United States
Securities And Exchange Commission
Washington, D.C. 20549
-----------------
Form 10-QSB
-----------------
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
Commission File Number: 000-33321
FELLOWS ENERGY LTD.
------------------
(Exact Name of Small Business Issuer as Specified in its Charter
Nevada 33-0967648
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
370 Interlocken Boulevard, Suite 400
Broomfield, Colorado 80021
(Address of Principal Executive Offices)
(303) 327-1525
(Registrant's Telephone Number, Including Area Code)
-----------------
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [ x ]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: As of November 8, 2005 there were
47,878,806 shares of the issuer's $.001 par value common stock issued and
outstanding.
Transitional Small Business Disclosure Format: |_| Yes |X| No
FELLOWS ENERGY LTD.
Quarterly Report on Form 10-QSB for the
Quarterly Period Ending September 30, 2005
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets:
September 30, 2005 (Unaudited) 3
Statements of Operations:
Three and Nine Months Ended September 30, 2005 and 2004 (Unaudited) 4
Statements of Cash Flows:
Nine Months Ended September 30, 2005 and 2004 (Unaudited) 5
Notes to Unaudited Financial Statements:
September 30, 2005 6-12
Item 2. Management Discussion and Analysis 13
Item 3. Controls and Procedures 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 23
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits 24
Signatures 25
2
Part I: Financial Information
Item 1. Financial Statements
Fellows Energy Ltd.
Balance Sheet
(Unaudited)
September 30,
2005
-----------------
Assets
Cash and Cash Equivalents $ 2,560,489
Marketable securities, available-for-sale 364,347
Accounts Receivable 1,976
Interest Receivable 179
Prepaid Expenses 15,000
-----------------
Total current assets 2,941,991
Unproved oil & gas property 5,213,912
Equipment, net of $12,014 accumulated depreciation 52,321
Deposits 475,500
Restricted cash 235,000
Deferred debt issue costs 610,022
Total assets $ 9,558,746
=================
Liabilities And Stockholders' Equity
Accounts payable $ 341,474
-----------------
Total current liabilities 341,474
Convertible debenture 6,145,599
Stockholders' equity:
Preferred stock, $.001 par value; 25,000,000 shares
authorized; none outstanding --
Common stock, $.001 par value; 100,000,000 shares
authorized; 47,878,806 shares issued and outstanding 47,878
Additional paid-in capital 7,980,602
Accumulated deficit (4,961,259)
Accumulated other comprehensive income 4,452
-----------------
Total stockholders' equity 3,071,673
-----------------
Total liabilities and stockholders' equity $ 9,558,746
=================
See accompanying notes to financial statements
3
Fellows Energy Ltd.
Statements of Operations
(Unaudited)
Nine Months Ended Three Months Ended
September 30, September 30,
-----------------------------------------------------------------
2005 2004 2005 2004
-----------------------------------------------------------------
Revenue $ -- $ -- $ -- $ --
Operating expense
Exploration 904,400 120,591 40,507 57,357
General and administrative 1,770,587 472,944 812,909 198,626
--------------- ------------- ------------ -----------
Operating (loss) (2,674,987) (593,535) (853,416) (255,983)
Other income (expense) (9,795) -- (4,142) --
Interest expense (175,184) (56,518) (45,870) (34,989)
Gain on Sale of Property 1,442,674 -- -- --
Gain on extinguishment of debt 383,531 -- -- --
--------------- ------------- ------------ -----------
Loss before income tax (1,033,761) (650,053) (1,503,428) (290,972)
Income tax expense -- -- -- --
Deferred tax benefit -- -- -- --
--------------- ------------- ------------ -----------
Net Loss $ (1,033,761) $ (650,053) $ (1,503,428) $ (290,972)
=============== ============== ============== ==============
Other comprehensive income (loss)
Unrealized holding gains on marketable securities 4,452 -- 4,452 --
Comprehensive Loss $ (1,029,309) (650,053) $ (1,498,876) (290,972)
Basic earnings (loss) per share $ (0.02) $ (0.02) $ (0.03) $ (0.01)
=============== ============== ============== ==============
Basic weighted average shares outstanding 45,632,281 42,169,938 47,523,716 41,493,150
=============== ============== ============== ==============
Diluted earnings (loss) per share (0.01) (0.02) (0.02) (0.01)
Diluted weighted average shares outstanding 71,700,527 42,169,938 73,591,962 41,493,150
=============== ============== ============== ==============
See accompanying notes to financial statements
4
Fellows Energy Ltd.
Cash Flow Statement
(Unaudited)
Nine Months Ended September 30,
2005 2004
------------------------------
Cash flow from operating activities:
Net income (loss) $ (1,033,761) $ (650,053)
Adjustments to reconcile net income to net cash used in operating activities:
Loss on sale of marketable securities 183 --
Gain on sale of unproved oil and gas property (1,442,674) --
Gain from extinguishment of debt (383,531) --
Debt issue costs and discount amortization 361,835 --
Depreciation 6,987 1,100
Expenses paid with stock issuance 264,500 --
Interest paid with stock issuance 44,711 --
Changes in operating assets and liabilities:
Receivables (2,155) --
Prepaid expense (15,000) --
Deferred debt issue costs (610,022) --
Accounts payable (92,937) 449,005
-------------- --------------
Net cash provided by (used in) operating activities (2,901,864) (199,948)
-------------- --------------
Cash flow from investing activities:
Purchase of marketable securities (360,000) --
Deposits (475,500) --
Proceeds on sale of oil and gas property 1,930,083 --
Unproved oil and gas property additions (1,412,673) (5,257,617)
Restricted Cash (100,000) (135,000)
Purchase of equipment (42,745) --
-------------- --------------
Net cash provided by (used in) investing activities (460,835) (5,392,617)
-------------- --------------
Cash flow from financing activities:
Proceeds from issuance of convertible debenture 6,024,633 1,000,000
Issuance of common stock 922,376 3,698,092
Borrowings on note payable 80,000 625,000
Payments on notes payable (1,252,848) --
-------------- --------------
Net cash provided by financing activities: 5,774,161 5,323,092
-------------- --------------
Net increase in cash and equivalents 2,411,462 (269,473)
-------------- --------------
Cash and equivalents at beginning of period 149,027 291,445
Cash and equivalents at end of period $ 2,560,489 $ 21,972
============== ==============
Supplemental Disclosure of Cash Flow and Non-cash Investing and Financing
Activity:
Income tax paid $ --- $ --
Interest paid $ 81,750 $ --
Non cash:
Conversion of $350,000 convertible note into common stock $ 394,711 $ --
Acquisition of oil & gas interest in exchange for common stock $ 600,000 $ --
See accompanying notes to financial statements
5
Fellows Energy Ltd.
Notes to Unaudited Financial Statements
September 30, 2005
Note 1 -Basis of Presentation and Nature of Operations
We have prepared the accompanying unaudited condensed financial statements in
accordance with accounting principles generally accepted in the United States
for interim financial information. They do not include all information and notes
required by generally accepted accounting principles for complete financial
statements. You should read these financial statements with our Annual Report on
Form 10-KSB for the year ended December 31, 2004, as well as the 10-QSB for the
quarters ended March, 31, 2005 and June 30, 2005. In our opinion, we have
included all adjustments (consisting of normal recurring adjustments) considered
necessary for a fair presentation. Operating results for the quarters presented
are not necessarily indicative of the results that you may expect for the full
year.
We are engaged in the exploration, extraction, processing and reclamation of
coal bed methane, natural gas, and oil projects in the western United States. We
were incorporated in the state of Nevada on April 9, 2001 as Fuel Centers, Inc.
On November 12, 2003, we changed our name to Fellows Energy Ltd. Our principal
offices are located in Broomfield, Colorado.
Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income reflects changes in equity that result
from transactions and economic events from non-operating sources. For the
Company, such items consisted of unrealized holding gains and losses on market
securities for the current period.
Earnings (Loss) per share
We compute basic and diluted earnings (loss) per share as net income or loss
divided by the weighted average number of shares of common stock outstanding for
the period. Diluted earnings per share is similar to basic earnings per share
but also presents the dilutive effect on a per share basis of securities
convertible into common shares (e.g. stock options, warrants and other
convertible securities) as if they had been converted at the beginning of the
periods presented. In periods in which we incur losses we exclude potential
shares from convertible securities from the computation of diluted loss per
share as their effect is antidilutive in those periods.
Stock Options
We account for stock options to employees in accordance with Accounting
Principles Board Opinion No. 25 ("APB 25"), Accounting for Stock Issued to
Employees, and related interpretations. Pursuant to APB No. 25, we record no
compensation expense to employees on the date of grant because in issuing the
grants we set the exercise price of the underlying stock at or above the market
value of the stock on the date of the grant. Stock options granted to
consultants are accounted for under the fair value method, in accordance with
Statement of Financial Accounting Standards No. 123 (Statement 123), Accounting
for Stock-Based Compensation.
Statement 123 and Statement 148, Accounting for Stock-Based Compensation
Transition and Disclosure, require disclosure of pro forma information regarding
net income and earnings per share. The Statements require that the information
be determined as if we had accounted for employee stock options under the fair
value method of the statements. We estimate the fair value of the options we
grant at the date of grant using a Black-Scholes option pricing model with the
following weighted-average assumptions for the quarter ended September 30, 2005:
a risk-free interest rate of 3%; no expected dividend; a volatility factor of
30.4%; and a maturity date of ten years.
6
For purposes of pro forma disclosures, we amortize to expense the estimated fair
value of the options over the options' vesting period. Our pro forma information
for the third quarter of 2005 is as follows (in thousands, except per share
amounts).
Nine Months Nine Months
Ended Ended
September 30, September
2005 30, 2004
-----------------------------------
Net Income (loss) as reported $ (1,029,309) $ (650,053)
Deduct: Total stock based employee compensation expense
determined under fair value based method for all awards (51,100) --
---------------- -----------------
Pro forma net income (loss) $ (1,080,409) $ (650,053)
================ =================
Basic and diluted earnings per share--as reported $ -nil- $ -nil-
================ =================
Pro forma basic and diluted gain per share $ -nil- $ -nil-
================ =================
The Black-Scholes option-pricing model was developed for use in estimating the
fair value of traded options that have no vesting restrictions, are fully
transferable, and are not subject to trading restrictions or blackout periods.
In addition, option valuation models require the input of highly subjective
assumptions, including the expected stock price volatility. Because our employee
stock options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, it is our opinion that the existing models do
not necessarily provide a reliable single measure of the fair value of our
employee stock options.
In December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 123(R) (Statement 123(R)), Accounting for
Stock-Based Compensation. Statement 123(R) establishes standards for the
accounting for transactions in which an entity exchanges its equity instruments
for goods or services. This statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. Statement 123(R) requires that the fair value of such equity
instruments be recognized as an expense in the historical financial statements
as services are performed. Prior to Statement 123(R), only certain pro forma
disclosures of fair value were required. The provisions of this statement are
effective at the beginning of the next fiscal year. Accordingly, we will adopt
Statement 123(R) commencing with the quarter ending March 31, 2006. We believe
the adoption of Statement 123(R) may have a material effect on our results of
operations.
Reclassifications
We have made certain reclassifications to the 2004 financial statements to
conform with the 2005 financial statement presentation.
Note 2 - Going Concern
As shown in the accompanying financial statements, we have incurred significant
operating losses since inception. From the inception of our oil and gas
exploration business, we have not produced or sold any hydrocarbons. As of
September 30, 2005 we have strengthened our financial resources. However, our
ability to maintain profitability and positive cash flow is dependent upon our
ability to exploit our mineral holdings, generate revenue from our planned
business operations and control our exploration cost. We continue to seek
additional financing. Should we not obtain adequate financing we may not be able
to continue operations at our current scope of activity.
7
Note 3--Sale of Oil and Gas Property
In February 2005 we agreed to sell the Circus project for $1.98 million to an
unrelated third party. We have received the full $1.98 million of the proceeds
from the sale. We acquired the leases in October, 2004, with a total cost
through the sale of $487,000. Additionally, we incurred $53,000 of closing cost
on the sale.
Note 4--Deposits
In July and August 2005, we entered into three separate agreements to option the
acquisition interests in one producing and two exploration oil and gas
properties. In connection with those options, we made deposits totaling
$475,500, to negotiate and close acquisition agreements. One project known as
the Carbon County project is currently producing and selling 30 million cubic
feet of natural gas per month. The company has placed 300,000 on deposit to hold
the property, 30,000 of which became non-refundable as of September 30, 2005. We
expect to close on the project on or before November 30, 2005. We made deposits
of $66,000, $65,000 and $44,500 on other projects for which we are negotiating.
All the funds are fully refundable.
Note 5--Marketable Securities
The Company determines the appropriate classification of its investments in debt
and equity securities at the time of purchase and reevaluates such
determinations at each balance-sheet date. Debt securities are classified as
held-to-maturity when the Company has the positive intent and ability to hold
the securities to maturity. Debt securities for which the Company does not have
the intent or ability to hold to maturity are classified as available-for-sale.
Held-to-maturity securities are recorded as either short-term or long-term on
the Balance Sheet based on contractual maturity date and are stated at amortized
cost. Marketable securities that are bought and held principally for the purpose
of selling them in the near term are classified as trading securities and are
reported at fair value, with unrealized gains and losses recognized in earnings.
Debt and marketable equity securities not classified as held-to-maturity or as
trading, as classified as available-for-sale, and are carried at fair market
value, with the unrealized gains and losses included in the determination of
comprehensive income and reported in stockholders' equity.
The fair value of substantially all securities is determined by quoted market
prices. The estimated fair value of securities for which there are no quoted
market prices is based on similar types of securities that are traded in the
market.
Note 6--Note Payable
In February 2005 we paid $750,000 principal of the 18% $1,500,000 note payable
to JMG Exploration, Inc., plus accrued interest of $82,000. The remaining
$750,000 was due on April 30, 2005.
In May 2005, we assigned our remaining 50% interest in the Gordon Creek and
Weston County properties to JMG as full payment of the unpaid principal and
accrued interest on the note. As part of the settlement agreement, JMG's
commitment to spend $2,000,000 in exploration and drilling activity on the two
projects by November 7, 2005 was terminated and JMG granted us the option to
re-acquire our 50% ownership by June 30, 2005 for the amount of $391,000. We
exercised this option in June 2005. Under this transaction, the Company removed
itself from the liability of the note payable, and re-acquired the 50% ownership
in the Gordon Creek and Weston County properties for $391,000. In connection
with this transaction, we recorded a gain from extinguishment of debt of
$383,531.
Note 7--Related Party Transactions
At March 31, 2005 we owed $35,000 on an unsecured, 8% demand note payable to an
entity controlled by our CEO. During the quarter ending June 30, 2005, we
borrowed $379,000 and paid down principal of $414,000 on the note, resulting in
the paying off of the remaining balance owed plus interest of $500.
8
Note 8--Common Stock
In April 2005 we issued 2,999,265 shares of common stock for the following stock
issuance obligations:
o 200,000 shares of common stock to Quaneco, LLC pursuant to a March 16, 2004
agreement;
o 50,000 shares of common stock to a business consultant pursuant to an
August 1, 2004 agreement;
o 150,000 shares of common stock to a business consultant pursuant to a
November 8, 2004 agreement;
o 100,000 shares of common stock to a business advisor pursuant to a January
10, 2005 agreement;
o 50,000 shares of common stock to a business consultant pursuant to a
February 1, 2005 agreement;
o 2,449,265 shares of common stock on conversion of the 8% $350,000
convertible note issued September 9, 2003.
In April 2005, we issued 1,000,000 shares of common stock to Quaneco, LLC
pursuant to a March 1, 2005 agreement as part of the consideration for the
acquisition of the Kirby and Castle Rock projects. In accordance with the final
purchase agreement, we have valued these shares at $0.60 per share. See Note 8.
On May 18, 2005, we closed on the private placement of $1,064,000 of securities.
We incurred an estimated $141,000 of fees and cost, netting approximately
$922,000. We sold 1,936,391 shares of common stock and 818,192 warrants. Each
warrant entitles the holder to purchase one share of common stock for $1.00
until May 18, 2008. We also issued 81,819 of the same warrants to the placement
agent as additional compensation. We have agreed to register the resale of the
shares sold and the shares underlying the warrants with the U.S. Securities and
Exchange Commission.
In June 2005, we issued a total of 200,000 shares of common stock in connection
with agreements with a financial consultant.
Durig the third quarter ending September 30, 2005, we issued no new or
additional shares of common stock.
Note 9--Convertible Debentures
On June 17, 2005, we closed a financing pursuant to a securities purchase
agreement with three accredited investors for the issuance of $5,501,200 in face
amount of debentures maturing at the end of the 27th month from the date of
issuance, and three year warrants to purchase common stock of the company. The
debentures bear no interest and the investors paid $3,849,685, after discounts
of $1,651,515, for the debentures. A commission of 9% on the $3.85 million was
paid in connection with the transaction, and we paid $100,000 in legal fees,
resulting in net proceeds to the company of $3,403,267. The debentures are
unsecured and we are obligated to pay 1/24th of the face amount of the debenture
on the first of every month, starting October 1, 2005, which payment can be made
in cash or in common stock. We may pay this amortization payment in cash or in
stock at the lower of $0.60 per share (the Set Price) or 80% of the volume
weighted average price of the stock for the five trading days prior to the
repayment date. In the event that we make the payment in cash, we shall pay 110%
of the monthly redemption amount. At any time after 90 days from the date that a
registration statement registering the shares of common stock underlying the
debentures and warrants is declared effective (the Effective Date), and if
certain conditions are met, we have the right to redeem some or all of the
debentures in a cash amount equal to 110% of the face amount of the debentures
being redeemed. At any time, the debentures are convertible into common stock at
the Set Price.
We issued warrants to the investors, expiring June 17, 2008, to purchase
4,584,334 shares of restricted common stock, exercisable at a per share of
$0.649. In addition, the exercise price of the warrants will be adjusted in the
event we issue common stock at a price below the exercise price, with the
exception of any securities issued pursuant to a stock or option plan adopted by
our board of directors, issued in connection with the debentures issued pursuant
to the securities purchase agreement, or securities issued in connection with
acquisitions or strategic transactions. Upon an issuance of shares of common
stock below the exercise price, the exercise price of the warrants will be
reduced to equal the share price at which the additional securities were issued
and the number of warrant shares issuable will be increased such that the
aggregate exercise price payable for the warrants, after taking into account the
decrease in the exercise price, shall be equal to the aggregate exercise price
prior to such adjustment.
9
Warrants to purchase 250,000 shares, at the same price and for the same term as
the warrants issued to the investors, have been issued to HPC Capital Management
as additional compensation for its services in connection with the transaction
with the investors.
In addition to the $1,651,515 cash discount, we also recorded a discount of
$626,042 based on a Black-Scholes model valuation of the 4,584,334 warrants
issued to the debenture holders and the 250,000 warrants issued to HPC Capital
Management.
On September 21, 2005, we closed a financing pursuant to a securities purchase
agreement with two accredited investors for the issuance of $3,108,000 in face
amount of debentures maturing December 21, 2008, and three year warrants to
purchase common stock of the company. The debentures do not accrue interest and
the investors paid $2,174,947.52 for the debentures. A commission of 8% on
$2,000,000 raised was paid to in connection with the transaction, and we placed
$50,000 in escrow for the payment of future legal fees, resulting in net
proceeds to the company of $1,964,947.52 before $39,000 in associated current
legal fees. Net proceeds will be used for general working capital. The
debentures are unsecured and we are obligated to pay 1/24th of the face amount
of the debenture on the first of every month, starting January 1, 2006, which
payment can be made in cash or in restricted common stock. We may pay this
amortization payment in cash or in stock at the lower of $0.75 per share (the
Set Price) or 80% of the volume weighted average price of the stock for the five
trading days prior to the repayment date, provided that there is an effective
registration statement and the monthly conversion price is greater of than
$0.60. In the event that we make the payment in cash, we shall pay 110% of the
monthly redemption amount. At any time after 90 days from the date that a
registration statement registering the shares of common stock underlying the
debentures and warrants is declared effective (the Effective Date), and if
certain conditions are met, we have the right to redeem some or all of the
debentures in a cash amount equal to 110% of the face amount of the debentures
being redeemed. At any time, the debentures are convertible to restricted common
stock at the Set Price.
We issued warrants to the investors, expiring September 21, 2008, to purchase
2,072,000 shares of restricted common stock, at a price per share of $0.80. The
number of shares underlying the warrants equals 50% of the shares issuable on
full conversion of the debentures at the set price (as if the debentures were so
converted on September 21, 2005). In addition, the exercise price of the
warrants will be adjusted in the event we issue common stock at a price below
the exercise price, with the exception of any securities issued pursuant to a
stock or option plan adopted by our board of directors, issued in connection
with the debentures issued pursuant to the securities purchase agreement, or
securities issued in connection with acquisitions or strategic transactions.
Upon an issuance of shares of common stock below the exercise price, the
exercise price of the warrants will be reduced to equal the share price at which
the additional securities were issued and the number of warrant shares issuable
will be increased such that the aggregate exercise price payable for the
warrants, after taking into account the decrease in the exercise price, shall be
equal to the aggregate exercise price prior to such adjustment.
Warrants to purchase 100,000 shares, at the same price and for the same term as
the warrants issued to the investors, have been issued to HPC Capital Management
as additional compensation for its services in connection with the transaction
with the investors.
In addition to the $933,052 cash discount, we also recorded a discount of
$614,905 based on a Black-Scholes model valuation of the 2,072,000 warrants
issued to the debenture holders and the 100,000 warrants issued to HPC Capital
Management.
Note 10--Unproved Oil and Gas Property
On April 14, 2005, we entered into a letter of intent to purchase the John's
Valley project, and we are under continuing negotiations to purchase the project
or an interest in the project through an earn-in arrangement. We have made a
payment of $300,000 toward the purchase. We are currently in negotiations to
enter into an industry standard earn-in agreement on the project.
On May 2, 2005, we entered into two option agreements with Thomasson Partner
Associates, Inc. to participate in the Platte and Badger projects located in
Garden and Keith Counties, Nebraska, and Stanley and Hughes Counties, South
Dakota. Under the agreements, the initial project fee is $100,000 for the Platte
project and $150,000 for the Badger project. Upon execution of definitive
agreements we have paid Thomasson $80,000 for Platte, and $105,000 for Badger.
This is made up of half of the initial project fees plus reimbursement of Land
Sat cost of $30,000 each. In addition, there will be additional cost for a
GeoChem survey on Platte and an air photo study on Badger for the amounts of
$13,000 and $12,000 respectively. The geochemical survey and analysis has
commenced on the Platte project in preparation for target delineation. We have
made payments toward the total cost of these projects due to Thomasson by paying
$50,000 for Platte and $75,000 for Badger. The total cost of these projects is
$143,000 and $217,000 respectively.
10
In March 2005 we agreed, subject to customary closing conditions, with Quaneco
to acquire a 12.5% working interest in the Kirby and Castle Rock Coal Bed
Methane projects for $3,850,000 in cash and one million dollars worth of shares
of restricted common stock. In April 2005 we issued Quaneco, 1,000,000 shares of
our common stock in connection with this agreement. On June 23, 2005, we entered
into a definitive purchase agreement with Quaneco and paid $500,000 toward the
purchase, which vests in us a pro rata portion of the 12.5% interest, and we had
until September 1, 2005 to pay additional amounts of the purchase price and vest
in additional amounts. During the quarter ending September 30, 2005, we
negotiated with Quaneco for an extension of the time to make payments, but have
not yet finalized any extension. Under the terms of the agreement, we will
participate in a 48 well drilling program during 2005 on the Kirby project that
will extend out from an existing 16 well pilot program of previously drilled
wells. The other working interest owners in the Kirby project include Quaneco
(25.0%), Pinnacle Gas Resources (50%) and Galaxy Energy Corporation (12.5%).
Operations continue on the dewatering and discharge of water from the first 16
wells drilled on the Kirby project. The construction of the pipeline to service
the project is nearing completion. The water treatment plant is completed and
under operation. We believe that production is imminent from the first 16 wells,
while the drilling of the next 48 wells on Kirby is underway, and permits have
been applied for for the drilling on the first 48 wells on Castle Rock.
On September 12, 2005, we entered into an agreement to purchase a gas field
in Carbon County, Utah (the "Carbon County Project") currently producing
approximately 30 million cubic feet of natural gas per month. The field
comprises 5,953 gross acres (4,879 net acres) with three gas wells currently
producing and has an additional six wells drilled that are presently shut-in.
Production is derived from the Ferron Sandstone formation, and the gas is
marketed into the adjacent gas pipeline operated by Questar Gas Resources. The
field has potential for 20 additional well sites on 160 acre spacing on the
undeveloped acreage. The property is adjacent to our Gordon Creek project and to
the successful Drunkards Wash field originally developed by River Gas Corp. The
closing of the purchase agreement is subject to numerous terms and conditions,
including technical and legal due diligence which we are in the process of
completing, and anticipate closing the acquisition by the end of November. A
favorable engineering study has been completed by Sproule & Associates verifying
the proven, developed producing reserves and undeveloped reserves.
On October 25, 2005, the Company announced that it had entered into a
participation agreement with Mountain Oil and Gas, Inc., Creston Resources Ltd,
and Homeland Gas and Oil Ltd. (collectively "Creston"), and is completing
arrangements with private investors, whereby the Company will supply operating
expertise and program supervision to earn working interests in up to 45
producing oil wells in the Uintah Basin of Utah. The Company will immediately
commence a rework program to re-complete previously-completed zones and extend
behind pipe reserves in the wells, located primarily in the prolific
Altamont-Bluebell Field, which has produced over 350 million barrels of oil
equivalent. Creston will retain the current or historical production while
Fellows and the private investors will earn a variable percentage of the
production increase resulting from the reworking operations. Work is scheduled
to begin on the first four wells immediately, maintaining continuous operations
until all wells have been brought to full potential.
Under the participation agreement, Fellows will begin reworking wells as
necessary to revitalize production across the 9,000 acres that pertain to the
wells. Due to the over-pressured, fractured nature of reservoir in the field, as
well as the large vertical extent of potential pay zones, many of the wells have
formation damage resulting from high drilling mud weights and cementing
operations. These conditions have left many zones unable to produce to their
potential. Fellows will employ a variety of conventional and innovative
proprietary techniques to reduce the effects of formation damage and increase
oil and gas recovery.
In mid-2004 we drilled the 10-33C2 well on the Johns Valley Project in Utah
to its planned depth of 1,365 feet. We drilled through a potentially productive
coal seam. We cored the well and have sent the core to a lab for evaluation. We
have expensed the cost of this well as exploration expense. On April 14, 2005,
we entered into a letter of intent to purchase the project, and we are under
continuing negotiations to purchase the project or an interest in the project
through an earn-in arrangement.
11
On August 12, 2005 we entered into a Purchase and Option Agreement with
Western States Molybdenum Company ("Western States") for the purchase of all of
its interests in oil and gas properties in Southern Utah. In the event we make
the purchase, the negotiated price in $100,000, net of deposits previously made.
We have through December 31, 2005 to exercise the option.
The last four agreements described above are the result of negotiations
that took place during the quarter and were the subject of the $300,000,
$66,000, $65,000 and $44,500 refundable deposits, respectively, described in
Note 4 - Deposits.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
This report includes certain forward-looking statements. Forward-looking
statements are statements that predict the occurrence of future events and are
not based on historical fact. Forward-looking statements may be identified by
the use of forward-looking terminology, such as "may", "shall", "will", "could",
"expect", "estimate", "anticipate", "predict", "probable", "possible", "should",
"continue", or similar terms, variations of those terms or the negative of those
terms. We have written the forward-looking statements specified in the following
information on the basis of assumptions we consider to be reasonable. However,
we cannot predict our future operating results. Any representation, guarantee,
or warranty should not be inferred from those forward-looking statements.
The assumptions we used for purposes of the forward-looking statements
specified in the following information represent estimates of future events and
are subject to uncertainty in economic, legislative, industry, and other
circumstances. As a result, judgment must be exercised in the identification and
interpretation of data and other information and in their use in developing and
selecting assumptions from and among reasonable alternatives. To the extent that
the assumed events do not occur, the outcome may vary substantially from
anticipated or projected results. Accordingly we express no opinion on the
achievability of those forward-looking statements. We cannot guarantee that any
of the assumptions relating to the forward-looking statements specified in the
following information are accurate. We assume no obligation to update any such
forward-looking statements.
Overview
On January 5, 2004, we began operations as an oil and gas exploration
company. We acquired interests in certain assets owned by Diamond Oil & Gas
Corporation, in exchange for 3,500,000 shares of common stock. The assets
included certain oil and gas projects, as well as the right to enter into the
Exploration Services Funding Agreement with Thomasson Partner Associates, Inc.
of Denver, Colorado. Diamond is controlled by our CEO, George S. Young. The
operations we plan for 2005 include exploring leases we have acquired as well as
seeking to acquire and explore additional property. Our goal is to discover
substantial commercial quantities of oil and gas, including coalbed methane, on
the properties.
In February 2005 we amended our Exploration Services Agreement with
Thomasson Partner Associates. Thomasson Partner Associates provides large-scale
exploration opportunities to the oil and gas industry. By this agreement
Thomasson Partner Associates provides to us the first right to review and
purchase up to a 50% interest (as amended, a 100% interest beginning in February
2005) in oil and natural gas exploration projects developed by Thomasson Partner
Associates. Under the agreement, in 2005, Thomasson Partner Associates will
present to us a minimum of eight project opportunities with the reasonable
potential of at least 200 Bcf of natural gas reserves or 20 million barrels of
oil reserves. We have the first right to review exploration projects developed
by Thomasson Partner Associates and, after viewing a formal presentation
regarding a project, we have a period of thirty days in which to acquire up to
100% of the project. We are not obligated to acquire any project. In
consideration, in 2004 we paid to Thomasson Partner Associates a $400,000
overhead fee, and will pay an $800,000 fee in 2005. We also pay a fee for each
project we acquire from Thomasson Partner Associates. The agreement continues
year to year until either party gives 90 days written notice of termination.
Projects acquired from Thomasson Partner Associates include the Weston County
project in Wyoming, the Gordon Creek project in Utah, the Carter Creek project
in Wyoming, the Circus project in Montana and the Bacaroo project in Colorado.
In 2004 we incurred charges from Thomasson Partner Associates totaling
$1,255,000, including the $400,000 overhead fee.
Operations Plans
During the next twelve months, we expect to pursue oil and gas operations
on some or all of our property, including the acquisition of additional acreage
through leasing, farmout or option and participation in the drilling of oil and
gas wells. We intend to continue to evaluate additional opportunities in areas
where we feel there is potential for oil and gas reserves and production and may
participate in areas other than those already identified, although we cannot
assure that additional opportunities will be available, or if we participate in
additional opportunities, that those opportunities will be successful.
13
Our current cash position is not sufficient to fund our cash requirements
during the next twelve months, including operations and capital expenditures. We
intend to continue equity and/or debt financing efforts to support our current
and proposed oil and gas operations and capital expenditures. We may sell
interests in our properties. We cannot assure that continued funding will be
available.
We have not entered into commodity swap arrangements or hedging
transactions. Although we have no current plans to do so, we may enter into
commodity swap and/or hedging transactions in the future in conjunction with oil
and gas production. We have no off-balance sheet arrangements.
Our future financial results continue to depend primarily on (1) our
ability to discover or purchase commercial quantities of oil and gas; (2) the
market price for oil and gas; (3) our ability to continue to source and screen
potential projects; and (4) our ability to fully implement our exploration and
development program with respect to these and other matters. We cannot assure
that we will be successful in any of these activities or that the prices of oil
and gas prevailing at the time of production will be at a level allowing for
profitable production.
Recent Activity
In February 2005 we agreed to sell the Circus project for $1.98 million to
an unrelated third party. We completed the sale in June 2005. We acquired the
leases in October 2004, with a total cost through the sale of $487,000.
Additionally, we incurred $53,000 of closing cost on the sale.
In February 2005 we extended our agreement with a financial consultant and
are obligated to issue an additional 50,000 shares to the consultant for
compensation for his services, as well as a monthly fee of $7,500 for three
months through April 2005. In April 2005, we further extended our agreement with
the financial consultant through October 2005 on the same terms as the prior
extension.
In March 2005 we agreed, subject to customary closing conditions, with
Quaneco L.L.C. to acquire up to a 12.5% working interest in the Kirby and Castle
Rock Coal Bed Natural Gas projects for $3,850,000 in cash and one million
dollars worth of shares of restricted common stock. Under the terms of the
agreement, we will participate in a 48-well drilling program during 2005 on the
Kirby project that will extend out from an existing 16-well pilot program of
previously drilled wells. The other working interest owners in the Kirby project
include Quaneco (25.0%), Pinnacle Gas Resources (50%) and Galaxy Energy
Corporation (12.5%). We are currently seeking financing to fund our
participation in this project.
On May 2, 2005, we entered into two option agreements with Thomasson
Partner Associates to participate in the Platte and Badger projects located in
Garden and Keith Counties, Nebraska, and Stanley and Hughes Counties, South
Dakota, respectively. Under the agreements, the initial project fee is $100,000
for the Platte project and $150,000 for the Badger project. Upon execution of
definitive agreements we paid Thomasson Partner Associates $80,000 for Platte,
and $105,000 for Badger. This amount represents approximately of the initial
project fees plus reimbursement of Land Sat cost of $30,000 each. In addition,
there will be additional costs for a GeoChem survey on Platte and an air photo
study on Badger for the amounts of $13,000 and $12,000, respectively. The total
cost of these projects is $143,000 and $217,000 respectively.
On May 18, 2005, we closed on $1,063,650 in equity financing and issued
approximately 545,461 units, at a price of $1.95 per unit, each unit consisting
of 3.55 shares of our common stock, and one and one-half Series A warrants to
purchase our common stock. The units were sold to a limited number of accredited
investors through a private placement memorandum and were exempt from
registration under the Securities Act, pursuant to Section 4(2) of the
Securities Act. We also agreed to pay the following to a placement agent: (1) a
placement fee equal to 10% of the gross proceeds received from sales to certain
investors identified by the placement agent; (2) a warrant or warrants,
identical to the warrants contained in the units, equal to 15% of the number of
units issued to certain investors identified by the placement agent, and (3) a
non-accountable expense allowance of 3% of the aggregate gross proceeds of the
private placement.
14
Each whole warrant entitles the holder to purchase one share of our common
stock for a price of $1.00 per share for three years from the date of purchase
of the unit. The warrants also contain limited anti-dilution rights. The
warrants are subject to adjustment in the event of (1) any subdivision or
combination of our outstanding common stock or (2) any distribution by us to
holders of common stock of (x) a stock dividend, or (y) assets (other than cash
dividends payable out of retained earnings) to holders of common stock. In
addition, until two years from the date the registration statement filed
pursuant to the Registration Rights Agreement is declared effective, and except
for certain issuances of our common stock including (A) pursuant to rights,
warrants, convertible securities or options outstanding on the date of issuance
of the warrants, (B) pursuant to the private placement, or (C) in other limited
circumstances, if and when we issue or sell any common stock (including rights,
warrants, convertible securities or options for its capital stock) for a
consideration per share less than the per share purchase price of such common
stock in the private placement, then we shall issue additional common stock to
the investors so that the average per share purchase price of the shares of
common stock issued to the investors (of only the common stock still owned by
such investors) is equal to such other lower price per share.
In June 2005, we paid off the balance on our $1,500,000 loan to JMG
Exploration, Inc., an affiliate of JED Oil, Inc., through the assignment of the
our 50% interest in the Weston County and Gordon Creek projects.
On the Kirby and Castle Rock projects, operations continue on the
dewatering and discharge of water from the first 16 wells drilled on the Kirby
project. The construction of the pipeline to service the project is nearing
completion. The water treatment plant is completed and under operation. We
believe that production is imminent from the first 16 wells, while the drilling
of the next 48 wells on Kirby is underway, and permits have been applied for for
the drilling on the first 48 wells on Castle Rock.
On September 12, 2005, we entered into an agreement to purchase a gas field
in Carbon County, Utah currently producing approximately 30 million cubic feet
of natural gas per month. The field comprises 5,953 gross acres (4,879 net
acres) with three gas wells currently producing and has an additional six wells
drilled that are presently shut-in. Production is derived from the Ferron
Sandstone formation, and the gas is marketed into the adjacent gas pipeline
operated by Questar Gas Resources. The field has potential for 20 additional
well sites on 160 acre spacing on the undeveloped acreage. The property is
adjacent to our Gordon Creek project and to the successful Drunkards Wash field
originally developed by River Gas Corp. The closing of the purchase agreement is
subject to numerous terms and conditions, including technical and legal due
diligence which we are in the process of completing, and anticipate closing the
acquisition by the end of November. A favorable engineering study has been
completed by Sproule & Associates verifying the proven, developed producing
reserves and undeveloped reserves.
We will use the experience of our personnel who participated in the
development of Drunkards Wash to increase current production and expand
production in both the Ferron Sandstone and in the underlying coal bed methane
seams that are not currently being exploited by the existing wells. We will
immediately undertake to increase production in the existing wells, complete
those wells in the coal for their coal bed methane potential, and thereafter
drill additional wells on the acreage being acquired.
Oil & Gas Projects
Weston County, Wyoming
In November 2004 we executed a joint venture agreement with JMG
Exploration, to drill our Weston County and Gordon Creek projects. Under the
agreement, JMG Exploration will receive a 50% interest in exchange for spending
$2,000,000 in exploration and drilling activity on the two projects by November
7, 2005. In addition, JMG Exploration loaned $1,500,000 to us with a short-term
note. In connection with repayment of the JMG Exploration loan, we have assigned
the remaining 50% interest in the Weston County project to JMG Exploration,
subject to our right to reacquire those interests for approximately $391,000 by
June 30, 2005, which right has been exercised. As part of the full settlement of
the $1,500,000 note, JMG Exploration's commitment to spend $2,000,000 in
exploration and drilling activity by November 7, 2005 has been terminated. In
connection with this transaction, we recorded a gain from extinguishment of debt
of $383,531.
15
The Weston County project is a 19,290-acre project on the east flank of the
Powder River Basin. The prospect is a potential extension of an existing
producing field. We are continuing our work and evaluation with JMG Exploration
on permitting and other pre-drilling activities. In addition, we are targeting
nearby locations with potential in the Minnelusa sandstone and Dakota channel
sandstone formations.
Gordon Creek, Utah
JMG Exploration will also drill on the 5,242-acre Gordon Creek project,
which we acquired from The Houston Exploration Company for $288,000. The Gordon
Creek project is in an area of known coal resources in Carbon County in eastern
Utah near other operating coal bed methane projects, such as the Drunkard's Wash
Project, which our project personnel successfully drilled previously for River
Gas Corporation.
Based on exploration results, JMG Exploration has indicated its intent to
sell a portion of its working interest to Enterra Energy Trust in an arrangement
under which JED Oil, Inc. under a development agreement with Enterra, will
complete any development programs on the projects. In connection with repayment
of the JMG Exploration loan, we have assigned the remaining 50% interest in the
Gordon Creek project to JMG Exploration, subject to our right to reacquire those
interests for approximately $390,000 by June 30, 2005, which right has been
exercised.
Carter Creek, Wyoming
In 2004 we purchased the 10,678-acre Carter Creek Project in the southern
Powder River Basin. We plan to commence drilling in the near future at the
project, in which we have a 100% working interest. Based on our analysis of the
geologic structure of this region, we anticipate productive sections in the
Cretaceous, Niobrara, Turner (Frontier) and Mowry layers, in that several
existing wells in the Carter Creek area currently produce oil.
Work continues to identify additional areas for leasing and drillsite
delineation. We will continue our evaluation and preparation for drilling the
fractured shales. It is likely that horizontal drilling methods will be
identified as an effective technique to tap into the potential of this field.
Overthrust, Utah and Wyoming
In 2004 we optioned the Overthrust project for a 65% working interest in
183,000 acres of oil, gas and coal bed methane leases in northeastern Utah and
southwestern Wyoming from Quaneco, an Oklahoma company. We plan to test the
three identified coal seams that run through much of the area. Previous drilling
has included seven exploratory wells that identified multiple coal seams of
Tertiary and Cretaceous age that appear to be prospective for coal bed methane.
Some of the coal is of similar age and depositional condition to other
productive coal bed methane fields.
We drilled our first well in the project in 2004, the Crane 6-7, in Rich
County, Utah. The well reached a total depth of 4280 feet. We cored coal and
carbonaceous shale over a combined interval of 556 feet. In September 2004 we
received the results from the gas desorption tests from the Spring Valley coal
of the Frontier formation and the coal in the Bear River formation in the well.
Results showed 253 cubic feet of gas per ton on an ash-free basis in the coal in
the well. Lesser amounts of gas were present in the carbonaceous shale in the
well. These tests corroborate earlier data that was generated by Quaneco, our
partner on the project, suggesting that coal in an area of the project that lies
a considerable distance north of the Crane 6-7 may contain between 200 and 400
cubic feet of gas per ton. We have expensed the cost of this well as exploration
expense, although we may choose to re-enter the well at a later date. The
overall results indicate the potential for coal in a much wider area to contain
economic levels of coal bed methane, and will help to further guide our ongoing
logging, geologic and drilling operations. We believe the Overthrust project has
attractive coal bed methane potential, although additional exploration activity
will be necessary to prove up gas reserves.
During the quarter ending September 30, 2005, we paid $275,000 to Quaneco
representing payment obligations on the project and have negotiated extensions
for various payment and work commitments in the future. We have progressed in
the geologic evaluation of many of the potentially productive coal seams, and
have delineated a number of areas for further work. Previous drilling activities
have also identified reservoir quality sand which we believe has significant
potential for conventional gas production if present in a favorable structural
position. We will now review seismic data covering the area to evaluate the
conventional gas potential simultaneously with our ongoing activities to pursue
the coal bed methane potential of the project. After evaluating the seismic data
and further evaluation of the logs from previous drilling, we will design and
implement the next drilling phase to target both conventional and coal bed
methane gas.
16
Bacaroo, Colorado
In 2004 we optioned the Bacaroo project in Colorado through our affiliation
with Thomasson Partner Associates. We believe the project is an opportunity to
establish conventional oil and gas production with comparatively inexpensive
drilling in areas of established production, while other projects being reviewed
offer longer term, larger potential exploration opportunities. We are acquiring
acreage in the prospect.
Leasing and seismic evaluation activities continue. One entire target area
is now under lease, and two additional areas are now undergoing leasing. We will
perform additional geologic evaluation and permitting work in preparation for
drilling in early 2006.
Kirby and Castle Rock Projects, Powder River Basin, Montana
In March 2005 we agreed, subject to customary closing conditions, with
Quaneco to acquire a 12.5% working interest in the Kirby and Castle Rock Coal
Bed Methane projects for $3,850,000 in cash and one million dollars worth of
shares of restricted common stock. We have paid $500,000 toward the purchase,
which vests in us a pro rata portion of the 12.5% interest, and we have until
September 1, 2005 to pay additional amounts of the purchase price and vest in
additional amounts. During the quarter ending September 30, 2005, we negotiated
with Quaneco for an extension of the time to make payments, but have not yet
finalized any extension. Under the terms of the agreement, we will participate
in a 48 well drilling program during 2005 on the Kirby project that will extend
out from an existing 16 well pilot program of previously drilled wells. We will
have ownership in the previously drilled wells, which are currently being
dewatered and are expected to commence production later in the near future. The
other working interest owners in the Kirby project include Quaneco (25.0%),
Pinnacle Gas Resources (50%) and Galaxy Energy Corporation (12.5%).
We plan to participate in a 48 well drilling program during 2005 on the
Castle Rock project that will extend out from four previously drilled core
holes. The other working interest owners in the Castle Rock Project include
Quaneco (25.0%), Enterra Energy Trust (43.75%), Carrizo (6.25%) and Galaxy
Energy Corporation (12.5%).
The Powder River Basin coalfield of northeastern Wyoming and southeastern
Montana is an unconventional gas play that offers an unusual combination of
comparatively moderate risk and large economic potential. The large coal
deposits of the Powder River Basin are one of the greatest accumulations of coal
in the world. These coal deposits contain a large resource of biogenic coal bed
methane associated with numerous thick, laterally continuous, relatively shallow
(less than 3,000 feet deep) Tertiary coal beds.
The Kirby project is an extension of the Powder River Basin coal bed
methane play, which produces from the Tongue River Member of the Tertiary Fort
Union Formation, on the western margin of the Basin north of Sheridan, Wyoming.
This portion of the Basin has already seen considerable production from property
owned and managed by Huber Oil & Gas at Prairie Dog Field which is on the
Wyoming side, and Fidelity Oil & Gas at CX Field which straddles the
Montana/Wyoming border. The Kirby project has 95,000 acres of fee, state and
federal leasehold about 10 miles north of Decker, Montana. Fidelity's CX Field
is about 6 miles south of the southern boundary of the prospect.
A 16-well pilot well program has been drilled on the Kirby acreage and has
continued well into its dewatering phase. This pilot program will test the
productivity of the Wall and Flowers-Goodale coal formations. Gas content data
from mud logs and cores taken over these zones indicates that the prospective
coal is fully saturated with gas, which we believe will lead to a short period
of dewatering before commercial gas production volume is achieved. The
engineering firm Sproule Associates, Inc. has been retained to perform a
resource evaluation of the Kirby project. We believe hundreds of wells could
potentially be drilled on the 95,000-acre Kirby project.
The Castle Rock project is an extension of the Powder River Basin play on
the eastern margin of the Basin north of Gillette, Wyoming. This portion of the
Basin is where most of the Basin's production has occurred. The Castle Rock
project has 140,000 acres of fee, state and federal leasehold along the Pumpkin
Creek drainage about 20 miles west of Broadus, Montana. The eastern and northern
boundaries of the prospect are the outcrops of the Sawyer and Flowers Goodale
Coals. Sproule also conducted a resources evaluation of the Castle Rock project
with favorable results.
17
Circus Project, Montana
In May 2004, we optioned the Circus project through our affiliation with
Thomasson Partner Associates. In February 2005 we agreed to sell the Circus
project for $1.98 million to an unrelated third party. We completed the sale in
June 2005. We acquired the leases in October, 2004, with a total cost through
the sale of $487,000. Additionally, we incurred $53,000 of closing cost on the
sale.
Johns Valley Project, Utah
In early 2004 we acquired an agreement with Johns Valley Limited
Partnership whereby we have the option to earn 70% working interest in 25,201
acres of oil and gas leases from the Utah School and Institutional Trust Lands
Administration. The option, which expired in October 2004, was for fifteen oil
and gas leases that were for terms of ten years. Due to permitting delays and
other operating parameters in the field, we are negotiating to restructure the
potential option and the timing and amounts of our work commitments as provided
under the option assignment agreement.
In mid-2004 we drilled the 10-33C2 well in this project to its planned
depth of 1,365 feet. We drilled through a potentially productive coal seam. We
cored the well and have sent the core to a lab for evaluation. We have expensed
the cost of this well as exploration expense.
On April 14, 2005, we entered into a letter of intent to purchase the
project, and we are under continuing negotiations to purchase the project or an
interest in the project through an earn-in arrangement.
Present Activity
We described our present activity in detail by project in Oil and Gas
Projects, above. We have interests in wells currently drilling in the Kirby and
Castle Rock projects. Currently, we have interests in 16 wells that are
commencing the production phase and in drilling programs with 96 wells during
2005. We also have plans to finance and drill on the Overthrust project, the
Carter Creek project, the Bacaroo project and the Johns Valley project during
2005. We expect our partner, JMG Exploration, will also be drilling on the
Weston County and Gordon Creek projects in 2005. We are seeking capital which we
need in order to finance these projects.
Results of Operations
Revenue. Throughout 2004 and 2005 to date, we earned no revenue from our
exploration activity on our oil and gas property or from other operations.
Operating expense. For the quarter ended September 2005, our operating
expense was $1,453,000, compared to $256,000 in the September 2004 quarter. The
expense for both quarters came from oil and gas exploration, salaries, business
advisory services, legal and professional fees, travel, occupancy and investor
relations expense. The expense increased because of costs of capital and other
business advisory services.
Gain on sale of property. In the March 2005 quarter we earned a $1,437,000
gain on the sale of the Circus project, which we sold for $1,977,000. Our cost
on the leases was $487,000. Additionally, we incurred $53,000 of closing cost.
Interest expense. We incurred interest expense of $46,000 in the September
2005 quarter compared to $35,000 in the September 2004 quarter. Interest
increased because of an increase in our debt between the two quarters.
18
Liquidity and Capital Resources
In 2004 we incurred a loss of $3,760,000. In the quarter ended September
30, 2005, we incurred a net loss of $1,029,000. At September 30, 2005, we had
$2,560,000 of cash, total current assets of $2,942,000 and current liabilities
of $341,000. In February 2005 we sold the Circus project for $1.98 million to an
unrelated third party. We acquired the leases in October, 2004, with a total
cost through the sale of $487,000. Additionally, we incurred $53,000 of closing
cost on the sale. On May 18, 2005, we closed on the private placement of
$1,064,000 of securities. We incurred an estimated $141,000 of fees and cost,
netting approximately $922,000. We sold 1,936,391 shares of common stock and
818,192 warrants. Each warrant entitles the holder to purchase one share of
common stock for $1.00 until May 18, 2008. We also issued 81,819 of the same
warrants to the placement agent as additional compensation. On June 17, 2005, we
closed a financing pursuant to a securities purchase agreement with three
accredited investors for the issuance of $5.5 million in face amount of
debentures maturing at the end of the 27th month from the date of issuance, and
three year warrants to purchase common stock of the company. The debentures do
not accrue interest and the investors paid $3.85 million for the debentures. A
commission of 9% on the $3.85 million was paid in connection with the
transaction, and we paid $30,000 of the investor's counsel's legal fees,
resulting in net proceeds to the company of $3.4 million. Net proceeds will be
used for general working capital.
As shown in the accompanying financial statements, we have incurred
significant operating losses since inception. From the inception of our oil and
gas exploration business, we have not produced or sold any hydrocarbons.
Although we have acquired an option of interest in the Kirby and Castle Rock
projects which are now going into production, we have no assets at present which
are able to generate oil & gas sales without further expenditures for the
development of the reserves. Our ability to maintain profitability and positive
cash flow is dependent upon our ability to exploit our mineral holdings,
generate revenue from our planned business operations and control our
exploration cost. To fully carry out our business plans we need to raise a
substantial amount of additional capital, which we are currently seeking. We can
give no assurance that we will be able to raise such capital. We have limited
financial resources until such time that we are able to generate positive cash
flow from operations. Our ability to maintain profitability and positive cash
flow is dependent upon our ability to locate profitable natural gas or oil
properties, generate revenue from our planned business operations, and control
exploration cost. Should we be unable to raise adequate capital or to meet the
other above objectives, it is likely that we would have to substantially curtail
our business activity, and that our investors would incur substantial losses of
their investment.
June 2005 Private Placement
On June 17, 2005, we closed a financing pursuant to a securities purchase
agreement with three accredited investors for the issuance of $5,501,199.95 in
face amount of debentures maturing June 17, 2008, and three year warrants to
purchase our common stock. The debentures do not accrue interest and the
investors paid $3,849,685 for the debentures. A commission of 9% on the
$3,849,685 was paid by us to HPC Capital Management, a registered broker-dealer,
in connection with the transaction, and we paid $100,000 in expenses and fees
including $30,000 of the investors' counsel's legal fees, resulting in net
proceeds to us of $3,403,267.35. Net proceeds will be used by us for general
working capital.
The debentures are unsecured and we are obligated to pay 1/24th of the face
amount of the debenture on the first of every month, starting October 1, 2005,
which payment can be made in cash or in shares of our common stock. We may pay
this amortization payment in cash or in stock at the lower of $0.60 per share or
80% of the volume weighted average price of our stock for the five trading days
prior to the repayment date. In the event that we make the payment in cash, we
shall pay 110% of the monthly redemption amount. For the months of October and
November 2005, we elected to make the monthly payments in cash.
Except as provided in the succeeding paragraph and to the extent any
debentures remain outstanding, at any time, the debentures are convertible into
shares of our common stock at $0.60 per share.
At any time after January 15, 2006, and if certain conditions are met, we
have the right to redeem some or all of the debentures in a cash amount equal to
110% of the face amount of the debentures being redeemed.
If the closing price for our common stock exceeds $1.50 for 20 consecutive
trading days, we can require the holders to convert some or all of the
debentures at $0.60.
19
We issued warrants to the investors, expiring June 17, 2008, to purchase
4,584,334 shares of restricted common stock, exercisable at a per share of
$0.649. In addition, the exercise price of the warrants will be adjusted in the
event we issue common stock at a price below the exercise price, with the
exception of any securities issued pursuant to a stock or option plan adopted by
our board of directors, issued in connection with the debentures issued pursuant
to the securities purchase agreement, or securities issued in connection with
acquisitions or strategic transactions. Upon an issuance of shares of common
stock below the exercise price, the exercise price of the warrants will be
reduced to equal the share price at which the additional securities were issued
and the number of warrant shares issuable will be increased such that the
aggregate exercise price payable for the warrants, after taking into account the
decrease in the exercise price, shall be equal to the aggregate exercise price
prior to such adjustment.
Warrants to purchase 250,000 shares, at the same price and for the same
term as the warrants issued to the investors, have been issued to HPC Capital
Management as additional compensation for its services in connection with the
transaction with the investors.
If in any period of 20 consecutive trading days our stock price exceeds
250% of the warrants' exercise price, all of the warrants shall expire on the
30th trading day after we send a call notice to the warrant holders. If at any
time after one year from the date of issuance of the warrants there is not an
effective registration statement registering, or no current prospectus available
for, the resale of the shares underlying the warrants, then the holder may
exercise the warrant at such time by means of a cashless exercise. In the event
the investors exercise the warrants on a cashless basis, then we will not
receive any proceeds.
The conversion price of the debentures and the exercise price of the
warrants may be adjusted in certain circumstances such as if we pay a stock
dividend, subdivide or combine outstanding shares of common stock into a greater
or lesser number of shares, or take such other actions as would otherwise result
in dilution of the investors' position.
The investors have agreed to restrict their ability to convert their
debentures or exercise their warrants and receive shares of our common stock
such that the number of shares of common stock held by them in the aggregate and
their affiliates after such conversion or exercise does not exceed 4.99% of the
then issued and outstanding shares of common stock.
September 2005 Private Placement
On September 21, 2005, we closed a financing pursuant to a securities
purchase agreement with two accredited investors for the issuance of $3,108,000
in face amount of debentures maturing December 20, 2008, and three year warrants
to purchase our common stock. The debentures do not accrue interest and the
investors paid $2,174,947.52 for the debentures. A commission of 8% on
$2,000,000 raised was paid by us to HPC Capital Management, a registered
broker-dealer, in connection with the transaction and we placed $50,000 in
escrow for the payment of future legal fees in connection with our registration
statement, resulting in net proceeds to us of $1,964,947.52, before our legal
fees. Net proceeds will be used by us for general working capital.
The debentures are unsecured and we are obligated to pay 1/24th of the face
amount of the debenture on the first of every month, starting January 1, 2006,
which payment can be made in cash or in shares of our common stock. We may pay
this amortization payment in cash or in stock at the lower of $0.75 per share or
80% of the volume weighted average price of our stock for the five trading days
prior to the repayment date. In the event that we make the payment in cash, we
shall pay 110% of the monthly redemption amount.
Except as provided in the succeeding paragraph and to the extent any
debentures remain outstanding, at any time, the debentures are convertible into
shares of our common stock at $0.75 per share.
At any time after 90 days from the date that a registration statement
registering the shares of common stock underlying the debentures and warrants is
declared effective, and if certain conditions are met, we have the right to
redeem some or all of the debentures in a cash amount equal to 110% of the face
amount of the debentures being redeemed.
After the registration statement registering the shares of common stock
underlying the debentures and warrants is declared effective, if the closing
price for our common stock exceeds $1.875 for 20 consecutive trading days, we
can require the holders to convert some or all of the debentures at $0.75.
20
In the event of default, the investors may require payment, which shall be
the greater of: (A) 130% of the principal amount of the face amount of the
debenture to be prepaid, or (B) the principal amount of the debenture to be
prepaid, divided by the conversion price on (x) the date the default amount is
demanded or otherwise due or (y) the date the default amount is paid in full,
whichever is less, multiplied by the closing price on (x) the date the default
amount is demanded or otherwise due or (y) the date the default amount is paid
in full, whichever is greater
We issued warrants to the investors, expiring September 21, 2008, to
purchase 2,172,000 shares of restricted common stock, exercisable at a per share
of $0.80. In addition, the exercise price of the warrants will be adjusted in
the event we issue common stock at a price below the exercise price, with the
exception of any securities issued pursuant to a stock or option plan adopted by
our board of directors, issued in connection with the debentures issued pursuant
to the securities purchase agreement, or securities issued in connection with
acquisitions or strategic transactions. Upon an issuance of shares of common
stock below the exercise price, the exercise price of the warrants will be
reduced to equal the share price at which the additional securities were issued
and the number of warrant shares issuable will be increased such that the
aggregate exercise price payable for the warrants, after taking into account the
decrease in the exercise price, shall be equal to the aggregate exercise price
prior to such adjustment.
Warrants to purchase 100,000 shares, at the same price and for the same
term as the warrants issued to the investors, have been issued to HPC Capital
Management as additional compensation for its services in connection with the
transaction with the investors.
After the effective date of this registration statement, if in any period
of 20 consecutive trading days our stock price exceeds 250% of the warrants'
exercise price, all of the warrants shall expire on the 30th trading day after
we send a call notice to the warrant holders. If at any time after one year from
the date of issuance of the warrants there is not an effective registration
statement registering, or no current prospectus available for, the resale of the
shares underlying the warrants, then the holder may exercise the warrant at such
time by means of a cashless exercise. In the event the investors exercise the
warrants on a cashless basis, then we will not receive any proceeds.
The conversion price of the debentures and the exercise price of the
warrants may be adjusted in certain circumstances such as if we pay a stock
dividend, subdivide or combine outstanding shares of common stock into a greater
or lesser number of shares, or take such other actions as would otherwise result
in dilution of the investors' position.
The investors have agreed to restrict their ability to convert their
debentures or exercise their warrants and receive shares of our common stock
such that the number of shares of common stock held by them in the aggregate and
their affiliates after such conversion or exercise does not exceed 4.99% of the
then issued and outstanding shares of common stock.
Cash flow. In the September 2005 quarter we used $2,902,000 in our
operating activity. We used $461,000 in investing activity for property and
option acquisitions, and obtained $5,774,000 in financing activity from capital
obtained through financings. We increased our June 30, 2005 cash balance of
$2,503,000 to $2,560,000 at September 30, 2005.
Critical Accounting Policies and Estimates
Our Management's Discussion and Analysis of Financial Condition and Results
of Operations section discusses our consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires us
to make estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenue and expense during the reporting period. On an on-going basis, we
evaluate our estimates and judgments, including those related to revenue
recognition, accrued expense, financing operations, contingencies and
litigation. We base our estimates and judgments on historical experience and on
various other factors that we believe to be reasonable under the circumstances.
Our estimates and judgments form the basis for determining 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. These carrying values are some of the most significant accounting
estimates inherent in the preparation of our financial statements. These
accounting policies are described in relevant sections in this discussion and in
the notes to the financial statements included in our December 31, 2004 Form
10-KSB Annual Report.
21
Item 3. Controls and Procedures
a) Evaluation of Disclosure Controls and Procedures: As of September 30,
2005, our management carried out an evaluation, under the supervision
of our Chief Executive Officer and Chief Financial Officer of the
effectiveness of the design and operation of our system of disclosure
controls and procedures pursuant to the Securities and Exchange Act,
Rule 13a-15(e) and 15d-15(e) under the Exchange Act). Based on that
evaluation, our chief executive officer and chief financial officer
concluded that our disclosure controls and procedures are effective to
provide reasonable assurance that information we are required to
disclose in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms, and
that such information is accumulated and communicated to our
management, including our chief executive officer and chief financial
officer, as appropriate, to allow timely decisions regarding required
disclosure.
b) Changes in internal controls: There were no changes in internal
controls over financial reporting that occurred during the period
covered by this report that have materially affected, or are
reasonably likely to materially effect, our internal control over
financial reporting.
22
Part II: Other Information
Item 1. Legal Proceedings
From time to time, we may become involved in various lawsuits and legal
proceedings which arise in the ordinary course of business. However, litigation
is subject to inherent uncertainties, and an adverse result in these or other
matters may arise from time to time that may harm our business. Except as
described in our annual report on Form 10-KSB, filed with the Commission on June
30, 2005, we are currently not aware of any such legal proceedings or claims
that we believe will have, individually or in the aggregate, a material adverse
affect on our business, financial condition or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On September 21, 2005, we closed a financing pursuant to a securities
purchase agreement with two accredited investors for the issuance of $3,108,000
in face amount of debentures maturing December 20, 2008, and three year warrants
to purchase our common stock. The debentures do not accrue interest and the
investors paid $2,174,947.52 for the debentures. A commission of 8% on
$2,000,000 raised was paid by us to HPC Capital Management, a registered
broker-dealer, in connection with the transaction and we placed $50,000 in
escrow for the payment of future legal fees in connection with our registration
statement, resulting in net proceeds to us of $1,964,947.52, before our legal
fees. Net proceeds will be used by us for general working capital.
The debentures are unsecured and we are obligated to pay 1/24th of the face
amount of the debenture on the first of every month, starting January 1, 2006,
which payment can be made in cash or in shares of our common stock. We may pay
this amortization payment in cash or in stock at the lower of $0.75 per share or
80% of the volume weighted average price of our stock for the five trading days
prior to the repayment date. In the event that we make the payment in cash, we
shall pay 110% of the monthly redemption amount.
Except as provided in the succeeding paragraph and to the extent any
debentures remain outstanding, at any time, the debentures are convertible into
shares of our common stock at $0.75 per share.
At any time after 90 days from the date that a registration statement
registering the shares of common stock underlying the debentures and warrants is
declared effective, and if certain conditions are met, we have the right to
redeem some or all of the debentures in a cash amount equal to 110% of the face
amount of the debentures being redeemed.
After the registration statement registering the shares of common stock
underlying the debentures and warrants is declared effective, if the closing
price for our common stock exceeds $1.875 for 20 consecutive trading days, we
can require the holders to convert some or all of the debentures at $0.75.
In the event of default, the investors may require payment, which shall be
the greater of: (A) 130% of the principal amount of the face amount of the
debenture to be prepaid, or (B) the principal amount of the debenture to be
prepaid, divided by the conversion price on (x) the date the default amount is
demanded or otherwise due or (y) the date the default amount is paid in full,
whichever is less, multiplied by the closing price on (x) the date the default
amount is demanded or otherwise due or (y) the date the default amount is paid
in full, whichever is greater
We issued warrants to the investors, expiring September 21, 2008, to
purchase 2,172,000 shares of restricted common stock, exercisable at a per share
of $0.80. In addition, the exercise price of the warrants will be adjusted in
the event we issue common stock at a price below the exercise price, with the
exception of any securities issued pursuant to a stock or option plan adopted by
our board of directors, issued in connection with the debentures issued pursuant
to the securities purchase agreement, or securities issued in connection with
acquisitions or strategic transactions. Upon an issuance of shares of common
stock below the exercise price, the exercise price of the warrants will be
reduced to equal the share price at which the additional securities were issued
and the number of warrant shares issuable will be increased such that the
aggregate exercise price payable for the warrants, after taking into account the
decrease in the exercise price, shall be equal to the aggregate exercise price
prior to such adjustment.
23
Warrants to purchase 100,000 shares, at the same price and for the same
term as the warrants issued to the investors, have been issued to HPC Capital
Management as additional compensation for its services in connection with the
transaction with the investors.
After the effective date of this registration statement, if in any period
of 20 consecutive trading days our stock price exceeds 250% of the warrants'
exercise price, all of the warrants shall expire on the 30th trading day after
we send a call notice to the warrant holders. If at any time after one year from
the date of issuance of the warrants there is not an effective registration
statement registering, or no current prospectus available for, the resale of the
shares underlying the warrants, then the holder may exercise the warrant at such
time by means of a cashless exercise. In the event the investors exercise the
warrants on a cashless basis, then we will not receive any proceeds.
The conversion price of the debentures and the exercise price of the
warrants may be adjusted in certain circumstances such as if we pay a stock
dividend, subdivide or combine outstanding shares of common stock into a greater
or lesser number of shares, or take such other actions as would otherwise result
in dilution of the investors' position.
The investors have agreed to restrict their ability to convert their
debentures or exercise their warrants and receive shares of our common stock
such that the number of shares of common stock held by them in the aggregate and
their affiliates after such conversion or exercise does not exceed 4.99% of the
then issued and outstanding shares of common stock.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Securities Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14
and Rule 15d-14(a), promulgated under the Securities and Exchange
Act of 1934, as amended
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14
and Rule 15d 14(a), promulgated under the Securities and Exchange
Act of 1934, as amended
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (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 (Chief
Financial Officer)
24
Signatures
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
FELLOWS ENERGY LTD.
Date: November 21, 2005 By: /s/ GEORGE S. YOUNG
-----------------------
George S. Young
Chief Executive Officer
(Principal Executive Officer
Principal Accounting Officer
and Principal Financial Officer)
25