========================================================
Stock issued for interest and debt $ - $ - $ 13,742,538
=========================================================
Stock issued for convertible debentures $ - $ - $ 5,640,000
=========================================================
Warrants issued for offering and financing costs $ - $ - $ 1,685,850
=========================================================
Discount on convertible debt issued $ - $ - $ 14,883,630
=========================================================
Conversion of interest to debt $ - $ - $ 11,178
=========================================================
Stock issued for subsidiary - related $ - $ - $ (202,232)
=========================================================
Stock issued for oil and gas properties $ - $ - $ 9,146,800
=========================================================
Stock issued for selling costs of oil
and gas properties $ 410,000 $ - $ 410,000
=========================================================
The accompanying notes are an integral part of these financial statements.
5
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - ORGANIZATION
Galaxy Energy Corporation is an independent oil and gas company
primarily engaged in the exploration for, and the acquisition and
development of crude oil and natural gas. These activities have been
conducted primarily in the Rocky Mountain region of the United States.
The unaudited financial statements included herein were prepared from
the records of the Company in accordance with generally accepted
accounting principles in the United States applicable to interim
financial statements and reflect all adjustments which are, in the
opinion of management, necessary to provide a fair statement of the
results of operations and financial position for the interim periods.
Such financial statements conform to the presentation reflected in the
Company's Form 10-K filed with the Securities and Exchange Commission
for the year ended November 30, 2006. The current interim period
reported herein should be read in conjunction with the Company's Form
10-K for the year ended November 30, 2006.
The results of operations for the three months ended February 28, 2007
are not necessarily indicative of the results that may be expected for
the full fiscal year ending November 30, 2007.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the Company
and its wholly owned subsidiaries, Dolphin Energy Corporation
("Dolphin") and Pannonian International, Ltd. ("Pannonian"). All
significant intercompany transactions have been eliminated.
LIQUIDITY
During the three months ended February 28, 2007, the Company incurred a
net loss of $3,823,890 and used cash for operating activities of
$364,084. During the three months ended February 28, 2007, the
Company's working capital deficit increased to $16,661,726 from
$14,368,880 as of November 30, 2006. These matters raise substantial
doubt about the Company's ability to continue as a going concern. The
Company's continued operation is contingent upon its ability to raise
additional capital, and ultimately attaining profitability from its oil
and gas operations. On December 29, 2006, the Company entered into a
Purchase and Sale Agreement with a related party to sell all of the
Company's oil and gas interests in the Powder River Basin of Wyoming
and Montana (the "Powder River Basin Assets"). The purchase price for
the Powder River Basin Assets is $45 million, with $20 million to be
paid in cash and $25 million to be paid in shares of the purchaser's
common stock. Closing of the transaction is subject to approval by the
Company's secured noteholders, approval of all matters in its
discretion by the Company's Board of Directors, the purchaser obtaining
outside financing on terms acceptable to its Board of Directors, and
various other terms and conditions. The Company intends to use the cash
proceeds to repay the senior secured convertible notes and is in
negotiations with the subordinated noteholders to repay the principal
and accrued interest on their notes utilizing the shares of common
stock of the purchaser. If the Company is unable to close the asset
sale to the related party, those assets will be offered for sale to
other potential buyers; however there is no assurance such a sale would
be completed or that the Company will realize the full carrying value
of the assets. In such an event the Company may be required to write
off a portion of the carrying value and such write-off could be
material.
6
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company's continued operation is contingent upon its ability to
raise additional capital and ultimately attaining profitability from
its oil and gas operations. In addition to the sale of Powder River
Basin Assets, the Company is considering other options for raising
additional capital to fund its 2007 operational budget such as debt and
equity offerings, other asset sales, the farm-out of some of its
acreage and other similar type transactions. There is no assurance that
financing will be available to the Company on favorable terms or at all
or that any asset sale transaction will close. Any financing obtained
through the sale of Company equity will likely result in substantial
dilution to the Company's stockholders. If the Company is forced to
sell additional assets to meet its current liquidity needs, it may not
realize the full market value of the asset and the sales price could be
less than the Company's carrying value of the asset.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
The Company's financial statements are based on a number of significant
estimates, including oil and gas reserve quantities, which are the
basis for the calculation of depreciation, depletion and impairment of
oil and gas properties, and timing and costs associated with its
retirement obligation. In addition, significant estimates are required
in the valuation of undeveloped oil and gas properties. Actual results
could differ from those estimates and such differences could be
material. The Company has negotiated a purchase and sale agreement with
a related party to sell certain of its evaluated and unevaluated oil
and gas properties. The value at which such assets are carried on the
balance sheet is supported by an independent third party appraisal of
an amount approximately equal to such carrying value, and the
negotiated sales price for the assets is in excess of the carrying
value. If the Company is unable to close the asset sale to the related
party, those assets will be offered for sale to other potential buyers;
however there is no assurance such a sale would be completed or that
the Company will realize the full carrying value of the assets. In such
an event the Company may be required to write off in the near term a
portion of the carrying value and such write-off could be material.
The oil and gas industry is subject, by its nature, to environmental
hazards and clean-up costs. At this time, management knows of no
substantial costs from environmental accidents or events for which the
Company may be currently liable. In addition, the Company's oil and gas
business makes it vulnerable to changes in wellhead prices of crude oil
and natural gas. Such prices have been volatile in the past and can be
expected to be volatile in the future. By definition, proved reserves
are based on current oil and gas prices and estimated reserves. Price
declines reduce the estimated quantity of proved reserves and increase
annual amortization expense (which is based on proved reserves).
7
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OIL AND GAS PROPERTIES
The Company utilizes the full cost method of accounting for oil and gas
activities. Under this method, subject to a limitation based on
estimated value, all costs associated with property acquisition,
exploration and development, including costs of unsuccessful
exploration, are capitalized within a cost center. No gain or loss is
recognized upon the sale or abandonment of undeveloped or producing oil
and gas properties unless: 1) the sale represents a significant portion
of oil and gas properties within a cost center and the gain
significantly alters the relationship between capitalized costs and
proved oil and gas reserves of the cost center; or 2) the proceeds of
the sale are in excess of the capitalized costs within the cost center.
Depreciation, depletion and amortization of oil and gas properties is
computed on the units of production method based on proved reserves.
Amortizable costs include estimates of future development costs of
proved undeveloped reserves.
Capitalized costs of oil and gas properties may not exceed an amount
equal to the present value, discounted at 10%, of the estimated future
net cash flows from proved oil and gas reserves plus the cost, or
estimated fair market value, if lower, of unproved properties. Should
capitalized costs exceed this ceiling, an impairment is recognized. The
present value of estimated future net cash flows is computed by
applying year end prices of oil and natural gas to estimated future
production of proved oil and gas reserves as of year end, less
estimated future expenditures to be incurred in developing and
producing the proved reserves and assuming continuation of existing
economic conditions. During the year ended November 30, 2006, the
Company recorded an impairment expense of $1,328,473 representing the
excess of capitalized costs over the ceiling amount. No additional
impairment expense was recognized during the three months ended
February 28, 2007. Unevaluated properties are assessed periodically on
a cost center basis and any impairment is added to the amortization
base, which is subject to the full cost ceiling test limitations as
described above. During the year ended November 30, 2006, the Company
recognized properties with a carrying value of $473,265 as being
impaired and reclassified those costs from unevaluated properties to
evaluated properties and added those costs to the full cost pool
amortization base. No impairment or reclassification of costs was
recognized during the three months ended February 28, 2007.
IMPAIRMENT
The Company applies SFAS 144, "Accounting for the Impairment and
Disposal of Long-Lived Assets," which requires that long-lived assets
to be held and used be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Oil and gas properties accounted for using the
full cost method of accounting, the method utilized by the Company, are
excluded from this requirement, but will continue to be subject to the
ceiling test limitations as described above.
DEFERRED SELLING COSTS
In connection with the proposed sale of the Powder River Basin Assets,
the Company has incurred certain costs, which total $460,000 as of
February 28, 2007, and has recorded the costs as Deferred Selling Costs
on the balance sheet as of that date. These costs will be offset
against proceeds of the sale at closing. If it appears the sale will
not be completed the costs will be charged to operations as expense.
8
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ASSET RETIREMENT OBLIGATION
In 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement
Obligations." SFAS 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This statement
requires companies to record the present value of obligations
associated with the retirement of tangible long-lived assets in the
period in which it is incurred. The liability is capitalized as part of
the related long-lived asset's carrying amount. Over time, accretion of
the liability is recognized as an operating expense and the capitalized
cost is depreciated over the expected useful life of the related asset.
The Company's asset retirement obligations ("ARO") relate primarily to
the plugging, dismantlement, removal, site reclamation and similar
activities of its oil and gas properties.
The Company has, through acquisition and drilling, acquired working
interests in 243 natural gas wells. A limited number of these wells
have had initial gas production, and the others are in various stages
of completion and hook up at February 28, 2007. The Company adopted the
provisions of SFAS 143 to record the ARO associated with all wells in
which the Company owns an interest on the date such obligation arose.
Depreciation of the related asset, and accretion of the ARO on wells
from which production has commenced, has been calculated using the
Company's estimate of the lives of the wells, based upon the lives of
comparable wells in the area. The amounts recognized upon adoption are
based upon numerous estimates and assumptions, including future
retirement costs, future recoverable quantities of oil and gas, future
inflation rates and the credit-adjusted risk-free interest rate.
The information below reflects the change in the ARO during the periods
ended February 28,
2007 2006
---------- ----------
Balance beginning of period $1,288,337 $1,242,967
Liabilities incurred - -
Liabilities settled - -
Accretion 26,022 7,183
---------- ----------
Balance end of period $1,314,359 $1,250,150
========== ==========
SHARE BASED COMPENSATION
The Company had followed Accounting Principles Board ("APB") Opinion
No. 25,"Accounting for Stock Issued to Employees", and related
interpretations, through November 30, 2005 which resulted in the
accounting for grants of awards to employees at their intrinsic value
in the consolidated financial statements. Additionally, the Company has
recognized compensation expense in the financial statements for awards
granted to non-employees which must be re-measured each period under
the mark-to-market, as required under EITF 96-18, "Accounting for
Equity Instruments That Are Issued to Other Than Employees for
Acquiring or in Conjunction with Selling, Goods or Services". The
Company previously adopted the provisions of SFAS No.123, "Accounting
for Stock-Based Compensation", as amended by SFAS No. 148, "Accounting
for Stock-Based Compensation --Transition and Disclosure", through
disclosure only.
9
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Effective December 1, 2005, the Company adopted SFAS 123(R),
"Accounting for Stock-Based Compensation," using the modified
prospective method, which results in the provisions of SFAS 123(R)
being applied to the consolidated financial statements on a
going-forward basis. Prior periods have not been restated. SFAS 123(R)
requires companies to recognize share-based payments to employees as
compensation expense on a fair value method. Under the fair value
recognition provisions of SFAS 123(R), stock-based compensation cost is
measured at the grant date based on the fair value of the award and is
recognized as expense over the service period, which generally
represents the vesting period. The expense recognized over the service
period is required to include an estimate of the awards that will be
forfeited. Previously, no such forfeitures have occurred. The Company
is assuming no forfeitures going forward based on the Company's
historical forfeiture experience. The fair value of stock options is
calculated using the Black-Scholes option-pricing model.
As of February 28, 2007, options to purchase an aggregate of 4,955,000
shares of the Company's common stock were outstanding, of which
3,262,500 are exercisable. These options were granted during 2007,
2006, 2005, and 2004, to the Company's employees, directors and
consultants at exercise prices ranging from $0.19 to $3.51 per share.
The options vest at varying schedules within five years of their grant
date and typically expire within ten years from the grant date.
Stock-based compensation costs were $308,735 and $320,309, before tax,
for the three months ended February 28, 2007 and 2006, respectively.
These amounts were charged to operations as compensation expense and
included withing general and administrative expense.
(LOSS) PER COMMON SHARE
Basic (loss) per share is based on the weighted average number of
common shares outstanding during the period. Diluted (loss) per share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock. Convertible equity instruments such as stock options, warrants,
convertible debentures and notes payable are excluded from the
computation of diluted loss per share, as the effect of the assumed
exercises would be antidilutive.
RECLASSIFICATION
Certain amounts in the November 30, 2006 financial statements have been
reclassified to conform to the February 28, 2007 financial statement
presentation. The reclassifications have no effect on the Company's net
loss for the period.
10
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3 - PROPERTY AND EQUIPMENT
OIL AND GAS PROPERTIES
The Company recognizes three cost centers for its oil and gas
activities, the United States Cost Center, the Germany Cost Center and
the Romania Cost Center.
United States Cost Center
In 2003, the Company began the acquisition of unevaluated oil and gas
properties primarily in the Powder River Basin region of the Rocky
Mountain area. In 2004, the Company acquired additional unevaluated
properties, began its exploration program by drilling 135 wells and
commenced limited production of natural gas in the Powder River Basin.
During 2005, exploratory drilling activities continued in the Powder
River Basin, development of certain areas commenced and natural gas
production reached a level that allowed the Company to recognize proved
reserves on those producing properties. During 2006 and 2007, the
Company continued limited drilling operations in the Powder River Basin
and conducted extended de-watering operations on certain prospects in
the basin. On December 29, 2006, the Company entered into a Purchase
and Sale Agreement (the "PSA") with PetroHunter Energy Corporation
("PetroHunter") and its wholly owned subsidiary, PetroHunter Operating
Company, a related party. Pursuant to the PSA, the Company agreed to
sell the Powder River Basin Assets. The purchase price for the Powder
River Basin Assets is $45 million, with $20 million to be paid in cash
and $25 million to be paid in shares of PetroHunter common stock at the
rate of $1.50 per share.
Closing of the transaction is subject to approval by the Company's
secured noteholders, approval of all matters in its discretion by our
Board of Directors, PetroHunter obtaining outside financing on terms
acceptable to its Board of Directors, and various other terms and
conditions. Either party may terminate the agreement if closing has not
occurred by April 30, 2007.
Within ten (10) days of signing the PSA, PetroHunter was required and
did make an initial earnest money payment of $1.4 million. PetroHunter
made an additional earnest money payment of $600,000 in January 2007.
In the event the closing does not occur for any reason other than a
material breach by the Company, the deposit shall convert into a
promissory note, payable to PetroHunter, and shall be an unsecured
subordinated debt of the Company, which is payable only after repayment
of our senior indebtedness.
In 2005, the Company entered into an exploration project in the
Piceance Basin of northwestern Colorado, acquiring prospective acreage,
evaluating and planning for an exploratory drilling program. In 2006,
the Company, as operator, drilled four wells and participated as
non-operator in the drilling of four additional wells in the Piceance
basin. As of February 28, 2007, three of the Company's operated wells
are shut in pending completion operations and three of the non-operated
wells have commenced production of natural gas, condensate and other
hydrocarbon liquids.
11
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3 - PROPERTY AND EQUIPMENT (CONTINUED)
Germany Cost Center
In March 2005, the Company, through its wholly owned subsidiary,
Pannonian, entered into a farmout agreement with an unrelated party
(the "Farmee") to conduct exploration activities on its Neues Bergland
Exploration Permit in Germany. Prior to the farmout Pannonian owned a
50% interest in the permit. Under the terms of the agreement the Farmee
made an initial payment of $750,000 to Pannonian and its partners to
acquire a 40% interest in the permit, thereby reducing Pannonian's
ownership interest to 30%. The Company recognized a gain of $197,676 on
the transaction, representing the excess of the proceeds over the
original cost of the property. In December 2005, the Company commenced
drilling the initial test well on the permit. The well, in which the
Company had a carried interest, was completed in January 2006. In July
2006, the Company completed the testing of the four primary zones of
interest in the Glantal-1 well and no significant natural gas flows
were encountered. The wellbore was plugged and abandoned in August
2006. The Company and its joint venture partners are evaluating further
operations on the permit, which could include a seismic program and
additional exploratory drilling. The Company's balance sheet reflects
no capitalized oil and gas costs related to the Germany cost center
Romania Cost Center
In May 2005, the Company, through its wholly owned subsidiary,
Pannonian, entered into a farmout agreement with a related party whose
President is a significant shareholder of the Company (Falcon Oil &Gas
or "Falcon") to evaluate the concession held by Pannonian in the Jiu
Valley Coal Basin in Romania. This concession had been assigned to
Pannonian by the Romanian government, in October 2002, under the terms
of a Concession Agreement (the "Concession"). The farmout agreement
calls for the assignment of the Concession to Falcon; the assignment of
a 75% working interest in the Concession area; and for the drilling of
one test well and an additional, optional, test well, the cost of which
will be paid 100% by Falcon. In addition Falcon paid Pannonian $100,000
upon approval by the Romanian government of the assignment of the
Concession, and will pay the first $250,000 of Pannonian's
proportionate share of drilling and operating costs subsequent to the
drilling of the first two wells. The Company recognized a gain of
$72,713 on the transaction, representing the excess of the proceeds
over the original cost of the property. The first test well on the
property, in which the Company has a carried interest, was drilled in
2005. Subsequent to February 28, 2007, the Company and Falcon decided
to plug and abandon the test well. They are evaluating whether the
drilling of a second well should be commenced in 2007. Following the
recognition of the gain on farmout, the Company's balance sheet
reflects no capitalized oil and gas costs for the Romanian cost center.
12
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 4 - NOTES PAYABLE
RELATED PARTIES
As of February 28, 2007, the Company has issued six separate
subordinated unsecured promissory notes for a total of $6,900,000 in
favor of Bruner Family Trust UTD March 28, 2005, (the "Bruner Trust") a
related party. One of the trustees of the Bruner Trust is Marc E.
Bruner, the president and a director of the Company. Interest accrues
at the rate of 8% per annum and the note matures as summarized below or
the time at which the registrant's senior indebtedness has been paid in
full. In October 2006, the remaining balance of the promissory note
originally issued to DAR LLC, together with accrued interest, was
acquired by the Bruner Trust. The note, in the amount of $2,049,728
accrues interest at the rate of 12% per annum and is due on June 30,
2007.
At February 28, 2007 notes payable to the Bruner Trust are as follows:
Issue Date Due Date February 28, 2007 November 30, 2006
CURRENT LIABILITIES
January 14, 2004 June 30, 2007 $ 2,049,728 $ 2,049,728
================ =================
NON-CURRENT OBLIGATIONS
September 28, 2006 January 26, 2007 $ 2,500,000 $ 2,500,000
November 1, 2006 March 1, 2007 1,000,000 1,000,000
November 13, 2006 March 13, 2007 500,000 500,000
November 30, 2006 March 30, 2007 1,500,000 1,500,000
January 31, 2006 May 31, 2007 500,000 -
February 28, 2006 June 28, 2007 900,000 -
---------------- -----------------
$ 6,900,000 $ 5,500,000
================ =================
OTHER
In connection with the acquisition of oil and gas properties from DAR
LLC, ("DAR") the Company issued a promissory note to DAR in the amount
of $2,600,000. At February 28, 2007, the remaining balance of the note
payable was $2,049,728. The note together with accrued interest was
acquired by the Bruner Trust in October 2006.
NOTE 5 - CONVERTIBLE NOTES PAYABLE
2004 NOTES
In August and October 2004, the Company completed two tranches of a
private offering of Senior Secured Convertible Notes and Warrants.
Gross proceeds from the initial tranche of the offering were
$15,000,000. Gross proceeds from the second tranche of the offering
were $5,000,000. The notes pay interest at the prime rate plus 7.25%
per annum, mature two years from the date of issue, are collateralized
by substantially all the Company's assets, and are convertible into
10,695,187 shares of the Company's common stock based on a conversion
price of $1.87 per share. Monthly principal repayments of $833,333,
plus accrued interest commenced on March 1, 2005. At the Company's
option, and assuming the satisfaction of certain conditions, the
Company may pay the monthly installments in cash or through a partial
conversion of the notes into shares of the Company's common stock at a
conversion rate equal to the lesser of $1.87 (as may be adjusted to
prevent dilution), or 93% of the weighted average trading price of the
Company's common stock on the trading day preceding
13
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5 - CONVERTIBLE NOTES PAYABLE (CONTINUED)
the conversion. Note purchasers received warrants to purchase 5,194,806
shares of the Company's common stock at an exercise price of $1.54 per
share, for a period of three years.
On December 1, 2005, the Company and the holders of the 2004 Notes
entered into an agreement, that among other things lowered the
conversion price of the Notes, granted additional warrants to purchase
shares of common stock and lowered the exercise price of existing and
newly issued warrants. In accordance with SFAS 5, Accounting for
Contingencies, the Company recorded the effect of this agreement in the
financial statements as of November 30, 2005. In accordance with EITF
96-19, Debtor's Accounting for a Modification or Exchange of Debt
Instruments, the Company recognized this transaction as an
extinguishment of the existing debt and the issuance of new debt. The
Company wrote off unamortized discount and deferred financing
associated with the original debt in the amount of $773,564, including
the amount in interest and financing expense. In addition, in
accordance with EITF 98-5 and EITF 00-27, the Company recognized the
fair value of the warrants and the beneficial conversion feature
associated with the Notes aggregating $7,375,920 as a discount to the
Notes as additional paid in capital. During the three months ended
February 28, 2007, the Company recorded amortization of the discount in
the amount of $483,799 as interest expense.
On July 7, 2006, the Company and the holders of its senior secured
convertible notes issued in 2004 and 2005 entered into a Waiver and
Agreement. The Company had notified the holders of the 2004 Notes of an
Equity Liquidity Test Failure on July 3, 2006, as defined in its
agreements with the holders, triggering the holders' right to make an
early repayment election in the aggregate amount of $1,217,929.
In the Waiver and Agreement, the Company and the holders agreed to the
following:
o The waiver of the holders' right to make an early repayment
election as a result of the July 2006 Equity Liquidity Test
Failure and any Equity Liquidity Test Failure as of August 1,
2006 and/or September 1, 2006;
o The deferral of the August 2006 and September 2006 installment
payments on the 2004 Notes until October 2, 2006, unless
earlier converted by the holders;
o The ability of the holders to convert up to $5,000,000 in
principal amount of the 2004 Notes, plus related interest, at
their option as a "Company Alternative Conversion" under the
notes through September 30, 2006, with the amounts converted
to be applied first to the August 2006 installment payment,
second to the September 2006 installment payment, and then to
those installments nearest to the maturity date of the 2004
Notes; and
o The waiver of the Company's right to prepay any part of the
2004 or 2005 Notes.
During July, August and September 2006, the holders converted a total
of $4,812,249 of principal and accrued interest into 12,993,939 shares
of the Company's common stock, in accordance with the terms of the
Waiver and Agreement.
14
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5 - CONVERTIBLE NOTES PAYABLE (CONTINUED)
On November 29, 2006, the Company and the holders of the 2004 Notes
entered into a Waiver and Amendment Agreement. The Company had notified
the holders of the 2004 Notes of the fact that a Triggering Event under
the terms of the Notes had occurred as of August 31, 2006. Among other
things, this would have enabled the holders of the Notes to require the
Company to redeem all or any portion of the outstanding principal
amount of the Notes at a price equal to the greater of (i) 125% of such
principal plus accrued and unpaid interest and (ii) the product of the
current conversion rate in effect under the Notes multiplied by the
volume-weighted average price of Galaxy's common stock. The holders
agreed to waive the Triggering Event in consideration for an amendment
to the 2004 Notes that reset the principal amounts of the Notes to 125%
of the amounts outstanding as of October 31, 2006. The increased
principal in the amount of $957,101 was included in interest expense
for the year ended November 30, 2006.
MARCH 2005 NOTES
In March 2005, the Company completed a private offering of Senior
Secured Convertible Notes and Warrants to a group of accredited
investors. Gross proceeds from the offering were $7,695,000. The notes
pay interest at the prime rate plus 6.75% per annum, mature April 30,
2007, are subordinated to Galaxy's secured debt and existing senior
debt, and are convertible into 4,093,085 shares of common stock based
on a conversion price of $1.88 per share beginning September 1, 2005.
Note purchasers received warrants to purchase 1,637,235 shares of the
Company's common stock at an exercise price of $1.88 per share, for a
period of three years. Principal and interest on the notes are payable
upon maturity.
In connection with the agreement entered into with the Holders of the
2004 notes, as discussed above the terms of the March 2005 Notes were
also amended to lower the conversion price and lower the exercise price
of existing and newly issued warrants. In accordance with SFAS 5,
Accounting for Contingencies, the Company recorded the effect of this
agreement in the financial statements as of November 30, 2005. In
accordance with EITF 96-19, Debtor's Accounting for a Modification or
Exchange of Debt Instruments, the Company recognized this transaction
as an extinguishment of the existing debt and the issuance of new debt.
The Company wrote off unamortized discount and deferred financing
associated with the original debt in the amount of $1,389,033 including
the amount in interest and financing cost. In addition, in accordance
with EITF 98-5 and EITF 00-27 the Company recognized the fair value of
the warrants and the beneficial conversion feature associated with the
Notes aggregating $2,802,876 as a discount to the Notes and as
additional paid in capital. During the three months ended February 28,
2007 the Company recorded amortization of the discount in the amount of
$583,014 as interest expense.
15
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5 - CONVERTIBLE NOTES PAYABLE (CONTINUED)
MAY 2005 NOTES
In May 2005, the Company completed a private offering of Senior Secured
Convertible Notes to a group of accredited investors. Gross proceeds
from the offering were $10,000,000. The notes are secured by a security
interest in all of the assets of the Company and the domestic
properties of its subsidiaries. Such security interest ranks equally
with that of the 2004 Notes, and senior to the March 2005 Notes. The
notes pay interest at the prime rate plus 7.25% adjusted and payable
quarterly. They mature May 31, 2010, and are convertible into 5,319,149
shares of common stock at any time, based on a conversion price of
$1.88 per share. In addition, the Investors received a perpetual
overriding royalty interest ("ORRI") in Galaxy's domestic acreage
averaging from 1% to 3%, depending upon the nature and location of the
property, a right of first refusal with respect to future debt and/or
equity financings, and a right to participate in any farm-out financing
transactions that do not have operating obligations by the financing
party as a material component. The fair value of the ORRI has been
calculated to be the difference between the market price per share at
the date of issue ($1.14) and the conversion price ($1.88), times the
number of shares into which the notes are convertible (5,319,149) or
$3,936,170. This value has been recorded as a reduction of the
Company's undeveloped oil and gas properties full cost pool and as a
discount to the notes. The discount will be amortized over the
five-year term of the notes. Amortization of the discount of $194,006
is included in interest expense for the three months ended February 28,
2007.
On November 29, 2006, the Company and the holders of the May 2005 Notes
entered into a Waiver and Amendment Agreement. The Company had notified
the holders of the May 2005 Notes of the fact that a Triggering Event
under the terms of the Notes had occurred as of August 31, 2006. Among
other things, this would have enabled the holders of the Notes to
require the Company to redeem all or any portion of the outstanding
principal amount of the Notes at a price equal to the greater of (i)
125% of such principal plus accrued and unpaid interest and (ii) the
product of the current conversion rate in effect under the Notes
multiplied by the volume-weighted average price of Galaxy's common
stock. The holders agreed to waive the Triggering Event in
consideration for an amendment to the May 2005 Notes that reset the
principal amounts of the Notes to 125% of the amounts outstanding as of
October 31, 2006. The increased principal in the amount of $2,500,000
was included in interest expense for the year ended November 30, 2006.
APRIL 2006 DEBENTURES
In April 2006, the Company completed a private offering of Subordinated
Convertible Debentures and Warrants to a group of accredited investors.
Gross proceeds from the offering were $4,500,000. The Debentures pay
interest at 15% per annum, have a 30-month maturity which will extend
under the terms of the financing until all of the Company's senior debt
has been retired, and are subordinated to Galaxy's secured debt and
existing senior debt. The Debentures are convertible into 2,884,615
shares of common stock based on a conversion price of $1.56 per share.
Debenture purchasers received warrants to purchase 865,383 shares of
the Company's common stock at an exercise price of $1.60 per share, for
a period of five years. Principal and interest on the Debentures are
payable upon maturity.
16
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5 - CONVERTIBLE NOTES PAYABLE (CONTINUED)
The fair value of the warrants was estimated as of the issue date under
the Black-Scholes pricing model, with the following assumptions: common
stock based on a market price of $1.06 per share, zero dividends,
expected volatility of 67.46%, risk free interest rate of 4.875% and
expected life of 2.5 years. The fair value of the warrants of $295,029
resulted in a discount of $395,986 which has been recorded as
additional paid in capital and as a discount to the Debentures and is
being amortized over the term of the Debentures. Amortization of the
discount of $38,992 is included in interest expense for the three
months ended February 28, 2007.
JUNE 2006 DEBENTURES
In June 2006, the Company completed a private offering of Subordinated
Convertible Debentures and Warrants to an accredited investor. Gross
proceeds from the offering were $2,500,000. The Debentures pay interest
at 15% per annum, have a 30-month maturity which will extend under the
terms of the financing until all of the Company's senior debt has been
retired, and are subordinated to Galaxy's secured debt and existing
senior debt. The Debentures are convertible into 1,602,564 shares of
common stock based on a conversion price of $1.56 per share. The
Debenture purchaser received warrants to purchase 480,769 shares of the
Company's common stock at an exercise price of $1.60 per share, for a
period of five years. Principal and interest on the Debentures are
payable upon maturity.
The fair value of the warrants was estimated as of the issue date under
the Black-Scholes pricing model, with the following assumptions: common
stock based on a market price of $0.79 per share, zero dividends,
expected volatility of 67.36%, risk free interest rate of 5.125% and
expected life of 2.5 years. The fair value of the warrants of $92,695
resulted in a discount of $170,555 which has been recorded as
additional paid in capital and as a discount to the Debentures and is
being amortized over the term of the Debentures. Amortization of the
discount of $16,794 is included in interest expense for the three
months ended February 28, 2007.
The Company has evaluated the embedded conversion feature in the 2004,
the March 2005, and the May 2005 Notes, and the April 2006 and the June
2006 Debentures and concluded the feature does not require
classification as a derivative instrument because the feature would be
classified as equity if it were a freestanding instrument and
therefore, meets the scope exception found in SFAS 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS 133"). Included in
the evaluation is the conclusion the Notes and Debentures meet the
definition of "conventional convertible instrument" and therefore the
embedded conversion feature is not subject to the provisions of EITF
00-19. Further the Company has evaluated the detachable warrants
related to the 2004 and the March 2005 Notes and the April 2006 and the
June 2006 Debentures, and concluded that the warrants also meet the
scope exception found in SFAS 133 and are appropriately classified as
equity. The Company has also evaluated the freestanding registration
rights agreements attached to the Notes and Debentures and have
concluded they do meet the definition of derivative instruments under
SFAS 133. The fair value of the derivative liabilities has been
determined to not be significant based on a probability-weighted,
discounted cash flow evaluation of its terms.
17
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5 - CONVERTIBLE NOTES PAYABLE (CONTINUED)
At February 28, 2007 and November 30, 2006 convertible notes consist of
the following:
2007 2006
2004 Notes $ 2,285,505 $ 4,160,505
Less unamortized discount (179,204) (663,002)
March 2005 Notes 7,695,000 7,695,000
Less unamortized discount (589,492) (1,172,506)
May 2005 Notes 12,500,000 12,500,000
Less unamortized discount (2,556,570) (2,750,577)
April 2006 Notes 4,500,000 4,500,000
Less unamortized discount (261,680) (300,671)
June 2006 Notes 2,500,000 2,500,000
Less unamortized discount (123,155) (139,951)
-------------------------------
25,770,404 26,328,798
Less current portion, net (9,211,809) (10,019,996)
-------------------------------
Long term portion, net $ 16,558,595 $ 16,308,801
===============================
Total unamortized discount on all Notes and Debentures at February 28,
2007 in the amount of $3,710,101 will be amortized and recognized as
interest expense over the remaining terms of the respective debt
instruments.
Total principal payments due in the next twelve months, including
related party debt are $18,930,233. If the Company's common stock meets
certain conditions of trading volume and price, $9,980,505 of the
principal payments may be paid by issuing shares of common stock.
However, the Company currently plans to utilize the proceeds from the
proposed Powder River Basin Asset sale to pay those amounts.
NOTE 6 - STOCKHOLDERS/ EQUITY
During the three months ended February 28, 2007, the Company issued
2,000,000 shares of its common stock to its senior secured creditors in
exchange for the creditors' consent to the Powder River Basin Asset
Sale. The creditors' consent was required because they have a security
interest covering the assets to be sold. the Company issued the shares
at the closing market price per share on the dates of issuance and the
value associated with these shares, $410,000, is included in deferred
selling costs on the February 28, 2007 Balance Sheet. Such amounts will
be offset against the proceeds of the Sale upon consummation.
18
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 7 - STOCK OPTION PLAN
The Company adopted the 2003 Stock Option Plan (the "Plan"), as
amended. Under the Plan, stock options may be granted at an exercise
price not less than the fair market value of the Company's common stock
at the date of grant. Options may be granted to key employees and other
persons who contribute to the success of the Company. The Company has
reserved 6,500,000 shares of common stock for the plan. At February 28,
2007, and November 30, 2006, options to purchase 1,545,000 and
1,785,000 shares, respectively, were available to be granted pursuant
to the stock option plan.
On January 2, 2007, the Company granted each of the Company's outside
directors options to purchase 60,000 shares of the Company's common
stock for a term 10 years at the closing price of the common stock on
the date of grant. The options were vested upon grant.
NOTE 8 - SUBSEQUENT EVENTS
a) On April 2, 2007, the Company and PetroHunter amended the Powder
River Basin Purchase and Sale Agreement to extend the closing date to
on or before April 30, 2007.
b) On March 30, 2007, the Company issued a subordinated unsecured
promissory note in the amount of $1,350,000 in favor of Bruner Trust, a
related party. Interest accrues at the rate of 8% per annum and the
notes mature on the later of 120 days from issue or the time at which
the registrant's senior indebtedness has been paid in full.
c) The Company has made cash payments on the 2004 Notes of $625,000 on
the first business day of each of March and April 2007. As of April 15,
2007, the remaining balance of the 2004 Notes is $1,035,505.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW AND PLAN OF OPERATION
We spent fiscal years 2003, 2004, 2005 and 2006 obtaining oil and gas
properties in the Piceance Basin of Colorado and the Powder River Basin of
Wyoming and Montana and obtaining the funding to pay for those properties,
commence drilling operations and complete the infrastructure necessary to
deliver natural gas to nearby pipelines. Most of this funding has been
high-interest debt financing.
Our tasks now are to establish reserves on our properties and to place
our properties into production. As of April 1, 2007, we had interests in 175
completed wells (22 of which were delivering natural gas into sales pipelines),
60 wells in various stages of completion and 8 water disposal wells. We recorded
our first revenues from natural gas sales during the fiscal year ended November
30, 2004 and we currently are producing about 700 thousand cubic feet per day.
As our first wells come online in the Piceance Basin over the next few months
and as our coal bed methane wells continue to dewater and increase their
production of natural gas, we expect to generate significantly more revenues
during the current fiscal year. We anticipate that these revenues, while
significantly larger than in fiscal 2005 and 2006, will not be sufficient to
fund completely our planned operations, debt repayment and commitments.
At February 28, 2007, our working capital deficit was $16,661,726. As
of that date we, we had contractual obligations due within twelve months
totaling $17,066,260, as explained more fully below. To meet these obligations
and working capital needs, we have entered into a Purchase and Sale Agreement
("PSA") with PetroHunter a related party. Pursuant to the PSA, we agreed to sell
all of our Powder River Basin Assets. The purchase price for the Powder River
Basin Assets is $45 million, with $20 million to be paid in cash and $25 million
to be paid in shares of PetroHunter common stock. If this sale is completed, we
would pay off all of our convertible debt, leaving as our only outstanding debt
a portion of the notes due to Bruner Family Trust, which totaled $8,250,000 as
of April 5, 2007 and a note purchased by Bruner Family Trust in the principal
amount of $2,049,728 as of that date. We believe that we would then be able to
continue to pursue funding and industry participation alternatives to ensure our
ability to continue to acquire additional acreage and complete additional
drilling activity in the Piceance Basin.
There are significant contingencies in connection with this proposed
sale, including the ability of PetroHunter to raise the funds required to
complete this transaction. If this proposed sale is not completed, we will be
forced to find another buyer and suitable terms for a sale of the property. If
we cannot find another buyer and suitable terms for a sale, we may be forced to
seek the protection of bankruptcy laws. Furthermore, we may be required to
reduce the sale price compared to that provided for under the PSA, which could
result in a significant impairment (and loss to the Company) to the carrying
value of this asset.
GOING CONCERN
The report of our independent registered public accounting firm on the
financial statements for the year ended November 30, 2006, includes an
explanatory paragraph indicating substantial doubt as to our ability to continue
as a going concern. We have incurred a cumulative net loss of $67,523,408 for
the period from inception to February 28, 2007. We require significant
additional funding to sustain our operations and satisfy our contractual
obligations for our planned oil and gas exploration and development operations.
Our ability to establish the Company as a going concern is dependent upon our
ability to obtain additional financing, in order to fund our planned operations
and ultimately, to achieve profitable operations.
20
RESULTS OF OPERATIONS
THREE MONTHS ENDED FEBRUARY 28, 2007 COMPARED TO THE THREE MONTHS ENDED FEBRUARY
28, 2006
During the three months ended February 28, 2007, revenues from natural
gas sales decreased to $217,189 from $425,675 the year before. A total of 23
wells produced and sold 39,306 Mcf of natural gas in 2007, compared to 38 wells
that sold 53,036 Mcf in 2006. The 2007 production decrease reflects the shutting
in of an uneconomic producing field in the Powder River Basin. Average prices
received for gas sold decreased to $5.45 in 2007 from $8.03 in 2006. Lease
operating and production tax expenses also decreased in 2007 to $163,292 or
$4.15/Mcf, compared to $294,308 or $5.55/Mcf the year before. This decrease
reflects the effect of shutting in the uneconomic Powder River Basin field,
together with increased operating efficiencies achieved in the other Powder
River Basin fields.
We recorded interest income earned on cash deposits in commercial banks
and other income of $5,220 during the quarter ending February 28, 2007 compared
to $4,199 during the same period in 2006.
For the three months ended February 28, 2007 and 2006, we incurred
general and administrative expenses of $1,059,402 and $1,154,718, respectively,
as summarized below:
- --------------------------------------------------------------------------------
2006 2005
- --------------------------------------------------------------------------------
Stock based compensation $ 308,735 $ 320,309
- --------------------------------------------------------------------------------
Salaries and benefits 224,030 232,554
- --------------------------------------------------------------------------------
Professional and consulting fees 31,149 88,960
- --------------------------------------------------------------------------------
Investor relations 112,417 176,989
- --------------------------------------------------------------------------------
Legal 143,859 86,287
- --------------------------------------------------------------------------------
Travel and entertainment 12,983 12,776
- --------------------------------------------------------------------------------
Office lease and expenses 56,396 57,191
- --------------------------------------------------------------------------------
Audit and accounting 86,039 78,225
- --------------------------------------------------------------------------------
Directors fees 45,000 54,000
- --------------------------------------------------------------------------------
Insurance, prospect generation and other 38,794 47,427
- --------------------------------------------------------------------------------
Total $ 1,059,402 $ 1,154,718
- --------------------------------------------------------------------------------
Significant period-to-period variances include:
o Professional and consulting fees decrease reflects the termination of
the consulting contract with the founder of the Company effective
February 28, 2006, resulting in savings of $30,000; and reduced fees
paid to independent reservoir engineer as we did not require the
preparation of a market valuation report in 2007, having completed one
in 2006, resulting in savings of $25,000.
o Investor relations expenses in 2006 included the costs associated with
a special shareholders meeting to approve the issuance of additional
shares of common stock. No such special meeting was held in 2007,
resulting in savings of approximately $40,000. In addition, we
terminated the contract with one investor relations firm subsequent to
February 28, 2006, resulting in savings of $25,000.
o Increased legal fees in 2007 reflects legal fees incurred to prepare
and file numerous 8-K reports and file preliminary proxy statements
with the SEC; approximately $20,000 and in house legal fees incurred in
negotiations for the sale of certain oil and gas assets; approximately
$40,000.
Depreciation, depletion and amortization expense ("DD&A") of $143,277
in 2007 reflects a decrease from the 2006 amount of $176,344. The decrease
reflects lower DD&A on oil and gas properties of $86,130 or $2.19/Mcf in 2007
compared to $144,383 or $2.72/Mcf in 2006. The lower DD&A reflects
21
a lower amortization base following the impairment write-down of $1,328,432 in
2006. The impairment write-downs represented the excess of capitalized costs
over the ceiling as calculated in accordance with the full cost rules. The
decreased DD&A of oil and gas assets was partially offset by increased
depreciation of our asset retirement obligation ("ARO") asset and accretion of
our ARO in 2007 to $38,806 from $13,620 in 2006.
Interest and financing costs decreased to $2,680,329 in 2007 from
$4,582,103 in 2006, reflecting significantly lower amortization of discount on
the 2004 Notes, partially offset by the higher debt levels in 2007. The table
below summarizes interest and financing costs for the three months ended
February 28, 2007 and 2006.
- --------------------------------------------------------------------------------
2007 2006
- --------------------------------------------------------------------------------
Interest on outstanding debt $ 1,144,067 $ 1,103,832
- --------------------------------------------------------------------------------
Interest on outstanding debt, related party 172,518 -
- --------------------------------------------------------------------------------
Amortization of discount 1,316,605 3,301,468
- --------------------------------------------------------------------------------
Amortization of deferred finance costs 47,139 176,803
- --------------------------------------------------------------------------------
Total $ 2,680,329 $ 4,582,103
- --------------------------------------------------------------------------------
Significant year-to-year variances include:
o Interest on outstanding debt, related party in 2007 reflects costs
associated with borrowing from the Bruner Family Trust in late 2006 and
2007. No such borrowings existed in 2006.
o Lower amortization of discount in 2007 reflects the lower balance of
debt on the 2004 Notes in 2007 compared to 2006. As a result of the
principal repayment schedule of the 2004 Notes, higher amortization of
discount is recorded when debt levels are higher. As we have paid the
2004 Notes down from $12,500,000 in 2006 to $2,285,505 in 2007, related
amortization of discount is significantly less in 2007.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. For the three months ended February 28, 2007 we
used $364,084 for operating activities, as compared to $575,341 for the same
period in 2006. Significant adjustments to reconcile the net loss of $3,823,890
to net cash used by operating activities for 2007 were $1,363,064 for
amortization of discount and deferred financing costs on convertible debt,
$308,735 of stock based compensation expense and DD&A of $143,277. In contrast,
the equivalent adjustments for 2006 to the net loss of $5,777,599 included
$3,478,271 for amortization of discount and deferred financing costs on
convertible debt, $320,309 of stock based compensation expense and $176,344 of
DD&A.
INVESTING ACTIVITIES. Our investing activities provided net cash of
$1,147,852, after recoveries, in the three months ended February 28, 2007, as
compared to $767,345 of cash used for the comparable period of 2006. The
increase is due to an earnest money deposit we received of $1,975,000, net of
selling costs, on the proposed sale of our Powder River Basin assets in the 2007
period.
FINANCING ACTIVITIES. Since inception, we have funded our operating and
investing activities through the sale of our debt and equity securities, raising
net proceeds of $71,579,037 through the period ended February 28, 2007.
Financing activities used cash of $475,000 in the first three months of fiscal
2007, as compared to $190,062 in 2006.
From December 2002 through May 2003, we sold 1,602,000 shares of common
stock for gross proceeds of $1,602,000. In October 2003, we completed a
$5,640,000 private placement of 7% secured convertible debentures and warrants,
due two years from date of issue and secured by substantially all of
22
our assets. Debentures purchasers received five-year warrants to purchase
2,867,797 shares of common stock at an exercise price of $0.71 per share and
2,867,797 shares of common stock at an exercise price of $0.83 per share. We
filed a registration statement covering the shares underlying the debentures and
warrants, but did not meet the deadline associated with this filing obligation.
We paid a penalty of $404,000 to the holders of the debentures. During the year
ended November 30, 2004, all of the debentures were converted at $0.59 per share
into 9,559,322 shares of common stock.
In December 2003, we completed a private placement of 2,503,571 shares
of our common stock and warrants to purchase 500,715 common shares, resulting in
gross proceeds of $3,505,000. The warrants were exercisable for a four-year
period at an original price of $2.71 per share. In accordance with the
antidilutive rights provisions, the exercise prices of those warrants with
original exercise prices in excess of $1.54 were reset to $1.54 per share, in
connection with the issuance of the 2004 notes. We granted registration rights
to the purchasers in this private placement.
We completed a second private placement of 6,637,671 shares of our
common stock and warrants to purchase 1,327,535 common shares in January 2004,
resulting in gross proceeds of $11,947,800. The warrants were exercisable for a
five-year period at an original price of $4.05 per share. In accordance with the
antidilutive rights provisions, the exercise prices of those warrants with
original exercise prices in excess of $1.54 were reset to $1.54 per share, in
connection with the issuance of the 2004 Notes. We granted registration rights
to the purchasers in this private placement as well.
In August and October 2004, we completed two tranches of a private
placement of senior secured convertible notes (the "2004 Notes") and warrants
(the "2004 Warrants"). Gross proceeds from the initial tranche were $15,000,000,
while gross proceeds from the second tranche were $5,000,000. The 2004 Notes pay
interest at the prime rate plus 7.25% per annum, originally matured two years
from the date of issue, are collateralized by substantially all of our assets,
and were originally convertible into 10,695,187 shares of our common stock based
on a conversion price of $1.87 per share. In January 2005, under the terms of
the 2004 Notes, we were required to pay accumulated interest to that date.
Commencing on March 1, 2005 we were required to make monthly payments of
principal in the amount of $833,333 plus accrued interest. For the year ended
November 30, 2005, we made total payments on the 2004 Notes of $10,152,666
consisting of $7,500,000 in principal repayments and $2,652,666 of interest. Of
that amount we paid $8,337,748, or 82% of the total payment, using shares of
common stock. Note purchasers received the three-year, 2004 Warrants, which
originally allowed the holders to purchase 5,194,806 shares of common stock at
$1.54 per share.
On March 1, 2005, we completed a private placement of $7,695,000 in
senior subordinated convertible notes (the "March 2005 Notes") to a group of
accredited investors to fund our entry into our Piceance Basin project. The
March 2005 Notes are payable on April 30, 2007 (but are subordinated in payment
to the 2004 Notes), accrue interest at the prime rate plus 6.75% per annum,
adjusted quarterly and payable at maturity, and were originally convertible into
4,093,086 shares of our common stock based on a conversion price of $1.88 per
share. March 2005 Note purchasers received three-year warrants (the "2005
Warrants"), which originally allowed the holders to purchase 1,637,234 shares of
common stock at $1.88 per share.
On May 31, 2005, we completed a private offering of senior secured
convertible notes to essentially the same group of accredited investors that
purchased our 2004 Notes and Warrants (the "May 2005 Notes"). Gross proceeds
from the offering were $10,000,000. The May 2005 Notes are secured by a security
interest in all of our assets and the domestic properties of our subsidiaries.
Such security interest ranks equally with that of the 2004 Notes, and senior to
the March 2005 Notes. The May 2005 Notes
23
mature and are payable on May 31, 2010 (but can be redeemed by the holders after
May 31, 2008) and bear interest at the prime rate plus 7.25%, adjusted and
payable quarterly. The May 2005 Notes were originally convertible into 5,319,149
shares of our common stock based on a conversion price of $1.88 per share. In
addition, the Investors received a perpetual overriding royalty interest in our
domestic acreage averaging from 1% to 3%, depending upon the nature and location
of the property, a right of first refusal with respect to future debt and/or
equity financings, and a right to participate in any farm-out financing
transactions that do not have operating obligations by the financing party as a
material component.
On December 1, 2005, we entered into a Waiver and Amendment Agreement
(the "2005 Waiver and Amendment") with the holders of the 2004 Notes and the
holders of the 2005 Notes. Under the agreement, we and the holders waived all
claims in connection with Dolphin Energy Corporation, our wholly-owned
subsidiary, having entered into a Third Amendment to Participation Agreement
with our partner in our Piceance Basin project, Exxel Energy Corporation as of
October 4, 2005. The Third Amendment set the working interest between us and
Exxel at 25%/75%, consistent with the original intent of the parties. As such,
the Third Amendment clarified that Exxel was obligated to pay the next $14
million in project costs to bring its payments to 75% of the total costs,
thereby adjusting for us having paid about 50% of the land cost to get the
project started.
In addition, the 2005 Waiver and Amendment, among other things,
effected the following changes:
o Lowered the conversion price to $1.25 for conversions by the holders of
the 2004 Notes, the May 2005 Notes, and the March 2005 Notes;
o Lowered the exercise price of the 2004 Warrants and the 2005 Warrants
to $1.25 per share and increased the aggregate number of shares
purchasable under the 2004 Warrants from 5,194,806 to 6,400,002;
o Caused the exercise price of warrants issued in December 2003 and
January 2004 being lowered to $1.25 under the anti-dilution provisions
of such warrants;
o Deferred monthly installment payments on the 2004 Notes until April 1,
2006;
o Extended the maturity date of the 2004 Notes to July 1, 2007; and
o Extended any redemption or conversion of the 2004 Notes by Galaxy
until June 22, 2006.
On April 25, 2006, we entered into a Securities Purchase Agreement with
several accredited investors pursuant to which the investors purchased in the
aggregate, $4,500,000 principal amount of Subordinated Convertible Debentures.
In addition, the investors also received three-year warrants that allow the
holders to purchase 865,383 shares of common stock at $1.60 per share. The
debentures are convertible at any time by the holders into shares of our common
stock at a price equal to $1.56; are subordinated to all of our senior debt; pay
interest at 15% per annum, payable at maturity; and have a term of 30 months,
which will extend automatically until all of our senior debt has been retired.
Additionally, in the event the debentures are retired at maturity, the holders
are entitled to an additional payment equal to the sum of 25% plus 0.75% for
each month (or part thereof) in excess of 30 months that the debentures have
remained outstanding.
On June 20, 2006, we entered into a Securities Purchase Agreement with
an accredited investor pursuant to which the investor purchased $2,500,000
principal amount of Subordinated Convertible Debentures on the same terms and
conditions set forth in the previous paragraph.
During the year ended November 30, 2006,we issued four separate
subordinated unsecured promissory notes for a total of $5,500,000 in favor of
Bruner Family Trust UTD March 28, 2005 (the "Bruner Family Trust"), a related
party. One of the trustees of the Bruner Family Trust is Marc E. Bruner, the
president and a director of the company. Interest accrues at the rate of 8% per
annum and the note
24
matures at the later of 120 days from issue or the time at which our senior
indebtedness has been paid in full.
On November 29, 2006, we entered into a Waiver and Amendment Agreement
(the "2006 Waiver and Amendment") with the holders of the 2004 Notes and the
2005 Notes. We had earlier notified the holders of the 2004 Notes and May 2005
Notes of the fact that our accounts payable had exceeded the permitted
$2,500,000 ceiling set forth in the 2004 Notes and May 2005 Notes, thereby
resulting in a Triggering Event under the terms of those Notes. Among other
things, this would have enabled the holders of the Notes to require us to redeem
all or any portion of the outstanding principal amount of the Notes at a price
equal to the greater of (i) 125% of such principal plus accrued and unpaid
interest and (ii) the product of the current conversion rate in effect under the
Notes multiplied by the volume-weighted average price of our common stock. The
holders agreed to waive the Triggering Event in consideration for an amendment
to the 2004 Notes and May 2005 Notes that reset the principal amounts of the
Notes to 125% of the amounts outstanding as of October 31, 2006. We and the
holders also agreed to waive any future Triggering Event that might result from
our accounts payable exceeding $2,500,000. However, if our accounts payable
should exceed $5,000,000, it would result in an immediate breach of the Notes.
We and the holders agreed to other amendments with respect to the 2004 Notes and
May 2005 Notes and warrants previously issued by us to the holders.
We also obtained the consent of the holders of the 2004 Notes and May
2005 Notes to the proposed sale of our Powder River Basin assets (the "PRB
Sale") to PetroHunter as described above. Such consent is required as the
holders have a security interest covering these assets. The note holders
conditioned their consent on the following: completion of the PRB Sale by March
31, 2007 and our compliance with the Waiver and Amendment Agreement and all of
our obligations under the various agreements with the note holders. Further, we
will be required to (i) pay the 2004 Notes and May 2005 Notes in full, (ii)
deliver to the holders 1,000,000 of the PetroHunter shares to be received by us
as part of the PRB Sale consideration and 10,000,000 shares of our common stock
and (iii) retire all of our outstanding subordinated convertible debt using the
consideration we receive in the PRB Sale. Additionally, the holders and
PetroHunter must enter into a suitable registration rights agreement with
respect to the 1,000,000 PetroHunter shares. Since we and PetroHunter have
extended the deadline for completing the PRB Sale to April 30, 2007, we will
need to seek a similar extension from the note holders.
Because the PRB Sale was not consummated by January 31, 2007, we issued
2,000,000 additional shares of our common stock to the holders of the 2004 Notes
and the May 2005 Notes in order to maintain their consent to the PRB Sale, as
required under the 2006 Waiver and Amendment. We have agreed to register these
shares.
In October 2006, Bruner Family Trust, a related party, acquired a
promissory note we had issued to DAR, LLC in the original principal amount of
$2,600,000. While the note, as amended, had a stated maturity date of December
1, 2006, Bruner Family Trust has stated that it will not enforce its rights
under the note until June 30, 2007.
During the three months ended February 28, 2007, we issued two separate
subordinated unsecured promissory notes for a total of $1,400,000 in favor of
the Bruner Trust a related party. Interest accrues at the rate of 8% per annum
and the note matures at the later of 120 days from issue or the time at which
our senior indebtedness has been paid in full.
25
SCHEDULE OF CONTRACTUAL OBLIGATIONS
The following table summarizes our obligations and commitments to make
future payments under our notes payable, operating leases, employment contracts
and consulting agreement for the periods specified as of February 28, 2007.
- ---------------------------------------------------------------------------------------------------------------------
PAYMENTS DUE BY PERIOD
----------------------------------------------------------------------------
MORE
LESS THAN 1 THAN 5
CONTRACTUAL OBLIGATIONS (1)<F1> TOTAL YEAR 1-3 YEARS 3-5 YEARS YEARS
- ---------------------------------------------------------------------------------------------------------------------
Convertible Notes Payable
Senior Secured Notes Payable (2)<F2>
Principal $ 14,785,505 $ 2,285,505 $ - $12,500,000 $-
Interest 6,368,487 2,010,439 3,875,000 483,048 -
Senior Subordinated Notes Payable (3)<F3>
Principal 14,695,000 7,695,000 7,000,000 - -
Interest 5,062,881 2,435,415 2,627,466 - -
Notes payable, related party
Principal 8,949,728 2,049,728 - 6,900,000 -
Interest 2,330,909 382,241 - 1,948,668 -
- ---------------------------------------------------------------------------------------------------------------------
Office, Equipment Leases & Other 445,605 207,932 219,228 18,445 -
- ---------------------------------------------------------------------------------------------------------------------
TOTAL $ 52,538,115 $17,066,260 $13,721,694 $21,850,161 $-
- ---------------------------------------------------------------------------------------------------------------------
<FN>
(1)<F1> This table excludes the costs of drilling obligations in our European
permits, as we reached agreement with third parties to fund our share
of the obligation amount, should such amount be spent. In the event we
do not fulfill those drilling obligations, we will forfeit the permit.
We have excluded asset retirement obligations because we are not able
to precisely predict the timing for these amounts.
(2)<F2> Under certain conditions, as described elsewhere in this report, we
have the option to pay the principal and interest with shares of common
stock instead of cash. Interest payments were calculated using actual
interest rates charged through February 28, 2007, and 15.5% thereafter.
(3)<F3> Under certain conditions, as described elsewhere in this report, we
have the option to pay the principal and interest with shares of common
stock instead of cash. Interest payments were calculated using actual
interest rates charged through February 28, 2007, and 15% thereafter.
</FN>
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosures of
contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates, including those related to impairment of long-lived assets. We base
our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions; however, we believe
that our estimates, including those for the above-described items, are
reasonable.
26
OIL AND GAS PROPERTIES. We follow the full cost method of accounting
for oil and gas operations. Under this method, all costs related to the
exploration for and development of oil and gas reserves are capitalized on a
country-by-country basis. Costs include lease acquisition costs, geological and
geophysical expenses, overhead directly related to exploration and development
activities and costs of drilling both productive and non-productive wells.
Proceeds from the sale of properties are applied against capitalized costs,
without any gain or loss being recognized, unless such a sale would
significantly alter the rate of depletion and depreciation.
We calculate depreciation and depletion of our oil and gas using the
unit-of-production method based upon estimated proven oil and gas reserves. The
costs of significant unevaluated properties are excluded from costs subject to
depletion. For depletion and depreciation purposes, relative volumes of oil and
gas production and reserves are converted at the equivalent conversion based
upon relative energy content.
In applying the full cost method, we perform a ceiling test whereby the
carrying value of oil and gas properties and production equipment, net of
recorded future income taxes and the accumulated provision for site restoration
and abandonment costs, is compared annually to an estimate of future net cash
flow from the production of proven reserves. Costs related to undeveloped oil
and gas properties are excluded from the ceiling tests. Discounted net cash
flow, utilizing a 10% discount rate, is estimated using year end prices, less
estimated future general and administrative expenses, financing costs and income
taxes. If such capitalized costs exceed the ceiling, we will record a write-down
to the extent of such excess as a non-cash charge to earnings. Any such
write-down will reduce earnings in the period of occurrence and result in lower
depreciation and depletion in future periods. A write-down may not be reversed
in future periods, even though higher oil and natural gas prices may
subsequently increase the ceiling. We recorded a ceiling write down during the
year ended November 30, 2006 in the amount of $1,328,432 representing the excess
of capitalized costs over the ceiling amount. No impairment was recognized
during the three months ended February 28, 2007.
We intend to sell a significant portion of our oil and gas properties
and have negotiated a purchase and sale agreement with a related party to
dispose of those assets. Full cost accounting rules do not include provisions
for segregating those assets and identifying them as held for sale. Accordingly,
those assets are reflected on the balance sheet as either evaluated or
unevaluated oil and gas properties, as appropriate.
OIL AND GAS RESERVES. The determination of depreciation and depletion
expense as well as ceiling test write-downs related to the recorded value of our
oil and natural gas properties are highly dependent on the estimates of the
proved oil and natural gas reserves. Oil and natural gas reserves include proved
reserves that represent estimated quantities of crude oil and natural gas which
geological and engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating conditions. There are numerous uncertainties inherent in estimating
oil and natural gas reserves and their values, including many factors beyond our
control. Accordingly, reserve estimates are often different from the quantities
of oil and natural gas ultimately recovered and the corresponding lifting costs
associated with the recovery of these reserves. Price changes will affect the
economic lives of oil and gas properties and, therefore, price changes may cause
reserve revisions. We are not aware of any material adverse issues related to
our reserves regarding regulatory approval, the availability of additional
development capital, or the installation of additional infrastructure.
ASSET RETIREMENT OBLIGATIONS. SFAS No. 143, ACCOUNTING FOR ASSET
RETIREMENT OBLIGATIONS requires that we estimate the future cost of asset
retirement obligations, discount that cost to its present value, and record a
corresponding asset and liability in our consolidated balance sheets. The values
ultimately derived are based on many significant estimates, including future
abandonment costs, inflation, market risk premiums, useful life, and cost of
capital. The nature of these estimates requires us to make
27
judgments based on historical experience and future expectations. Revisions to
the estimates may be required based on such things as changes to cost estimates
or the timing of future cash outlays. Any such changes that result in upward or
downward revisions in the estimated obligation will result in an adjustment to
the related capitalized asset and corresponding liability on a prospective
basis.
REVENUE RECOGNITION. We derive our revenue primarily from the sale of
produced natural gas and crude oil. We report revenue gross for the amounts
received before taking into account production taxes and transportation costs
which are reported as separate expenses. Revenue is recorded in the month
production is delivered to the purchaser at which time title changes hands. We
make estimates of the amount of production delivered to purchasers and the
prices we will receive. We use our knowledge of our properties; their historical
performance; the anticipated effect of weather conditions during the month of
production; NYMEX and local spot market prices; and other factors as the basis
for these estimates. Variances between estimates and the actual amounts received
are recorded when payment is received. A majority of our sales are made under
contractual arrangements with terms that are considered to be usual and
customary in the oil and gas industry.
IMPAIRMENT OF LONG-LIVED ASSETS. Our long-lived assets include property
and equipment. We assess impairment of long-lived assets whenever changes or
events indicate that the carrying value may not be recoverable. In performing
our assessment we must make assumptions regarding estimated future cash flows
and other factors to determine the fair value of the respective assets. If these
estimates change in the future we may be required to record impairment charges
against these respective assets.
STOCK BASED COMPENSATION. On December 1, 2005, we adopted FAS No.
123(R), "Accounting for Stock-Based Compensation," using the modified
prospective method, which results in the provisions of FAS 123(R) being applied
to the consolidated financial statements on a going-forward basis. Prior periods
have not been restated. FAS 123(R) requires companies to recognize share-based
payments to employees as compensation expense on a fair value method. Under the
fair value recognition provisions of FAS 123(R), stock-based compensation cost
is measured at the grant date based on the fair value of the award and is
recognized as expense over the service period, which generally represents the
vesting period. The expense recognized over the service period is required to
include an estimate of the awards that will be forfeited. Previously, no such
forfeitures have occurred. We are assuming no forfeitures going forward based on
our historical forfeiture experience. The fair value of stock options is
calculated using the Black-Scholes option-pricing model
FORWARD-LOOKING STATEMENTS
This report includes "forward-looking statements." All statements other
than statements of historical facts included or incorporated by reference in
this report, including, without limitation, statements regarding our future
financial position, business strategy, budgets, projected costs and plans and
objectives of management for future operations, are forward-looking statements.
In addition, forward-looking statements generally can be identified by the use
of forward-looking terminology such as "may," "will," "expect," "intend,"
"project," "estimate," "anticipate," "believe," or "continue" or the negative
thereof or variations thereon or similar terminology. Although we believe that
the expectations reflected in such forward-looking statements are reasonable, we
cannot give any assurance that such expectations will prove to have been
correct. Important factors that could cause actual results to differ materially
from our expectations ("Cautionary Statements") include, but are not limited to,
our assumptions about energy markets, production levels, reserve levels,
operating results, competitive conditions, technology, the availability of
capital resources, capital expenditure obligations, the supply and demand for
oil and natural gas, the price of oil and natural gas, currency exchange rates,
the weather, inflation, the availability of goods and services, drilling risks,
future processing volumes and pipeline throughput, general economic conditions
(either internationally or nationally or in the jurisdictions in which we are
doing business),
28
legislative or regulatory changes (including changes in environmental
regulation, environmental risks and liability under federal, state and foreign
environmental laws and regulations), the securities or capital markets and other
factors disclosed above under "Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this report. All
subsequent written and oral forward-looking statements attributable to us, or
persons acting on our behalf, are expressly qualified in their entirety by the
cautionary statements. We assume no duty to update or revise our forward-looking
statements based on changes in internal estimates or expectations or otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk relates to changes in the pricing applicable to
the sales of gas production in the Powder River Basin in Wyoming and Montana.
This risk will become more significant to us as our production increases in
these areas. Although we are not using derivatives at this time to mitigate the
risk of adverse changes in commodity prices, we may consider using them in the
future.
ITEM 4. CONTROLS AND PROCEDURES
As required by SEC rules, we have evaluated the effectiveness of the
design and operation of our disclosure controls and procedures at the end of the
period covered by this report. This evaluation was carried out under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer. Based on this
evaluation, these officers have concluded that the design and operation of our
disclosure controls and procedures are effective. There were no changes in our
internal control over financial reporting or in other factors that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
Disclosure controls and procedures are our controls and other
procedures that are designed to ensure that information required to be disclosed
by us in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
SEC's rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by us in the reports that we file under the Exchange Act is
accumulated and communicated to our management, including principal executive
officer and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure.
29
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not a party to any pending legal proceedings.
ITEM 1A. RISK FACTORS
There were no material changes from the risk factors disclosed in
our Form 10-K for the fiscal year ended November 30, 2006.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended February 28, 2007, we issued 2,000,000
shares of common stock to our six senior lenders in order to
maintain their consent to the sale of our Powder River Basin
assets, as required under the 2006 Waiver and Amendment agreement
with such lenders. We relied upon the exemption from registration
contained in Section 4(2) of the Securities Act of 1933, as such
lenders were deemed to be sophisticated with regard to an
investment in our securities. Restrictive legends were placed on
the certificates evidencing these shares. No underwriters were
used.
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
- --------------------------------------------------------------------------------
REGULATION
S-K NUMBER EXHIBIT
- --------------------------------------------------------------------------------
2.1 Purchase and Sale Agreement Between Dolphin Energy Corporation,
and Galaxy Energy Corporation and PetroHunter Operating Company,
and PetroHunter Energy Corporation Dated December 29, 2006 (1)
- --------------------------------------------------------------------------------
2.2 Second Amendment to Purchase and Sale Agreement dated February
28, 2007 (2)
- --------------------------------------------------------------------------------
2.3 Third Amendment to Purchase and Sale Agreement dated March 30,
2007 (3)
- --------------------------------------------------------------------------------
3.1 Articles of Incorporation (4)
- --------------------------------------------------------------------------------
3.2 Articles of Amendment to Articles of Incorporation (5)(6)
- --------------------------------------------------------------------------------
30
- --------------------------------------------------------------------------------
REGULATION
S-K NUMBER EXHIBIT
- --------------------------------------------------------------------------------
3.3 Bylaws (4)
- --------------------------------------------------------------------------------
10.1 2003 Stock Option Plan (5)
- --------------------------------------------------------------------------------
10.2 Securities Purchase Agreement dated August 19, 2004 between
Galaxy Energy Corporation and the Buyers named therein (7)
- --------------------------------------------------------------------------------
10.3 Form of Initial Note (7)
- --------------------------------------------------------------------------------
10.4 Form of Conditional Note (7)
- --------------------------------------------------------------------------------
10.5 Form of Common Stock Purchase Warrant (7)
- --------------------------------------------------------------------------------
10.6 Registration Rights Agreement dated August 19, 2004 between
Galaxy Energy Corporation and the Buyers named therein (7)
- --------------------------------------------------------------------------------
10.7 Security Agreement dated August 19, 2004 among Galaxy Energy
Corporation, Dolphin Energy Corporation, and Pannonian
International, Ltd. and Promethean Asset Management L.L.C. a
Delaware limited liability company, in its capacity as
collateral agent for the Lender (7)
- --------------------------------------------------------------------------------
10.8 Guaranty dated August 19, 2004 by Dolphin Energy Corporation and
Pannonian International, Ltd. in favor of Promethean Asset
Management L.L.C. in its own behalf and in its capacity as agent
for the benefit of the Buyers (7)
- --------------------------------------------------------------------------------
10.9 Form of Mortgage (7)
- --------------------------------------------------------------------------------
10.10 Lease Acquisition and Development Agreement between Dolphin
Energy Corporation (Buyer/Operator) and Apollo Energy LLC and
ATEC Energy Ventures, LLC (Seller/Non-Operator) dated February
22, 2005 (8)
- --------------------------------------------------------------------------------
10.11 Participation Agreement between Dolphin Energy Corporation and
Marc A. Bruner dated February 23, 2005 (8)
- --------------------------------------------------------------------------------
10.12 Securities Purchase Agreement dated March 1, 2005 between Galaxy
Energy Corporation and the Buyers named therein (8)
- --------------------------------------------------------------------------------
10.13 Form of Note (8)
- --------------------------------------------------------------------------------
10.14 Form of Common Stock Purchase Warrant (8)
- --------------------------------------------------------------------------------
10.15 Registration Rights Agreement dated March 1, 2005 between Galaxy
Energy Corporation and the Buyers named therein (8)
- --------------------------------------------------------------------------------
10.16 Subordination Agreement (8)
- --------------------------------------------------------------------------------
10.17 Amended Participation Agreement between Marc A. Bruner and
Dolphin Energy Corporation dated March 16, 2005 (9)
- --------------------------------------------------------------------------------
10.18 Second Amendment to Participation Agreement dated May 24, 2005
(10)
- --------------------------------------------------------------------------------
10.19 Securities Purchase Agreement dated May 31, 2005 between Galaxy
Energy Corporation and the Buyers named therein (11)
- --------------------------------------------------------------------------------
31
- --------------------------------------------------------------------------------
REGULATION
S-K NUMBER EXHIBIT
- --------------------------------------------------------------------------------
10.20 Form of Note (11)
- --------------------------------------------------------------------------------
10.21 Form of Qualifying Issuance Warrants (11)
- --------------------------------------------------------------------------------
10.22 Form of Repurchase Warrants (11)
- --------------------------------------------------------------------------------
10.23 Form of Registration Rights Agreement (11)
- --------------------------------------------------------------------------------
10.24 Form of First Amendment to Security Agreement, Pledge Agreement
and Guaranty (11)
- --------------------------------------------------------------------------------
10.25 Form of Mortgage Amendment (11)
- --------------------------------------------------------------------------------
10.26 Form of Waiver and Amendment to 2004 Notes and Warrants (12)
- --------------------------------------------------------------------------------
10.27 Form of Waiver and Amendment to March 2005 Notes and Warrants
(11)
- --------------------------------------------------------------------------------
10.28 Form of Conveyances of Overriding Royalty Interests (11)
- --------------------------------------------------------------------------------
10.29 Form of March 2005 Subordination Agreement (11)
- --------------------------------------------------------------------------------
10.30 Second Amendment to Lease Acquisition and Development Agreement
(13)
- --------------------------------------------------------------------------------
10.31 Third Amendment to Participation Agreement dated October 4, 2005
(14)
- --------------------------------------------------------------------------------
10.32 Waiver and Amendment dated December 1, 2005 between Galaxy
Energy Corporation and the investors named therein (15)
- --------------------------------------------------------------------------------
10.33 Securities Purchase Agreement dated April 25, 2006 between
Galaxy Energy Corporation and the Buyers named therein (16)
- --------------------------------------------------------------------------------
10.34 Form of Debenture (16)
- --------------------------------------------------------------------------------
10.35 Form of Warrant (16)
- --------------------------------------------------------------------------------
10.36 Form of Subordination Agreement (16)
- --------------------------------------------------------------------------------
10.37 Securities Purchase Agreement dated June 20, 2006 between Galaxy
Energy Corporation and the Buyers named therein (17)
- --------------------------------------------------------------------------------
10.38 Waiver and Agreement dated July 7, 2006 between Galaxy Energy
Corporation and the investors named therein (18)
- --------------------------------------------------------------------------------
10.39 Subordinated Unsecured Promissory Note dated September 28, 2006
to Bruner Family Trust UTD March 28, 2005 (19)
- --------------------------------------------------------------------------------
10.40 Subordination Agreement dated September 28, 2006 (19)
- --------------------------------------------------------------------------------
10.41 Subordinated Unsecured Promissory Note dated November 1, 2006 to
Bruner Family Trust UTD March 28, 2005 (20)
- --------------------------------------------------------------------------------
10.42 Subordination Agreement dated November 1, 2006 (20)
- --------------------------------------------------------------------------------
10.43 Subordinated Unsecured Promissory Note dated November 13, 2006
to Bruner Family Trust UTD March 28, 2005 (21)
- --------------------------------------------------------------------------------
32
- --------------------------------------------------------------------------------
REGULATION
S-K NUMBER EXHIBIT
- --------------------------------------------------------------------------------
10.44 Subordination Agreement dated November 13, 2006 (21)
- --------------------------------------------------------------------------------
10.45 November 2006 Waiver and Amendment Agreement dated November
29, 2006 among Galaxy Energy Corporation, its subsidiaries
and the investors named therein (22)
- --------------------------------------------------------------------------------
10.46 Registration Rights Agreement dated November 29, 2006 (22)
- --------------------------------------------------------------------------------
10.47 Subordinated Unsecured Promissory Note dated November 30, 2006
to Bruner Family Trust UTD March 28, 2005 (23)
- --------------------------------------------------------------------------------
10.48 Subordination Agreement dated November 30, 2006 (23)
- --------------------------------------------------------------------------------
10.49 Subordinated Unsecured Promissory Note dated February 1, 2007 to
Bruner Family Trust UTD March 28, 2005 (24)
- --------------------------------------------------------------------------------
10.50 Subordination Agreement dated February 1, 2007 (24)
- --------------------------------------------------------------------------------
10.51 Subordinated Unsecured Promissory Note dated February 26, 2007
to Bruner Family Trust UTD March 28, 2005 (25)
- --------------------------------------------------------------------------------
10.52 Subordination Agreement dated February 26, 2007 (25)
- --------------------------------------------------------------------------------
10.53 Combined Amendment to Lease Acquisition and Development
Agreements and to Participation Agreement (26)
- --------------------------------------------------------------------------------
10.54 Forbearance Agreement between Galaxy Energy Corporation and
Bruner Family Trust UTD March 28, 2005 dated effective
December 1, 2006 (27)
- --------------------------------------------------------------------------------
10.55 Subordinated Unsecured Promissory Note dated March 30, 2007 to
Bruner Family Trust UTD March 28, 2005 (28)
- --------------------------------------------------------------------------------
10.56 Subordination Agreement dated March 30, 2007 (28)
- --------------------------------------------------------------------------------
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
- --------------------------------------------------------------------------------
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
- --------------------------------------------------------------------------------
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of
Chief Executive Officer
- --------------------------------------------------------------------------------
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of
Chief Financial Officer
- --------------------------------------------------------------------------------
- -------------------------
(1) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated December 29, 2006, filed January 4, 2007, file
number 0-32237.
(2) Incorporated by reference to the exhibits to amendment no. 1 to the
registrant's current report on Form 8-K dated December 29, 2006, filed
March 1, 2007.
(3) Incorporated by reference to the exhibits to amendment no. 2 to the
registrant's current report on Form 8-K dated December 29, 2006, filed
April 2, 2007.
(4) Incorporated by reference to the exhibits to the registrant's
registration statement on Form 10-SB, file number 0-32237.
33
(5) Incorporated by reference to the exhibits to the registrant's quarterly
report on Form 10-QSB for the quarter ended May 31, 2003, file number
0-32237.
(6) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated October 22, 2004, filed October 26, 2004, file
number 0-32237.
(7) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated August 19, 2004, filed August 20, 2004, file
number 0-32237.
(8) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated March 1, 2005, filed March 4, 2005, file
number 0-32237.
(9) Incorporated by reference to the exhibits to amendment no. 1 to the
registrant's current report on Form 8-K dated March 1, 2005, filed
March 21, 2005.
(10) Incorporated by reference to the exhibits to amendment no. 2 to the
registrant's current report on Form
8-K dated March 1, 2005, filed May 26, 2005.
(11) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated May 31, 2005, filed June 1, 2005, file number
0-32237.
(12) Incorporated by reference to the exhibits to amendment no. 1 to the
registrant's current report on Form 8-K dated May 31, 2005, filed June
2, 2005, file number 0-32237.
(13) Incorporated by reference to the exhibits to amendment no. 3 to the
registrant's current report on Form 8-K dated March 1, 2005, filed June
2, 2005, file number 0-32237.
(14) Incorporated by reference to the exhibits to amendment no. 4 to the
registrant's current report on Form 8-K dated March 1, 2005, filed
October 6, 2005, file number 0-32237.
(15) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated December 1, 2005, filed December 2, 2005, file
number 0-32237.
(16) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated April 25, 2006, filed April 26, 2006, file
number 0-32237.
(17) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated June 20, 2006, filed June 26, 2006, file
number 0-32237.
(18) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated July 7, 2006, filed July 11, 2006, file number
0-32237.
(19) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated September 28, 2006, filed October 3, 2006,
file number 0-32237.
(20) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated November 1, 2006, filed November 2, 2006, file
number 0-32237.
(21) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated November 13, 2006, filed November 16, 2006,
file number 0-32237.
(22) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated November 29, 2006, filed November 30, 2006,
file number 0-32237.
(23) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated November 30, 2006, filed December 1, 2006,
file number 0-32237.
(24) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated February 1, 2007, filed February 1, 2007, file
number 0-32237.
(25) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated February 26, 2007, filed February 27, 2007,
file number 0-32237.
(26) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated March 12, 2007, filed March 14, 2007, file
number 0-32237.
(27) Incorporated by reference to the exhibit to the registrant's annual
report on Form 10-K for the fiscal year ended November 30, 2006, filed
March 15, 2007, file number 0-32237.
(28) Incorporated by reference to the exhibit to the registrant's current
report on Form 8-K dated March 30, 2007, filed April 2, 2007, file
number 0-32237.
34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GALAXY ENERGY CORPORATION
April 16, 2007 By: /s/ CHRISTOPHER S. HARDESTY
---------------------------------------
Christopher S. Hardesty
Chief Financial Officer
35