GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
CONSOLIDATED
BALANCE SHEETS
|
|
August
31, 2007
(unaudited)
|
|
|
November
30, 2006
|
|
ASSETS
|
|
Current
assets
|
|
|
|
|
|
|
Cash
and cash
equivalents
|
|
$
|
52,170
|
|
|
$
|
608,180
|
|
Accounts
receivable, joint
interest
|
|
|
16,914
|
|
|
|
60,475
|
|
Accounts
receivable, joint
interest, related party
|
|
|
95,309
|
|
|
|
923,172
|
|
Accounts
receivable,
other
|
|
|
11,624
|
|
|
|
102,800
|
|
Prepaid
and
other
|
|
|
116,726
|
|
|
|
107,236
|
|
Total
Current
Assets
|
|
|
292,743
|
|
|
|
1,801,863
|
|
|
|
|
|
|
|
|
|
|
Oil
and gas properties, at cost, full cost method of
accounting
|
|
|
|
|
|
|
|
|
Unevaluated
oil and gas
properties
|
|
|
43,254,484
|
|
|
|
42,767,330
|
|
Evaluated
oil and gas
properties
|
|
|
13,013,975
|
|
|
|
10,991,945
|
|
Less
accumulated depletion,
amortization and impairment
|
|
|
(13,013,975
|
)
|
|
|
(8,966,135
|
)
|
|
|
|
43,254,484
|
|
|
|
44,793,140
|
|
|
|
|
|
|
|
|
|
|
Furniture
and equipment, net
|
|
|
71,141
|
|
|
|
121,945
|
|
|
|
|
|
|
|
|
|
|
Other
assets
|
|
|
|
|
|
|
|
|
Deferred
financing costs,
net
|
|
|
423,391
|
|
|
|
565,524
|
|
Restricted
investments
|
|
|
428,261
|
|
|
|
459,783
|
|
Other
|
|
|
61,303
|
|
|
|
18,003
|
|
|
|
|
912,955
|
|
|
|
1,043,310
|
|
|
|
|
|
|
|
|
|
|
Total
Assets
|
|
$
|
44,531,323
|
|
|
$
|
47,760,258
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDER’S EQUITY
Current
liabilities
|
|
|
|
|
|
|
Accounts
payable and accrued
expenses
|
|
$
|
1,506,654
|
|
|
$
|
1,548,168
|
|
Accounts
payable – related
party
|
|
|
49,413
|
|
|
|
64,400
|
|
Current
portion convertible
notes payable, net
|
|
|
|
|
|
|
10,019,996
|
|
Notes
payable – related
party
|
|
|
2,049,728
|
|
|
|
7,549,728
|
|
Interest
payable
|
|
|
755,399
|
|
|
|
2,488,451
|
|
Total
Current
liabilities
|
|
|
4,361,194
|
|
|
|
21,670,743
|
|
|
|
|
|
|
|
|
|
|
Non-current
obligations
|
|
|
|
|
|
|
|
|
Convertible
notes payable,
net
|
|
|
24,764,284
|
|
|
|
16,308,801
|
|
Notes
payable – related
party
|
|
|
14,118,777
|
|
|
|
|
|
Interest
payable
|
|
|
3,763,957
|
|
|
|
572,466
|
|
Interest
payable – related party
|
|
|
929,386
|
|
|
|
|
|
Asset
retirement
obligation
|
|
|
1,913,815
|
|
|
|
1,288,337
|
|
Total
Non-current
obligations
|
|
|
45,490,219
|
|
|
|
18,169,604
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity (deficit)
|
|
|
|
|
|
|
|
|
Preferred
stock, $001 par
value; Authorized – 25,000,000shares; Issued – none
|
|
|
|
|
|
|
|
|
Common
stock, $.001 par value;
Authorized – 400,000,000shares;Issued and outstanding – 83,661,968 shares
and
81,661,968
shares
|
|
|
83,662
|
|
|
|
81,662
|
|
Capital
in excess of par
value
|
|
|
72,837,413
|
|
|
|
71,537,766
|
|
Deficit
accumulated during the
development stage
|
|
|
(78,241,164
|
)
|
|
|
(63,699,517
|
)
|
Total
Stockholders’ equity
(deficit)
|
|
|
(5,320,089
|
)
|
|
|
7,919,911
|
|
|
|
|
|
|
|
|
|
|
Total
Liabilities and Stockholders’ Equity (deficit)
|
|
$
|
44,531,323
|
|
|
$
|
47,760,258
|
|
The
accompanying notes are an integral part of these financial
statements.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
CONSOLIDATED
STATEMENTS OF OPERATIONS
Unaudited
|
|
Three
Months Ended August 31,
|
|
|
|
2007
|
|
|
2006
|
|
Revenue
|
|
|
|
|
|
|
Natural
gas
sales
|
|
$
|
76,303
|
|
|
$
|
281,559
|
|
|
|
|
76,303
|
|
|
|
281,559
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
|
|
|
|
|
|
Lease
operating
expense
|
|
|
445,817
|
|
|
|
189,493
|
|
General
and
administrative
|
|
|
761,617
|
|
|
|
1,172,301
|
|
Impairment
of oil and gas
properties
|
|
|
2,370,880
|
|
|
|
1,031,160
|
|
Depreciation,
depletion and
amortization
|
|
|
232,056
|
|
|
|
318,379
|
|
|
|
|
3,810,370
|
|
|
|
2,711,333
|
|
|
|
|
|
|
|
|
|
|
Other
income (expense)
|
|
|
|
|
|
|
|
|
Interest
and other
income
|
|
|
4,749
|
|
|
|
3,283
|
|
Interest
expense and financing
costs
|
|
|
(2,044,630
|
)
|
|
|
(3,970,113
|
)
|
|
|
|
(2,039,881
|
)
|
|
|
(3,966,830
|
)
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(5,773,948
|
)
|
|
$
|
(6,396,604
|
)
|
|
|
|
|
|
|
|
|
|
Net
loss per common share – basic & diluted
|
|
$
|
(.07
|
)
|
|
$
|
(.09
|
)
|
|
|
|
|
|
|
|
|
|
Weighed
average number of common shares outstanding
-
basic and
diluted
|
|
|
83,661,968
|
|
|
|
70,536,771
|
|
The
accompanying notes are an integral part of these financial
statements.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
CONSOLIDATED
STATEMENTS OF OPERATIONS
Unaudited
|
|
Nine
Months Ended August 31,
|
|
|
From
Inception
(June
18, 2002) to
|
|
|
|
2007
|
|
|
2006
|
|
|
August
31, 2007
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
Natural
gas sales
|
|
$
|
447,232
|
|
|
$
|
955,895
|
|
|
$
|
3,061,523
|
|
Gain
on disposition of oil and
gas property
|
|
|
|
|
|
|
|
|
|
|
197,676
|
|
Gain
on disposition of oil and
gas property and
other
income, related
party
|
|
|
|
|
|
|
|
|
|
|
122,946
|
|
|
|
|
447,232
|
|
|
|
955,895
|
|
|
|
3,382,145
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs
and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease
operating
expense
|
|
|
704,151
|
|
|
|
590,311
|
|
|
|
2,509,602
|
|
General
and
administrative
|
|
|
2,801,617
|
|
|
|
3,652,158
|
|
|
|
19,887,519
|
|
Impairment
of oil and gas
properties
|
|
|
3,866,195
|
|
|
|
1,031,160
|
|
|
|
10,534,191
|
|
Depreciation,
depletion and
amortization
|
|
|
511,168
|
|
|
|
680,707
|
|
|
|
3,254,763
|
|
|
|
|
7,883,131
|
|
|
|
5,954,336
|
|
|
|
36,186,075
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
and other
income
|
|
|
14,043
|
|
|
|
12,588
|
|
|
|
244,344
|
|
Interest
expense and financing
costs
|
|
|
(7,119,791
|
)
|
|
|
(12,918,109
|
)
|
|
|
(45,681,578
|
)
|
|
|
|
(7,105,748
|
)
|
|
|
(12,905,521
|
)
|
|
|
(45,437,234
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
|
(14,541,647
|
)
|
|
|
(17,903,962
|
)
|
|
|
(78,241,164
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss per common share – basic and diluted
|
|
|
(.17
|
)
|
|
|
(.26
|
)
|
|
|
(1.45
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighed
average number of common shares
Outstanding
–
basic
and
diluted
|
|
|
83,321,309
|
|
|
|
69,290,943
|
|
|
|
54,119,024
|
|
The
accompanying notes are an integral part of these financial
statements.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
CONSOLIDATED
STATEMENTS OF CASH FLOWS
Unaudited
|
|
Nine
Months Ended August 31,
|
|
|
Cumulative
From
Inception
(June
18, 2002) to
|
|
|
|
2007
|
|
|
2006
|
|
|
August
31, 2007
|
|
Cash
flows from operating activities
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(14,541,647
|
)
|
|
$
|
(17,903,962
|
)
|
|
$
|
(78,241,164
|
)
|
Adjustments
to reconcile net loss
to net cash usedby operating activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
for
interest
|
|
|
|
|
|
|
45,913
|
|
|
|
4,352,508
|
|
Stock
for
services
|
|
|
|
|
|
|
|
|
|
|
264,600
|
|
Stock
for services – related
party
|
|
|
|
|
|
|
|
|
|
|
90,000
|
|
Oil
and gas properties for
services
|
|
|
|
|
|
|
|
|
|
|
732,687
|
|
Stock
for debt – related
party
|
|
|
|
|
|
|
|
|
|
|
233,204
|
|
Amortization
of discount and
deferred financing
costs
on convertible
debt
|
|
|
2,738,126
|
|
|
|
8,849,726
|
|
|
|
20,646,688
|
|
Deferred
selling costs
|
|
|
410,000
|
|
|
|
|
|
|
|
410,000
|
|
Finance
costs incurred for waiver
of triggering
event
|
|
|
|
|
|
|
|
|
|
|
3,457,101
|
|
Write-off
of discount and
deferred financing costsupon conversion of convertible
debt
|
|
|
|
|
|
|
346,083
|
|
|
|
2,979,404
|
|
Write-off
of discount and
deferred financing costsupon extinguishment of convertible
debt
|
|
|
|
|
|
|
|
|
|
|
2,162,597
|
|
Compensation
expense on vested
stock options
|
|
|
891,647
|
|
|
|
999,660
|
|
|
|
2,619,057
|
|
Depreciation,
depletion and
amortization and aaccretion of ARO expense
|
|
|
262,582
|
|
|
|
680,707
|
|
|
|
3,001,176
|
|
Gain
on disposition of oil and
gas assets
|
|
|
|
|
|
|
|
|
|
|
(270,389
|
)
|
Impairment
of oil and gas
properties
|
|
|
3,866,195
|
|
|
|
1,031,160
|
|
|
|
10,534,191
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
11,178
|
|
Changes
in assets and
liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
payable – trade,
accruals, bank overdrafts
|
|
|
(41,515
|
)
|
|
|
3,025,023
|
|
|
|
513,410
|
|
Accounts
payable – related
party
|
|
|
(14,987
|
)
|
|
|
(3,259
|
)
|
|
|
49,413
|
|
Interest
payable
|
|
|
2,387,825
|
|
|
|
1,363,098
|
|
|
|
5,448,742
|
|
Accounts
receivable, prepaid and
other current assets
|
|
|
953,110
|
|
|
|
(1,729,278
|
)
|
|
|
(234,666
|
)
|
Other
|
|
|
(43,300
|
)
|
|
|
2,642
|
|
|
|
(61,743
|
)
|
Net
cash used by operating activities
|
|
|
(3,131,964
|
)
|
|
|
(3,292,487
|
)
|
|
|
(21,302,006
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions
to oil and gas
properties
|
|
|
(1,967,853
|
)
|
|
|
(2,817,603
|
)
|
|
|
(47,908,147
|
)
|
Management
fees earned on
operating properties
|
|
|
56,303
|
|
|
|
1,506,394
|
|
|
|
1,752,133
|
|
Purchase
of furniture and
equipment
|
|
|
(2,289
|
)
|
|
|
(232
|
)
|
|
|
(283,461
|
)
|
Purchase
surety
bonds
|
|
|
|
|
|
|
(80,000
|
)
|
|
|
(459,783
|
)
|
Proceeds
from surety bonds
|
|
|
31,521
|
|
|
|
|
|
|
|
31,521
|
|
Proceeds
from sale of oil and gas
asset
|
|
|
|
|
|
|
|
|
|
|
340,000
|
|
Deposit
on oil and gas property
sale, net of sellingcosts
|
|
|
|
|
|
|
|
|
|
|
|
|
Advance
to
affiliated
|
|
|
|
|
|
|
|
|
|
|
(60,000
|
)
|
Cash
received upon
recapitalization and merger
|
|
|
|
|
|
|
|
|
|
|
4,234
|
|
Net
cash (used for) investing activities
|
|
|
(1,882,318
|
)
|
|
|
(1,391,441
|
)
|
|
|
(46,583,503
|
)
|
The
accompanying notes are an integral part of these financial
statements.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
CONSOLIDATED
STATEMENTS OF CASH FLOWS
Unaudited
|
|
Nine
Months Ended August 31,
|
|
|
Cumulative
From
Inception
(June
18, 2002) to
|
|
|
|
2007
|
|
|
2006
|
|
|
August
31, 2007
|
|
Cash
flows from financing activities
|
|
|
|
|
|
|
|
|
|
Proceeds
from sale of common
stock
|
|
|
|
|
|
|
|
|
17,905,300
|
|
Proceeds
from sale of convertible
notes payable
|
|
|
|
|
|
7,000,000
|
|
|
|
44,695,000
|
|
Proceeds
from sale of convertible
debentures
|
|
|
|
|
|
|
|
|
|
5,040,000
|
|
Proceeds
from sale on notes
payable – related party
|
|
|
8,618,777
|
|
|
|
|
|
|
|
14,118,777
|
|
Proceeds
from exercise of
warrants
|
|
|
|
|
|
|
|
|
|
|
1,019,306
|
|
Debt
and stock offering
costs
|
|
|
|
|
|
|
(127,700
|
)
|
|
|
(3,980,569
|
)
|
Payment
of convertible notes
payable
|
|
|
(4,160,505
|
)
|
|
|
(3,333,333
|
)
|
|
|
(10,180,285
|
)
|
Payment
of note payable – related
party
|
|
|
|
|
|
|
(16,909
|
)
|
|
|
(129,578
|
)
|
Payment
of note
payable
|
|
|
|
|
|
|
|
|
|
|
(550,272
|
)
|
Net
cash provided by financing activities
|
|
|
4,458,272
|
|
|
|
3,522,058
|
|
|
|
67,937,679
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(decrease) increase in cash
|
|
|
(556,010
|
)
|
|
|
(1,161,870
|
)
|
|
|
52,170
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning of period
|
|
|
608,180
|
|
|
|
1,328,469
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
52,170
|
|
|
$
|
166,599
|
|
|
$
|
52,170
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
schedule of cash flow information
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
paid for
interest
|
|
$
|
1,585,045
|
|
|
$
|
2,238,288
|
|
|
$
|
6,144,329
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosures of non-cash investing and financing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt
incurred for oil and gas
properties
|
|
$
|
|
|
|
$
|
|
|
|
$
|
3,646,000
|
|
Debt
incurred for finance
costs
|
|
$
|
|
|
|
$
|
|
|
|
$
|
3,547,101
|
|
Stock
issued for
services
|
|
$
|
|
|
|
$
|
|
|
|
$
|
354,600
|
|
Stock
issued for interest and
debt
|
|
$
|
|
|
|
$
|
3,076,780
|
|
|
$
|
13,742,538
|
|
Stock
issued for convertible
debentures
|
|
$
|
|
|
|
$
|
|
|
|
$
|
5,640,000
|
|
Warrants
issued for offering and
financing costs
|
|
$
|
|
|
|
$
|
27,274
|
|
|
$
|
1,685,850
|
|
Discount
on convertible debt
issued
|
|
$
|
|
|
|
$
|
566,540
|
|
|
$
|
14,883,630
|
|
Conversion
of interest to
debt
|
|
$
|
|
|
|
$
|
|
|
|
$
|
11,178
|
|
Stock
issued for subsidiary –
related
|
|
$
|
|
|
|
$
|
|
|
|
$
|
(202,232
|
)
|
Stock
issued for oil and gas
properties
|
|
$
|
|
|
|
$
|
|
|
|
$
|
9,146,800
|
|
Stock
issued in connection with
oil and gas
asset
sale
|
|
$
|
410,000
|
|
|
$
|
|
|
|
$
|
410,000
|
|
The
accompanying notes are an integral part of these financial
statements.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
1 - ORGANIZATION
Galaxy
Energy Corporation is an independent oil and gas company primarily engaged
in
the exploration for, and the acquisition and development of crude oil and
natural gas. These activities have been conducted primarily in the
Rocky Mountain region of the United States.
The
unaudited financial statements included herein were prepared from the records
of
the Company in accordance with generally accepted accounting principles in
the
United States applicable to interim financial statements and reflect all
adjustments which are, in the opinion of management, necessary to provide a
fair
statement of the results of operations and financial position for the interim
periods. Such financial statements conform to the presentation
reflected in the Company’s Form 10-K filed with the Securities and Exchange
Commission for the year ended November 30, 2006. The current interim
period reported herein should be read in conjunction with the Company’s Form
10-K for the year ended November 30, 2006.
The
results of operations for the nine months ended August 31, 2007 are not
necessarily indicative of the results that may be expected for the full fiscal
year ending November 30, 2007.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS
OF
PRESENTATION
The
accompanying consolidated financial statements include the Company and its
wholly owned subsidiaries, Dolphin Energy Corporation (“Dolphin”) and Pannonian
International, Ltd. (“Pannonian”). All significant intercompany
transactions have been eliminated.
LIQUIDITY
During
the nine months ended August 31, 2007, the Company incurred a net loss of
approximately $14,542,000 and used cash for operating activities of
approximately $3,132,000. The Company also has a working capital
deficit of approximately $4,000,000, a stockholders’ deficit of approximately
$5,300,000 and debt due to debt holders of approximately $56,000,000 that is
payable over the next 3 years. These matters raise substantial doubt
about the Company’s ability to continue as a going concern. The
Company’s continued operation is contingent upon its ability to raise additional
capital, and ultimately attaining profitability from its oil and gas
operations.
On
December 29, 2006, the Company entered into a Purchase and Sale Agreement with
a
related party to sell all of the Company’s oil and gas interests in the Powder
River Basin of Wyoming and Montana (the “Powder River Basin Assets”)
.
The purchase price
for the Powder River Basin Assets was $45 million, with $20 million to be paid
in cash and $25 million to be paid in shares of the purchaser’s common
stock. The purchase and sale agreement expired on August 31, 2007 and
was not extended.
The
Company is currently searching for other buyers and suitable terms for a sale
of
some of its assets; however there is no assurance a sale will be completed
or
that the Company will realize the full carrying value of the
assets. In such an event, the Company may be required to write off a
portion of the carrying value and such write-off could be material.
Any
financing obtained through the sale of Company equity will likely
result in substantial dilution to the Company’s stockholders.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
DEVELOPMENT
STAGE
The
Company is considered a development stage company as defined by Statement of
Financial Accounting Standards (“SFAS”) No. 7, and its principal activities
since inception have been raising capital through the sale of common stock
and
convertible notes and the acquisition of oil and gas properties in the Western
United States, Germany and Romania. The Company has recorded limited
production from wells in the Powder River Basin of Wyoming and the Piceance
Basin of Colorado; however, management does not consider that the Company has
commenced principal operations as of August 31, 2007.
USE
OF
ESTIMATES
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those
estimates.
The
Company’s financial statements are based on a number of significant estimates,
including oil and gas reserve quantities, which are the basis for the
calculation of depreciation, depletion and impairment of oil and gas properties,
and timing and costs associated with its retirement obligation. In
addition, significant estimates are required in the valuation of undeveloped
oil
and gas properties. Actual results could differ from those estimates
and such differences could be material.
The
oil
and gas industry is subject, by its nature, to environmental hazards and
clean-up costs. At this time, management knows of no substantial
costs from environmental accidents or events for which the Company may be
currently liable. In addition, the Company’s oil and gas business
makes it vulnerable to changes in wellhead prices of crude oil and natural
gas. Such prices have been volatile in the past and can be expected
to be volatile in the future. By definition, proved reserves are
based on current oil and gas prices and estimated reserves. Price
declines reduce the estimated quantity of proved reserves and increase annual
amortization expense (which is based on proved reserves).
OIL
AND
GAS PROPERTIES
The
Company utilizes the full cost method of accounting for oil and gas
activities. Under this method, subject to a limitation based on
estimated value, all costs associated with property acquisition, exploration
and
development, including costs of unsuccessful exploration, are capitalized within
a cost center. No gain or loss is recognized upon the sale or
abandonment of undeveloped or producing oil and gas properties unless: 1) the
sale represents a significant portion of oil and gas properties within a cost
center and the gain significantly alters the relationship between capitalized
costs and proved oil and gas reserves of the cost center; or 2) the proceeds
of
the sale are in excess of the capitalized costs within the cost
center. Depreciation, depletion and amortization of oil and gas
properties is computed on the units of production method based on proved
reserves. Amortizable costs include estimates of future development
costs of proved undeveloped reserves.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
OIL
AND
GAS PROPERTIES (Continued)
Capitalized
costs of oil and gas properties may not exceed an amount equal to the present
value, discounted at 10%, of the estimated future net cash flows from proved
oil
and gas reserves plus the cost, or estimated fair market value, if lower, of
unproved properties. Should capitalized costs exceed this ceiling, an
impairment is recognized. The present value of estimated future net
cash flows is computed by applying year end prices of oil and natural gas to
estimated future production of proved oil and gas reserves as of year end,
less
estimated future expenditures to be incurred in developing and producing the
proved reserves and assuming continuation of existing economic
conditions. As of August 31, 2007, based upon natural gas prices of
$2.32 per mcf, the full cost pool exceeded the above-described ceiling by
$2,370,880. Accordingly, impairment expense of $2,370,880 was
recorded for the three months ended August 31, 2007. The Company had
previously recorded $1,495,315 in impairment expense in quarter ended May 31,
2007. At August 31, 2007, the Company’s net full cost pool after
these impairments is zero.
Unevaluated
properties are assessed periodically on a cost center basis and costs associated
with any properties determined to be impaired are reclassified to evaluated
properties and such costs are added to the amortization base, which is subject
to the full cost ceiling test limitations as described
above. Approximately $2,000,000 of no impairment or reclassification
of unevaluated property costs was recognized during the nine months ended August
31, 2007.
IMPAIRMENT
The
Company applies SFAS 144, “Accounting for the Impairment and Disposal of
Long-Lived Assets,” which requires that long-lived assets to be held and used be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Oil and
gas properties accounted for using the full cost method of accounting, the
method utilized by the Company, are excluded from this requirement, but will
continue to be subject to the ceiling test limitations as described
above.
DEFERRED
SELLING COSTS
In
connection with the proposed sale of the Powder River Basin Assets, the Company
has incurred certain costs, which totaled $461,895, and were recorded as
Deferred Selling Costs. These costs were expensed as the sale to the
related party was not completed.
ASSET
RETIREMENT OBLIGATION
In
2001,
the FASB issued SFAS 143, “Accounting for Asset Retirement
Obligations.” SFAS 143 addresses financial accounting and reporting
for obligations associated with the retirement of tangible long-lived assets
and
the associated asset retirement costs. This statement requires
companies to record the present value of obligations associated with the
retirement of tangible long-lived assets in the period in which it is
incurred. The liability is capitalized as part of the related
long-lived asset’s carrying amount. Over time, accretion of the
liability is recognized as an operating expense and the capitalized cost is
depreciated over the expected useful life of the related asset. The
Company’s asset retirement obligations (“ARO”) relate primarily to the plugging,
dismantlement, removal, site reclamation and similar activities of its oil
and
gas properties.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
ASSET
RETIREMENT OBLIGATION
(Continued)
The
Company has, through acquisition and drilling, acquired working interests in
243
natural gas wells. A limited number of these wells have had initial
gas production, and the others are in various stages of completion and hook
up
at August 31, 2007. The Company adopted the provisions of SFAS 143 to
record the ARO associated with all wells in which the Company owns an interest
on the date such obligation arose. Depreciation of the related asset,
and accretion of the ARO on wells from which production has commenced, has
been
calculated on a unit of production basis. The amounts recognized upon
adoption are based upon numerous estimates and assumptions, including future
retirement costs, future recoverable quantities of oil and gas, future inflation
rates and the credit-adjusted risk-free interest rate.
The
Company evaluated the liability associated with its asset retirement obligations
and determined that due to its inability to place certain of these assets into
service that the liability at August 31, 2007 for approximately 145 wells should
equal its estimated plugging and abandonment cost. The Company
recorded an additional $543,025 in liability and ARO asset.
The
information below reflects the change in the ARO during the periods ended August
31,
|
|
2007
|
|
|
2006
|
|
Balance
beginning of period
|
|
$
|
1,288,337
|
|
|
$
|
1,242,967
|
|
Liabilities
incurred
|
|
|
-
|
|
|
|
52,975
|
|
Revisions
|
|
|
543,025
|
|
|
|
(106,878
|
)
|
Liabilities
settled
|
|
|
-
|
|
|
|
-
|
|
Accretion
|
|
|
82,453
|
|
|
|
66,724
|
|
Balance
end of period
|
|
$
|
1,913,815
|
|
|
$
|
1,255,788
|
|
SHARE
BASED COMPENSATION
Effective
December 1, 2005, the Company adopted SFAS 123(R), “Accounting for
Stock-Based Compensation,” using the modified prospective method, which results
in the provisions of SFAS 123(R) being applied to the consolidated financial
statements on a going-forward basis. Prior periods have not been
restated. SFAS 123(R) requires companies to recognize share-based
payments to employees as compensation expense on a fair value
method. Under the fair value recognition provisions of SFAS 123(R),
stock-based compensation cost is measured at the grant date based on the fair
value of the award and is recognized as expense over the service period, which
generally represents the vesting period. The expense recognized over
the service period is required to include an estimate of the awards that will
be
forfeited. Previously, no such forfeitures have
occurred. The Company is assuming no forfeitures going forward based
on the Company's historical forfeiture experience. The fair value of
stock options is calculated using the Black-Scholes option-pricing
model.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
SHARE
BASED COMPENSATION (Continued)
As
of
August 31, 2007, options to purchase an aggregate of 4,955,000 shares of the
Company's common stock were outstanding, of which 3,632,500 are
exercisable. These options were granted during 2007, 2006, 2005, and
2004, to the Company’s employees, directors and consultants at exercise prices
ranging from $0.19 to $3.51 per share. The options vest at varying
schedules within five years of their grant date and typically expire within
ten
years from the grant date. Stock-based compensation costs were
$891,647 and $999,660, before tax, for the nine months ended August 31, 2007
and
2006, respectively. These amounts were charged to operations as
compensation expense and included within general and administrative
expense.
(LOSS)
PER COMMON SHARE
Basic
(loss) per share is based on the weighted average number of common shares
outstanding during the period. Diluted (loss) per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common
stock. Convertible equity instruments such as stock options,
warrants, convertible debentures and notes payable are excluded from the
computation of diluted loss per share, as the effect of the assumed exercises
would be anti dilutive.
RECLASSIFICATION
Certain
amounts in the financial statements have been reclassified to conform to the
August 31, 2007 financial statement presentation. The
reclassifications have no effect on the Company's net loss for the
period.
NOTE
3 – PROPERTY AND EQUIPMENT
OIL
AND
GAS PROPERTIES
The
Company recognizes three cost centers for its oil and gas activities, the United
States Cost Center, the Germany Cost Center and the Romania Cost
Center.
United
States Cost Center
In
2003,
the Company began the acquisition of unevaluated oil and gas properties
primarily in the Powder River Basin region of the Rocky Mountain
area. In 2004, the Company acquired additional unevaluated
properties, began its exploration program by drilling 135 wells and commenced
limited production of natural gas in the Powder River Basin. During
2005, exploratory drilling activities continued in the Powder River Basin,
development of certain areas commenced and natural gas production reached a
level that allowed the Company to recognize proved reserves on those producing
properties. During 2006 and to date, the Company continues limited
dewatering operations in the Powder River Basin.
In
2005,
the Company entered into an exploration project in the Piceance Basin of
northwestern Colorado, acquiring prospective acreage, evaluating and planning
for an exploratory drilling program. In 2006, the Company, as operator, drilled
four wells and participated as non-operator in the drilling of four additional
wells in the Piceance basin. As of August 31, 2007, three of the
Company’s operated wells are shut in pending completion operations and three of
the non-operated wells have commenced production of natural gas, condensate
and
other hydrocarbon liquids.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
3 – PROPERTY AND EQUIPMENT (continued)
OIL
AND GAS PROPERTIES
(Continued0
As
of
August 31, 2007, based upon natural gas prices of $2.32 per mcf, all of Galaxy’s
properties were not economic. Additionally, the Company impaired
certain of its unproved acreage totalling $2,000,000. Such costs were
transferred to the full cost pool. Accordingly impairment expense of
$2,370,880 was recorded for the three months ended August 31, 2007. The Company
had previously recorded $1,495,315 in impairment expense in quarter ended May
31, 2007. Following the ceiling test write downs, the Company’s
balance sheet reflects no capitalized oil and gas costs for the United States
cost center.
Germany
Cost Center
In
March
2005, the Company, through its wholly owned subsidiary, Pannonian, entered
into
a farmout agreement with an unrelated party (the “Farmee”) to conduct
exploration activities on its Neues Bergland Exploration Permit in
Germany. Prior to the farmout Pannonian owned a 50% interest in the
permit. Under the terms of the agreement, the Farmee made an initial
payment of $750,000 to Pannonian and its partners to acquire a 40% interest
in
the permit, thereby reducing Pannonian’s ownership interest to 30%. The Company
recognized a gain of $197,676 on the transaction, representing the excess of
the
proceeds over the original cost of the property. In December 2005,
the Company commenced drilling the initial test well on the
permit. The well, in which the Company had a carried interest, was
completed in January 2006. In July 2006, the Company completed the
testing of the four primary zones of interest in the Glantal-1 well and no
significant natural gas flows were encountered. The wellbore was
plugged and abandoned in August 2006. The Company and its joint
venture partners are evaluating further operations on the permit, which could
include a seismic program and additional exploratory drilling. The
Company’s balance sheet reflects no capitalized oil and gas costs related to the
Germany cost center
Romania
Cost Center
In
May
2005, the Company, through its wholly owned subsidiary, Pannonian, entered
into
a farmout agreement with a related party whose President is a significant
shareholder of the Company (Falcon Oil & Gas or “Falcon”) to evaluate the
concession held by Pannonian in the Jiu Valley Coal Basin in
Romania. This concession had been assigned to Pannonian by the
Romanian government, in October 2002, under the terms of a Concession Agreement
(the “Concession”). The farmout agreement calls for the assignment of
the Concession to Falcon; the assignment of a 75% working interest in the
Concession area; and for the drilling of one test well and an additional,
optional, test well, the cost of which will be paid 100% by
Falcon. In addition Falcon paid Pannonian $100,000 upon approval by
the Romanian government of the assignment of the Concession, and will pay the
first $250,000 of Pannonian’s proportionate share of drilling and operating
costs subsequent to the drilling of the first two wells. The Company
recognized a gain of $72,713 on the transaction, representing the excess of
the
proceeds over the original cost of the property. The first test well
on the property, in which the Company had a carried interest, was drilled in
2005 and completion testing was carried out in 2006. Based upon the
completion test results , the partners in the project determined to plug and
abandon the well. The Company and Falcon are evaluating whether the
drilling of a second well should be commenced in 2007. Following the
recognition of the gain on farmout, the Company’s balance sheet reflects no
capitalized oil and gas costs for the Romanian cost center.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
4 - NOTES PAYABLE
RELATED
PARTIES
As
of
August 31, 2007, the Company has issued eleven separate subordinated unsecured
promissory notes for a total of $11,625,000 in favor of Bruner Family Trust
UTD
March 28, 2005, (the “Bruner Trust”) a related party. One of the trustees
of the Bruner Trust is Marc E. Bruner, the president and a director of the
Company. Interest accrues at the rate of 8% per annum and the notes
mature as summarized below or the time at which the Company’s senior
indebtedness has been paid in full. As the senior indebtedness is
scheduled for repayment on May 31, 2010, the related party notes are classified
as non-current obligations as of August 31, 2007.
In
connection with the acquisition of oil and gas properties from DAR LLC, (“DAR”)
the Company issued a promissory note to DAR in the amount of
$2,600,000. At August 31, 2007, the remaining balance of the note
payable was $2,049,728. The note together with accrued interest was
acquired by the Bruner Trust in October 2006. The note, in the amount of
$2,049,728 accrues interest at the rate of 12% per annum. While the
note, as amended, has a stated maturity date of December 1, 2006, the Bruner
Family Trust has stated that it will not enforce its rights under the note
until
November 30, 2007.
At
August
31, 2007 and November 30, 2006, notes payable to the Bruner Trust are as
follows:
Issue
Date
|
Due
Date
|
August
31, 2007
|
|
November
30, 2006
|
|
|
|
|
|
Current
liabilities
|
|
|
|
|
January
14, 2004
|
November
30, 2007
|
$ 2,049,728
|
|
$
2,049,728
|
|
|
|
|
|
Non-current
obligations
|
|
|
|
|
September
28, 2006
|
January
26, 2007
|
$
2,500,000
|
|
$
2,500,000
|
November
1, 2006
|
March
1, 2007
|
1,000,000
|
|
1,000,000
|
November
13, 2006
|
March
13, 2007
|
500,000
|
|
500,000
|
November
30, 2006
|
March
30, 2007
|
1,500,000
|
|
1,500,000
|
February
1, 2007
|
June
1, 2007
|
500,000
|
|
-
|
February
26, 2007
|
June
26, 2007
|
900,000
|
|
-
|
March
30, 2007
|
July
28, 2007
|
1,350,000
|
|
-
|
April
25, 2007
|
August
23, 2007
|
1,200,000
|
|
-
|
May
4, 2007
|
September
1, 2007
|
450,000
|
|
-
|
May
31, 2007
|
September
28, 2007
|
600,000
|
|
-
|
June
29, 2007
|
October
27, 2007
|
750,000
|
|
|
August
22, 2007
|
December
20, 2007
|
125,000
|
|
|
August
29, 2007
|
December
27, 2007
|
250,000
|
|
|
|
|
|
|
|
|
|
$ 1,625,000
|
|
$
5,500,000
|
Subsequent
to August 31, 2007 and through the date of the filing of this report, the
Company has borrowed an additional $975,000 from the Bruner Trust, under the
same terms and conditions as the other notes.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
4 - NOTES PAYABLE (Continued)
On
December 29, 2006, the Company entered into a Purchase and Sale Agreement (PSA)
with a related party (PetroHunter Energy Corporation) to sell all of the
Company’s oil and gas interests in the Powder River Basin of Wyoming and Montana
(the “Powder River Basin Assets”)
.
The purchase price
for the Powder River Basin Assets was $45 million, with $20 million to be paid
in cash and $25 million to be paid in shares of the purchaser’s common
stock. The sale was not completed.
As
part
of the PSA, PetroHunter was required and did make an initial earnest money
payment of $1.4 million. PetroHunter made an additional earnest money
payment of $600,000 in January 2007. Furthermore, PetroHunter paid the company
$243,777 in March 2007 and $250,000 in July 2007 to cover operating expenses
since January 1, 2007 of the fields covered by the PSA. Since the
sale was not completed, these deposits and advances have converted into a
promissory note, payable to PetroHunter, and are unsecured subordinated debt
of
the Company, which is payable only after repayment of our senior
indebtedness. Interest on the note accrues at the rate of 8% per
annum. The $2,493,777 is recorded in notes payable related party.
NOTE
5 – CONVERTIBLE NOTES PAYABLE
2004
NOTES
In
August
and October 2004, the Company completed two tranches of a private offering
of
Senior Secured Convertible Notes and Warrants. Gross proceeds from
the initial tranche of the offering were $15,000,000. Gross proceeds
from the second tranche of the offering were $5,000,000. The notes
pay interest at the prime rate plus 7.25% per annum, mature two years from
the
date of issue, are collateralized by substantially all the Company’s assets, and
are convertible into 10,695,187 shares of the Company’s common stock based on a
conversion price of $1.87 per share. Monthly principal repayments of
$833,333, plus accrued interest commenced on March 1, 2005. At the
Company’s option, and assuming the satisfaction of certain conditions, the
Company may pay the monthly installments in cash or through a partial conversion
of the notes into shares of the Company’s common stock at a conversion rate
equal to the lesser of $1.87 (as may be adjusted to prevent dilution), or 93%
of
the weighted average trading price of the Company’s common stock on the trading
day preceding the conversion. Note purchasers received warrants to
purchase 5,194,806 shares of the Company’s common stock at an exercise price of
$1.54 per share, for a period of three years.
On
December 1, 2005, the Company and the holders of the 2004 Notes entered into
an
agreement, that among other things lowered the conversion price of the Notes,
granted additional warrants to purchase shares of common stock and lowered
the
exercise price of existing and newly issued warrants. In accordance
with SFAS 5, Accounting for Contingencies, the Company recorded the effect
of
this agreement in the financial statements as of November 30,
2005. In accordance with EITF 96-19, Debtor’s Accounting for a
Modification or Exchange of Debt Instruments, the Company recognized this
transaction as an extinguishment of the existing debt and the issuance of new
debt. The Company wrote off unamortized discount and deferred
financing associated with the original debt in the amount of $773,564, including
the amount in interest and financing expense. In addition, in
accordance with EITF 98-5 and EITF 00-27, the Company recognized the fair value
of the warrants and the beneficial conversion feature associated with the Notes
aggregating $7,375,920 as a discount to the Notes as additional paid in
capital.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
5 – CONVERTIBLE NOTES PAYABLE (continued)
2004
NOTES (Continued)
On
July
7, 2006, the Company and the holders of its senior secured convertible notes
issued in 2004 and 2005 entered into a Waiver and Agreement. The
Company had notified the holders of the 2004 Notes of an Equity Liquidity Test
Failure on July 3, 2006, as defined in its agreements with the holders,
triggering the holders’ right to make an early repayment election in the
aggregate amount of $1,217,929.
In
the
Waiver and Agreement,
the Company and the holders agreed
to the following:
·
|
The
waiver of the holders’ right to make an early repayment election as a
result of the July 2006 Equity Liquidity Test Failure and any Equity
Liquidity Test Failure as of August 1, 2006 and/or September 1,
2006;
|
·
|
The
deferral of the August 2006 and September 2006 installment payments
on the
2004 Notes until October 2, 2006, unless earlier converted by the
holders;
|
·
|
The
Company gave the holders the right to convert up to $5,000,000
in principal amount of the 2004 Notes, plus related interest, as
a
“Company Alternative Conversion” under the notes through September 30,
2006, with the amounts converted to be applied first to the August
2006
installment payment, second to the September 2006 installment payment,
and
then to those installments nearest to the maturity date of the 2004
Notes;
and
|
·
|
The
waiver of the Company’s right to prepay any part of the 2004 or 2005
Notes.
|
During
July, August and September 2006, the holders converted a total of $4,812,249
of
principal and accrued interest into 12,993,939 shares of the
Company’s common stock, in accordance with the terms of the Waiver and
Agreement.
On
November 29, 2006, the Company and the holders of the 2004 Notes entered into
a
Waiver and Amendment Agreement. The Company had notified the holders
of the 2004 Notes of the fact that a Triggering Event under the terms of the
Notes had occurred as of August 31, 2006. Among other things, this
would have enabled the holders of the Notes to require the Company to redeem
all
or any portion of the outstanding principal amount of the Notes at a price
equal
to the greater of (i) 125% of such principal plus accrued and unpaid interest
and (ii) the product of the current conversion rate in effect under the Notes
multiplied by the volume-weighted average price of Galaxy’s common
stock. The holders agreed to waive the Triggering Event in
consideration for an amendment to the 2004 Notes that reset the principal
amounts of the Notes to 125% of the amounts outstanding as of October 31,
2006. In accordance with EITF 96-19,
Debtor's Accounting for a
Modification or Exchange of Debt Instruments
”, the Company recognized this
transaction as an extinguishment of the existing debt and the issuance of new
debt. The Company wrote off unamortized discount and deferred
financing associated with the original debt in the amount of $957,101 including
the amount in interest and financing cost. In addition, in accordance
with EITF 98-5 and EITF 00-27 the Company recognized the fair value of the
warrants and the beneficial conversion feature associated with the Notes
aggregating $663,002 as a discount to the
Notes
.
During the nine months ended August 31, 2007
the Company recorded amortization of the discount in the amount of $663,002
as
interest expense. In addition, the Company paid in cash the full
balance due on the 2004 Notes.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
5 – CONVERTIBLE NOTES PAYABLE (continued)
MARCH
2005 NOTES
In
March
2005, the Company completed a private offering of Senior Secured Convertible
Notes and Warrants to a group of accredited investors. Gross proceeds
from the offering were $7,695,000. The notes pay interest at the
prime rate plus 6.75% per annum, mature April 30, 2007, are subordinated to
Galaxy’s secured debt and existing senior debt, and are convertible into
4,093,085 shares of common stock based on a conversion price of $1.88 per share
beginning September 1, 2005. Note purchasers received warrants to
purchase 1,637,235 shares of the Company’s common stock at an exercise price of
$1.88 per share, for a period of three years. Principal and interest
on the notes are payable upon maturity.
In
connection with the agreement entered into with the Holders of the 2004 notes,
as discussed above the terms of the March 2005 Notes were also amended to lower
the conversion price and lower the exercise price of existing and newly issued
warrants. In accordance with SFAS 5, Accounting for Contingencies,
the Company recorded the effect of this agreement in the financial statements
as
of November 30, 2005. In accordance with EITF 96-19, Debtor’s
Accounting for a Modification or Exchange of Debt Instruments, the Company
recognized this transaction as an extinguishment of the existing debt and the
issuance of new debt. The Company wrote off unamortized discount and
deferred financing associated with the original debt in the amount of $1,389,033
including the amount in interest and financing cost. In addition, in
accordance with EITF 98-5 and EITF 00-27 the Company recognized the fair value
of the warrants and the beneficial conversion feature associated with the Notes
aggregating $2,802,876 as a discount to the Notes and as additional paid in
capital. During the nine months ended August 31, 2007 the Company
recorded amortization of the discount in the amount of $1,172,506 as interest
expense.
|
On
April 27, 2007 the Company and the Holders of the March 2005 Notes
entered
into an Waiver and Amendment Agreement, which, among other things,
extended the term of the March 2005 notes to the earliest of (A)
the date
of consummation of the PRB Sale,(B) October 31, 2007, and (C) such
date as
all amounts due under the Notes have been fully paid. In
addition each of the Holders agreed and confirmed the 2005 Subordinated
Notes continue to be subordinate to the senior secured indebtedness.
As
the PRB Sale was not consummated and the Company is prohibited from
paying
the March 2005 Notes until the senior secured indebtedness is paid
in full
(currently scheduled for May 31, 2010), the March 2005 Notes are
recorded
as non-current obligations on the Company’s August 31, 2007 Balance
Sheet.
|
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
5 – CONVERTIBLE NOTES PAYABLE (continued)
MAY
2005
NOTES
In
May
2005, the Company completed a private offering of Senior Secured Convertible
Notes to a group of accredited investors. Gross proceeds from the
offering were $10,000,000. The notes are secured by a security
interest in all of the assets of the Company and the domestic properties of
its
subsidiaries. Such security interest ranks equally with that of the
2004 Notes, and senior to the March 2005 Notes. The notes pay
interest at the prime rate plus 7.25% adjusted and payable
quarterly. They mature May 31, 2010, and are convertible into
5,319,149 shares of common stock at any time, based on a conversion price of
$1.88 per share. In addition, the Investors received a perpetual overriding
royalty interest (“ORRI”) in Galaxy’s domestic acreage averaging from 1% to 3%,
depending upon the nature and location of the property, a right of first refusal
with respect to future debt and/or equity financings, and a right to participate
in any farm-out financing transactions that do not have operating obligations
by
the financing party as a material component. The fair value of the
ORRI has been calculated to be the difference between the market price per
share
at the date of issue ($1.14) and the conversion price ($1.88), times the number
of shares into which the notes are convertible (5,319,149) or
$3,936,170. This value has been recorded as a reduction of the
Company’s undeveloped oil and gas properties full cost pool and as a discount to
the notes. The discount will be amortized over the five-year term of
the notes.
On
November 29, 2006, the Company and the holders of the May 2005 Notes entered
into a Waiver and Amendment Agreement. The Company had notified the
holders of the May 2005 Notes of the fact that a Triggering Event under the
terms of the Notes had occurred as of August 31, 2006. Among other
things, this would have enabled the holders of the Notes to require the Company
to redeem all or any portion of the outstanding principal amount of the Notes
at
a price equal to the greater of (i) 125% of such principal plus accrued and
unpaid interest and (ii) the product of the current conversion rate in effect
under the Notes multiplied by the volume-weighted average price of Galaxy’s
common stock. The holders agreed to waive the Triggering Event in
consideration for an amendment to the May 2005 Notes that reset the principal
amounts of the Notes to 125% of the amounts outstanding as of October 31,
2006. In accordance with EITF 96-19, the Company recognized this
transaction as an extinguishment of the existing debt and the issuance of new
debt. The Company wrote off unamortized discount and deferred
financing associated with the original debt in the amount of $2,500,000
including the amount in interest and financing cost. In
addition, in accordance with EITF 98-5 and EITF 00-27 the Company recognized
the
fair value of the warrants and the beneficial conversion feature associated
with
the Notes aggregating $2,750,577 as a discount to the Notes. During
the nine months ended August 31, 2007 the Company recorded amortization of
the
discount in the amount of $590,641 as interest expense.
APRIL
2006 DEBENTURES
In
April
2006, the Company completed a private offering of Subordinated Convertible
Debentures and Warrants to a group of accredited investors. Gross
proceeds from the offering were $4,500,000. The Debentures pay
interest at 15% per annum, have a 30-month maturity which will extend under
the
terms of the financing until all of the Company’s senior debt has been retired,
and are subordinated to Galaxy’s secured debt and existing senior
debt. The Debentures are convertible into 2,884,615 shares of common
stock based on a conversion price of $1.56 per share. Debenture
purchasers received warrants to purchase 865,383 shares of the Company’s common
stock at an exercise price of $1.60 per share, for a period of five
years. Principal and interest on the Debentures are payable upon
maturity.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
5 – CONVERTIBLE NOTES PAYABLE (continued)
APRIL
2006 DEBENTURES (Continued)
The
fair
value of the warrants was estimated as of the issue date under the Black-Scholes
pricing model, with the following assumptions: common stock based on a market
price of $1.06 per share, zero dividends, expected volatility of 67.46%, risk
free interest rate of 4.875% and expected life of 2.5 years. The fair
value of the warrants of $295,029 resulted in a discount of $395,986 which
has
been recorded as additional paid in capital and as a discount to the Debentures
and is being amortized over the term of the Debentures. Amortization
of the discount of $118,709
is included in interest
expense for the nine months ended August 31, 2007.
JUNE
2006
DEBENTURES
In
June
2006, the Company completed a private offering of Subordinated Convertible
Debentures and Warrants to an accredited investor. Gross proceeds
from the offering were $2,500,000. The Debentures pay interest at 15%
per annum, have a 30-month maturity which will extend under the terms of the
financing until all of the Company’s senior debt has been retired, and are
subordinated to Galaxy’s secured debt and existing senior debt. The
Debentures are convertible into 1,602,564 shares of common stock based on a
conversion price of $1.56 per share. The Debenture purchaser received
warrants to purchase 480,769 shares of the Company’s common stock at an exercise
price of $1.60 per share, for a period of five years. Principal and
interest on the Debentures are payable upon maturity.
The
fair
value of the warrants was estimated as of the issue date under the Black-Scholes
pricing model, with the following assumptions: common stock based on a market
price of $0.79 per share, zero dividends, expected volatility of 67.36%, risk
free interest rate of 5.125% and expected life of 2.5 years. The fair
value of the warrants of $92,695 resulted in a discount of $170,555 which has
been recorded as additional paid in capital and as a discount to the Debentures
and is being amortized over the term of the Debentures. Amortization
of the discount of $51,129 is included in interest expense for the nine months
ended August 31, 2007.
The
Company has evaluated the embedded conversion feature in the 2004, the March
2005, and the May 2005 Notes, and the April 2006 and the June 2006 Debentures
and concluded the feature does not require classification as a derivative
instrument because the feature would be classified as equity if it were a
freestanding instrument and therefore, meets the scope exception found in SFAS
133,
Accounting for Derivative Instruments and Hedging Activities
(“SFAS 133”). Included in the evaluation is the conclusion the
Notes and Debentures meet the definition of “conventional convertible
instrument” and therefore the embedded conversion feature is not subject to the
provisions of EITF 00-19. Further the Company has evaluated the
detachable warrants related to the 2004 and the March 2005 Notes and the April
2006 and the June 2006 Debentures, and concluded that the warrants also meet
the
scope exception found in SFAS 133 and are appropriately classified as
equity. The Company has also evaluated the freestanding registration
rights agreements attached to the Notes and Debentures and have concluded they
do meet the definition of derivative instruments under SFAS 133. The
fair value of the derivative liabilities has been determined not to be
significant based on a probability- weighted, discounted cash flow evaluation
of
its terms.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
5 - CONVERTIBLE NOTES PAYABLE (continued)
At
August
31, 2007 and November 30, 2006 convertible notes consist of the
following:
|
|
2007
|
|
|
2006
|
|
2004
Notes
|
|
$
|
-
|
|
|
$
|
4,160,505
|
|
Less
unamortized discount
|
|
|
-
|
|
|
|
(663,002
|
)
|
March
2005 Notes
|
|
|
7,695,000
|
|
|
|
7,695,000
|
|
Less
unamortized discount
|
|
|
-
|
|
|
|
(1,172,506
|
)
|
May
2005 Notes
|
|
|
12,500,000
|
|
|
|
12,500,000
|
|
Less
unamortized discount
|
|
|
(2,159,936
|
)
|
|
|
(2,750,577
|
)
|
April
2006 Notes
|
|
|
4,500,000
|
|
|
|
4,500,000
|
|
Less
unamortized discount
|
|
|
(181,963
|
)
|
|
|
(300,671
|
)
|
June
2006 Notes
|
|
|
2,500,000
|
|
|
|
2,500,000
|
|
Less
unamortized discount
|
|
|
(88,823
|
)
|
|
|
(139,951
|
)
|
|
|
|
24,764,278
|
|
|
|
26,328,798
|
|
Less
current portion, net
|
|
|
-
|
|
|
|
(10,019,996
|
)
|
long
term portion, net
|
|
$
|
24,764,278
|
|
|
$
|
16,308,802
|
|
Total
unamortized discount on all Notes and Debentures at August 31, 2007 in the
amount of $2,430,722 will be amortized and recognized as interest expense over
the remaining terms of the respective debt instruments.
Total
principal payments scheduled to be made in the next twelve months, including
related party debt, are $23,863,505; however, under the terms of the Senior
Secured Debt, the Company is prohibited from making $16,168,505 of such
principal payments until the senior indebtedness has been paid. The Senior
Secured Debt is scheduled for repayment on May 31, 2010; however, the Company
currently plans to utilize the proceeds from any future sale of the Company’s
oil and gas properties to repay or reduce those amounts.
NOTE
6 – STOCKHOLDERS’ EQUITY
During
the nine months ended August 31, 2007, the Company issued 2,000,000 shares
of
its common stock to its senior secured creditors in exchange for the creditors’
consent to the Powder River Basin Asset Sale. The creditors’ consent
was required because they have a security interest covering the assets to be
sold. The Company issued the shares at the closing market price per
share on the dates of issuance, and the value associated with these shares,
$410,000 was included in deferred selling costs. Since the purchase
and sale agreement expired on August 31, 2007 and was not extended, the $410,000
was charged to interest expense at August 31, 2007.
GALAXY
ENERGY CORPORATION
(A
Development Stage Company)
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
7 – STOCK OPTION PLAN
The
Company adopted the 2003 Stock Option Plan (the “Plan”), as
amended. Under the Plan, stock options may be granted at an exercise
price not less than the fair market value of the Company’s common stock at the
date of grant. Options may be granted to key employees and other
persons who contribute to the success of the Company. The Company has
reserved 6,500,000 shares of common stock for the plan. At August 31, 2007,
and
November 30, 2006, options to purchase 1,545,000 and 1,785,000 shares,
respectively, were available to be granted pursuant to the stock option
plan.
On
January 2, 2007, the Company granted each of the Company’s outside directors
options to purchase 60,000 shares of the Company’s common stock for a term 10
years at the closing price of the common stock on the date of
grant. The options were vested upon grant.
NOTE
8 – SUBSEQUENT EVENTS
|
Subsequent
to August 31, 2007 and through the date of the filing of this report,
the
Company has borrowed an additional $975,000 from the Bruner Trust,
under
the same terms and conditions as the other
notes.
|
|
On
August 30, 2007, the Company submitted a revised plan of action,
which
took the termination of the PSA with PetroHunter into account, to
bring the Company into compliance with AMEX’s continued listing
standards. On October 15, 2007 AMEX notified the Company that
AMEX accepted such revised plan based on the expectation that the
Company will complete a sale of certain assets and utilize the
proceeds to pay down a significant portion of its
outstanding debt, and continued the Company’s listing pursuant to an
extension until December 31, 2007. The Company will be subject
to periodic review by AMEX staff during the extension
period.
|
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Overview
and Plan of Operation
We
spent
fiscal years 2003, 2004, 2005 and 2006 obtaining oil and gas properties in
the
Piceance Basin of Colorado and the Powder River Basin of Wyoming and Montana
and
obtaining the funding to pay for those properties, commence drilling operations
and complete the infrastructure necessary to deliver natural gas to nearby
pipelines. Most of this funding has been high-interest debt
financing.
As
of
October 5, 2007, we had interests in 176 completed wells (26 of which were
delivering natural gas into sales pipelines), 61 wells in various stages of
completion and 8 water disposal wells. We recorded our first revenues
from natural gas sales during the fiscal year ended November 30, 2004 and we
currently are producing about 365 thousand cubic feet per day. If we
are successful in completing the sale of a portion of our Powder River Basin
assets as discussed below, the well count will be reduced. We will
require additional capital to continue to dewater wells in the Powder River
Basin and to complete and commence production from any remaining existing
uncompleted wells and to drill additional wells in both the Powder River and
Piceance Basins. If we are successful in securing the necessary
funding and in completing the existing wells and adding additional wells, we
anticipate an increase in production of natural gas and sales revenues during
future fiscal years; however, until such natural gas production and sales
revenues increase sufficiently these revenues will not cover all of our ongoing
exploration and development operations, debt repayments and other
commitments.
At
August
31, 2007, our working capital deficit was approximately$4,000,000 and a
stockholders’ deficit of approximately $5,320,000. As of that date we
had contractual obligations due within twelve months totaling approximately
$30,000,000, as explained more fully below. To settle such debt, the Company
is
exploring the sale of a portion of its oil and gas properties. If a
sale is completed, we will first pay down or pay off all of our senior debt
and
then we will negotiate to convert all or substantially all of our convertible
debt into common stock of the Company. We believe that we would then
be able to continue to pursue funding and industry participation alternatives
to
ensure our ability to continue to acquire additional acreage and complete
additional drilling activity on any remaining acreage.
If
we
cannot find a buyer and suitable terms for a sale, or additional debt or equity
placements, we may be forced to seek the protection of the bankruptcy
laws. Furthermore to close a sale, we may be required to reduce the
sale price of an asset sale, which could result in a significant impairment
(and
loss to the Company) to the carrying value of the oil and gas
properties.
Going
Concern
The
report of our independent registered public accounting firm on the financial
statements for the year ended November 30, 2006, includes an explanatory
paragraph indicating substantial doubt as to our ability to continue as a going
concern. We have incurred a cumulative net loss of approximately
$78,000,000 for the period from inception to August 31, 2007. We will
require significant monies to sustain our operations and satisfy our contractual
obligations for our planned oil and gas exploration and development
operations. Our ability to establish the Company as a going concern
is dependent upon our ability to obtain additional financing or proceeds from
the sale of assets, in order to fund our planned operations and ultimately,
to
achieve profitable operations.
Results
of Operations
Three
months ended August 31, 2007 compared to the three months ended August 31,
2006
During
the three months ended August 31, 2007, revenues from natural gas sales
decreased to $76,303 from $281,559 the year before. A total of 16
wells produced and sold approximately 45,000 Mcf of natural gas in 2007,
compared to 38 wells that sold 51,719 Mcf in 2006. The 2007
production decrease reflects the shutting in of the uneconomic Glasgow field
in
the Powder River Basin and mechanical problems encountered on 4 wells in the
West Recluse Field. Average prices received for gas sold has
decreased, $2.68 in 2007 compared to $4.38 in 2006, due to the pipeline line
constraints out of the Rocky Mountain region. Lease operating expense
increased significantly to $445,000 as the Company discontinued the
capitalization of certain dewatering costs ($346,000 for the quarter ended
August 31, 2007) compared to $106,510 the year before.
For
the
three months ended August 31, 2007 and 2006, we incurred general and
administrative expenses of $761,617 and $1,172,301, respectively, as summarized
below:
|
|
2007
|
|
|
2006
|
|
Stock
based compensation
|
|
$
|
289,589
|
|
|
$
|
315,407
|
|
Salaries
and benefits
|
|
|
212,595
|
|
|
|
233,717
|
|
Professional
and consulting fees
|
|
|
12,245
|
|
|
|
42,869
|
|
Investor
relations
|
|
|
108,593
|
|
|
|
238,783
|
|
Legal
|
|
|
41,555
|
|
|
|
112,373
|
|
Travel
and entertainment
|
|
|
10,864
|
|
|
|
34,690
|
|
Office
lease and expenses
|
|
|
39,575
|
|
|
|
61,557
|
|
Audit
and accounting
|
|
|
15,990
|
|
|
|
31,166
|
|
Directors
fees, insurance, prospect generation & other
|
|
|
30,611
|
|
|
|
101,739
|
|
Total
|
|
$
|
761,617
|
|
|
$
|
1,172,301
|
|
Significant
period-to-period variances include:
·
|
Lower
stock based compensation expense in 2007 versus 2006 is due to the
Company
granting fewer options than in prior years and certain of the previous
grants being fully expensed in prior
periods.
|
·
|
Professional
and consulting fees decrease reflects the termination of our consulting
geologist which had been employed by the Company in 2006, resulting
in
savings of $24,000; and as a result of our concerted effort to control
such costs.
|
·
|
Investor
relations expenses in 2006 included the costs associated with a special
shareholders meeting to approve the issuance of additional shares
of
common stock. No such special meeting was held in 2007,
resulting in savings of approximately $40,000. In 2006 we
incurred expenses for the preparation and distribution of our annual
report to shareholders of approximately $50,000. We have not prepared
an
annual report to shareholders for
2007.
|
·
|
Travel
and entertainment costs reflect a significant decrease in 2007 compared
to
2006 as a result of our concerted effort to control such costs, together
with the significantly decreased level of operational activity in
2007.
|
·
|
Decreased
audit and accounting fees in 2007 primarily reflects the reduction
of
outside accounting services as compared to 2006 when our level of
operations was significantly
greater.
|
As
a
result of lower natural gas prices at August 31, 2007 we recorded an impairment
expense of $2,370,880 for the three months then ended, representing the excess
of capitalized costs over the ceiling as
calculated
in accordance with the full cost rules. Impairment expense of
$1,031,160 was recorded for the three months ended August 31, 2006.
Depreciation,
depletion and amortization expense (“DD&A”) of $232,056 in 2007 reflects a
decrease from the 2006 amount of $318,379. The decrease reflects
lower DD&A on oil and gas properties of
$
19,837 or $.44/Mcf
in 2007 compared to $177,363 or $3.13/Mcf in 2006. The lower DD&A
reflects a lower amortization base following the impairment write-down of
$1,031,160 in 2006 and the impairment expense recognized in the first six months
of this fiscal year.
Interest
and financing costs decreased to $2,044,630in 2007 from $3,970,113 in 2006,
reflecting significantly lower amortization of discount on the 2004 Notes,
partially offset by the higher debt levels in 2007. The table below
summarizes interest and financing costs for the three months ended August 31,
2007 and 2006.
|
|
2007
|
|
|
2006
|
|
Interest
on outstanding debt
|
|
$
|
1,044,969
|
|
|
$
|
1,324,744
|
|
Interest
on outstanding debt, related party
|
|
|
284,682
|
|
|
|
-
|
|
Amortization
of discount
|
|
|
303,184
|
|
|
|
2,251,447
|
|
Amortization
of deferred finance costs
|
|
|
411,795
|
|
|
|
47,839
|
|
Discount
on shares issued upon conversion of
principal
and interest at below market rates
|
|
|
-
|
|
|
|
346,083
|
|
Total
|
|
$
|
2,044,630
|
|
|
$
|
3,970,113
|
|
Significant
year-to-year variances include:
·
|
Interest
on outstanding debt, related party in 2007 reflects costs associated
with
borrowing from the Bruner Family Trust in late 2006 and
2007. No such borrowings existed in the period ended August 31,
2006.
|
·
|
Lower
amortization of discount in 2007 reflects the lower balance of debt
on the
2004 Notes in 2007 compared to 2006. As a result of the
principal repayment schedule of the 2004 Notes, higher amortization
of
discount is recorded when debt levels are higher. As we have
paid the 2004 Notes down from $12,500,000 in 2006 to $0 in 2007,
related
amortization of discount is significantly less in
2007.
|
Nine
months ended August 31, 2007 compared to the nine months ended
August 31, 2006
During
the nine months ended August 31, 2007 we recorded natural gas sales volumes
of
118,000 mcf compared to 161,501 mcf in the same period in
2006. We recorded natural gas sales revenues of $447,232
($3.79/mcf) and lease operating and production tax expense of $704,151
($5.97/mcf) for the nine months ending August 2007 compared to natural gas
sales
revenues of $955,895 ($5.92/mcf) and $590,311 ($3.66/mcf) of lease operating
and
production tax expense during the same period in 2006. Depreciation,
depletion and amortization (“DD&A”) expenses associated with the gas sales
were $180,645 ($1.53/mcf) during the nine months ended August 31, 2007, compared
with $523,263 ($3.24/mcf) of DD&A expenses during the same period of
2006.
For
the
nine-month periods ended August 31, 2007 and 2006, we recorded general and
administrative costs of $2,801,617 and $3,652,158, respectively, as summarized
below.
|
|
Nine
months ended August 31,
|
|
|
|
2007
|
|
|
2006
|
|
Stock
Based compensation
|
|
$
|
891,647
|
|
|
$
|
999,660
|
|
Salaries
and benefits
|
|
|
648,589
|
|
|
|
714,912
|
|
Professional
and consulting
|
|
|
51,412
|
|
|
|
189,182
|
|
Investor
relations
|
|
|
331,864
|
|
|
|
659,103
|
|
Legal
|
|
|
267,172
|
|
|
|
290,092
|
|
Travel
& entertainment
|
|
|
46,049
|
|
|
|
97,769
|
|
Office
lease and expenses
|
|
|
144,386
|
|
|
|
173,234
|
|
Audit
and accounting
|
|
|
167,439
|
|
|
|
227,580
|
|
Director
fees
|
|
|
133,700
|
|
|
|
165,774
|
|
Insurance,
prospect generation and other
|
|
|
119,359
|
|
|
|
134,852
|
|
|
|
$
|
2,801,617
|
|
|
$
|
3,652,158
|
|
Significant
period-to-period variances include:
·
|
Lower
stock based compensation expense in 2007 versus 2006 is due to the
Company
granting fewer options than in prior years and certain of the previous
grants being fully expensed in prior
periods.
|
·
|
Professional
and consulting fees decrease in 2007 reflects the termination of
our
consulting geologist which we had employed in 2006, resulting in
savings
of $24,000; reduced fees paid to independent reservoir engineer for
the
2007 reserve report, resulting in savings of $20,000, the termination
of
the consulting agreement with our Founder, resulting in savings of
$30,000, and savings associated with the fact we did not require
the
preparation of a market valuation report in 2007, having completed
one in
2006, resulting in savings of
$30,000.
|
·
|
Investor
relations expenses in 2006 included the costs associated with a special
shareholders meeting to approve the issuance of additional shares
of
common stock, resulting in savings of approximately $40,000. In
2006 we incurred expenses for the preparation and distribution of
our
annual report to shareholders of approximately $50,000. We have
not prepared an annual report to shareholders for 2007. In addition,
we
terminated the contract with one investor relations firm subsequent
to
August 31, 2006, resulting in savings of $43,000 in
2007.
|
·
|
Increased
legal fees in 2007 reflects legal fees incurred to prepare and file
numerous 8-K reports and file preliminary proxy statements with the
SEC;
approximately $20,000 and in house legal fees incurred in negotiations
for
the sale of certain oil and gas assets; approximately
$40,000.
|
·
|
Travel
and entertainment costs reflect a significant decrease in 2007 compared
to
2006 as a result of our concerted effort to control such costs, together
with the significantly decreased level of operational activity in
2007.
|
·
|
Decreased
audit and accounting fees in 2007 primarily reflects the reduction
of
outside accounting services as compared to 2006 when our level of
operations was significantly
greater.
|
As
a
result of lower natural gas prices at August 31, 2007 we recorded an impairment
expense of $3,866,195 for the nine months then ended, representing the excess
of
capitalized costs over the ceiling as calculated in accordance with the full
cost rules. Impairment expense of $1,031,160 was recognized in
2006.
Depreciation,
depletion and amortization expense (“DD&A”) of $511,168 in 2007 reflects a
decrease from the 2006 amount of $680,707. The decrease reflects
lower DD&A on oil and gas
production
as discussed above. The lower DD&A reflects a lower amortization
base following the impairment write-down of $1,031,160 in 2006. Lower DD&A
on oil and gas production was partially offset by higher depreciation of ARO
assets, and higher accretion of ARO of $82,453 in 2007 compared to $3,493 in
2006.
We
recorded interest and financing costs of $7,119,791 in the nine months ending
August 31, 2007 compared to $12,918,109 in the previous year’s
period. The table below summarizes interest and financing costs for
the nine months ended August 31:
|
|
2007
|
|
|
2006
|
|
Interest
on outstanding debt
|
|
$
|
3,282,157
|
|
|
$
|
3,647,299
|
|
Interest
on outstanding debt – related party
|
|
|
687,714
|
|
|
|
-
|
|
Amortization
of discount
|
|
|
2,738,125
|
|
|
|
8,586,741
|
|
Amortization
of deferred finance costs
|
|
|
411,795
|
|
|
|
262,986
|
|
Discount
on shares issued upon conversion of principal and interest at below
market
rates
|
|
|
|
|
|
|
346,083
|
|
Fees
paid to extend note
|
|
|
-
|
|
|
|
75,000
|
|
Total
|
|
$
|
7,119,791
|
|
|
$
|
12,918,109
|
|
Significant
year-to-year variances include:
·
|
Interest
on outstanding debt, related party in 2007 reflects costs associated
with
borrowing from the Bruner Family Trust in late 2006 and
2007. No such borrowings existed in the period ended August 31,
2006.
|
·
|
Lower
amortization of discount in 2007 reflects the lower balance of debt
on the
2004 Notes in 2007 compared to 2006. As a result of the
principal repayment schedule of the 2004 Notes, higher amortization
of
discount is recorded when debt levels are higher. As we have
paid the 2004 Notes down from $12,500,000 in 2006 to $-0- in 2007,
related
amortization of discount is significantly less in
2007.
|
·
|
Lower
amortization of deferred finance costs reflects the write off of
unamortized balances of such costs when the related debt was extinguished
and reissued on November 30, 2005.
|
Liquidity
and Capital Resources
Operating
Activities.
For the nine months ended August 31, 2007
we used $3,131,964 for operating activities, as compared to $3,292,487 for
the
same period in 2006. Significant adjustments to reconcile the net
loss of $14,541,647 to net cash used by operating activities for 2007 were
$2,738,126 for amortization of discount and deferred financing costs on
convertible debt, $891,647 of stock based compensation expense, $3,866,195
of
impairment of oil and gas properties and DD&A of $511,168. In
contrast, the equivalent adjustments for 2006 to the net loss of $17,903,962
included $8,849,726 for amortization of discount and deferred financing costs
on
convertible debt, $999,660 of stock based compensation expense, $1,031,160
impairment of oil and gas properties and $680,707 of DD&A.
Investing
Activities.
Our investing activities used net cash of
$1,882,318 after recoveries, in the nine months ended August 31, 2007, as
compared to $1,391,441 of cash used for the comparable period of
2006. The increase is due to an earnest money deposit and
reimbursement of operating costs we received of $2,216,882, on the proposed
sale
of our Powder River Basin assets in the 2007 period that was not
completed.
Financing
Activities.
Since inception, we have funded our
operating and investing activities through the sale of our debt and equity
securities, raising net proceeds of $75,179,037 through the period ended August
31, 2007. Financing activities raised cash of $4,458,272 in the first
nine months of fiscal 2007, as compared to $3,522,058 in 2006.
From
December 2002 through May 2003, we sold 1,602,000 shares of common stock for
gross proceeds of $1,602,000. In October 2003, we completed a
$5,640,000 private placement of 7% secured convertible debentures and warrants,
due two years from date of issue and secured by substantially all of our
assets. Debentures purchasers received five-year warrants to purchase
2,867,797 shares of common stock at an exercise price of $0.71 per share and
2,867,797 shares of common stock at an exercise price of $0.83 per
share. We filed a registration statement covering the shares
underlying the debentures and warrants, but did not meet the deadline associated
with this filing obligation. We paid a penalty of $404,000 to the
holders of the debentures. During the year ended November 30, 2004,
all of the debentures were converted at $0.59 per share into 9,559,322 shares
of
common stock.
In
December 2003, we completed a private placement of 2,503,571 shares of our
common stock and warrants to purchase 500,715 common shares, resulting in gross
proceeds of $3,505,000. The warrants were exercisable for a four-year
period at an original price of $2.71 per share. In accordance with
the antidilutive rights provisions, the exercise prices of those warrants with
original exercise prices in excess of $1.54 were reset to $1.54 per share,
in
connection with the issuance of the 2004 notes. We granted
registration rights to the purchasers in this private placement.
We
completed a second private placement of 6,637,671 shares of our common stock
and
warrants to purchase 1,327,535 common shares in January 2004, resulting in
gross
proceeds of $11,947,800. The warrants were exercisable for a
five-year period at an original price of $4.05 per share. In
accordance with the antidilutive rights provisions, the exercise prices of
those
warrants with original exercise prices in excess of $1.54 were reset to $1.54
per share, in connection with the issuance of the 2004 Notes. We
granted registration rights to the purchasers in this private placement as
well.
In
August
and October 2004, we completed two tranches of a private placement of senior
secured convertible notes (the “2004 Notes”) and warrants (the “2004
Warrants”). Gross proceeds from the initial tranche were $15,000,000,
while gross proceeds from the second tranche were $5,000,000. The
2004 Notes paid interest at the prime rate plus 7.25% per annum, originally
matured two years from the date of issue, were collateralized by substantially
all of our assets, and were originally convertible into 10,695,187 shares of
our
common stock based on a conversion price of $1.87 per share. In
January 2005, under the terms of the 2004 Notes, we were required to pay
accumulated interest to that date. Commencing on March 1, 2005, we
were required to make monthly payments of principal in the amount of $833,333
plus accrued interest. For the year ended November 30, 2005, we made
total payments on the 2004 Notes of $10,152,666 consisting of $7,500,000 in
principal repayments and $2,652,666 of interest. Of that amount we
paid $8,337,748, or 82% of the total payment, using shares of common
stock. Note purchasers received the three-year, 2004 Warrants, which
originally allowed the holders to purchase 5,194,806 shares of common stock
at
$1.54 per share.
On
March
1, 2005, we completed a private placement of $7,695,000 in senior subordinated
convertible notes (the “March 2005 Notes”) to a group of accredited investors to
fund our entry into our Piceance Basin project. The March 2005 Notes
were originally payable on April 30, 2007 (but were subordinated in payment
to
the 2004 Notes), accrue interest at the prime rate plus 6.75% per annum,
adjusted quarterly and payable at maturity, and were originally convertible
into
4,093,086 shares of our common stock based on a conversion price of $1.88 per
share. March 2005 Note purchasers received
three-year
warrants (the “2005 Warrants”), which originally allowed the holders to purchase
1,637,234 shares of common stock at $1.88 per share.
On
May
31, 2005, we completed a private offering of senior secured convertible notes
to
essentially the same group of accredited investors that purchased our 2004
Notes
and Warrants (the “May 2005 Notes”). Gross proceeds from the offering
were $10,000,000. The May 2005 Notes are secured by a security
interest in all of our assets and the domestic properties of our
subsidiaries. Such security interest ranks equally with that of the
2004 Notes, and senior to the March 2005 Notes. The May 2005 Notes
mature and are payable on May 31, 2010 (but can be redeemed by the holders
after
May 31, 2008) and bear interest at the prime rate plus 7.25%, adjusted and
payable quarterly. The May 2005 Notes were originally convertible
into 5,319,149 shares of our common stock based on a conversion price of $1.88
per share. In addition, the Investors received a perpetual overriding
royalty interest in our domestic acreage averaging from 1% to 3%, depending
upon
the nature and location of the property, a right of first refusal with respect
to future debt and/or equity financings, and a right to participate in any
farm-out financing transactions that do not have operating obligations by the
financing party as a material component.
On
December 1, 2005, we entered into a Waiver and Amendment Agreement (the “2005
Waiver and Amendment”) with the holders of the 2004 Notes and the holders of the
2005 Notes. Under the agreement, we and the holders waived all claims
in connection with Dolphin Energy Corporation, our wholly-owned subsidiary,
having entered into a Third Amendment to Participation Agreement with our
partner in our Piceance Basin project, Exxel Energy Corporation as of October
4,
2005. The Third Amendment set the working interest between us and
Exxel at 25%/75%, consistent with the original intent of the
parties. As such, the Third Amendment clarified that Exxel was
obligated to pay the next $14 million in project costs to bring its payments
to
75% of the total costs, thereby adjusting for us having paid about 50% of the
land cost to get the project started.
In
addition, the 2005 Waiver and Amendment, among other things, effected the
following changes:
·
|
Lowered
the conversion price to $1.25 for conversions by the holders of the
2004
Notes, the May 2005 Notes, and the March 2005
Notes;
|
·
|
Lowered
the exercise price of the 2004 Warrants and the 2005 Warrants to
$1.25 per
share and increased the aggregate number of shares purchasable under
the
2004 Warrants from 5,194,806 to
6,400,002;
|
·
|
Caused
the exercise price of warrants issued in December 2003 and January
2004
being lowered to $1.25 under the anti-dilution provisions of such
warrants;
|
·
|
Deferred
monthly installment payments on the 2004 Notes until April 1,
2006;
|
·
|
Extended
the maturity date of the 2004 Notes to July 1, 2007;
and
|
·
|
Extended
any redemption or conversion of the 2004 Notes by Galaxy until June
22,
2006.
|
On
April
25, 2006, we entered into a Securities Purchase Agreement with several
accredited investors pursuant to which the investors purchased in the aggregate,
$4,500,000 principal amount of Subordinated Convertible
Debentures. In addition, the investors also received three-year
warrants that allow the holders to purchase 865,383 shares of common stock
at
$1.60 per share. The debentures are convertible at any time by the
holders into shares of our common stock at a price equal to $1.56; are
subordinated to all of our senior debt; pay interest at 15% per annum, payable
at maturity; and have a term of 30 months, which will extend automatically
until
all of our senior debt has been retired. Additionally, in the event
the debentures are retired at maturity, the holders are entitled to an
additional payment equal to the sum of 25% plus 0.75% for each month (or part
thereof) in excess of 30 months that the debentures have remained
outstanding.
On
June
20, 2006, we entered into a Securities Purchase Agreement with an accredited
investor pursuant to which the investor purchased $2,500,000 principal amount
of
Subordinated Convertible Debentures on the same terms and conditions set forth
in the previous paragraph.
During
the year ended November 30, 2006, we issued four separate subordinated unsecured
promissory notes for a total of $5,500,000 in favor of Bruner Family Trust
UTD
March 28, 2005 (the “Bruner Family Trust”), a related party. One of
the trustees of the Bruner Family Trust is Marc E. Bruner, the president and
a
director of the company. Interest accrues at the rate of 8% per annum
and the note matures at the later of 120 days from issue or the time at which
our senior indebtedness has been paid in full.
On
November 29, 2006, we entered into a Waiver and Amendment Agreement (the “2006
Waiver and Amendment”) with the holders of the 2004 Notes and the 2005
Notes. We had earlier notified the holders of the 2004 Notes and May
2005 Notes of the fact that our accounts payable had exceeded the permitted
$2,500,000 ceiling set forth in the 2004 Notes and May 2005 Notes, thereby
resulting in a Triggering Event under the terms of those Notes. Among
other things, this would have enabled the holders of the Notes to require us
to
redeem all or any portion of the outstanding principal amount of the Notes
at a
price equal to the greater of (i) 125% of such principal plus accrued and unpaid
interest and (ii) the product of the current conversion rate in effect under
the
Notes multiplied by the volume-weighted average price of our common
stock. The holders agreed to waive the Triggering Event in
consideration for an amendment to the 2004 Notes and May 2005 Notes that reset
the principal amounts of the Notes to 125% of the amounts outstanding as of
October 31, 2006. We and the holders also agreed to waive any future
Triggering Event that might result from our accounts payable exceeding
$2,500,000. However, if our accounts payable should exceed $5,000,000, it would
result in an immediate breach of the Notes. We and the holders agreed
to other amendments with respect to the 2004 Notes and May 2005 Notes and
warrants previously issued by us to the holders.
We
also
obtained the consent of the holders of the 2004 Notes and May 2005 Notes to
the
proposed sale of our Powder River Basin assets (the “PRB Sale”) to PetroHunter
as described above. Such consent was required as the holders have a
security interest covering these assets. The note holders conditioned
their consent on the following: completion of the PRB Sale by
February 28, 2007 and our compliance with the Waiver and Amendment Agreement
and
all of our obligations under the various agreements with the note
holders. Further, were required to (i) pay the 2004 Notes and May
2005 Notes in full, (ii) deliver to the holders 1,000,000 of the PetroHunter
shares to be received by us as part of the PRB Sale consideration and 10,000,000
shares of our common stock and (iii) retire all of our outstanding subordinated
convertible debt using the consideration we received in the PRB
Sale. Additionally, the holders and PetroHunter were required to
enter into a suitable registration rights agreement with respect to the
1,000,000 PetroHunter shares. The purchase and sale agreement expired
on August 31, 2007 and was not extended. The Company is currently searching
for
other buyers and suitable terms for a sale of some of its assets
Because
the PRB Sale was not consummated by January 31, 2007, we issued 2,000,000
additional shares of our common stock to the holders of the 2004 Notes and
the
May 2005 Notes in order to maintain their consent to the PRB Sale, as required
under the 2006 Waiver and Amendment. We have agreed to register these
shares.
In
October 2006, Bruner Trust, a related party, acquired a promissory note we
had
issued to DAR, LLC in the original principal amount of
$2,600,000. While the note, as amended, had a stated maturity date of
December 1, 2006, Bruner Trust has stated that it will not enforce its rights
under the note until November 30, 2007.
In
April
2007, we entered into a Waiver and Amendment Agreement with the holders of
the
March 2005 Notes, which, among other things, extended the term of the March
2005
Notes to the earliest of (A) the date of consummation of the PRB Sale, (B)
October 31, 2007, and (C) such date as all amounts due under the Notes have
been
fully paid. We are seeking an extension of the October 31, 2007 date
to February 29, 2008.
During
the nine months ended August 31, 2007, we issued nine separate subordinated
unsecured promissory notes for a total of $6,125,000 in favor of the Bruner
Family Trust a related party. Interest accrues at the rate of 8% per
annum and the note matures at the later of 120 days from issue or the time
at
which our senior indebtedness has been paid in full.
Schedule
of Contractual Obligations
The
following table summarizes our obligations and commitments to make future
payments under our notes payable, operating leases, employment contracts and
consulting agreement for the periods specified as of August 31,
2007.
Contractual
obligations (1)
|
Payments
due by period
|
Total
|
Less
than 1 year
|
1-3
years
|
3-5
years
|
More
than 5 years
|
Convertible
Notes Payable
Senior
Secured Notes Payable
(2)
Principal
Interest
Senior
Subordinated Notes Payable
(3)
Principal
Interest
Notes
payable, related party
Principal
Interest
Principal
Interest
|
$12,500,000
5,324,144
14,695,000
5,543,555
14,118,777
632,215
2,049,728
484,672
|
$ -
1,942,808
7,695,000
(4)
2,916,089
(4)
14,118,777
(4)
632,215
(4)
2,049,728
484,672
|
$12,500,000
3,381,336
7,000,000
2,627,466
-
-
|
$ -
-
-
-
-
-
|
$
-
-
-
-
-
-
|
Office,
Equipment Leases & Other
|
333,702
|
122,051
|
211,652
|
-
|
-
|
TOTAL
|
$55,681,793
|
$29,961,340
|
$25,720,454
|
$ -
|
$ -
|
(1)
|
This
table excludes the costs of drilling obligations in our European
permits,
as we reached agreement with third parties to fund our share of the
obligation amount, should such amount be spent. In the event we
do not fulfill those drilling obligations, we will forfeit the
permit. We have excluded asset retirement obligations because
we are not able to precisely predict the timing for these
amounts.
|
(2)
|
Under
certain conditions, as described elsewhere in this report, we have
the
option to pay the principal and interest with shares of common stock
instead of cash. Interest payments were calculated using actual
interest rates charged through August 31, 2007, and 15.5%
thereafter.
|
(3)
|
Under
certain conditions, as described elsewhere in this report, we have
the
option to pay the principal and interest with shares of common stock
instead of cash. Interest payments were calculated using actual
interest rates charged through August 31, 2007, and 15%
thereafter.
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(4)
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The
due dates of these Notes fall within the period specified above;
however,
we are prohibited for repaying these Notes until the senior secured
indebtedness has been satisfied. These notes have been
classified as non-current obligations as of August 31,
2007.
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Critical
Accounting Policies and Estimates
Our
discussion and analysis of our financial condition and results of operations
are
based upon our condensed consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosures
of contingent assets and liabilities. On an ongoing basis, we
evaluate our estimates, including those related to impairment of long-lived
assets. We base our estimates on historical experience and on various
other assumptions that we believe to be reasonable under the circumstances,
the
results of which form the basis for making judgments about the carrying value
of
assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under
different assumptions or conditions; however, we believe that our estimates,
including those for the above-described items, are reasonable.
Oil
and Gas Properties
. We follow the full cost method of
accounting for oil and gas operations. Under this method, all costs
related to the exploration for and development of oil and gas reserves are
capitalized on a country-by-country basis. Costs include lease
acquisition costs, geological and geophysical expenses, overhead directly
related to exploration and development activities and costs of drilling both
productive and non-productive wells. Proceeds from the sale of
properties are applied against capitalized costs, without any gain or loss
being
recognized, unless such a sale would significantly alter the rate of depletion
and depreciation.
We
calculate depreciation and depletion of our oil and gas using the
unit-of-production method based upon estimated proven oil and gas
reserves. The costs of significant unevaluated properties are
excluded from costs subject to depletion. For depletion and
depreciation purposes, relative volumes of oil and gas production and reserves
are converted at the equivalent conversion based upon relative energy
content.
In
applying the full cost method, we perform a ceiling test whereby the carrying
value of oil and gas properties and production equipment, net of recorded future
income taxes and the accumulated provision for site restoration and abandonment
costs, is compared annually to an estimate of future net cash flow from the
production of proven reserves. Costs related to undeveloped oil and
gas properties are excluded from the ceiling tests. Discounted net
cash flow, utilizing a 10% discount rate, is estimated using year end prices,
less estimated future general and administrative expenses, financing costs
and
income taxes. If such capitalized costs exceed the ceiling, we will
record a write-down to the extent of such excess as a non-cash charge to
earnings. Any such write-down will reduce earnings in the period of
occurrence and result in lower depreciation and depletion in future
periods. A write-down may not be reversed in
future
periods, even though higher oil and natural gas prices may subsequently increase
the ceiling. As a result of lower natural gas prices at August 31, 2007 and
May
31, 2007, we recorded an impairment expense of $3,866,195 for the nine
months then ended, representing the excess of capitalized costs over the ceiling
at that date. We recorded a ceiling write down during the year ended November
30, 2006 in the amount of $1,328,432 representing the excess of capitalized
costs over the ceiling amount.
We
intend
to sell a portion of our oil and gas properties. Full cost
accounting rules do not include provisions for segregating those assets and
identifying them as held for sale. Accordingly, those assets are
reflected on the balance sheet as either evaluated or unevaluated oil and gas
properties, as appropriate.
Oil
and Gas Reserves.
The determination of depreciation and
depletion expense as well as ceiling test write-downs related to the recorded
value of our oil and natural gas properties are highly dependent on the
estimates of the proved oil and natural gas reserves. Oil and natural
gas reserves include proved reserves that represent estimated quantities of
crude oil and natural gas which geological and engineering data demonstrate
with
reasonable certainty to be recoverable in future years from known reservoirs
under existing economic and operating conditions. There are numerous
uncertainties inherent in estimating oil and natural gas reserves and their
values, including many factors beyond our control. Accordingly,
reserve estimates are often different from the quantities of oil and natural
gas
ultimately recovered and the corresponding lifting costs associated with the
recovery of these reserves. Price changes will affect the economic
lives of oil and gas properties and, therefore, price changes may cause reserve
revisions. We are not aware of any material adverse issues related to
our reserves regarding regulatory approval, the availability of additional
development capital, or the installation of additional
infrastructure.
Asset
Retirement Obligations.
SFAS No. 143,
Accounting
for Asset Retirement Obligations
requires that we estimate the future cost
of asset retirement obligations, discount that cost to its present value, and
record a corresponding asset and liability in our consolidated balance
sheets. The values ultimately derived are based on many significant
estimates, including future abandonment costs, inflation, market risk premiums,
useful life, and cost of capital. The nature of these estimates
requires us to make judgments based on historical experience and future
expectations. Revisions to the estimates may be required based on
such things as changes to cost estimates or the timing of future cash
outlays. Any such changes that result in upward or downward revisions
in the estimated obligation will result in an adjustment to the related
capitalized asset and corresponding liability on a prospective
basis.
Revenue
Recognition
.
We derive our revenue
primarily from the sale of produced natural gas and crude oil. We
report revenue gross for the amounts received before taking into account
production taxes and transportation costs which are reported as separate
expenses. Revenue is recorded in the month production is delivered to
the purchaser at which time title changes hands. We make estimates of
the amount of production delivered to purchasers and the prices we will
receive. We use our knowledge of our properties; their historical
performance; the anticipated effect of weather conditions during the month
of
production; NYMEX and local spot market prices; and other factors as the basis
for these estimates. Variances between estimates and the actual
amounts received are recorded when payment is received. A majority of
our sales are made under contractual arrangements with terms that are considered
to be usual and customary in the oil and gas industry.
Impairment
of long-lived assets
.
Our long-lived
assets include property and equipment. We assess impairment of
long-lived assets whenever changes or events indicate that the carrying value
may not be recoverable. In performing our assessment we must make
assumptions regarding estimated future cash flows and other factors to determine
the fair value of the respective assets. If these estimates change in
the future we may be required to record impairment charges against these
respective assets.
Stock
based compensation
.
On December 1,
2005, we adopted FAS No. 123(R), “Accounting for Stock-Based Compensation,”
using the modified prospective method, which results in the provisions of FAS
123(R) being applied to the consolidated financial statements on a going-forward
basis. Prior periods have not been restated. FAS 123(R)
requires companies to recognize share-based payments to employees as
compensation expense on a fair value method. Under the fair value
recognition provisions of FAS 123(R), stock-based compensation cost is measured
at the grant date based on the fair value of the award and is recognized as
expense over the service period, which generally represents the vesting
period. The expense recognized over the service period is required to
include an estimate of the awards that will be forfeited. Previously,
no such forfeitures have occurred. We are assuming no forfeitures
going forward based on our historical forfeiture experience. The fair
value of stock options is calculated using the Black-Scholes option-pricing
model
Forward-Looking
Statements
This
report includes “forward-looking statements.” All statements other
than statements of historical facts included or incorporated by reference in
this report, including, without limitation, statements regarding our future
financial position, business strategy, budgets, projected costs and plans and
objectives of management for future operations, are forward-looking
statements. In addition, forward-looking statements generally can be
identified by the use of forward-looking terminology such as “may,” “will,”
“expect,” “intend,” “project,” “estimate,” “anticipate,” “believe,” or
“continue” or the negative thereof or variations thereon or similar
terminology. Although we believe that the expectations reflected in
such forward-looking statements are reasonable, we cannot give any assurance
that such expectations will prove to have been correct. Important
factors that could cause actual results to differ materially from our
expectations (“Cautionary Statements”) include, but are not limited to, our
assumptions about energy markets, production levels, reserve levels, operating
results, competitive conditions, technology, the availability of capital
resources, capital expenditure obligations, the supply and demand for oil and
natural gas, the price of oil and natural gas, currency exchange rates, the
weather, inflation, the availability of goods and services, drilling risks,
future processing volumes and pipeline throughput, general economic conditions
(either internationally or nationally or in the jurisdictions in which we are
doing business), legislative or regulatory changes (including changes in
environmental regulation, environmental risks and liability under federal,
state
and foreign environmental laws and regulations), the securities or capital
markets and other factors disclosed above under “Item 2. Management’s Discussion
and Analysis of Financial Condition and Results of Operations” and elsewhere in
this report. All subsequent written and oral forward-looking
statements attributable to us, or persons acting on our behalf, are expressly
qualified in their entirety by the cautionary statements. We assume
no duty to update or revise our forward-looking statements based on changes
in
internal estimates or expectations or otherwise.