UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 for the quarterly period ended June 30, 2006.
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from:
Commission file number: 000-25170
Aurora Oil & Gas Corporation
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(Exact name of small business issuer as specified in its charter)
Utah
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(State or other jurisdiction of incorporation or organization)
87-0306609
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(IRS Employer Identification No.)
4110 Copper Ridge Drive, Suite 100, Traverse City, MI 49684
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(Address of principal executive offices)
(231) 941-0073
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(Issuer's telephone number)
Cadence Resources Corporation
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(Former name, former address and former fiscal year,
if changed since last report)
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.
Yes |X| 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: 82,025,017.
Transitional Small Business Disclosure Format (Check one):
Yes [ ] No |X|
AURORA OIL & GAS CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
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Page
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PART I ................................................................. 1
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm..............2
Condensed Consolidated Balance Sheets as of June 30, 2006
(Unaudited) and December 31, 2005............................3-4
Unaudited Statements of Operations for the Three Months and
Six Months Ended June 30, 2006 and 2005.......................5
Unaudited Statement of Shareholders' Equity for the Six Months
Ended June 30, 2006 ..........................................6
Unaudited Statements of Cash Flows for the Six Months Ended
June 30, 2006 and 2005........................................7
Notes to Unaudited Condensed Consolidated Financial Statements...... 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.........................20
ITEM 3. CONTROLS AND PROCEDURES........................................31
PART II .................................................................31
ITEM 1. LEGAL PROCEEDINGS..............................................31
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES........................31
ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............32
ITEM 5. OTHER INFORMATION..............................................32
ITEM 6. EXHIBITS.......................................................32
PART I
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended ("Securities Act"), and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). You can find many of these statements by looking for words such as
"believes," "expects," "anticipates," "estimates", or similar expressions used
in this report.
These forward-looking statements are subject to numerous assumptions,
risks and uncertainties. Factors which may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievements expressed or implied by us in those statements include, among
others, the following:
o the quality of our properties with regard to, among other things,
the existence of reserves in economic quantities;
o uncertainties about the estimates of reserves;
o our ability to increase our production and oil and gas income
through exploration and development;
o the number of well locations to be drilled and the time frame within
which they will be drilled;
o the timing and extent of changes in commodity prices for natural gas
and crude oil;
o domestic demand for oil and natural gas;
o drilling and operating risks;
o the availability of equipment, such as drilling rigs and
transportation pipelines; and
o the adequacy of our capital resources and liquidity including, but
not limited to, access to credit.
Because such statements are subject to risks and uncertainties, actual
results may differ materially from those expressed or implied by the
forward-looking statements. You are cautioned not to place undue reliance on
such statements, which speak only as of the date of this report.
1
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Aurora Oil & Gas Corporation
Traverse City, Michigan
We have reviewed the accompanying condensed consolidated balance sheet of Aurora
Oil & Gas Corporation and Subsidiaries as of June 30, 2006, and the related
condensed consolidated statements of operations for the three month and six
month periods ended June 30, 2006 and 2005, shareholders' equity for the six
month period ended June 30, 2006, and cash flows for the six month periods ended
June 30, 2006 and 2005. These consolidated interim financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States of America.
We have previously audited, in accordance with the auditing standards of the
Public Company Accounting Oversight Board (United States), the consolidated
balance sheet of Aurora Oil & Gas Corporation and Subsidiaries as of December
31, 2005, and the related consolidated statements of operations, shareholders'
equity and cash flows for the year then ended (not presented herein); and in our
report dated February 24, 2006, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying condensed consolidated balance sheet as of December 31, 2005,
is fairly stated, in all material respects, in relation to the consolidated
balance sheet from which it has been derived.
RACHLIN COHEN & HOLTZ LLP
Miami, Florida
August 7, 2006
2
AURORA OIL & GAS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
June 30, December 31,
2006 2005
ASSETS (Unaudited) (Audited)
------------- -------------
CURRENT ASSETS:
Cash and cash equivalents $ 3,594,953 $ 11,980,638
Accounts receivable
Oil and gas sales 2,189,886 2,409,675
Joint interest owners 6,401,514 4,380,606
Notes receivable
Related party 50,720 35,720
Other 236,626 208,626
Drilling advances 988,734 --
Prepaid expenses and other current assets 328,770 240,242
Short-term derivative instruments 962,015 --
------------- -------------
Total current assets 14,753,218 19,255,507
------------- -------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, using full cost accounting:
Proved properties 79,213,485 39,643,003
Unproved properties 33,791,338 37,279,889
Properties held for sale 21,365,575 --
Less: accumulated depletion and amortization (10,072,195) (7,962,138)
------------- -------------
Total oil and gas properties, net 124,298,203 68,960,754
Pipelines 4,831,358 --
Other property and equipment 3,943,612 3,723,918
Less: accumulated depreciation (359,973) (113,780)
------------- -------------
Total property and equipment, net 132,713,200 72,570,892
------------- -------------
OTHER ASSETS:
Deposits on purchase of oil and gas properties -- 3,206,102
Goodwill 15,973,346 15,973,346
Intangibles (net of accumulated amortization of
$2,174,583 and $1,407,083, respectively) 2,430,417 3,197,917
Other investments 934,606 1,855,977
Debt issuance costs (net of accumulated amortization of
$462,242 and $79,096, respectively) 2,731,396 723,993
Other -- 38,411
------------- -------------
Total other assets 22,069,765 24,995,746
------------- -------------
TOTAL ASSETS $ 169,536,183 $ 116,822,145
============= =============
The accompanying notes are an integral part of these condensed
consolidated financial statements
-3-
AURORA OIL & GAS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
June 30, December 31,
2006 2005
(Unaudited) (Audited)
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 10,062,326 $ 7,053,288
Accrued liabilities 42,604 417,291
Short-term bank borrowings 10,000 6,210,000
Current portion of obligations under capital leases 7,173 8,823
Current portion of note payable - related party -- 69,833
Current portion of mortgage payable 81,902 72,877
Drilling advances 622,537 --
Deposit on sale of oil and gas properties -- 3,509,319
------------- -------------
Total current liabilities 10,826,542 17,341,431
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LONG-TERM LIABILITIES:
Obligations under capital leases, net of current portion -- 2,262
Asset retirement obligation 1,013,329 --
Mortgage payable 2,751,495 2,792,600
Senior secured credit facility 40,000,000 --
Mezzanine financing 40,000,000 40,000,000
------------- -------------
Total long-term liabilities 83,764,824 42,794,862
------------- -------------
Total liabilities 94,591,366 60,136,293
------------- -------------
COMMITMENTS, CONTINGENCIES AND
SUBSEQUENT EVENTS
REDEEMABLE CONVERTIBLE PREFERRED STOCK:
Authorized 20,000,000 shares; outstanding 11,650 shares in 2006
and 34,950 shares in 2005 19,924 59,925
------------- -------------
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value; authorized 250,000,000 shares; issued and
outstanding 81,965,017 shares in 2006 and
61,536,261 shares in 2005 819,651 615,363
Additional paid-in capital 77,757,502 58,670,698
Accumulated other comprehensive income 962,015 --
Accumulated deficit (4,614,275) (2,660,134)
------------- -------------
Total shareholders' equity 74,924,893 56,625,927
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 169,536,183 $ 116,822,145
============= =============
The accompanying notes are an integral part of these condensed
consolidated financial statements
-4-
AURORA OIL & GAS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
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Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
REVENUES:
Oil and gas sales $ 5,524,354 $ 719,285 $ 10,941,220 $ 1,097,906
Interest income 138,556 71,245 244,214 165,910
Equity in (loss) gain of
unconsolidated subsidiary (67,976) 26,806 (158,714) 12,397
Other income 194,694 118,285 596,999 349,611
------------ ------------ ------------ ------------
Total revenues 5,789,628 935,621 11,623,719 1,625,824
------------ ------------ ------------ ------------
EXPENSES:
General and administrative 1,676,019 627,348 3,242,713 1,126,396
Pipeline operating expenses 107,695 -- 284,201 --
Production and lease operating 1,573,821 378,200 3,411,051 652,957
Depletion, depreciation and amortization 1,614,449 59,027 3,024,166 102,227
Interest expense 1,970,019 189,067 3,564,154 237,354
Taxes 27,694 -- 29,361 237,697
------------ ------------ ------------ ------------
Total expenses 6,969,697 1,253,642 13,555,646 2,356,631
------------ ------------ ------------ ------------
LOSS BEFORE MINORITY INTEREST (1,180,069) (318,021) (1,931,927) (730,807)
MINORITY INTEREST IN LOSS
OF SUBSIDIARIES (5,119) (7,472) (17,919) (6,190)
------------ ------------ ------------ ------------
NET LOSS $ (1,185,188) $ (325,493) $ (1,949,846) $ (736,997)
============ ============ ============ ============
NET LOSS PER COMMON SHARE -
BASIC AND DILUTED $ (0.01) $ (0.01) $ (0.03) $ (0.02)
============ ============ ============ ============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC AND DILUTED 81,693,808 38,092,366 76,011,115 36,157,838
============ ============ ============ ============
The accompanying notes are an integral part of these condensed
consolidated financial statements
-5-
AURORA OIL & GAS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 2006
(Unaudited)
- --------------------------------------------------------------------------------
Shares Amount
------------ ------------
COMMON STOCK:
Balance, beginning 61,536,261 $ 615,363
Cashless exercise of common stock options and warrants 3,280,105 32,801
Conversion of redeemable convertible preferred stock to common stock 23,334 233
Exercise of common stock options and warrants 15,565,457 155,655
Issuance of common stock to related party 90,000 900
Issuance of common stock to related party in lieu
of commission relating to exercise of warrants 1,469,860 14,699
------------ ------------
Balance, end 81,965,017 819,651
------------ ------------
ADDITIONAL PAID-IN CAPITAL:
Balance, beginning 58,670,698
Cashless exercise of common stock options and warrants (32,801)
Conversion of redeemable convertible preferred stock to common stock 39,768
Stock-based compensation 757,442
Exercise of common stock options and warrants 17,988,794
Issuance of common stock to related party 348,300
Issuance of common stock to related party in lieu of
commission relating to exercise of warrants (14,699)
------------
Balance, end 77,757,502
------------
ACCUMULATED OTHER COMPREHENSIVE INCOME:
Balance, beginning --
Unrealized gains on derivative instrument 1,754,365
Reclassification of gain on derivative instrument (792,350)
------------
Balance, end 962,015
------------
ACCUMULATED DEFICIT:
Balance, beginning (2,660,134)
Dividends accrued (4,295)
Net loss (1,949,846)
------------
Balance, end (4,614,275)
------------
TOTAL SHAREHOLDERS' EQUITY $ 74,924,893
============
The accompanying notes are an integral part of these condensed
consolidated financial statements
-6-
AURORA OIL & GAS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
- --------------------------------------------------------------------------------
Six Months Ended
June 30,
----------------------------
2006 2005
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET LOSS $ (1,949,846) $ (736,997)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation, depletion and amortization 3,024,166 117,504
Amortization of debt issuance costs 383,422 --
Accretion of asset retirement obligation 36,989 --
Stock-based compensation 392,149 --
Equity in loss of non-consolidated entities 158,714 (12,397)
Other (20,950) --
Minority interest in loss of subsidiaries 17,919 6,190
Changes in operating assets and liabilities, net
Accounts receivable (1,568,754) 65,667
Accounts receivable - related party -- (10,792)
Drilling advances (988,734) --
Prepaid expenses (88,528) (36,752)
Accounts payable 2,634,781 126,333
Drilling advances 622,537 (143,807)
Accrued liabilities (16,959) 165,080
------------ ------------
Net cash provided by (used in) operating activities 2,636,906 (459,971)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures for oil and gas development (42,459,080) (14,447,849)
Capital expenditures for property and equipment (219,694) (105,677)
Proceeds from sale of oil and gas properties 10,500,000 7,373,737
Proceeds from sale of other investments 13,096 --
Payments for capitalized merger costs -- (263,092)
Advances of notes receivable (30,000) (72,379)
Advances of notes receivable - related parties (30,000) --
Payments received on notes receivable - related parties 17,000 85,000
Purchase of member interest in Hudson Pipelines and Processing Co., L.L.C. (162,108) (501,956)
Investment in unconsolidated subsidiary (475,000) (14,000)
------------ ------------
Net cash used in investing activities (32,845,786) (7,946,216)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-term bank borrowings (payments) (6,200,000) (350,000)
Advances on senior secured credit facility, net of financing costs of $2,386,613 9,997,394 --
Advances on mezzanine financing, net of financing costs of $150,000 -- 9,850,000
Payments on mortgage obligation (32,080) --
Payments on notes payable - related party (69,833) (2,948,698)
Payments on capital lease obligations (3,912) (4,068)
Distributions to minority interest members -- (805,000)
Net proceeds from sales of common stock -- 11,025,000
Net proceeds from exercise of options and warrants 18,144,449 --
Dividends paid on preferred stock (12,823) (44,340)
Other -- 20,177
------------ ------------
Net cash provided by financing activities 21,823,195 16,743,071
------------ ------------
Net (decrease) increase in cash and cash equivalents (8,385,685) 8,336,884
Cash and cash equivalents, beginning of the period 11,980,638 5,179,582
------------ ------------
Cash and cash equivalents, end of the period $ 3,594,953 $ 13,516,466
============ ============
NON-CASH FINANCING AND INVESTING ACTIVITIES:
Oil and natural gas properties asset retirement obligation $ 976,343 $ --
============ ============
Purchase of oil and gas working interest through senior secured credit facility $ 27,615,993 $ --
============ ============
CASH PAID FOR INTEREST $ 3,430,225 $ 632,500
============ ============
The accompanying notes are an integral part of these condensed
consolidated financial statements
-7-
AURORA OIL & GAS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND NATURE OF BUSINESS
Effective May 11, 2006, Cadence Resources Corporation ("Cadence") and
its wholly owned subsidiaries ("the Company") amended its articles of
incorporation to change the parent company name to Aurora Oil & Gas
Corporation ("AOG"). AOG is an oil and gas company engaged in the
exploration, acquisition, development, production and sale of natural
gas and crude oil. AOG generates most of its revenue from the
production and sale of natural gas. The Company is currently focused on
acquiring and developing operating interests in unconventional drilling
programs in the Michigan Antrim Shale and the New Albany Shale of
Indiana and Kentucky.
On October 31, 2005, AOG (formerly Cadence) acquired Aurora Energy,
Ltd. ("Aurora") through the merger of a wholly owned subsidiary with
and into Aurora. As a result of the merger, Aurora became a
wholly-owned subsidiary. The merger has been accounted for as a reverse
acquisition using the purchase method of accounting. Although the
merger was structured such that Aurora became a wholly-owned subsidiary
of AOG (formerly Cadence), Aurora has been treated as the acquiring
company for accounting purposes under Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations", due to the
following factors: (1) Aurora's stockholders received the larger share
of the voting rights in the merger; (2) Aurora received the majority of
the members of the board of directors; and (3) Aurora's senior
management prior to the merger dominated the senior management of the
combined company.
As an independent oil and gas producer, the Company's revenue,
profitability and future rate of growth are substantially dependent on
prevailing prices of natural gas and oil. Historically, the energy
markets have been very volatile and it is likely that oil and gas
prices will continue to be subject to wide fluctuations in the future.
A substantial or extended decline in natural gas and oil prices could
have a material adverse effect on the Company's financial position,
results of operations, cash flows and access to capital, and on the
quantities of natural gas and oil reserves that can be economically
produced.
NOTE 2. BASIS OF PRESENTATION
The financial information included herein is unaudited, except the
balance sheet as of December 31, 2005, which has been derived from our
audited consolidated financial statements as of December 31, 2005.
However, such information includes all adjustments (consisting solely
of normal recurring adjustments), which are, in the opinion of
management, necessary for a fair presentation of financial position,
results of operations and cash flows for the interim periods. The
results of operations for interim periods are not necessarily
indicative of the results to be expected for an entire year. Certain
amounts as reported in the 2005 financial statements have been
reclassified to conform with the 2006 presentation.
Certain information, accounting policies and footnote disclosures
normally included in the financial statements prepared in accordance
with accounting principles generally accepted in the United States of
America have been condensed or omitted in this Form 10-QSB pursuant to
certain rules and regulations of the Securities and Exchange
Commission. These financial statements should be read in conjunction
with the audited consolidated financial statements and notes included
in our Annual Report on Form 10-KSB for the year ended December 31,
2005.
As a result of the reverse acquisition discussed in Note 1, the
historical financial statements presented for periods prior to the
acquisition date are the financial statements of Aurora. The
operations of the former Cadence businesses have been included in
the financial statements from the date of acquisition. The common
stock per share information in the condensed consolidated financial
statements for the three months and six months ended June 30, 2005
and related notes have been retroactively adjusted to give effect to
the reverse merger on October 31, 2005.
8
AURORA OIL & GAS CORPORATION AND SUBSUDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 3. ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT OBLIGATIONS
On January 1, 2006, the Company adopted Financial Accounting Standards
Board ("FASB") Interpretation No. 47, "Accounting for Conditional Asset
Retirement Obligations," and FASB Statement No. 143 "Accounting for
Asset Retirement." This Interpretation clarifies that the term
"conditional asset retirement obligation" refers to a legal obligation
to perform an asset retirement activity in which the timing and/or
method of settlement are conditional on a future event that may or may
not be within the control of the entity. Accordingly, an entity is
required to recognize a liability for the fair value of a conditional
asset retirement obligation if the fair value can be reasonably
estimated. The Company estimated the fair value of the obligation by
identifying costs associated with the future dismantlement and removal
of production equipment and facilities and the restoration and
reclamation of a field's surface lands to ecological condition similar
to that existing before oil and gas extraction began. Prior to January
1, 2006, such amount was not considered material.
Effective January 1, 2006, the Company recorded a liability of $812,634
(an "asset retirement obligation" or "ARO") on the consolidated balance
sheet and capitalized the asset retirement cost to oil and gas
properties. In general, the amount of an ARO and the costs capitalized
will be equal to the estimated future cost to satisfy the abandonment
obligation using current prices that are escalated by an assumed
inflation factor up to the estimated settlement date, which is then
discounted back to the date that the abandonment obligation was
incurred using an assumed cost of funds for the company. After
recording these amounts, the ARO is accreted to its future estimated
value using the same assumed cost of funds and the additional
capitalized costs are depreciated on a unit-of-production basis within
the related full cost pool. The accretion expense is included in
interest expense and the depreciation expense is included in
depreciation, depletion and amortization on the condensed consolidated
statement of operations.
The change in the ARO for the six months ended June 30, 2006 is as
follows:
Balance as of January 1, 2006 $ 812,634
Accretion expense 15,237
-----------
Balance as of March 31, 2006 827,871
-----------
Additions 263,026
Revisions (99,317)
Accretion expense 21,749
-----------
Balance as of June 30, 2006 $ 1,013,329
===========
NOTE 4. RECENT ACCOUNTING PRONOUCEMENTS
In February 2006, the FASB issued SFAS 155, "Accounting for Certain
Hybrid Financial Instrument" which eliminates the exemption from
applying SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities" to interests in securitized financial assets so that
similar instruments are accounted for similarly regardless of the form
of the instruments. SFAS 155 also allows the election of fair value
measurement at acquisition, at issuance, or when a previously
recognized financial instrument is subject to a re-measurement event.
Adoption is effective for all financial instruments acquired or issued
after the beginning of the first fiscal year that begins after
September 15, 2006. Management believes the adoption of this standard
will not have a material impact on the consolidated financial position,
results of operations, or liquidity.
9
AURORA OIL & GAS CORPORATION AND SUBSUDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
In February 2006, the FASB issued Financial Staff Position ("FSP") No.
FAS 123(R)-4 "Classification of Options and Similar Instruments Issued
as Employee Compensation That Allow for Cash Settlement upon the
Occurrence of a Contingent Event." This FSP amends SFAS No. 123(R),
addressing cash settlement features that can be exercised only upon the
occurrence of a contingent event that is outside the employee's
control. These instruments are not required to be classified as a
liability until it becomes probable that the event will occur. The
Company adopted this FSP in the second quarter of 2006. The
implementation did not have an effect on the results of operations or
financial position.
In April 2006, the FASB issued FSP No. FIN 46(R)-6, "Determining the
Variability to Be Considered in Applying FASB Interpretation No.
46(R)," which requires the use of a "by design" approach for
determining whether an interest is variable when applying FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities."
This approach includes evaluating whether an interest is variable based
on a thorough understanding of the design of the potential variable
interest entity ("VIE"), including the nature of the risks that the
potential VIE was designed to create and pass along to interest holders
in the entity. The guidance in this FSP is effective for reporting
periods beginning after June 15, 2006. The Company will adopt the
guidance presented in this FSP in the third quarter of 2006 on a
prospective basis. The Company does not expect the adoption of this FSP
to have a material impact on results of operations or financial
position.
In July 2006, FASB issued Interpretation No. 48. This Interpretation
clarifies the accounting for uncertainty in income taxes recognized in
an enterprise's financial statements in accordance with SFAS Statement
No. 109, "Accounting for Income Taxes". This Interpretation prescribes
a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. This Interpretation also provides
guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition. This
Interpretation is effective for fiscal years beginning after December
15, 2006. The Company currently is assessing the impact of
Interpretation No. 48 on results of operations and financial position.
NOTE 5. RISK MANAGEMENT ACTIVITIES
Derivative Instruments
In order to reduce exposure to fluctuations in the price of natural
gas, the Company will periodically enter into financial instruments
with a major financial institution. The Company has entered into a swap
instrument in order to hedge a portion of its production. The purpose
of the swap is to provide a measure of stability to the Company's cash
flow in meeting financial obligations while operating in a volatile gas
market environment. The derivative reduces the Company's exposure on
the hedged volumes to decreases in commodity prices and limits the
benefit the Company might otherwise receive from any increases in
commodity prices on the hedged volumes.
The Company recognizes all derivative instruments as assets or
liabilities in the balance sheet at fair value. The accounting
treatment for changes in fair value as specified in SFAS No. 133 is
dependent upon whether or not a derivative instrument is designated as
hedge. For derivatives designated as cash flow hedges, changes in fair
value, to the extent the hedge is effective, are recognized in
Accumulated Other Comprehensive Income on the accompanying balance
sheet until the hedged item is recognized in earnings as gas revenue.
If this hedge has an ineffective portion, that particular portion of
the gain or loss would be immediately reported in earnings.
10
AURORA OIL & GAS CORPORATION AND SUBSUDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Effective April 1, 2006, the Company entered into financial swap
contract for 5,000 MMBtu per day at a fixed price of $8.59 per MMBtu
covering a 12-month period. For the six months ended June 30, 2006, the
Company has recognized in Accumulated Other Comprehensive Income, net
unrealized gain of $962,015 on a swap contract that has been designated
as a cash flow hedge on forecasted sales of natural gas. The balance is
expected to be reclassified into earnings within the next nine months.
The Company has also recorded as of June 30, 2006, a corresponding
short-term derivative instrument asset totaling $962,015 in Current
Assets. In addition, for six months ended June 30, 2006, the Company
recorded a $792,350 net gain in earnings from hedging activities
(included in oil and gas revenues).
For the six months ended June 30, 2005, the Company had no derivative
instruments to manage price risk on its natural gas production.
On July 14, 2006, the Company entered into another financial swap
contract for 5,000 MMBtu per day at a fixed price of $9.00 per MMBtu
for the period from April 1, 2007 through December 31, 2008.
Financial Instruments
The Company's financial instruments consist primarily of cash, accounts
receivable, loans receivable, accounts payable, accrued expenses and
debt. The carrying amounts of such financial instruments approximate
their respective estimated fair value due to the short-term maturities
and approximate market interest rates of these instruments.
NOTE 6. ACQUISITIONS AND DISPOSITIONS
2006-Hudson Pipeline and Processing Co., L.L.C.
On January 31, 2006, Aurora Antrim North, L.L.C. ("North"), a
wholly-owned subsidiary of Aurora, completed the acquisition of oil and
gas leases, working interests, and interests in related pipelines and
production facilities that are located in the Hudson Township area of
the Michigan Antrim gas play. The interests acquired are collectively
referred to as the Hudson Properties. In addition, the interests in the
related pipelines and production facilities were acquired through a
membership interest in Hudson Pipeline and Processing Co., L.L.C.
("HPPC"). North previously owned a working interest in the properties
and membership interest in HPPC. This acquisition increased North's
working interest in the Hudson Properties from an average of 49% to 96%
and increased the membership interest in HPPC from 48.75% to 90.94%.
The total purchase price for the Hudson Properties and HPPC was
$27,500,000 subject to certain adjustments provided for in the purchase
agreement. North also acquired an additional 2.5% membership interest
in HPPC effective January 1, 2006 which increased the membership
interest to 93.44%.
With these increases in membership interest in HPPC, effective January
1, 2006 HPPC was converted from the equity method to being consolidated
as a subsidiary in the Company's accompanying financial statements.
2006-Wabash Project
On February 2, 2006, Aurora closed on two Purchase and Sale Agreements
with respect to certain New Albany Shale acreage located in Indiana,
commonly called the Wabash project. Aurora acquired 64,000 acres of oil
and gas leases from Wabash Energy Partners, L.P. for a purchase price
of $11,840,000. Aurora then sold half its interest in a combined 95,000
acre lease position in the Wabash project to New Albany-Indiana, L.L.C.
("New Albany"), an affiliate of Rex Energy Operating Corporation, for a
sale price of $10,500,000. Internal funds of Aurora were used to pay
the net transaction cost of these transactions.
11
AURORA OIL & GAS CORPORATION AND SUBSUDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2005-New Albany
On January 3, 2005, El Paso Corporation exercised an option to purchase
95% of the working interest in certain New Albany Shale acreage in
Indiana. As result of this transaction, Aurora received gross proceeds
in the amount of $7,373,737. After deducting a distribution to
subsidiary members of $805,000 and an additional $1,000,000 set aside
for the subsidiary's share of anticipated future drilling expense,
approximately $5,500,000 of net proceeds was retained by Aurora.
2005- Geopetra Partners, L.L.C. Investment
In June 2005, the Company acquired a 30% interest in Geopetra Partners,
L.L.C. ("Geopetra") for $14,000. Geopetra is a limited liability
company engaged primarily in the following activities (i)
identification and evaluation for acquisition of oil and gas properties
and interest and entities which hold such properties and interests,
(ii) areas to be explored and developed for the production of oil and
gas and (iii) providing consultation, advice and recommendations to the
members of Geopetra in connection with other oil and gas properties and
interests, operations and activities. Geopetra was formed April 1,
2005.
NOTE 7. DEBT
Short-Term Bank Borrowings
On October 12, 2005, the Company entered into a $7.5 million revolving
line-of-credit agreement with Northwestern Bank for general corporate
purposes. On January 31, 2006, the credit availability on this line of
credit was reduced to $5.0 million to meet the requirements of the
senior secured credit facility (as described below). To secure this
line of credit, a Company executive officer pledged certain shares of
AOG common stock under his control. The interest rate is Wall Street
prime with interest payable monthly in arrears. Principal is payable at
the expiration of the line of credit, October 15, 2006. As of June 30,
2006, Northwestern Bank reduced the revolving line-of-credit by $90,000
for outstanding letters of credit (as described in Note 13
"Contingencies and Commitments"). Interest expense for the three and
the six months ended June 30, 2006 was $106,626 and $178,454,
respectively.
Note Payable - Related Parties
Through May 1, 2006, the Company was indebted under a note payable to a
minority member of Indiana Royalty Trustory, L.L.C., an affiliated
company, in the amount of $69,833. The interest rate was 10.5% per
year. The note payable matured on May 1, 2006 and was paid in full.
Mortgage Payable
On October 4, 2005, the Company entered into a mortgage loan from
Northwestern Bank in the amount of $2,925,000 for the purchase of an
office condominium and associated interior improvements. The security
for this mortgage is the office condominium real estate, plus personal
guaranties of three of the Company's officers. The payment schedule is
monthly interest only for the first three months starting on November
1, 2005, and beginning on February 1, 2006, principal and interest in
32 monthly payments of $21,969 with one principal and interest payment
of $2,733,994 on October 1, 2008. The interest rate is 6.5% per year.
The maturity date is October 1, 2008. Interest expense for the three
months and the six months ended June 30, 2006 was $52,465 and $99,734,
respectively.
12
AURORA OIL & GAS CORPORATION AND SUBSUDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Mezzanine Financing
On December 8, 2005, the Company entered into an Amended Note Purchase
Agreement, to increase its five-year mezzanine credit facility with
Trust Company of the West ("TCW") from $30 million to $50 million for
the Michigan Antrim drilling program. The borrower is North. Upon
closing of the BNP Paribas ("BNP") senior secured credit facility
discussed below, TCW now holds a second lien position in the Michigan
Antrim natural gas properties. The interest rate is fixed at 11.5% per
year, calculated and payable in arrears. Beginning September 28, 2006
and quarterly thereafter, the required principal payment is 75% (100%
if coverage deficiency or default occurs) of Adjusted Net Cash Flow
("ANCF") determined by deducting applicable operating expenses and
capital expenditures from gross revenue. The maturity date is September
30, 2009. The borrowing base is impacted by, among other factors, the
fair value of the Company's natural gas reserves that are pledged to
TCW. Changes in the fair value of the natural gas reserves are caused
by changes in prices for natural gas, operating expenses and the
results of drilling activity. A significant decline in the fair value
of these reserves could reduce the borrowing base as the Company may
not be able to meet certain facility covenants.
The mezzanine credit facility contains, among other things, certain
covenants relating to restricted payments (as defined), loans or
advances to others, additional indebtedness, and incurrence of liens;
and provides for the maintenance of certain financial and operating
ratios, including current ratio and specified coverage ratios
(collateral coverage and proved developed producing reserves coverage
ratios).
Pursuant to the mezzanine financing arrangement, North conveyed to TCW
a 4% overriding royalty interest net to North's interest, in all of
North's existing oil and gas leases in the counties of Alcona, Alpena,
Charlevoix, Cheboygan, Montmorency and Otsego in the State of Michigan.
Additionally, North is required to convey a 4% overriding royalty
interest, net to its interest, in any new leases acquired in these
counties while the loan is outstanding.
For the three months ended June 30, 2006, interest expense for the
mezzanine credit facility was $1,150,139 of which $154,748 was
capitalized. For the three months ended June 30, 2005 interest expense
was $360,110 of which $175,556 was capitalized.
For the six months ended June 30, 2006, interest expense for the
mezzanine credit facility was $2,351,111 of which $555,522 was
capitalized. For the six months ended June 30, 2005 interest expense
was $641,221 of which $456,667 was capitalized.
Senior Secured Credit Facility
On January 31, 2006, the Company entered into a senior secured credit
facility with BNP for drilling, development, and acquisitions as well
as other general corporate purposes. The borrower is North. The initial
borrowing base is $40 million without hedges. As proved reserves are
added, this borrowing base may increase to $50 million without TCW
consent, and $100 million with TCW consent. A required semi-annual
reserve report may result in an increase or decrease in credit
availability. The security for this facility is a first lien position
in certain Michigan Antrim assets; a guarantee from Aurora; and a
guarantee from AOG secured by a pledge of its stock in Aurora. This
facility matures the earlier of January 31, 2010 or 91 days prior to
the maturity of the mezzanine credit facility. This facility provides
for borrowings tied to prime rate or LIBOR plus 1.25 to 2.0% depending
on the borrowing base utilization, as selected by the Company. For the
three months ended June 30, 2006, interest expense was $714,167 of
which $91,455 was capitalized. For the six months ended June 30, 2006,
interest expense was $1,106,397 of which $91,455 was capitalized.
13
AURORA OIL & GAS CORPORATION AND SUBSUDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
On July 14, 2006, the senior secured credit facility was amended in two
respects. The credit availability was increased to $50 million. In
addition, the trailing 12-month interest coverage ratio covenant was
amended to defer the testing until the fourth quarter of 2006, and to
provide for a reduced ratio for that quarter. The latter amendment was
intended to correct a previous error in the covenant, which failed to
account for the fact that the acquisition of the Hudson Properties (as
describe in Note 6 "Acquisitions and Dispositions") in the first
quarter of 2006 would not have a full trailing 12 months of cash flow
included in the financial statements until the first quarter of 2007.
This amendment supersedes the waiver BNP issued regarding the interest
coverage covenant for first quarter of 2006.
The senior secured credit facility contains, among other things,
certain covenants relating to restricted payments (as defined), loans
or advances to others, additional indebtedness, and incurrence of
liens; and provides for the maintenance of certain financial and
operating ratios, including current ratio and specified coverage ratios
(collateral coverage and proved developed producing reserves coverage
ratios).
NOTE 8. COMMON STOCK
From late December 2005 through early February 2006, the Company
reduced the exercise price of certain outstanding options and warrants
in order to encourage the early exercise of these securities. Each
holder who took advantage of the reduced exercise price was required to
execute a six-month lock up agreement with respect to the shares issued
in the exercise. As a result of the options and warrants exercised
pursuant to this reduced exercise price arrangement, and pursuant to
other exercises of outstanding options, an additional 20,315,422 shares
were issued during the six months ended June 30, 2006 representing
15,565,457 shares issued for cash proceeds of $18,144,449, and
4,749,965 shares issued pursuant to cashless exercises of the
applicable and other warrants or options. In December 2005 an
additional 2,160,000 shares were issued for cash proceeds of
$2,916,000.
In June 2006, an officer of the Company was issued 30,000 shares for
services provided in 2005. Compensation expense related to this
activity was recorded in 2005.
Additionally in June 2006, two directors of the Company were issued
30,000 shares each for their services provided to Aurora Energy, Ltd.
as Board members prior to the merger with Cadence. Compensation expense
related to this activity was recorded in 2005.
NOTE 9. STOCK-BASED COMPENSATION
On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
"Share-Based Payment," (SFAS No. 123R) to account for stock-based
employee compensation. Among other items, SFAS No. 123R eliminates the
use of Accounting Principles Board Opinion ("APB") No. 25, "Accounting
for Stock Issued to Employees," and the intrinsic value method of
accounting and requires companies to recognize the cost of employee
services received in exchange for stock-based awards based on the grant
date fair value of those awards in their financial statements. The
Company elected to use the modified prospective method for adoption,
which requires compensation expense to be recorded for all unvested
stock options beginning in the first quarter of adoption. For
stock-based awards granted or modified subsequent to January 1, 2006,
compensation expense, based on the fair value on the date of grant,
will be recognized in the financial statements over the vesting period.
For the three months ended June 30, 2006, the Company recorded
stock-based compensation of $386,976 under the 2006 Stock Incentive
Plan (as described in Note 10 "Common Stock Options") and a certain
employment agreement (as described in Note 13 "Contingencies and
Commitments"). Of that amount, $234,757 has been included in general
and administrative expense on the consolidated statement of operations
and $152,219 has been capitalized in oil and gas properties.
14
AURORA OIL & GAS CORPORATION AND SUBSUDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
For the six months ended June 30, 2006, the Company recorded
stock-based compensation of $757,442 under the 2006 Stock Incentive
Plan (as described in Note 10 "Common Stock Options") and a certain
employment agreement (as described in Note 13 "Contingencies and
Commitments"). Of that amount, $392,149 has been included in general
and administrative expense on the condensed consolidated statement of
operations and $365,293 has been capitalized in oil and gas properties.
The impact on future net income is estimated to be $4,538,193
recognized over the applicable requisite service period of
approximately three years.
Prior to 2006, the Company applied APB No. 25 and related
interpretations in accounting for its plans. Under APB 25, the exercise
price of the stock options was more than the market value of the shares
at the date of grant and, accordingly, no compensation cost has been
recognized in the condensed consolidated financial statements. The
following table illustrates the effect on net loss and loss per share
as if the Company had applied the fair value recognition provisions of
SFAS 123 during the six months ended June 30, 2005:
2005
-----------
Net loss $ (736,997)
Deduct total stock-based compensation expense determined
under fair value based method for all awards, net of
relaxed tax effects --
-----------
Pro forma net loss $ (736,997)
===========
Loss per share - basic and diluted
As reported $ (0.02)
Pro forma $ (0.02)
There were no options granted during the six months ended June 30,
2005.
NOTE 10. COMMON STOCK OPTIONS
Stock Option Plans
At December 31, 2005, the Company had two stock-based compensation
plans, which are more fully described in Note 18 in the Annual Report
on Form 10-KSB for the year ended December 31, 2005. Prior to 2006, the
Company accounted for those plans under the recognition and measurement
provisions of APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and its related Interpretations. No stock-based employee
compensation cost was reflected in previously reported results, as all
options granted under those plans had an exercise price equal to the
market value of the underlying common stock on the date of grant.
On March 16, 2006, the Company's Board of Directors adopted an
incentive stock option plan as part of a larger equity incentive plan
(the "2006 Stock Incentive Plan") that also provides for non-statutory
stock options, stock bonuses and restricted stock awards. The
stockholders approved the Plan at the annual meeting of the
stockholders on May 19, 2006. The purpose of the Plan is to promote the
interests of the Company by aligning the interests of employees
(including directors and officers who are employees) of the Company,
consultants and non-employee directors of the Company and to provide
incentives for such persons to exert maximum efforts for the success of
the Company and affiliates. The 2006 Stock Incentive Plan provides that
no more than 8,000,000 shares of stock may be issued in equity awards
under the plan, the exercise price for incentive stock options shall
not be less than 100% of fair market value on the date of grant, and
unless otherwise determined by the Board, the exercise price for
non-statutory stock options shall be not less than 100% of fair market
value on the date of grant. The maximum term of options granted is 10
years.
15
AURORA OIL & GAS CORPORATION AND SUBSUDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Activity related to the three stock option plans (2006 Stock Incentive
Plan, 2004 Equity Incentive Plan and the 1997 Stock Option Plan) was as
follows for the six months ended June 30, 2006 and 2005:
2006 2005
---------- ----------
Options outstanding at beginning of period 1,205,000 344,000
Options granted 2,333,500 --
Options forfeited and other adjustments (419,266) --
Options exercised (254,734) --
---------- ----------
Options outstanding at end of period 2,864,500 344,000
========== ==========
The weighted average assumptions used in the Black-Scholes
option-pricing model used to determine fair value were as follows:
2006 2005
---- ----
Risk-free interest rate 4% --
Expected years until exercise 2.5-6.0 --
Expected stock volatility 41% --
Dividend yield 0% --
For three months ended June 30, 2006, the Company recorded stock-based
compensation of $352,291 for the 2006 Stock Incentive Plan. Of that
amount, $200,072 has been included in general and administrative
expense on the consolidated statement of operations and $152,219 has
been capitalized.
For six months ended June 30, 2006, the Company recorded stock-based
compensation of $722,757 for the 2006 Stock Incentive Plan. Of that
amount, $357,464 has been included in general and administrative
expense on the consolidated statement of operations and $365,293 has
been capitalized.
All Stock Options
Activity with respect to all stock options is presented below for six
months ended June 30, 2006 and 2005:
2006 2005
--------------------------- --------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
----------- -------- ---------- -----------
Options outstanding at beginning of
period 6,448,468 $0.72 2,700,664 $0.99
Options granted 2,333,500 3.96 -- --
Options exercised (3,642,926) 0.67 -- --
Forfeitures and other adjustments (344,266) 4.76 -- --
---------- ----------
Options outstanding at end of Period 4,794,776 $2.05 2,700,664 $0.99
========== ==========
Exercisable at end of period 2,751,609 $0.81
==========
Weighted average fair value of options granted $4.84
=====
The intrinsic value of a stock option is the amount by which the
current market value of the underlying stock exceeds the exercise price
of the option. The intrinsic value of the options outstanding at June
30, 2006 was approximately $9,942,000 and intrinsic value of the
options exercisable at June 30, 2006 was approximately $8,605,000. The
intrinsic value of the options exercised during the six months ended
June 30, 2006 was $12,118,000.
16
AURORA OIL & GAS CORPORATION AND SUBSUDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The weighted average remaining life by exercise price as of June 30,
2006 is summarized below:
Range of Outstanding Average Exercisable Average
Exercise Prices Shares Life Shares Life
--------------- -------------- ---- -------------- ----
$0.25 - $0.38 857,996 3.9 857,996 3.9
$0.50 - $0.75 1,580,000 2.5 1,580,000 2.5
$1.25 - $1.75 402,000 7.4 110,000 2.2
$2.45 - $2.55 150,280 3.5 60,280 3.0
$3.62 1,000,000 4.4 - -
$4.55 - $4.70 554,500 9.6 3,333 8.8
$5.19 - $5.54 250,000 6.2 140,000 4.7
-------------- --------------
4,794,776 4.5 2,751,609 3.0
============== ==============
NOTE 11. COMMON STOCK WARRANTS
The following table provides information related to stock warrant
activity for the six months ended June 30, 2006:
Number of Shares
Underlying Warrants
-------------------
Outstanding at beginning of the period 19,697,500
Granted --
Exercised under early exercise program (13,182,625)
Exercised (3,489,871)
Forfeited (945,504)
-----------
Outstanding at the end of the period 2,079,500
===========
As of June 30, 2006, these common stock warrants had an average
remaining contractual life of 2.39 years and weighted average exercise
price per share of $1.71.
NOTE 12. NET INCOME (LOSS) PER SHARE
Basic earnings (loss) per share are computed by dividing net income
(loss) by the weighted average number of common shares outstanding for
the period. The computation of diluted net income (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 or resulted in the issuance of common stock that would then share
in the earnings of the Company.
During the six months ended June 30, 2006 and 2005, stock options,
warrants and convertible preferred stock were excluded in the
computation of diluted loss per share because their effect was
anti-dilutive.
NOTE 13. CONTINGENCIES AND COMMITMENTS
Environmental Risk
Due to the nature of the oil and gas business, the Company is exposed
to possible environmental risks. The Company manages its exposure to
environmental liabilities for both properties it owns as well as
properties to be acquired. The Company has historically not experienced
any significant environmental liability, and is not aware of any
potential material environmental issues or claims at June 30, 2006.
17
AURORA OIL & GAS CORPORATION AND SUBSUDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Letters of Credit
For each salt water disposal well drilled in the State of Michigan, the
Company is required to issue a letter of credit to the Michigan
Supervisor of Wells. The Supervisor of Wells may draw on the letter of
credit if the Company fails to comply with the regulatory requirements
relating to the locating, drilling, completing, producing, reworking,
plugging, filling of pits, and clean up of the well site. The letter of
credit or a substitute financial instrument is required to be in place
until the salt water disposal well is plugged and abandoned. For
drilling natural gas wells, the Company is required to issue a blanket
letter of credit to the Michigan Supervisor of Wells. This blanket
letter of credit allows the Company to drill an unlimited number of gas
wells. The existing letters of credit have been issued by Northwestern
Bank of Traverse City, Michigan, and are secured only by a
Reimbursement and Indemnification Commitment issued by the Company,
together with a right of set-off against all of the Company's deposit
accounts with Northwestern Bank. At June 30, 2006, a total of $852,500
letters of credit to the Michigan Supervisor of Wells were outstanding.
Employment Agreement
Effective June 19, 2006, the Company hired Ronald E. Huff to serve as
Chief Financial Officer of the Company. The Company has entered into a
two-year Employment Agreement with Mr. Huff, providing for an annual
salary of $200,000 per year and an award of a stock bonus in the amount
of 500,000 shares of the Company's common stock on January 1, 2009, so
long as he remains employed by the Company through June 18, 2008. If
his employment with the Company is terminated prior to this date
without just cause or if the Company undergoes a change in control, he
will nonetheless be awarded the full 500,000 shares. If his employment
is terminated prior to June 18, 2008 due to death or disability, he
will receive a prorated stock award. Mr. Huff forfeited the option to
purchase 200,000 shares that he was previously awarded for his service
as a director of the Company. Mr. Huff remains a director of the
Company.
NOTE 14. RETIREMENT BENEFITS
Effective May 1, 2006, the Company established a qualified retirement
plan referred to as Aurora 401(k) Plan ("the Plan"). The Plan is
available to all employees who have completed at least 1,000 hours of
service over their first twelve consecutive months of employment and
are at least 21 years of age. Effective July 1, 2006, the Company
waived the age and service requirements for any employee employed by
the Company on or before July 1, 2006. The Company may provide: 1)
discretionary matching of employee contributions, 2) discretionary
profit sharing contributions and 3) qualified non-elective
contributions to the Plan. Company-provided contributions are subject
to certain vesting schedules.
NOTE 15. OIL AND GAS PROPERTIES HELD FOR SALE
Management is currently in the process of evaluating the Company's
property portfolio to ensure that the oil and gas properties portfolio
properly matches the Company's long-term strategic plan. During the
second quarter of 2006, the Company identified certain leasehold
properties as held for sale due to their high probability of being sold
within the next 12 months. Total oil and gas properties held for sale
amounted to $21,365,575 at June 30, 2006 of which $11,857,821 is proved
and $9,507,754 is unproved. These properties are carried at the lower
of historical cost or fair value. Under the full cost method, sales of
oil and gas properties, whether or not being amortized currently, are
accounted for as adjustments of capitalized costs, with no gain or loss
recognized unless such adjustments would significantly alter the
relationship between capitalized costs and proved reserves. The Company
has evaluated the proved reserves of these properties and determined
that there is no significant effect on the proved reserves regarding
the assets held for sale. At June 30, 2005, no properties were
classified as held for sale.
18
AURORA OIL & GAS CORPORATION AND SUBSUDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 16. SUBSEQUENT EVENTS
Pending Acquisition
On May 9, 2006, North signed a letter of intent with a third party to
acquire oil and gas leases, working interests, and interests in related
pipelines and production facilities that are located in the Michigan
Antrim. This encompasses two projects that are still in development,
but already are generating some production. On June 30, 2006, the
letter of intent was amended to extend the due diligence effort through
September 30, 2006 with anticipated closing of the transaction on or
before November 15, 2006. This acquisition remains contingent on the
review and approval of the financial institutions providing financing
to the Company.
Bach Acquisition
On July 10, 2006, the Company entered into a binding letter of intent
to purchase all the assets of Bach Enterprises, Inc., certain assets
owned by Bach Energy, L.L.C. and a limited liability company known as
Kingsley Development L.L.C. (together "Bach"). The letter of intent
contemplates a 60 day due diligence period followed by notice and a 30
day cure period if material issues are identified in the due diligence
process. Closing is expected to occur within 90 days. Bach is primarily
an oil and gas service company. The Company has been working
exclusively with Bach as a service business in Michigan for several
years. Services they have provided include building compressors, CO2
removal, pipelining, and facility construction.
DeSoto Parish, Louisiana Disposition
On July 20, 2006, the Company entered into a Purchase and Sale
Agreement with respect to the DeSoto Parish, Louisiana properties to
sell certain assets to BEUSA Energy, Inc. for a purchase price of
$4,750,000. BEUSA Energy, Inc. is the current operator and joint
interest owner in these properties. The properties included: 1) 14
gross wells with working interest ranging from 22.5% to 45%; 2) 4,480
(1,657 net) acres; and 3) various pipelines and facilities. The
effective date of the sale is July 1, 2006.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion in conjunction with
management's discussion and analysis contained in our 2005 Annual Report on Form
10-KSB, as well as the consolidated financial statement and notes hereto
included in this quarterly report on Form 10-QSB. The following discussion
contains forward-looking statements that involve risks, uncertainties, and
assumptions such as statements of our plans, objectives, expectations,
intentions and estimated reserves. Our actual results may differ materially from
those discussed in these forward-looking statements because of the risks and
uncertainties inherent in future events. For additional risk factors affecting
our business, see the information in Item 1A in our 2005 Annual Report on Form
10-KSB and subsequent filings.
BUSINESS OVERVIEW
We are a growing independent energy company focused on the exploration,
exploitation, and development of unconventional natural gas reserves. Our
unconventional natural gas projects target "black shale" plays where large
acreage blocks can be easily evaluated with a series of low cost test wells.
Black shale plays tend to be characterized by high drilling success and
relatively low drilling costs when compared to conventional exploration and
development plays. Our project areas are focused in the Antrim Shale of Northern
Michigan and New Albany Shale of Southern Indiana and Western Kentucky.
On October 31, 2005, Cadence Resources Corporation acquired Aurora Energy,
Ltd. ("Aurora") through the merger of a wholly owned subsidiary with and into
Aurora. The acquisition of Aurora was accounted for as a reverse merger, with
Aurora being the acquiring party for accounting purposes. The Aurora executive
management team also assumed management control at the time the merger closed,
and we moved our corporate offices to Traverse City, Michigan. As a result of
the reverse merger, the historical financial statements presented for periods
prior to the acquisition date are the financial statements of Aurora. The
operations of the former Cadence Resources Corporation businesses have been
included in the financial statements from the date of acquisition. Effective May
11, 2006, Cadence Resources Corporation amended its articles of incorporation to
change the parent company name to Aurora Oil & Gas Corporation ("AOG").
Our strategy is to maximize stockholder value by leveraging our
significant acreage position. As an early stage developer of properties, we
anticipate that reserve growth will be our initial focus followed in a few years
by a more traditional balance between reserve and production growth. As of
December 31, 2005, our leasehold acres (both developed and undeveloped) were
815,465 (364,091 net) which represent a 46% increase over our December 31, 2004
net acres. Our 2005 drilling program resulted in us participating in 152 (108
net) wells of which 77 (51 net) wells were waiting hook-up. As of December 31,
2005, we were operating 96 (82 net) wells and participating in another 309 (101
net) wells operated by other companies. This 2005 drilling activity increased
our proved reserves by nearly 178% to 64 bcfe of which 99% were natural gas
reserves.
We generate most of our revenues from the production and sale of natural
gas. Our revenue, profitability and future rate of growth are substantially
dependent on our ability to find, develop and acquire gas reserves that are
economically recoverable based on prevailing prices of natural gas and oil.
Historically, the energy markets have been very volatile and it is likely that
oil and gas prices will continue to be subject to wide fluctuations in the
future. A substantial or extended decline in natural gas and oil prices could
have a material adverse effect on our financial position, results of
operations, cash flows and access to capital, and on the quantities of natural
gas and oil reserves that can be economically produced.
RECENT HIGHLIGHTS
For the first six months of 2006, we continued to execute our strategy of
focusing on lower risk core development projects. As of June 30, 2006, our
leasehold acres (both developed and undeveloped) were 1,105,739 (621,290 net)
which represent a 71% increase over our December 31, 2005 net acres. Of the
290,274 (257,200 net) leasehold acres acquired, 47,830 net acres were in the
Antrim Shale play and 177,568 net acres were in the New Albany Shale play.
20
With regard to our strategy to generate growth through drilling, we
drilled or participated in 72 (33 net) wells for the first six months of 2006.
As of June 30, 2006, we have 378 (170 net) producing wells and 86 (37 net) wells
awaiting hook-up. For the first six months of 2006, we placed 70 (46 net) wells
into production. We also continued our strategy to have greater control over our
projects by operating 175 (151 net) wells, thus operating 38% of our gross
wells. We also supplemented our drilling strategy with the Hudson properties
acquisition. This acquisition increased our proved reserves by approximately 24
bcfe in the Antrim Shale play.
We began 2006 with estimated proved reserves of 64 bcfe and ended the
Current Quarter with 108 bcfe, an increase of 44 bcfe, or 69%. Of the 108 bcfe
in estimated proved reserve, 103 bcfe was from the Antrim Shale play and 2 bcfe
was from the New Albany Shale play.
In order to reduce exposure to fluctuations in the price of natural gas,
we will periodically enter into financial instruments with a major financial
institution. We have entered into swap instruments in order to hedge a portion
of our production. The purpose of the swap is to provide a measure of stability
to our cash flow in meeting financial obligations while operating in a volatile
gas market environment. The derivative reduces our exposure on the hedged
volumes to decreases in commodity prices, but also limits the benefit we might
otherwise receive from any increases in commodity prices on the hedged volumes.
We have entered into a financial swap contract for 5,000 MMBtu per day at a
fixed price of $8.59 per MMBtu covering the period of April 2006 through March
2007 and another financial swap contract on July 14, 2006 for 5,000 MMBtu per
day at a fixed price of $9.00 per MMBtu for the period from April 2007 through
December 2008.
To further our growth, we entered into a senior secured credit facility on
January 31, 2006 with an initial borrowing base of $40 million. As proved
reserves are added, the borrowing base may increase to $50 million without
consent from our mezzanine financing arrangement and $100 million with consent
from the mezzanine financing arrangement. Effective July 14, 2006, the borrowing
base was increased to $50 million.
The public market has also been a source of our long-term financing. From
late December 2005 through early February 2006, we reduced the exercise price of
certain outstanding options and warrants in order to encourage the early
exercise of these securities. As a result of the options and warrants exercised
pursuant to this reduced exercise price arrangement, and pursuant to other
exercises of outstanding options, an additional 20,315,422 shares were issued
during the six months ended June 30, 2006 representing 15,565,457 shares issued
for cash proceeds of $18,144,449 and 4,749,965 shares issued pursuant to
cashless exercises of the applicable warrants or options. In December 2005 an
additional 2,160,000 shares were issued for cash proceeds of $2,916,000.
21
RESULTS OF OPERATION
Operating Statistics
The following table sets forth certain key operating statistics for the three
and six months ended June 30, 2006 (the "Current Quarter" and the "Current
Period") and the three and six months ended June 30, 2005 (the "Prior Quarter"
and the "Prior Period"):
Three Months Ended June 30, Six Months Ended June 30,
2006 2005 2006 2005
----------- ----------- ----------- -----------
Net Acreage Acquired
Antrim Shale 40,705 13,463 47,830 34,487
New Albany Shale 74,649 56,355 177,568 (29,923)
Other 29,576 410 31,802 2,236
----------- ----------- ----------- -----------
Total 144,930 70,228 257,200 6,800
Total Net Acreage Held
Antrim Shale 125,993 59,428 125,993 59,428
New Albany Shale 449,460 139,431 449,460 139,431
Other 45,837 3,520 45,837 3,520
----------- ----------- ----------- -----------
Total 621,290 202,379 621,290 202,379
Net Wells Drilled
Antrim Shale 17 12 27 19
New Albany Shale 1 -- 2 --
Other 4 -- 4 --
----------- ----------- ----------- -----------
Total 22 12 33 19
Total Net Wells
Net producing 170 47 170 47
Net waiting hookup 37 20 37 20
----------- ----------- ----------- -----------
Total 207 67 207 67
Production:
Natural gas (mcfs) 630,206 94,531 1,224,551 147,899
Crude oil (bbls) 5,286 1,312 11,888 2,764
Average daily production:
Natural gas (mcfs) 6,925 1,039 6,765 817
Crude oil (bbls) 58 14 66 15
Average sales prices
Natural gas (mcfs) $ 6.92 $ 6.96 $ 7.68 $ 6.55
Crude oil (bbls) $ 69.92 $ 46.80 $ 62.34 $ 46.60
Total production revenue $ 5,524,354 $ 719,285 10,941,220 $ 1,097,906
Natural gas $ 5,154,728 $ 657,938 10,200,110 $ 968,738
Crude oil $ 369,626 $ 61,347 741,110 $ 129,168
Production expense per mcfe $ 2.38 $ 3.70 $ 2.63 $ 3.97
Number of employees 53 30
22
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2006 ("CURRENT QUARTER")
VS. JUNE 30, 2005 ("PRIOR QUARTER")
- General
For the Current Quarter, we had a net loss of $1,185,188 on total
revenues of $5,789,628. This compares to net loss of $325,493 on total revenue
of $935,621 during the Prior Quarter. This $4,854,007 increase in revenue
represents the initial results that we are realizing as an early stage developer
of properties.
- Oil and Gas Sales
During the Current Quarter, oil and gas sales were $5,524,354 compared
to $719,285 in the Prior Quarter. We produced and sold 661,922 mcfe at a
weighted average price $8.35 compared to 102,403 mcfe at a weighted average
price of $7.02. This increase was primarily due to the ramping up of production
from new wells placed into production, acquisition of additional working
interests in Hudson properties and the producing assets from the Cadence reverse
merger. The Antrim Shale play represented approximately 92% of our oil and gas
revenue for the Current Quarter.
At the end of this Current Quarter, we had 170 net wells producing
compared to 47 net wells at the end of the Prior Quarter. During the Current
Quarter, we had a favorable volume variance by placing 33 net wells into
production and increasing our existing ownership interest in 5 net wells. The
favorable average price variance included $792,350 of realized gains from the
gas derivative entered into this Current Quarter. The gas derivative covered
approximately 72% of our average daily production for the Current Quarter.
- Other Income
Other income for the Current Quarter primarily includes pipeline
revenue from the Hudson acquisition while the Prior Quarter includes prospect
fees generated from joint ventures. During the Current Quarter, other income was
$194,694 compared to $118,285 in the Prior Quarter. This increase was primarily
due to the Hudson properties acquisition which included a revenue generating
pipeline business.
- General and Administrative Expenses
Our general and administrative expenses include officer and employee
compensation, travel, audit, tax and legal fees, office supplies, utilities,
insurance, other consulting fees and office related expense. Effective January
1, 2006, general and administrative expenses excludes certain internal payroll
and benefit costs that can be directly identified with our acquisition,
exploration and development activities. For the Current Quarter, $411,642 of
payroll and benefit costs were capitalized to oil and gas properties.
The $1,048,671 increase in general and administrative expenses for the
Current Quarter was primarily the result of the company growth strategy of
acquiring and developing operating interests in unconventional drilling programs
in the Michigan Antrim Shale and the New Albany Shale. This growth has resulted
in substantial increases in employees and related costs, legal and accounting
services related to SEC filings as well as increased consulting services. In
addition, we continue to experience significant general and administrative
expenses as a result of the Cadence merger. The Prior Quarter expenses reflect
Aurora as a private entity whereas the Current Quarter represents both
development costs associated with becoming a public entity and on-going public
costs.
We incurred an additional $232,515 in compensation and benefit expenses
related to 23 new employees. In addition, stock-based compensation in the
Current Quarter was $386,976. Of that amount $234,757 has been included in
general and administrative expense and $152,219 has been capitalized. The Prior
Quarter did not have any stock-based compensation. Effective January 1, 2006 we
adopted FASB Statement No. 123R "Shared Based Payment" to account for
stock-based employee compensation which requires us to recognize the cost of
employee services received in exchange for stock-based awards based on the grant
date fair value of those awards in our financial statements. We elected to use
the modified prospective method for adoption, which requires compensation
expense to be recorded for all unvested stock options beginning in the first
quarter of adoption. For stock-based awards granted or modified subsequent to
January 1, 2006, compensation expense, based on the fair value on the date of
grant, will be recognized in the financial statements over the vesting period.
The impact on future net income is estimated to be $4,538,193 which will be
recognized over the applicable requisite service period of approximately three
years.
23
We continue to experience significant legal, accounting and other
consulting services as a result of the Cadence merger including development
costs associated with becoming a public entity and on-going public costs. The
following table sets forth the majority of our outside services for the Current
Quarter as compared to the Prior Quarter:
For three months ended For three months ended
Expense category June 30, 2006 June 30, 2005
- ---------------------------------- ------------------------- --------------------------
Legal expenses $156,077 $11,961
Accounting expenses 177,655 23,193
Consulting and other expenses 247,633 137
- ---------------------------------- ------------------------- --------------------------
Total $581,365 $35,291
The Current Quarter legal expenses include significant SEC services
covering Form 10-K, Form 8-K, S-8 registration, corporate issues, lost
certificates of shareholder stock, stock options, etc. We believe that a certain
amount of these legal expenses will diminish as internal systems and staffing
are introduced. The Current Quarter accounting expenses include approximately
$71,000 of additional 2005 year-end audit work. The Current Quarter consulting
and other expenses include the following expenditures: 1) $50,000 for publishing
the annual report and proxy statement; 2) one-time fee of $65,000 for our AMEX
listing and $23,000 annual prorated AMEX listing fee; 3) $18,000 fee for the
stock transfer agent, and 4) $35,000 for consulting services that addressed
process improvements.
- Production and Lease Operating Expenses
Our production and lease operating expenses include services related to
producing oil and gas, such as severance taxes, post production costs (including
marketing and transportation), and lease operating expenses (including expenses
to operating the wells and equipment on a producing lease).
Production and lease operating expenses were $1,573,821 for the Current
Quarter compared to $378,200 for the Prior Quarter. On a unit of production
basis, production expenses were $2.38 per mcfe in the Current Quarter compared
to $3.70 for Prior Quarter. The decrease in the Current Quarter was primarily a
result of our continuing strategy to have greater cost control over our
properties by operating 38% of our gross wells. In addition, the fixed costs
of control processing facilities and water disposal facilities are starting to
be spread over more production as new development wells come on line. We also
recognized transportation expense reduction of $74,418 due to the Hudson
pipeline acquisition.
The following table sets forth the major components of production and
operating expenses for the Current Quarter and Prior Quarter:
For three months ended June For three months ended
30, 2006 June 30, 2005
----------------------- -----------------------
Per Per
Expense category Mcfe Amount Mcfe Amount
- ------------------------ ----- ---------- ----- ----------
Severance taxes $ .35 $ 231,666 $ .29 $ 29,437
Post-production expenses .67 443,906 1.21 123,985
Lease operating expenses 1.36 898,249 2.20 224,778
- ------------------------ ----- ---------- ----- ----------
Total $2.38 $1,573,821 $3.70 $ 378,200
24
- Depletion, depreciation and amortization (DD&A)
Depletion, depreciation and amortization was $1,614,449 and $59,027 for
the Current Quarter and the Prior Quarter, respectively. DDA of oil and gas
properties was $1,055,338 during the Current Quarter. This increase reflects the
transfer to production assets of approximately $76.8 million; of which $22.0
million represents additions for the Current Quarter. This represents wells
being placed into production with costs being transferred from unproven
properties to proven properties.
Other depreciation and amortization was $559,111 during the Current
Quarter; of which $383,750 represented amortization of intangible assets
recognized in connection with the Cadence merger, $115,729 represented
depreciation of the Hudson pipeline assets, $13,079 represented amortization of
ARO and $46,553 represents depreciation of other property and equipment.
- Interest expense
Interest expense was $1,970,019 in the Current Quarter compared to
$189,067 in the Prior Quarter. This increase is due to higher utilization of
debt to continue our growth strategy of acquiring and developing operating
interests in the Michigan Antrim Shale and the New Albany Shale. The amount of
capitalized interest has decreased significantly from Prior Quarter as our
properties are transferred from undeveloped to producing or as financing is used
for proven acquisition. As of June 30, 2006, we had outstanding borrowings of
$82.8 million compared to $13.9 million as of the June 30, 2005.
- Taxes
Tax expense was $27,694 in the Current Quarter compared to $0 in the
Prior Quarter. This increase represents 2004 Michigan Single Business Tax
expense that was not previously accrued.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2006 ("CURRENT PERIOD") VS. JUNE 30, 2005 ("PRIOR
PERIOD")
- - General
For the Current Period, we had net loss of $1,949,846 on total revenues
of $11,623,719. This compares to net loss of $736,997 on total revenue of
$1,625,824 during the Prior Period. The $9,997,895 increase in revenue
represents the results of the initial steps that we are taking as an early stage
developer of properties. We had 170 net wells producing at the end of the
Current Period as compared to 47 net wells producing at the end of the Prior
Period.
- Oil and Gas Sales
During the Current Period, oil and gas sales were $10,941,220 compared
to $1,097,906 in the Prior Period. We produced 1,295,879 mcfe at a weighted
average price $8.44 compared to 164,483 mcfe at a weighted average price of
$6.67. This increase in production was due to the ramping up of production from
new wells placed into production, acquisition of additional working interest in
Hudson properties and the producing assets from the Cadence reverse merger. The
Antrim Shale play represented approximately 87% of our oil and gas revenue for
the Current Period.
At the end of the Current Period, we had 170 net wells producing
compared to 47 net wells at the end of the Prior Period. During the Current
Period, we had a favorable volume variance by placing 123 net wells into
production as compared to Prior Period. In addition, we placed 47 net wells into
production during the Current Period. The favorable average price variance
included $792,350 of realized gains from the gas derivative entered into the
Current Period.
25
- Other Income
Other income for the Current Period primarily includes pipeline revenue
from the Hudson acquisition while Prior Period includes prospect fees generated
from joint ventures. During the Current Period, other income was $596,999
compared to $349,611 in the Prior Quarter. This increase was primarily due to
the Hudson properties acquisition that includes a revenue generating pipeline
business.
- General and Administrative Expenses
Our general and administrative expenses include officer and employee
compensation, travel, audit, tax and legal fees, office supplies, utilities,
insurance, other consulting fees and office related expense. Effective January
1, 2006, general and administrative expenses excludes certain internal payroll
and benefit costs that can be directly identified with our acquisition,
exploration and development activities. For the Current Period, $992,372 of
payroll and benefit costs were capitalized to oil and gas properties.
The $2,116,317 increase in general and administrative expenses for the
Current Period was the result of the company growth strategy in land
acquisitions and drilling program. This growth has resulted in substantial
increases in employees and related costs, legal and accounting services related
to SEC filings as well as increased consulting services. In addition, we
continue to experience significant general and administrative expenses as a
result of the Cadence merger. The Prior Period expenses reflect Aurora as a
private entity whereas the Current Period represents both development costs
associated with becoming a public entity and on-going public costs.
We incurred $309,953 of additional compensation and benefit expenses
related to 23 new employees. In addition, stock-based compensation in the
Current Period was $757,442. Of that amount $392,149 has been included in
general and administrative expense and $365,293 has been capitalized. The Prior
Period did not have any stock-based compensation.
We continue to experience significant legal, accounting and other
consulting services as a result of the reverse merger including development
costs associated with becoming a public entity and on-going public costs. The
following table sets forth the majority of our outside services for the Current
Period as compared to the Prior Period:
For six months ended For six months ended
Expense Category June 30, 2006 June 30, 2005
----------------------------- ---------- ----------
Legal expenses $ 424,910 $ 14,386
Accounting expenses 451,144 35,388
Consulting and other expenses 454,680 60,630
----------------------------- ---------- ----------
Total $1,330,734 $ 110,404
The Current Period legal expenses include significant SEC services
covering various SEC filings for financial reporting, stock-compensation plans,
and corporate issues concerning stock options, lost certificates of stock,
corporate structuring, acquisitions, etc. We incurred an additional $99,289 in
legal expenses associated with 2005 transactions. We also believe that a certain
amount of legal expenses will diminish as internal systems and staffing are
introduced. The Current Period accounting expenses include approximately
$177,752 associated with 2005 year end audit work, work associated with the
Hudson acquisition, and disclosures on reserves. The Current Period consulting
and other expenses include the following expenditures: 1) $50,000 for publishing
the annual report and proxy; 2) one-time fee of $65,000 for our AMEX listing and
$23,000 annual prorated AMEX listing fee; 3) $18,000 fee for the stock transfer
agent, 4) $35,000 for consulting services that addressed process improvements;
5) $122,470 in one-time consulting fees and temporary help; and 6) $65,250
one-time rent settlement.
- Production and Lease Operating Expenses
Our production and lease operating expenses include services related to
producing oil and gas, such as severance taxes, post production costs (including
marketing and transportation), and lease operating expenses (including expenses
to operating the wells and equipment on a producing lease).
26
Production and lease operating expenses were $3,411,051 for the Current
Period compared to $652,957 for the Prior Period. On a unit of production basis,
production expenses were $2.63 per mcfe in the Current Period compared to $3.97
for Prior Period. The decrease in the Current Period was primarily due to our
continuing strategy to have greater cost control over our projects by operating
38% of our gross wells. In addition, the fixed costs of control processing
facilities and water disposal facilities are starting to be spread over more
production as new development wells come on line. We also recognized
transportation expense reduction of $150,695 due to the Hudson pipeline
acquisition.
The following table sets forth the major components of production and
operating expenses for the Current Period and Prior Period:
For three months ended June For three months ended
30, 2006 June 30, 2005
----------------------- -----------------------
Per Per
Expense category Mcfe Amount Mcfe Amount
- ------------------------ ----- ---------- ----- ----------
Severance taxes $ .34 $ 445,825 $ .30 $ 49,079
Post-production expenses .58 743,309 1.20 197,636
Lease operating expenses 1.71 2,221,917 2.47 406,242
- ------------------------ ----- ---------- ----- ----------
Total $2.63 $3,411,051 $3.97 $ 652,957
- Depletion, depreciation and amortization (DD&A)
Depletion, depreciation and amortization was $3,024,166 and $102,227
during the Current Period and the Prior Period, respectively. DDA of oil and gas
properties was $1,976,378 during the Current Quarter. This increase reflects the
increase to production assets of approximately $76.8 million. This represents
wells being placed into production with costs being transferred from unproven
properties to proven properties. In addition, there was an increase in depletion
rates associated with the producing assets from the Cadence merger, since these
assets have reserves with shorter lives than the Michigan Antrim Shale.
Other depreciation and amortization was $1,047,788 during the Current
Period of which $767,500 represented amortization of the intangible assets
recognized in connection with the Cadence merger and $156,360 represented
depreciation related to the Hudson pipeline acquisition. $34,005 represented
amortization of ARO and $89,923 represents depreciation of other property and
equipment.
- Interest expense
Interest expense was $3,564,154 in the Current Period compared to
$237,354 in the Prior Period. This increase is due to higher utilization of debt
to continue our growth strategy of acquiring and developing operating interests
in the Michigan Antrim Shale and the New Albany Shale. The amount of capitalized
interest has decreased significantly from the Prior Period as our properties are
transferred from undeveloped to producing or as financing is used for proven
acquisition. As of June 30, 2006, we had borrowed $82.8 million compared to
$13.9 million as of June 30, 2005.
- Taxes
Tax expense was $29,361 in the Current Period compared to $237,697 in
the Prior Period. This decrease resulted from the reversal of an accrual related
to the January 2005 sale of the 95% working interest to El Paso Corporation in
certain New Albany Shale acreage.
CAPITAL RESOURCES AND LIQUIDITY
We will fund our growth strategy using a combination of debt, existing
cash balances, internally generated cash flows from natural gas production, and
possible proceeds from the sale of equity. We do not expect the combination of
our current capital resources to be sufficient to fully execute our total 2006
budgeted capital requirements. We are currently in the process of determining
the options available to fund our total budgeted capital expenditures. The
options being evaluated include increased debt financing and the issuance of
equity securities.
27
Our original drilling and development budget for 2006 was approximately
$45 million. This included a Antrim drilling program where we would participate
in over 150 (75 to 100 net) wells and a New Albany Shale drilling program where
we would participate in over 50 (25 net) wells. Our 2006 lease acquisition
budget was $15 million to secure additional acreage in both the Michigan Antrim
Shale and the New Albany Shale. Since our budget is intended to be highly
discretionary, we are currently re-evaluating our lease acquisition plan and
planned drilling schedule. We anticipate that the remaining drilling and
development budget will be approximately $40 million for the second half of
2006. We anticipate participating in 112 net Antrim Shale wells and 5 net New
Albany Shale wells.
Certain factors such as the increase in production revenues and our
ability to secure equity will impact our ability to complete our 2006 drilling
program. Production revenues are impacted by commodity prices that are subject
to fluctuation. This may impact our ability to secure additional debt and to
raise capital through the issuance of securities. Natural gas prices were
favorable in 2004 and 2005 and industry analysts expect them to remain strong in
the foreseeable future. If our revenues were to decrease significantly as a
result of unexpected declines in price and/or production volumes, we could be
forced to curtail our drilling and development activities.
Our ability to access equity will depend upon the conditions in the
capital markets and other factors including the price of natural gas and
investment climate for energy companies. We may consider from time to time the
issuance of equity and use the proceeds to refinance current indebtedness or
additional acquisitions or investments in assets or businesses that complement
our existing assets and businesses. Acquisitions, if any, may also be financed
through existing cash on hand or bank borrowings.
There is no assurance that any desired increase in available credit
will be realized, nor is there any assurance that desired sources of equity
financing will be available in 2006. If capital resources are inadequate or
unavailable, we may curtail acquisition, development and other activities or in
severe cases, be forced to sell some of our assets on an untimely or unfavorable
basis.
SOURCES OF LIQUIDITY
Our primary sources of liquidity are outlined below:
Our mezzanine financing is a $50 million credit facility with TCW for
the Michigan Antrim Shale drilling program. It has a maturity date of September
30, 2009. Borrowings under the TCW credit facility as of June 30, 2006 were $40
million with available borrowing capacity of $10 million. The TCW borrowing base
is subject to semi-annual re-determination and certain other re-determinations
based upon several factors. The borrowing base is impacted by, among other
factors, the fair value of our gas reserves that are pledged to TCW. Changes in
the fair value of our oil and gas reserves are caused by changes in prices for
natural gas and crude oil, operating expenses and the results of drilling
activity. A significant decline in the fair value of these reserves could reduce
our borrowing base as we may not be able to meet certain facility covenants. The
TCW loan agreement prohibits the declaration or payment of dividends and
contains certain covenants. As of June 30, 2006, we were in compliance with all
of the applicable covenants.
Our senior secured credit facility is a $100 million senior secured
credit facility with BNP Paribas ("BNP"). The initial borrowing base under this
facility was $40 million. As proved reserves are added, this borrowing base may
increase to $50 million without TCW consent, and $100 million with TCW consent.
A required semi-annual reserve report may result in an increase or decrease in
credit availability. On July 14, 2006, the senior secured credit facility was
amended in the following manner: 1) the credit availability was increased to $50
million, and 2) the trailing 12-month interest coverage ratio covenant was
amended to defer the testing until the fourth quarter of 2006, and to provide
for a reduced ratio for that quarter. At June 30, 2006, our total borrowings
under this facility were $40 million with a current available borrowing capacity
of $10 million.
28
The senior secured credit facility contains, among other things,
certain covenants relating to restricted payments (as defined), loans or
advances to others, additional indebtedness, and incurrence of liens; and
provides for the maintenance of certain financial and operating ratios,
including current ratio and specified coverage ratios (collateral coverage and
proved developed producing reserves coverage ratios). As of June 30, 2006, we
were in compliance with all of the applicable covenants.
Our short-term line of credit is a $5 million revolving line of credit
with Northwestern Bank for general corporate purposes. At June 30, 2006, our
total borrowings under this facility were $10,000 with available borrowing
capacity of $4.990 million.
From late December 2005 through early February 2006, we reduced the
exercise price of certain outstanding options and warrants in order to encourage
the early exercise of these securities. Each holder who took advantage of the
reduced exercise price was required to execute a six-month lock up agreement
with respect to the shares issued in the exercise. As a result of the options
and warrants exercised pursuant to this reduced exercise price arrangement, and
pursuant to other exercises of outstanding options, an additional 20,315,422
shares were issued during the six months ended June 30, 2006 representing
15,565,457 shares issued for cash proceeds of $18,144,449 and 4,749,965 shares
issued pursuant to cashless exercises of the applicable warrants or options. In
December 2005 an additional 2,160,000 shares were issued for cash proceeds of
$2,916,000.
Our total capitalization was as follows:
As of As of
June 30, 2006 December 31, 2005
------------ ------------
Short-term bank borrowings $ 10,000 $ 6,210,000
Obligations under capital lease 7,173 11,085
Related party notes payable -- 69,833
Mortgage payable 2,833,397 2,865,477
Mezzanine financing 40,000,000 40,000,000
Senior secured credit facility 40,000,000 --
------------ ------------
Total Debt $ 82,850,570 $ 49,156,395
------------ ------------
Stockholders' equity 74,924,893 56,625,927
------------ ------------
Total Capitalization $157,775,463 $105,782,322
============ ============
CASH FLOWS ACTIVITIES
We generated $2,636,906 in net cash from operations in the Current
Period compared to using $459,971 in the Prior Period. The $3,096,877 increase
was primarily due to higher realized prices and higher volumes of oil and gas
production as discussed in the Results of Operations. We believe this level of
development and revenue generation will continue as our drilling program ramps
up in the Michigan Antrim Shale and New Albany Shale plays.
Net cash flows used in investing activities was $32,845,786 in the
Current Period compared to $7,946,216 used in the Prior Period. This excludes
asset retirement obligation of $976,343, capitalized stock-based compensation of
$365,293 and investment adjustment for Hudson acquisition of $1,366,887. The
following table describes our significant investing transactions that we
completed in the Current Period compared to Prior Period:
29
Six Months Ended June 30,
2006 2005
------------ ------------
Acquisitions of leasehold
Michigan Antrim Shale $ 3,342,686 $ 1,059,396
New Albany Shale (see note A) 18,036,545 2,429,786
Other 348,588 --
Drilling and development of oil and gas properties
Michigan Antrim Shale 15,962,547 10,958,670
New Albany Shale 643,860 --
Other 295,592 --
Infrastructure properties
Michigan Antrim Shale 3,538,393 --
Acquisitions of producing properties 290,869 --
Additions to pipeline 162,108 --
Additions to other investments 475,000 515,956
Additions to other property and equipment 219,694 105,674
Capitalized merger cost -- 263,092
Advances on note receivable 60,000 72,379
------------ ------------
Subtotal of capital expenditures $ 43,375,882 $ 15,404,953
Disposition of oil and gas properties (see note A) (10,500,000) (7,373,737)
Divestiture of other receivable and investment (30,096) (85,000)
------------ ------------
Subtotal of capital divestitures $(10,530,096) $ (7,458,737)
Total $ 32,845,786 $ 7,946,216
============ ============
(A) On February 2, 2006, Aurora closed on two Purchase and Sales
Agreements with respect to certain New Albany Shale acreage located in
Indiana, commonly called the Wabash project. Aurora acquired 64,000
acres of oil and gas leases from Wabash Energy Partners, L.P. for a
purchase price of $11,840,000. Aurora then sold half its interest in a
combined 95,000 acre lease position in the Wabash project to New
Albany-Indiana, L.L.C. ("New Albany"), an affiliate of Rex Energy
Operating Corporation for a sale price of $10,500,000. Internal funds
of Aurora were used to pay the net transaction cost of theses
transactions.
Cash flows provided by financing activities for the Current Period was
$21,823,195 compared to $16,743,071 during the Prior Period. Cash flows provided
and used for the Current Period included: 1) $37,613,387 of senior secured
borrowing, of which, $27,615,993 was paid directly for the Hudson acquisition;
2) $18,144,449 of proceeds received from exercise of common stock options and
warrants; and 3) pay-down of $6,200,000 in short-term bank borrowings. Cash
flows provided and used by financing activities for the Prior Period included:
1) $11,025,000 of proceeds received from sales of common stock; 2) $9,850,000 of
mezzanine borrowing, net of financing costs of $150,000; 3) pay-off of
$2,948,698 of certain related-party notes; 4) distributions of $805,000 to
minority interest members for their proportionate share of the El Paso sales
proceeds.
RECENT ACCOUNTING PRONOUNCEMENTS
Reference is made to Notes 4 and 9 to the Financial Statements included
elsewhere in this filing for a description of certain recently issued accounting
pronouncements. We do not expect any of such recently issued accounting
pronouncements to have a material effect on our consolidated financial position
or results of operations.
30
CRITICAL ACCOUNTING POLICIES
Our financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America. The reported
financial results and disclosures were determined using the significant
accounting policies, practices and estimates described in the notes to the
financial statements. We believe that the reported financial results are
reliable and the ultimate actual results will not differ materially from those
reported. Uncertainties associated with the methods, assumptions and estimates
underlying our critical accounting measurements are discussed in the audited
consolidated financial statements and notes included in our Annual Report on
Form 10-KSB for year-end December 31, 2005. We consider accounting policies
related to oil and gas properties, oil and gas reserves, ceiling test,
stock-based compensation, and income taxes to be critical policies.
ITEM 3. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer have evaluated
the effectiveness of our disclosure controls and procedures (as defined in Rule
13a-15 and Rule 15d-15 of the Securities Exchange Act of 1934, as amended) as of
June 30, 2006. They have concluded that these disclosure controls and procedures
are effective to provide reasonable assurance that information required to be
disclosed in our periodic filings under the Securities Exchange Act of 1934, as
amended, is accumulated and communicated to our management to allow timely
decisions regarding required disclosure.
PART II
ITEM 1. LEGAL PROCEEDINGS
Our management is unaware of any threatened or pending material legal
claims or procedures of a non-routine nature.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES
During the period from April 1, 2006 through June 30, 2006, we issued
345,000 shares of our common stock to various holders of our outstanding
options. Some of the option exercises were paid for with cash, and some were
exercised using a net issue election pursuant to which some option shares were
forfeited to pay for the shares issued. We also issued 90,000 shares of common
stock to two directors and one officer as compensation under our 2006 Stock
Incentive Plan.
Of the 435,000 shares issued, 175,000 shares were issued pursuant to
the exemption from registration provided by Section 4(2) of the Securities Act
of 1933, as amended, and the balance were issued pursuant to an effective
registration statement.
We did not repurchase any of our outstanding equity securities during
the quarter ended June 30, 2006.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An annual meeting of the stockholders was held on May 19, 2006. The
following matters were voted upon.
o The Board of Directors was elected upon the following votes:
Name For Against Withheld
------------------ ---------- ------- --------
William W. Deneau 50,333,399 0 2,820
Gary J. Myles 50,333,399 0 2,820
Earl V. Young 50,333,399 0 2,820
Howard M. Crosby 47,821,271 0 2,514,948
Kevin D. Stulp 50,321,699 0 14,520
Richard M. Deneau 50,321,699 0 14,520
Ronald E. Huff 50,333,399 0 2,820
o Approve the Company's 2006 Stock Incentive Plan, upon the following
vote:
Favor - 50,299,612
Opposed - 34,767
Abstain - 1,840
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
3.1* Restated Articles of Incorporation of Aurora Oil & Gas Corporation.
3.2* Bylaws of Aurora Oil & Gas Corporation.
4.1 Articles of Amendment to Articles of Incorporation, relating to the
Class A Preferred Stock (Filed as an exhibit to our Form 10-KSB for
the fiscal year ended September 30, 2003, filed with the SEC on
January 13, 2004.)
10.1 Securities Purchase Agreement between Cadence Resources Corporation
and the investors signatory thereto, dated April 2, 2004. (Filed as
an exhibit to our Current Report on Form 8-K filed with the SEC on
April 5, 2004.)
10.2 Agreement and Plan of Merger dated as of January 31, 2005 between
Cadence Resources Corporation, Aurora Acquisition Corp. and Aurora
Energy, Ltd. (Filed as an exhibit to our Form S-4 Registration
Statement filed with the SEC on May 13, 2005.)
10.3(1) Asset Purchase Agreement with Nor Am Energy, L.L.C., Provins Family,
L.L.C. and O.I.L. Energy Corp. dated January 10, 2006.
10.4(1) First Amendment to First Amended and Restated Note Purchase
Agreement between Aurora Antrim North, L.L.C., et al., and TCW Asset
Management Company, dated January 31, 2006.
10.5(1) Credit Agreement among Aurora Antrim North, L.L.C., et al. and BNP
Paribas, et al., dated January 31, 2006.
10.6(1) Intercreditor and Subordination Agreement among BNP Paribas, et al.,
TCW Asset Management Company, and Aurora Antrim North, L.L.C., dated
January 31, 2006.
10.7(1) Promissory Note from Aurora Energy, Ltd. to Northwestern Bank dated
January 31, 2006.
10.8(1) Confirmation from BNP Paribas to Aurora Antrim North, L.L.C., dated
February 22, 2006 relating to gas sale commitment.
10.9 2006 Stock Incentive Plan. (Filed as an exhibit to our Form S-8
Registration Statement filed with the SEC on May 16, 2006.)
10.10* Employment Agreement with Ronald E. Huff dated June 19, 2006.
10.11 Letter Agreement with Bach Enterprises dated July 10, 2006. This
Agreement is confidential, has been omitted from this filing, and
has been filed separately with the SEC.
32
10.12* First Amendment to Credit Agreement between Aurora Antrim North,
L.L.C., et al. and BNP Paribas dated July 14, 2006.
10.13* The Denthorn Trust Commercial Guaranty of obligations to
Northwestern Bank.
10.14* William W. Deneau Commercial Guaranty of obligations to Northwestern
Bank.
10.15* White Pine Land Services, Inc. Commercial Pledge Agreement to
Northwestern Bank.
10.16* The Denthorn Trust Commercial Pledge Agreement to Northwestern Bank.
15* Awareness letter from Rachlin Cohen & Holtz, LLP
31.1* Rule 13a-14(a) Certification of Principal Executive Officer.
31.2* Rule 13a-14(a) Certification of Principal Financial and Accounting
Officer.
32.1* Section 1350 Certification of Principal Executive Officer.
32.2* Section 1350 Certification of Principal Financial and Accounting
Officer.
(1) Filed as an exhibit to our Form 10-KSB for the fiscal year ended December
31, 2005, filed with the SEC on March 31, 2006.
*Filed with this report.
33
SIGNATURES
In accordance with the requirements of the Securities Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned duly
authorized.
AURORA OIL & GAS CORPORATION
Date: August 7, 2006 By: /s/William W. Deneau
--------------------------------------------------
William W. Deneau, President and Chief Executive
Officer
(Principal Executive Officer)
By: /s/ Ronald E. Huff
--------------------------------------------------
Ronald E. Huff Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
34