Note 1—Basis of Presentation and Nature of
Operations
We have prepared the accompanying
unaudited condensed financial statements in accordance with accounting
principles generally accepted in the United States for interim financial
information and with the instructions to Form 10-QSB and item 310(b) of
Regulation S-B. They do not include all information and notes required by
generally accepted accounting principles for complete financial statements. You
should read these financial statements with our Annual Report on Form 10-KSB for
the year ended December 31, 2006, as well as the 10-QSB for the quarters
ended June 30, 2007, March 31, 2007, and September 30, 2006. In our
opinion, we have included all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation. Operating results for
the quarters presented are not necessarily indicative of the results that you
may expect for the full year.
We are engaged in the
exploration, extraction, processing and reclamation of coal bed methane, natural
gas, and oil projects in the western United States. We were incorporated in the
state of Nevada on April 9, 2001 as Fuel Centers, Inc. On November 12, 2003, we
changed our name to Fellows Energy Ltd. Our principal offices are located in
Lafayette, Colorado.
Cash
and Cash Equivalents
We consider all highly liquid
debt instruments purchased with maturity of three months or less to be cash
equivalents. At September 30, 2007 and 2006, we had approximately $1,700
and $180,000 in cash equivalents respectively.
Property
and Equipment
Property and equipment is
recorded at cost. Depreciation is provided for on the straight-line method over
the estimated useful lives of the related assets as follows:
Furniture and fixtures: 5
years
Software: 3 to 10 years
(depending on software)
Computer and office equipment: 3
to 5 years (depending on equipment)
Field equipment: 1 to 30 years
(depending on equipment)
The cost of maintenance and
repairs is charged to expense in the period incurred. Expenditures that increase
the useful lives of assets are capitalized and depreciated over the remaining
useful lives of the assets. When items are retired or disposed of, the cost and
accumulated depreciation are removed from the accounts and any gain or loss is
included in income.
Investment
in Oil and Gas Properties
We follow the successful-efforts
method of accounting for oil and gas property as defined under Statement of
Financial Accounting Standards No. 19, Financial Accounting and Reporting by Oil
and Gas Producing Companies (“FAS 19”). Under this method of accounting, we
capitalize all property acquisition cost and cost of exploratory and development
wells when incurred, pending determination of whether the well has found proved
reserves. If an exploratory well does not find proved reserves, we charge to
expense the cost of drilling the well. We include exploratory dry hole cost in
cash flow from investing activities within the cash flow statement. We
capitalize the cost of development wells whether productive or nonproductive. We
had no exploratory well cost that had been suspended for one year or more as
of September 30, 2007.
We expense as incurred geological
and geophysical cost and the cost of carrying and retaining unproved property.
We will provide depletion, depreciation and amortization (DD&A) of
capitalized cost of proved oil and gas property on a field-by-field basis using
the units-of-production method based upon proved reserves. In computing DD&A
we take into consideration restoration, dismantlement and abandonment cost and
the anticipated proceeds from equipment salvage. When applicable, we will apply
the provisions of Statement of Financial Accounting Standards No. 143,
Accounting for Asset Retirement Obligations, which provides guidance on
accounting for dismantlement and abandonment cost.
We review our long-lived assets
for impairment when events or changes in circumstances indicate that an
impairment may have occurred. In the impairment test we compare the expected
undiscounted future net revenue on a field-by-field basis with the related net
capitalized cost at the end of each period. Should the net capitalized cost
exceed the undiscounted future net revenue of a property, we will write down the
cost of the property to fair value, which we will determine using discounted
future net revenue. We will provide an impairment allowance on a
property-by-property basis when we determine that the unproved property will not
be developed.
Fellows Energy
Ltd.
Notes to
Unaudited Financial Statements
September 30,
2007
Impairment
of Unproved (Non-Producing) Property
Unproved properties will be
assessed periodically, to determine whether or not they have been impaired. We
will provide an impairment allowance on unproved property at any time we
determine that a property will not be developed. At September 30, 2007, we
consider our current property to be economically and operationally viable, in
accordance with FAS 19. In determining that there was no impairment of the
unproved property, we considered such factors as our commitment to bring the
project into production, the cost being incurred to develop the project, and
others.
Sales
of Producing and Non-producing Property
We account for the sale of a
partial interest in a proved property as normal retirement. We recognize no gain
or loss as long as this treatment does not significantly affect the
unit-of-production depletion rate. We recognize a gain or loss for all other
sales of producing properties and include the gain or loss in the results of
operations. We account for the sale of a partial interest in an unproved
property as a recovery of cost when substantial uncertainty exists as to
recovery of the cost applicable to the interest retained. We recognize a gain on
the sale to the extent that the sales price exceeds the carrying amount of the
unproved property. We recognize a gain or loss for all other sales of
non-producing properties and include the gain or loss in the results of
operations.
Asset
Retirement Obligation
We follow the Statement of
Financial Accounting Standards (“SFAS”) No. 143, “Accounting for Asset
Retirement Obligations”, which requires that the fair value of a liability for
an asset retirement obligation be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The associated
asset retirement costs are capitalized as part of the carrying amount of the
long-lived asset. The carrying value of a property associated with the
capitalization of an asset retirement cost are included in proved oil and gas
property in the balance sheets. The future cash outflows for oil and gas
property associated with settling the asset retirement obligations are accrued
in the balance sheets, and are excluded from ceiling test calculations. Our
asset retirement obligation consists of costs related to the plugging of wells
and removal of facilities and equipment on its oil and gas properties. The asset
retirement liability is allocated to operating expenses using a systematic and
rational method.
Use
of Estimates
The preparation of financial
statements in conformity with U.S. GAAP requires us to make certain estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Although these estimates are based on the knowledge of
current events and actions that we may undertake in the future, they may
ultimately differ from actual results. Included in these estimates are
assumptions about allowances for valuation of deferred tax assets. Accounts
receivable are stated after evaluation as to their collectability and an
appropriate allowance for doubtful accounts is provided where considered
necessary. The provision for asset retirement obligation, depletion, as well as
our impairment assessment on our oil and gas properties and other long lived
assets are based on estimates and by their nature, these estimates are subject
to measurement uncertainty and the effect on the financial statements of changes
in these estimates, in future periods, could be significant.
Revenue
Recognition
We use the sales method of
accounting for oil and gas revenues. Under this method, revenues are recognized
based on the actual volumes of gas and oil sold to purchasers. The volume sold
may differ from the volumes we are entitled to, based on our individual interest
in the property. Periodically, imbalances between production and nomination
volumes can occur for various reasons. In cases where imbalances have occurred,
a production imbalance receivable or liability will be recorded. Costs
associated with production are expensed in the period in which they are
incurred.
Income
Tax
Income taxes are determined using
the liability method in accordance with Statement of Financial Accounting
Standards (SFAS) No. 109, Accounting for Income Taxes. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using the enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the period that includes the enactment
date. In addition, a valuation allowance is established to reduce any deferred
tax asset for which it is determined that it is more likely than not that some
portion of the deferred tax asset will not be realized.
Fellows Energy
Ltd.
Notes to
Unaudited Financial Statements
September 30,
2007
Net
Loss per Common Share
We have adopted Statement of
Financial Accounting Standards No. 128, Earnings Per Share. Statement 128
requires the reporting of basic and diluted earnings/loss per share. We
calculate basic loss per share by dividing net loss by the weighted average
number of outstanding common shares during the period. We calculate diluted loss
per share by dividing net loss by the weighted average number of outstanding
common shares including all potentially dilutive securities during the period.
For the period ended September 30, 2007, all weighted average shares
outstanding have been included in the calculation, and all of our warrants
have an anti-dilutive effect on per common share amounts.
Accumulated
Other Comprehensive Income (Loss)
Accumulated other comprehensive
income reflects changes in equity that result from transactions and economic
events from non-operating sources.
New
Accounting Pronouncements
Accounting
for Uncertainty in Income Taxes – In June 2006, the FASB issued FASB
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”),
an interpretation of FASB Statement No. 109, “Accounting for Income Taxes”. FIN
48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. The Interpretation requires that the
Company recognize in the financial statements, the impact of a tax position, if
that position is more likely than not of being sustained on audit, based on the
technical merits of the position. FIN 48 also provides guidance on recognition,
classification, interest and penalties, accounting in interim periods and
disclosure. FIN 48 is effective for fiscal years beginning after December 15,
2006, and is required as of the beginning of fiscal 2008, with the cumulative
effect of the change in accounting principle recorded as an adjustment to the
opening balance of deficit. We have evaluated the impact of FIN 48 on our
financial statements, and have concluded that the Company has not taken any tax
positions that would be less than likely of being sustained upon
audit.
Fair Value Measurements – In
September 2006, the FASB issued FAS No. 157, “Fair Value Measurements” (“FAS
157”), which defines fair value, establishes a framework for measuring fair
value and expands disclosures about fair value measurements. FAS 157 is
effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years, and is
applicable beginning in the first quarter of 2008. We are currently evaluating
the impact that FAS 157 will have on our financial statements.
The Fair Value Option for
Financial Assets and Financial Liabilities – In February 2007, the FASB issued
FAS No. 159, “The Fair Value Option for Financial Assets and Financial
Liabilities – Including an amendment of FASB Statement No. 115”, (“FAS 159”)
which permits entities to choose to measure many financial instruments and
certain other items at fair value at specified election dates. A business entity
is required to report unrealized gains and losses on items for which the fair
value option has been elected in earnings at each subsequent reporting date.
This statement is expected to expand the use of fair value measurement. FAS 159
is effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years, and is
applicable beginning in the first quarter of 2008. We are currently evaluating
the impact that FAS 159 will have on our financial statements.
Stock
Options
On October 9, 2003, we adopted an
incentive stock option plan, pursuant to which shares of our common stock are
reserved for issuance to satisfy the exercise of options. The plan authorizes up
to 2,000,000 shares of authorized common stock to be purchased pursuant to the
exercise of options. Our stockholders approved the plan on November 10, 2003. On
September 15, 2004, we granted an option for 200,000 shares to our CEO, 150,000
shares to our vice president and 125,000 shares to an employee. These options
are exercisable at $0.80 per share, the price of our stock on the grant date.
The options vested 50% on the grant date and vest 50% on September 15, 2005. On
October 3, 2005, we granted an option for 100,000 shares to our CEO, 150,000 to
our Vice President and 175,000 and 200,000 shares to two employees respectively.
On November 1, 2006, we granted an option for 300,000 shares to our Vice
President of Business Development.
Effective the date of the
debenture conversion price, February 15, 2007, amendment and corresponding share
issuance having issued all authorized common stock as described in Note 9, the
Board of Directors of the Company elected to cancel all outstanding stock
options, as they had been significantly "out of the money" and worthless as
valued under the black-scholes option value pricing model since December 2005.
Therefore all the options in the plan have been returned to the treasury of the
option plan.
Reclassifications
We have made certain
reclassifications to the 2006 financial statements to conform with the 2007
financial statement presentation.
Fellows Energy
Ltd.
Notes to
Unaudited Financial Statements
September 30,
2007
Note
2—Asset Retirement Obligation
The Company follows Statement of
Financial Accounting Standards (“SFAS”) No. 143, “Accounting for Asset Retirement
Obligations”, which requires that the fair value of a liability for an
asset retirement obligation be recognized in the period in which it is incurred
if a reasonable estimate of fair value can be made. The associated asset
retirement costs are capitalized as part of the carrying amount of the
long-lived asset. The increase in carrying value of a property associated
with the capitalization of an asset retirement cost is included in proved oil
and gas properties in the consolidated balance sheets.
The Company depletes the amount
added to proved oil and gas property costs. The future cash outflows for
oil and gas properties associated with settling the asset retirement obligations
that have been accrued in the accompanying balance sheets are excluded from the
ceiling test calculations. The Company’s asset retirement obligation
consists of costs related to the plugging of wells and removal of facilities and
equipment on its oil and gas properties. The asset retirement liability is
allocated to operating expenses using a systematic and rational method.
At September 30, 2007, the asset retirement obligation and accretion
expense were zero.
Note
3—Going Concern
As shown in the accompanying
financial statements, we have incurred significant operating losses since
inception and previously incurred a loss on our discontinued automotive fuel
business. As of September 30, 2007, we have limited financial resources
until such time that we are able to generate positive cash flow from operations.
These factors raise substantial doubt about our ability to continue as a going
concern. Our ability to achieve and maintain profitability and positive cash
flow is dependent upon our ability to locate profitable mineral properties,
generate revenue from our planned business operations, and control exploration
cost. Management plans to fund its future operation by joint venturing,
obtaining additional financing, and attaining additional commercial production.
However, there is no assurance that we will be able to obtain additional
financing from investors or private lenders, or that additional commercial
production can be attained. Although management believes that
production from the Carbon County and Creston projects will generate
revenues sufficient to sustain the Company, no assurance can be given that such
revenues will be generated from the projects.
Note
4—Deposits
In March of 2006, we acquired the
interests in one producing property and maintained our interest in three other
exploration oil and gas properties. The project we acquired is known as the
Carbon County project. As of September 30, 2007, we have $28,000 held
on deposit for properties.
Note
5—Settlement Receivable
In August and September 2005 as
part of our earn-in arrangement, we agreed to advance Mountain Oil and Gas a
total of $66,000 for purposes of working capital in exchange for oilfield and
rig services. Originally this balance was classified as a deposit,
and has since been reclassified as a note receivable. As indicated in
the agreement, in the event that sufficient services were not performed, the
amount would convert to a loan, 12% per annum, commencing February,
2006. The amount is secured with field equipment including a pumping
unit, engine, treater, and rods.
In addition to the foregoing, and in
October 2005, we entered into an agreement to obtain up to a 75% working
interest in certain well bores owned by Mountain Oil and Gas. In
connection with this, we agreed to advance Mountain Oil and Gas a total of
$100,000 for the purpose of well bonding and working capital. This
was due and payable back to the Company on December 30, 2005. Upon
default, and pursuant to the Master Wellbore Agreement dated, October 19, 2005,
the Company became entitled to $160,000 of the net revenues from the 1-16A1E
well effective January 1, 2006. Repayment is secured by a pumping
unit located on the Dye-Hall well for the value of the working capital and well
bonding. As of September 30, 2007, we had collected $20,000 on
the note. As of October 2007, we reached a settlement agreement with
regards to the above note, which is further described in Note 11,
Subsequent Events.
Fellows Energy
Ltd.
Notes to
Unaudited Financial Statements
September 30,
2007
Note
6—Notes Payable
At September 30, 2007, we
owed two unsecured demand notes of $2,049,343 and $600,000. The notes
accrue interest at a rate of 10% and 18% per annum compounded daily to an entity
controlled by our CEO. This notes include $236,422 due in
interest.
In 2006, we obtained $1.25 million in
industry partner financing to carry the Creston project forward. The
repayment of the $1.25 million in financing is secured with 1.6 million shares
of restricted stock held in escrow and is personally guaranteed by George S.
Young, our CEO, and by his private company, Diamond Oil and Gas
Corporation. On May 31, 2007, we refinanced this note to lower the monthly
payments from $90,000 to $45,000 and extend the due date until June 1,
2008. In exchange for this, we agreed to relinquish a 4%
working interest in the Bacaroo project and issue 3,600,000 warrants
upon an increase in the authorized common stock of the Company. The terms
of the warrants remained unformalized, and as such, we could not place a value
on such warrants as of June 30, 2007. Furthermore, the Company has issued all of
its authorized shares and that such warrants would not be exercisable unless and
until an increase in the authorized shares occurs. The interest rate on this
note is 18% per annum. As of September 2007, we owed $511,000 on the
note.
In March 2006, we borrowed
$750,000 on a secured 12% note payable for a period of 36 months in exchange for
a 5% overriding royalty interest in Carbon County, as well as the right to
participate in any future exploration activities on the project on the basis of
a 10% working interest. As of September 30, 2007, we had paid $226,000
towards the principal and interest. On August 6, 2007, we entered into a
purchase and sale agreement for the sale of our interests in the
Carbon County project to our joint venture partner Thunderbird Energy
Corporation. Under the terms of the sale, Thunderbird assumed the
remaining liability of this note.
In May 2006, we borrowed $500,000
at 12% interest in exchange for a 2% overriding royalty interest in
Carbon County as well as 50,000 shares of common stock. As of
September 30, 2007, we had paid $170,000 towards the principal and interest. On
August 6, 2007, we entered into a purchase and sale agreement for the sale of
our interests in the Carbon County project to our joint venture
partner Thunderbird Energy, Inc. Under the terms of the sale, Thunderbird
assumed the remaining liability of this note.
Note
7—Related Party Transactions
At September 30, 2007,
we owed two unsecured demand notes of $2,049,343 and $600,000. The
notes accrue interest at a rate of 10% and 18% per annum compounded daily to an
entity controlled by our CEO. This note includes $236,422 due in
interest.
In 2006, we obtained $1.25 million in
industry partner financing to carry the Creston project forward. The
repayment of the $1.25 million in financing is secured with 1.6 million shares
of restricted stock held in escrow and is personally guaranteed by George S.
Young, our CEO, and by his private company, Diamond Oil and Gas
Corporation. On May 31, 2007, we refinanced this note to lower the monthly
payments from $90,000 to $45,000 and extend the due date until June 1,
2008. In exchange for this, we agreed to relinquish a 4%
working interest in the Bacaroo project and issue 3,600,000 warrants
upon an increase in the authorized common stock of the Company. The terms
of the warrants remained unformalized, and as such, we could not place a value
on such warrants as of June 30, 2007. Furthermore, the Company has issued all of
its authorized shares and that such warrants would not be exercisable unless and
until an increase in the authorized shares occurs. The interest rate on this
note is 18% per annum. As of September 2007, we owed $511,000 on the
note.
Note
8 —Common Stock
We issued 11,189,947 shares of
common stock in the first quarter of 2007, for the debt service of our
convertible debentures. The first quarter redemption share payments
amounted to 1,075,343 shares, 118,057 shares, and 7,025,789 shares. We
also issued 2,970,758 shares for warrants exercised at an average price of $0.09
per share.
In addition to the redemption
issuances above, we issued 5,454,546, 1,449,825, and 6,458,063 at $0.09 in
connection with the convertible debenture restructuring.
In January 2007, we issued
2,000,000 shares to our legal counsel as payment for services relating to the
debenture restructuring as well as outstanding legal fees, which we valued at
$120,000.
We issued no stock during the
second or third quarter of 2007, as all authorized stock is issued and
outstanding.
Fellows Energy
Ltd.
Notes to
Unaudited Financial Statements
September 30,
2007
Note
9 —Convertible Debentures
On June
4, 2004, we entered into a financing arrangement whereby we issued a convertible
debenture with a conversion price of $1.25 per share of common stock, subject to
anti-dilution adjustments. The offering resulted in gross proceeds prior to the
deduction of fees and costs, of approximately $1,000,000, with 8% simple
interest. In connection with the placement, we also issued warrants to purchase
an aggregate amount of up to 400,000 shares at $1.50 per share, which have
expired. The net proceeds from the offering were used for working capital needs
and other general corporate purposes. As of September 30, 2007, the
debentures and accrued interest due was $1,265,700.
On February 15, 2007, we entered
into a series of transactions to restructure securities issued pursuant to
securities purchase agreements dated June 17, 2005 and September 21,
2005.
Background
June 2005
Financing
On June 17, 2005, we closed a
financing pursuant to a securities purchase agreement with three accredited
investors, Palisades Master Fund, L.P. (“Palisades”), Crescent International
Ltd. (“Crescent”) and JGB Capital L.P. (“JGB”) for the issuance of
$5,501,200 in face amount of debentures maturing September 17, 2007 (the
“June Debentures”). The June Debentures were unsecured and we were obligated to
pay 1/24th of the face amount of the debenture on the first of every month,
starting October 1, 2005. Payment could be made either in the form of cash or in
stock at the lower of $0.60 per share or 80% of the volume weighted average
price of our stock for the five trading days prior to the repayment date. In the
event that we made the payment in cash, we paid 110% of the monthly redemption
amount.
In addition, we issued warrants
to the investors, expiring June 17, 2007, to purchase 4,584,334 shares of
restricted common stock, exercisable at a per share of $0.649 (the “June
Warrants”). In addition, the exercise price of the June Warrants would be
adjusted in the event we issued common stock at a price below the exercise
price, with the exception of any securities issued pursuant to a stock or option
plan adopted by our board of directors, issued in connection with the debentures
issued pursuant to the securities purchase agreement, or securities issued in
connection with acquisitions or strategic transactions.
If in any period of 20
consecutive trading days our stock price exceeds 250% of the June Warrants’
exercise price, all of the June Warrants shall expire on the 30th trading day
after we send a call notice to the June Warrant holders. If at any time after
one year from the date of issuance of the June Warrants there is not an
effective registration statement registering, or no current prospectus available
for, the resale of the shares underlying the June Warrants, then the holder may
exercise the June Warrant at such time by means of a cashless
exercise.
September 2005
Financing
On September 21, 2005, we closed
a financing pursuant to a securities purchase agreement with two accredited
investors, Palisades and Crescent for the issuance of $3,108,000 in face amount
of debentures maturing December 20, 2007 (the “September
Debentures”).
The September debentures were
unsecured and we were obligated to pay 1/24th of the face amount of the
debenture on the first of every month, starting January 1, 2006. Payment could
be made either in the form of cash or in stock at the lower of $0.75 per share
or 80% of the volume weighted average price of our stock for the five trading
days prior to the repayment date. In the event that we made the payment in cash,
we paid 110% of the monthly redemption amount.
In addition, we issued warrants
to the investors, expiring September 21, 2008, to purchase 2,072,000 shares of
restricted common stock, exercisable at a per share of $0.80. In addition, the
exercise price of the September Warrants would be adjusted in the event we
issued common stock at a price below the exercise price, with the exception of
any securities issued pursuant to a stock or option plan adopted by our board of
directors, issued in connection with the debentures issued pursuant to the
securities purchase agreement, or securities issued in connection with
acquisitions or strategic transactions.
If in any period of 20
consecutive trading days our stock price exceeds 250% of the September Warrants’
exercise price, all of the September Warrants shall expire on the 30th trading
day after we send a call notice to the September Warrant holders. If at any time
after one year from the date of issuance of the September Warrants there is not
an effective registration statement registering, or no current prospectus
available for, the resale of the shares underlying the September Warrants, then
the holder may exercise the September Warrant at such time by means of a
cashless exercise.
Fellows Energy
Ltd.
Notes to
Unaudited Financial Statements
September 30,
2007
Restructuring
On February 15, 2007, the
following transactions took place with regards to the June Debentures and the
September Debentures (“Old Debentures”) and the warrants issued under the June
Debentures and the September Debentures (“ Old Warrants”):
1) JGB entered into an assignment
agreement with Crescent, pursuant to which Crescent purchased from JGB the June
Debentures issued to JGB. The face value of the June Debentures issued to JGB at
the time of the transaction was $333,333 and Crescent paid $250,000 to JGB for
the assignment;
2) We entered into a settlement
agreement with JGB for the sum of $83,333. We amended the terms of the Old
Warrants held by JGB to remove the ratchet and call provisions and JGB agreed to
release any shares reserved for issuance of the Old Warrants and to not exercise
such Old Warrants until we obtain an increase in the authorized shares of common
stock. Upon obtaining the increase in authorized shares, we agreed to issue JGB
500,000 shares of restricted common stock;
3) We entered into a first
amendment and waiver agreement with Palisades for the amendment of the Old
Debentures issued to Palisades (the “Palisades Amendment Agreement”);
and
4) We entered into a first
amendment and waiver agreement with Crescent for the amendment of the Old
Debentures issued to JGB (and purchased by Crescent) and Crescent (the “Crescent
Amendment Agreement” and together with the Palisades Amendment Agreement, the
“Restructuring Amendments”).
Palisades and Crescent agreed to
amend the Old Debentures to remove the mandatory monthly liquidation provision
and to amend the fixed conversion price of the Old Debentures to $0.1375 (the
“Fixed Conversion Price”). As a result, the principal amount
remaining on the Old Debentures is now due and payable at maturity, unless
sooner converted into shares of common stock by the investors, at the Fixed
Conversion Price. Palisades and Crescent further agreed to waive any
and all existing defaults under the Old Debentures.
Pursuant to the Palisades
Amendment Agreement, we agreed to issue 7,025,789 shares of common stock (the
“Monthly Redemption Shares”) to Palisades upon conversion of $608,433 in
principal amount of the Old Debentures. Such Monthly Redemption
Shares were issued as payment for the previously delinquent monthly redemptions
owed to Palisades for the periods from December 1, 2006 through February 1, 2007
pursuant to the Old Debentures. These Monthly Redemption Shares were
not issued while we negotiated the terms of a potential buy-out or restructuring
of the Old Debentures. The Monthly Redemption Shares were previously
registered for resale pursuant to resale registration statements filed with the
Securities and Exchange Commission and represent the remaining shares of common
stock registered thereunder for Palisades pursuant to the Old
Debentures. In addition, the exercise price of the Old Warrants was
reduced to $0.0866, which Palisades exercised on a cashless basis and received
an additional 2,970,758 shares of common stock which were previously registered
for resale pursuant to resale registration statements filed with the Securities
and Exchange Commission.
We agreed to pay Palisades a
forbearance fee of $150,000 a month, for six months. The fee, however, was
immediately settled upon the issuance of 5,454,546 shares of restricted common
stock. We also issued Palisades 1,449,825 shares of common stock in
the form of a commitment fee for the restructuring of the Old
Debentures.
In
connection with the restructuring, we executed a security agreement (the
“Security Agreement”) in favor of Palisades and JGB granting them a first
priority security interest in all of our goods, inventory, contractual rights
and general intangibles, receivables, documents, instruments, chattel paper, and
intellectual property, except for our Carbon County prospect, which Palisades
and JGB took a second priority interest and for our Carter Creek and Weston
County prospects, which the investors were not granted any security
interest. The Security Agreements state that if an event of default
occurs under the Old Debentures or Security Agreement, the Investors have the
right to take possession of the collateral, to operate our business using the
collateral, and have the right to assign, sell, lease or otherwise dispose of
and deliver all or any part of the collateral, at public or private sale or
otherwise to satisfy our obligations under these agreements.
Fellows Energy
Ltd.
Notes to
Unaudited Financial Statements
September 30,
2007
February,
2007 Financing
On February 15, 2007, we
closed a financing pursuant to a securities purchase agreement with Palisades
for the issuance of a $714,500 face amount debenture maturing September 15, 2007
(the “New Debenture”). The New Debenture does not accrue interest and the
investors paid $500,000 for the New Debenture. We paid a commission of $100,000
to HPC Capital Management (a registered broker-dealer) in connection with the
transaction, resulting in net proceeds to us of $400,000 before our legal fees.
We used the net proceeds to pay our settlement agreement payment to JGB,
repayment of a bridge loan to Petro Capital Securities, LLC and the remainder
for general working capital purposes. We also issued HPC Capital Management
6,458,063 shares of restricted common stock and agreed to issue an additional
1,041,937 shares of restricted common stock upon obtaining an increase in our
authorized shares of common stock, which shares are additional compensation for
its services in connection with the transaction with the investors.
The convertible debentures are
secured and are convertible into our common stock, at Palisades’ option, at a
fixed conversion price of $0.1375. Based on this conversion price, the $714,500
secured convertible debenture is convertible into 5,196,364 shares of our common
stock.
In the event of default, the
investors may require payment, which shall be the greater of: (A) 130% of the
principal amount of the face amount of the debenture to be prepaid, or (B) the
principal amount of the debenture to be prepaid, divided by the conversion price
on (x) the date the default amount is demanded or otherwise due or (y) the date
the default amount is paid in full, whichever is less, multiplied by the closing
price on (x) the date the default amount is demanded or otherwise due or (y) the
date the default amount is paid in full, whichever is greater
The conversion price of the
debenture may be adjusted in certain circumstances such as if we pay a stock
dividend, subdivide or combine outstanding shares of common stock into a greater
or lesser number of shares, or take such other actions as would otherwise result
in dilution of the investor’s position.
The Company has agreed to file a
registration statement with the Securities and Exchange Commission to cover the
future sale by the investors of the shares issuable upon conversion of the Old
and New Debentures. If the registration statement is not filed by the filing
deadline or if the registration statement is not declared effective by the
effective deadline, we would be required to pay liquidated damages to the
investors.
Note
10—Proved and Unproved Oil and Gas Property
Carbon
County Project, Utah
On September 12, 2005, we entered
into an option agreement to purchase a gas field in Carbon County, Utah which
was producing approximately 30 million cubic feet of natural gas per month. The
field comprises 5,953 gross acres (2,440 net acres) with three gas wells
currently producing and has an additional five wells drilled that are presently
shut-in. Production is derived from the Ferron Sandstone formation, and the gas
is marketed into the adjacent gas pipeline operated by Questar Gas Resources.
The acquisition included an associated gas gathering system and a 6 mile
pipeline and compression facility servicing the project and adjacent production.
The field has potential for 20 additional well sites on 160 acre spacing on the
undeveloped acreage. The property is adjacent to our Gordon Creek project and to
the very successful Drunkards Wash field originally developed by River Gas
Corp.
On March 13, 2006, we closed the
acquisition of this project for a total of $1.5 million. After
several months of production and workover efforts, as of June 2007, we
decided it was in the best interest of the Company to sell our ownership in
the Carbon County project. The decision was made to sell this project
after considering our required outstanding debenture obligations, the prospect
of paying off a significant portion of our debt, as well as record a
gain on the sale. Subsequently, on August 6, 2007, we entered into a
purchase and sale agreement pursuant to which we sold our
interests in the Carbon County project for total consideration of $3.0 million
The purchase was consummated via the assumption of and payment on various debts
owed by the Company amounting to $2,763,000, with the remainder held as a note
receivable in the amount of $237,000. The major classes of assets and
liabilities pertaining to the discontinued operations are as
follows:
Fellows Energy
Ltd.
Notes to
Unaudited Financial Statements
September 30,
2007
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Creston
Project, Uintah Basin, Utah
On October 25, 2005, we announced
that we had entered into a participation agreement with Mountain Oil and Gas,
Inc., Creston Resources Ltd, and Homeland Gas and Oil Ltd. (collectively
“Creston”), and are completing arrangements with private investors, whereby we
are to supply operating expertise and program supervision to earn working
interests in up to 45 producing oil wells in the Uintah Basin of Utah. We have
since commenced a rework program to re-complete previously-completed zones and
extend behind pipe reserves in the wells, located primarily in the
Altamont-Bluebell Field. Creston will retain the current or historical
production while we and the private investors will earn a variable percentage of
the production increase resulting from the reworking operations. Work has
commenced on two of the first four, and we plan on maintaining continuous
operations until all wells have been brought to full potential.
Under the participation
agreement, we are to begin reworking wells as necessary to revitalize production
across the 9,000 acres that pertain to the wells. Due to the over-pressured,
fractured nature of reservoir in the field, as well as the large vertical extent
of potential pay zones, many of the wells have formation damage resulting from
high drilling mud weights and cementing operations. These conditions have left
many zones unable to produce to their potential. We will employ a variety of
conventional and innovative proprietary techniques to reduce the effects of
formation damage and attempt to increase oil and gas recovery.
During the first quarter of 2006,
we completed the workover on the first well which commenced production at a
daily rate of 100 BOE. We are now evaluating the next wells to be re-completed.
In addition, we received joint venture financing arrangements with private
investors to provide for $1.25 million in funds to conduct the reworking
program. The Company is now evaluating the results of the program to
date prior to performing any additional work on the Creston
wells. The Company is also considering working with other owners or
operating companies in the area and may discontinue working with Creston in
favor of working with other operators.
Weston
County, Wyoming
The Weston County project is
a 19,290-acre project on the east flank of the Powder River Basin. The
prospect is a potential extension of an existing producing field. We are
continuing our work and evaluation with JMG Exploration on permitting and other
pre-drilling activities. In addition, we are targeting nearby locations with
potential in the Minnelusa sandstone and Dakota channel sandstone
formations.
During the second quarter of
2007, we entered into an agreement with Thunderbird Energy Corp, whereby they
committed to expend $3.5 million, over the next 24 months, in connection with
the drilling and completion of three wells located on the Dakota
formation. In exchange, Thunderbird will receive an additional 25%
working interest in the Weston County project. We reserve the option to
commence drilling under the previous joint venture structure if Thunderbird does
not commence drilling by May 31, 2008.
Gordon
Creek, Utah
JMG Exploration will also drill
on the 5,242-acre Gordon Creek project, which we acquired from The Houston
Exploration Company for $288,000. The Gordon Creek project is in an area of
known coal resources in Carbon County in eastern Utah near other operating
coal bed methane projects, such as the Drunkard’s Wash Project, which our
project personnel successfully drilled previously for River Gas
Corporation.
Based on exploration results, JMG
Exploration has indicated its intent to sell a portion of its working interest
to Enterra Energy Trust in an arrangement under which JED Oil, Inc. under a
development agreement with Enterra, will complete any development programs on
the projects. The Company now anticipates that Thunderbird Energy
Corp. (its former joint venture partner on the adjacent Carbon County
project) will acquire the interests of JMG Exploration and proceed with
development jointly with the Company on the Gordon Creek project in response to
favorable results on the Carbon County project.
Fellows Energy
Ltd.
Notes to
Unaudited Financial Statements
September 30,
2007
Carter Creek,
Wyoming
In 2004 we purchased the
10,678-acre Carter Creek Project in the southern Powder River
Basin. Although we previously contemplated drilling on the
project, and we believe much of the project acreage is drill-ready, we have not
yet commenced any drilling activities, and during the quarter, we dropped the
project due to capital constraints. This amounted to
$2,075,368.
Overthrust,
Utah and Wyoming
The Overthrust coal bed methane
project was an unconventional play with 183,000 gross and 118,950 net acres
targeting coal bed natural gas in southwestern Wyoming and northeastern Utah
that we entered into with Quaneco, LLC in 2004. This project also had the
potential for conventional oil and gas.
Bacaroo,
Colorado
In 2004 we optioned the Bacaroo
project in Colorado through our affiliation with Thomasson Partner Associates,
Inc. We believe the project is an opportunity to establish conventional oil and
gas production with comparatively inexpensive drilling in areas of established
production, while other projects being reviewed offer longer term, larger
potential exploration opportunities. We are acquiring acreage in the prospect
prior to commencing drilling operations.
Leasing and seismic evaluation
activities continue. One entire target area is now under lease, and two
additional areas are now undergoing leasing. We will perform additional geologic
evaluation and permitting work in preparation for drilling.
Johns Valley
Project, Utah
In 2004, we acquired an agreement
with Johns Valley Limited Partnership whereby we have the option to earn a 70%
working interest in 25,201 acres of oil and gas leases from the Utah School
and Institutional Trust Lands Administration. Due to permitting delays and other
operating parameters in the field, we negotiated to restructure the potential
option and the timing and amounts of our work commitments as provided under the
option assignment agreement. During the fourth quarter of 2006, due to capital
constraints, we determined not to pursue the option on this project and
relinquished our rights related thereto.
Note
11—Subsequent Events
On October 30th, 2007, we entered
into an agreement to provide for (1) the earn-in on the Divide, Pinedale and
Wilkens Ridge projects; (2) the hiring of Mark S. Dolar and Ken Allen into the
management, and their appointment as directors; and (3) to provide for the
potential growth of the Company through a joint venture or other financing
arrangement, or a potential business combination whereby we would merge
with a new company, through a reverse merger with the new company. It is
expected that we would continue to conduct the business of Fellows and of Dolar
and would raise capital through a joint venture, or other financing, or in
connection with a merger with the new company and to acquire and/or develop
the assets (“Dolar
Transaction”).b b
On
October 19, 2007, we entered into a settlement agreement with Alpha Capital in
connection with the May 2005 equity financing. Pursuant to the terms of the
settlement, the Company owes Alpha Capital $200,000 due and payable no later
than February 15, 2008 or upon the Company’s merger with a third party as
contemplated by the Dolar transaction. Should such amount not be paid at that
time, the creditor has the right to convert the outstanding amount owed into
equity at a15% discount of the last 30 day average trading price. Should the
creditor not choose to convert the obligation into equity, the obligation
reverts to a note payable at the rate of 18% per
annum.
On
October 15, 2007, we entered into a settlement agreement with Creston Resources
Ltd (successor in interest to Mountain Oil and Gas, Inc.) to settle the notes
receivable owed to us, as mentioned in Note 5 above. The settlement
agreement releases all claims by either party except; $31,169 as consideration
for oil sales on the 1-34B well payable to us, and a promissory note for the
amount of $300,000 payable to us without interest (except in case of default) in
twelve equal monthly installments of $25,000. The first payment was due
and payable on October 15, 2007, and payable on the 15th of each month
thereafter until paid in full.
Item 2. Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Forward-Looking
Statements
This
report includes certain forward-looking statements. Forward-looking statements
are statements that predict the occurrence of future events and are not based on
historical fact. Forward-looking statements may be identified by the use of
forward-looking terminology, such as “may”, “shall”, “will”, “could”, “expect”,
“estimate”, “anticipate”, “predict”, “probable”, “possible”, “should”,
“continue”, or similar terms, variations of those terms or the negative of those
terms. We have written the forward-looking statements specified in the following
information on the basis of assumptions we consider to be reasonable. However,
we cannot predict our future operating results. Any representation, guarantee,
or warranty should not be inferred from those forward-looking
statements.
The
assumptions we used for purposes of the forward-looking statements specified in
the following information represent estimates of future events and are subject
to uncertainty in economic, legislative, industry, and other circumstances. As a
result, judgment must be exercised in the identification and interpretation of
data and other information and in their use in developing and selecting
assumptions from and among reasonable alternatives. To the extent that the
assumed events do not occur, the outcome may vary substantially from anticipated
or projected results. Accordingly we express no opinion on the achievability of
those forward-looking statements. We cannot guarantee that any of the
assumptions relating to the forward-looking statements specified in the
following information are accurate. We assume no obligation to update any such
forward-looking statements.
Overview
On
January 5, 2004, we began operations as an oil and gas exploration company. We
acquired interests in certain assets owned by Diamond Oil & Gas Corporation,
in exchange for 3,500,000 shares of common stock. The transaction was deemed to
have a value of $6,405,000. The assets included certain oil and gas projects, as
well as the right to enter into the Exploration Services Funding Agreement with
Thomasson Partner Associates, Inc. of Denver, Colorado. Diamond is controlled by
our CEO, George S. Young. Our goal is to discover substantial commercial
quantities of oil and gas, including coalbed methane, on the properties as well
as to acquire and explore additional property.
Projects
acquired from Thomasson Partner Associates, Inc. under the Exploration Services
Funding Agreement (as Amended) include the Weston County project in Wyoming, the
Gordon Creek project in Utah, the Carter Creek project in Wyoming, the Circus
project in Montana, the Bacaroo project in Colorado, the Platte project in
Nebraska, and the Badger project in South Dakota. During the
year ended December 31, 2006, we abandoned the Platte and Badger
projects. As of December 31, 2006, we terminated our formal agreement
with Thomasson Partner Associates, Inc. and will continue accessing
projects informally, without having any first right to any project.
On
October 30th, 2007, we entered into an agreement to provide for (1) the earn-in
on the Divide, Pinedale and Wilkens Ridge projects; (2) the hiring of Mark S.
Dolar and Ken Allen into the management, and their appointment as directors; and
(3) to provide for the potential growth of the Company through a joint venture
or other financing arrangement, or a potential business combination
whereby we would merge with a new company through a reverse merger with the
new company. It is expected that we would continue to conduct the business of
Fellows and of Dolar and would raise capital through a joint venture, or other
financing, or in connection with a merger with the new company and to
acquire and/or develop the assets.
Plan
of Operations
During
the next twelve months, we expect to pursue oil and gas operations on some or
all of our property, including the acquisition of additional acreage through
leasing, farm-out or option and participation in the drilling of oil and gas
wells. We intend to pursue the Dolar transactions until completion,
including the possible merger or acquisition as contemplated in the Dolar
transaction. We also intend to continue to evaluate additional opportunities in
areas where we feel there is potential for oil and gas reserves and production,
and may participate in areas other than those already identified, although we
cannot assure that additional opportunities will be available, or if we
participate in additional opportunities, that those opportunities will be
successful.
Our
current cash position is not sufficient to fund our cash requirements during the
next twelve months, including operations and capital expenditures. We intend to
continue joint venture or equity and/or debt financing efforts to support our
current and proposed oil and gas operations and capital expenditures. We may
sell interests in our properties. We cannot assure that continued funding will
be available.
We have
not entered into commodity swap arrangements or hedging transactions. Although
we have no current plans to do so, we may enter into commodity swap and/or
hedging transactions in the future in conjunction with oil and gas production.
We have no off-balance sheet arrangements.
Our
future financial results continue to depend primarily on (1) our ability to
discover or purchase commercial quantities of oil and gas; (2) the market price
for oil and gas; (3) our ability to continue to source and screen potential
projects and finance them through joint ventures and potential business
combinations; and (4) our ability to fully implement our exploration and
development program with respect to these and other matters. We cannot assure
that we will be successful in any of these activities or that the prices of oil
and gas prevailing at the time of production will be at a level allowing for
profitable production.
Results
of Operations
For the three months
ended September 30, 2007 as compared to the three months
ended September 30, 2006.
Revenue.
For the three months ended September 30, 2007, we earned $0 from our
Carbon County project, compared to $111,000 in revenue for the three months
ended September 30, 2006. This difference relates to the
sale of the Carbon County project effective June
2007.
Operating
expense. For the three months ended September 30, 2007, our
operating expense was approximately $69,000, compared to $1,081,000 for the
three months ended September 30, 2006. The expenses came from oil and gas
exploration and production, salaries, business advisory services, legal and
professional fees, travel, and investor relations expense. Primarily the
difference between the two periods relates to lower exploration and production
costs, legal, business advisory, and stock issuance costs associated
with the convertible debentures for the three months
ended September 30, 2006. Expenses for the three months
ended September 30, 2007 consisted of $3,000 in exploration expenses,
$28,000 in legal, consulting, and audit services, $8,000 in
payroll, $17,000 in insurance costs, and $13,000 in other costs including
rent, bank fees, travel, and telephone expenses.
Interest
expense. We incurred interest expense of $1,468,000 for the three months
ended September 30, 2007, compared to $31,000 for the three months
ended September 30, 2006. Interest expense for the quarter primarily
consisted of amortized convertible debenture discount and deferred debt issue
costs.
For the nine months
ended September 30, 2007 as compared to the nine months
ended September 30, 2006.
Revenue.
For the nine months ended September 30, 2007, we had no further
revenue earned after the sale of the Carbon County project, which has been
classified as discontinued operations, in comparison to $454,000
in revenue for the nine months ended September 30,
2006.
Operating
expense. For the nine months ended September 30, 2007, our
operating expense was approximately $3,221,000, compared to $3,296,000 for
the nine months ended September 30, 2006. The expenses came from oil and
gas exploration and production, salaries, business advisory services, legal and
professional fees, travel, investor relations expense, and debt service.
Primarily the difference between the two periods relates to higher exploration
and production costs, legal, business advisory, and stock issuance costs
associated with the convertible debentures for the period ended September
30, 2006, as well as the relinquishment of property options during the second
quarter of 2007. In addition to the $2,075,000 in property option
relinquishment, expenses for nine months ending September 30, 2007
consisted of $78,000 in depreciation, depletion, and amortization, and
$1,068,000 in legal, consultant, audit and other costs including rent,
insurance, payroll, payroll taxes, and stock issuance costs. There was
also approximately $1,200,000 in expenses in connection with the debt
restructuring.
Interest
expense. We incurred interest expense of $2,174,000 for the nine
months ended September 30, 2007, compared to $108,000 for the nine
months ended September 30, 2006. This difference primarily relates to
convertible debenture interest incurred. Interest expense for the
year primarily consisted of amortized convertible debenture discount and
deferred debt issue costs.
Liquidity
and Capital Resources
For the
quarter ended September 30, 2007, we had net income of $272,000,
which was primarily due to the sale of the Carbon County
project. For the quarter ended September 30, 2006, we incurred a net
loss of $1,065,000. At September 30, 2007, we had $1,700 of cash and cash
equivalents, total current assets of $443,000, and current liabilities of
$3,456,000 for a working capital deficit of $3,013,000.
Based
upon our significant operating losses from inception, there is substantial doubt
as to our ability to continue as a going concern. Our audited and unaudited
financial statements have been prepared on a basis that contemplates our
continuation as a going concern and the realization of assets and liquidation of
liabilities in the ordinary course of business. Our audited and unaudited
consolidated financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should we be unable to
continue as a going concern.
At this
point, we have not generated sufficient oil and gas sales to sustain our
operations. To fully carry out our business plans we need to increase production
revenues, raise a substantial amount of additional capital, sell project assets,
or obtain industry joint venture financing, which we are currently seeking. We
can give no assurance that we will be able to increase production or raise such
capital. We have limited financial resources until such time that we are able to
generate such additional financing or additional cash flow from operations. Our
ability to obtain profitability and positive cash flow is dependent upon our
ability to exploit our mineral holdings, generate revenue from our planned
business operations and control our exploration cost. To fully carry out our
business plans we need to raise a substantial amount of additional capital,
which we are currently seeking. We can give no assurance that we will be able to
raise such capital. We have limited financial resources until such time that we
are able to generate positive cash flow from operations. Our ability to maintain
profitability and positive cash flow is dependent upon our ability to locate
profitable natural gas or oil properties, generate revenue from our planned
business operations, and control exploration cost. Should we be unable to raise
adequate capital or to meet the other above objectives, it is likely that we
would have to substantially curtail our business activity, and that our
investors would incur substantial losses of their investment.
Cash
Flow
For
the nine months ended September 30, 2007, we used $3,540,000 in
our operating activities. We obtained $5,074,000 in investing activity for
our property and interest disposition, and used $1,712,000 in
financing activity from making payments on capital obtained through financings.
We decreased our December 31, 2006 cash balance of $180,000 to $1,700
at September 30, 2007.
Critical
Accounting Policies and Estimates
Our
Management's Discussion and Analysis of Financial Condition and Results of
Operations section discusses our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenue and expense during the reporting period. On an on-going basis, we
evaluate our estimates and judgments, including those related to revenue
recognition, accrued expense, financing operations, contingencies and
litigation. We base our estimates and judgments on historical experience and on
various other factors that we believe to be reasonable under the circumstances.
Our estimates and judgments form the basis for determining the carrying value of
assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions. These carrying values are some of the most significant accounting
estimates inherent in the preparation of our financial statements. These
accounting policies are described in relevant sections in this discussion and in
the notes to the financial statements included in our December 31, 2006 Form
10-KSB Annual Report.