U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended February 28, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from______________ to _________________
Commission file number 0-32237
GALAXY ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
COLORADO 98-0347827
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1331 - 17TH STREET, SUITE 730, DENVER, COLORADO 80202
(Address of principal executive offices) (Zip Code)
(303) 293-2300
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [x]Yes [ ]No
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). [ ]Yes [x]No
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
60,752,703 SHARES OF COMMON STOCK, $0.001 PAR VALUE, AS OF
FEBRUARY 28, 2005
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
FEBRUARY 28, 2005 NOVEMBER 30, 2004
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 5,399,478 $ 10,513,847
Accounts receivable 99,732 43,786
Prepaid and other 293,670 154,216
---------------- ----------------
Total Current Assets 5,792,880 10,711,849
---------------- ----------------
UNDEVELOPED OIL AND GAS ASSETS, AT COST,
FULL COST METHOD OF ACCOUNTING 42,285,188 37,491,529
---------------- ----------------
FURNITURE AND EQUIPMENT, NET 181,306 130,083
---------------- ----------------
OTHER ASSETS
Deferred financing costs, net 1,018,523 1,310,650
Other 4,053 4,054
---------------- ----------------
1,022,576 1,314,704
---------------- ----------------
TOTAL ASSETS $ 49,281,950 $ 49,648,165
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 3,037,678 $ 2,152,977
Accounts payable - related party 103,738 113,758
Current portion of notes payable - related party - 15,946
Current portion of convertible notes payable, net 8,766,214 6,249,557
Notes payable 2,600,000 2,100,000
Interest payable 494,360 705,719
---------------- ----------------
Total Current Liabilities 15,001,990 11,337,957
---------------- ----------------
LONG TERM OBLIGATIONS
Convertible notes payable, net 8,766,214 10,415,928
Notes payable - 500,000
Asset retirement obligation 748,401 713,073
---------------- ----------------
Total long term obligations 9,514,615 11,629,001
---------------- ----------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.001 par value
Authorized - 25,000,000 shares
Issued - none - -
Common stock, $.001 par value
Authorized - 400,000,000 shares and
100,000,000 shares
Issued and outstanding - 60,752,703 shares
and 58,817,509 shares 60,753 58,818
Capital in excess of par value 41,638,827 40,173,154
Deficit accumulated during the development stage (16,934,235) (13,550,765)
---------------- ----------------
Total Stockholders' Equity 24,765,345 26,681,207
---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 49,281,950 $ 49,648,165
================ ================
The accompanying notes are an integral part of these consolidated
financial statements.
2
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
CUMULATIVE FROM
INCEPTION
THREE MONTHS ENDED (JUNE 18, 2002) TO
FEBRUARY 28, 2005 FEBRUARY 29, 2004 FEBRUARY 28, 2005
REVENUE
Natural gas sales $ 111,877 $ - $ 234,332
------------------ ---------------- --------------------
COSTS AND EXPENSES
Lease operating expense 172,137 - 231,384
General and administrative 1,255,511 676,424 8,021,627
Abandoned oil and gas properties - 65,769
-
Depreciation and amortization 68,904 1,335 80,399
------------------ ---------------- --------------------
1,496,552 677,759 8,399,179
------------------ ---------------- --------------------
OTHER INCOME (EXPENSE)
Interest income 36,560 13,337 101,293
Interest expense and financing costs (2,035,355) (771,924) (8,870,681)
------------------ ---------------- --------------------
(1,998,795) (758,587) (8,769,388)
------------------ ---------------- --------------------
NET (LOSS) $ (3,383,470) $ (1,436,346) $ (16,934,235)
================== ================ ====================
NET (LOSS) PER COMMON SHARE -
BASIC AND DILUTED $ (0.06) $ (0.03) $ (0.40)
================== ================ ====================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING BASIC AND DILUTED
59,873,805 43,023,687 41,969,541
================== ================ ====================
The accompanying notes are an integral part of these consolidated
financial statements.
3
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
CUMULATIVE FROM
INCEPTION
THREE MONTHS ENDED (JUNE 18, 2002) TO
FEBRUARY 28, 2005 FEBRUARY 29, 2004 FEBRUARY 28, 2005
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (3,383,470) $ (1,436,346) $ (16,934,235)
Adjustments to reconcile net loss to net cash
used by operating activities
Stock for interest 985,098 - 985,098
Stock for services - - 264,600
Stock for services - related party - - 90,000
Stock for debt - related party - - 233,204
Amortization of discount on convertible
debentures 866,943 595,696 2,802,300
Amortization of deferred financing costs 292,127 65,580 849,520
Writeoff of discount on convertible
debentures and warrants upon conversion - - 2,537,518
Writeoff of deferred financing costs upon
Conversion - - 441,886
Compensation expense on vested stock
options to non-employees 31,238 - 65,759
Depreciation, depletion, and amortization
expense 68,904 1,336 80,399
Abandonment of oil and gas properties - - 65,769
Other - - 23,253
Changes in assets and liabilities
Accounts payable 355,946 19,071 273,263
Accounts payable - related (10,020) (55,812) 103,738
Interest payable (211,360) 5,496 494,360
Prepaids and other current assets (195,400) (130,318) (392,497)
Other - (6,280) (4,987)
------------------ ------------------ ------------------
Net cash used by operating activities (1,199,994) (941,577) (8,021,052)
------------------ ------------------ ------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to oil and gas properties (4,285,970) (1,174,004) (26,692,146)
Purchase of furniture and equipment (63,731) (60,531) (214,852)
Advance for prepaid drilling costs - (1,662,932) -
Advance to affiliate - - (60,000)
Cash received upon recapitalization and merger - - 4,234
------------------ ------------------ ------------------
Net cash used in investing activities (4,349,701) (2,897,467) (26,962,764)
------------------ ------------------ ------------------
The accompanying notes are an integral part of these consolidated
financial statements.
4
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(CONTINUED)
CUMULATIVE FROM
INCEPTION
THREE MONTHS ENDED (JUNE 18, 2002) TO
FEBRUARY 28, 2005 FEBRUARY 29, 2004 FEBRUARY 28, 2005
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of common stock - 15,452,800 17,905,300
Proceeds from the sale of convertible notes
payable - - 20,000,000
Proceeds from sale of convertible debentures - - 5,040,000
Debt and stock offering costs - (1,175,781) (2,910,700)
Payment of note payable - related party (15,946) (22,500) (129,578)
Proceeds from exercise of warrants 451,272 27,000 478,272
------------------ ------------------ ------------------
Net cash provided by financing activities 435,326 14,281,519 40,383,294
------------------ ------------------ ------------------
NET (DECREASE) INCREASE IN CASH (5,114,369) 10,442,475 5,399,478
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIODS 10,513,847 2,239,520 -
------------------ ------------------ ------------------
CASH AND CASH EQUIVALENTS, END OF PERIODS $ 5,399,478 $ 12,681,995 $ 5,399,478
================== ================== ==================
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Cash paid for interest $ 102,547 $ 105,151 $ 311,248
================== ================== ==================
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND
FINANCING ACTIVITIES
Debt incurred for oil and gas properties $ - $ 2,600,000 $ 3,646,000
================== ================== ==================
Stock issued for services $ - $ - $ 354,600
================== ================== ==================
Stock issued for interest and debt $ 985,098 $ - $ 1,108,719
================== ================== ==================
Stock issued for convertible debt $ - $ 900,000 $ 5,640,000
================== ================== ==================
Warrants issued for offering and financing costs $ - $ 1,058,103 $ 1,569,702
================== ================== ==================
Discount on convertible notes and debentures
issued $ - $ - $ 7,807,387
================== ================== ==================
Conversion of interest to debt $ - $ - $ 11,178
================== ================== ==================
Stock issued for subsidiary - related $ - $ - $ (202,232)
================== ================== ==================
Stock issued for oil and gas properties $ - $ 8,200,000 $ 9,146,800
================== ================== ==================
The accompanying notes are an integral part of these consolidated
financial statements.
5
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - ORGANIZATION
Galaxy Energy Corporation is an independent oil and gas company primarily
engaged in the exploration for, and the acquisition and development of
crude oil and natural gas. These activities have been conducted primarily
in the Rocky Mountain region of the United States.
The unaudited financial statements included herein were prepared from the
records of the Company in accordance with generally accepted accounting
principles in the United States applicable to interim financial
statements and reflect all adjustments which are, in the opinion of
management, necessary to provide a fair statement of the results of
operations and financial position for the interim periods. Such financial
statements conform to the presentation reflected in the Company's Form
10-K filed with the Securities and Exchange Commission for the year ended
November 30, 2004. The current interim period reported herein should be
read in conjunction with the Company's Form 10-K for the year ended
November 30, 2004.
The results of operations for the three months ended February 28, 2005
are not necessarily indicative of the results that may be expected for
the full fiscal year ending November 30, 2005.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the Company
and its wholly owned subsidiaries, Dolphin Energy Corporation ("Dolphin")
and Pannonian International, Ltd. ("Pannonian"). All significant
intercompany transactions have been eliminated.
LIQUIDITY
During the three months ended February 28, 2005, the Company incurred a
net loss of $3,383,470 and used cash for operating activities of
$1,199,994. As of February 28, 2005, the Company had a working capital
deficiency of $9,209,110. Included in current liabilities at February 28,
2005 is the current portion of convertible notes payable of $8,766,214
and related accrued interest of $318,272. The Company may, subject to
certain conditions, make payment of these amounts in shares of common
stock rather than cash. As discussed in Note 8, subsequent to February
28, 2005 the Company made principal and interest payments to the
Convertible Note Holders in both common stock and cash; issued $7,695,000
in Senior Subordinated Convertible Notes; and agreed in principle,
subject to completion and execution of definitive documentation, to terms
of a senior secured convertible note financing in the aggregate principal
amount of $10,000,000.
Management believes these transactions are an indication of the Company's
ability to generate additional capital to meet its obligations during the
remainder of the year. However, the Company's drilling program for the
coming year will require additional capital and will require the Company
to raise additional funds by selling securities, issuing debt, selling
assets or farm-outs or similar type arrangements. Any financing obtained
through the sale of the Company's equity will likely result in
substantial dilution to the Company's stockholders. If the Company is
forced to sell assets to meet its operating and capital requirements, it
may not realize the full market value of the assets and the sales price
could be less than the Company's carrying value of the assets.
6
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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
obligations.
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 the
sale represents a significant portion of oil and gas properties and the
gain significantly alters the relationship between capitalized costs and
proved oil and gas reserves of the cost center. Depreciation, depletion
and amortization of oil and gas properties is computed on the units of
production method based on proved reserves. Amortizable costs include
estimates of future development costs of proved undeveloped reserves.
Capitalized costs of oil and gas properties may not exceed an amount
equal to the present value, discounted at 10%, of the estimated future
net cash flows from proved oil and gas reserves plus the cost, or
estimated fair market value, if lower, of unproved properties. Should
capitalized costs exceed this ceiling, an impairment is recognized. The
present value of estimated future net cash flows is computed by applying
year end prices of oil and natural gas to estimated future production of
proved oil and gas reserves as of year end, less estimated future
expenditures to be incurred in developing and producing the proved
reserves and assuming continuation of existing economic conditions. As of
February 28, 2005, the Company has recognized initial natural gas
production from a number of its wells; however, due to the limited
production history, all oil and gas property costs are considered to be
unevaluated and are recorded at the lower of cost or fair market value.
7
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
ASSET RETIREMENT OBLIGATION
In 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement
Obligations." SFAS 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets
and the associated asset retirement costs. This statement requires
companies to record the present value of obligations associated with the
retirement of tangible long-lived assets in the period in which it is
incurred. The liability is capitalized as part of the related long-lived
asset's carrying amount. Over time, accretion of the liability is
recognized as an operating expense and the capitalized cost is
depreciated over the expected useful life of the related asset. The
Company's asset retirement obligations ("ARO") relate primarily to the
plugging, dismantlement, removal, site reclamation and similar activities
of its oil and gas properties.
The Company has, through acquisition and drilling, acquired working
interests in 222 natural gas wells. A limited number of these wells have
had initial gas production, and the others are in various stages of
completion and hook up at February 28, 2005. The Company adopted the
provisions of SFAS 143 to record the ARO associated with all wells in
which the Company owns an interest on the date such obligation arose.
Depreciation of the related asset, and accretion of the ARO on wells from
which production has commenced, has been calculated using the Company's
estimate of the life of the wells, based upon the lives of comparable
wells in the area. The amounts recognized upon adoption are based upon
numerous estimates and assumptions, including future retirement costs,
future recoverable quantities of oil and gas, future inflation rates and
the credit-adjusted risk-free interest rate. The information below
reflects the change in the ARO during the three months ended February 28,
2005:
Asset retirement obligation beginning of period $ 713,073
Liabilities incurred 32,452
Accretion 2,876
---------
Asset retirement obligation end of period $ 748,401
=========
SHARE BASED COMPENSATION
In October 1995, the FASB issued SFAS 123, Accounting for Stock-Based
Compensation, effective for fiscal years beginning after December 15,
1995. This statement defines a fair value method of accounting for
employee stock options and encourages entities to adopt that method of
accounting for its stock compensation plans. SFAS 123 allows an entity to
continue to measure compensation costs for these plans using the
intrinsic value based method of accounting as prescribed in
8
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Accounting Pronouncement Bulletin Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25). The Company has elected to continue to
account for its employee stock compensation plans as prescribed under APB
25. Had compensation cost for the Company's stock-based compensation plan
been determined based on the fair value at the grant dates for awards
under those plans consistent with the method prescribed in SFAS 123, the
Company's net (loss) and (loss) per share for the three months ended
February 28, 2005 and February 29, 2004 would have been adjusted to the
pro-forma amounts indicated below.
February 28, 2005 February 29, 2004
Net loss
As reported $ (3,383,470) $ (1,436,346)
Add stock based compensation
included in reported net loss 31,238 -
Deduct stock based compensation expense
determined under fair value method (374,271) -
------------- -------------
Pro forma net loss $ (3,726,503) $ (1,436,346)
============= =============
Net (loss) per share
As reported $ (0.06) $ (0.03)
============= =============
Pro forma $ (0.06) $ (0.03)
============= =============
The calculated value of stock options granted during 2005 and 2004 under
the plan, following calculation methods prescribed by SFAS 123, uses the
Black-Scholes stock option pricing model with the following assumptions
used:
2005 2004
Expected option life-years 10 10
Risk-free interest rate 4.25% 2 - 4.75%
Dividend yield 0 0
Volatility 66 - 78% 79 - 110%
(LOSS) PER COMMON SHARE
Basic (loss) per share is based on the weighted average number of common
shares outstanding during the period. Diluted (loss) per share reflects
the potential dilution that could occur if securities or other contracts
to issue common stock were exercised or converted into common stock.
Convertible equity instruments such as stock options, warrants,
convertible debentures and notes payable are excluded from the
computation of diluted loss per share, as the effect of the assumed
exercises would be antidilutive.
RECLASSIFICATION
Certain amounts in the 2004 financial statements have been reclassified
to conform to the 2005 financial statement presentation.
9
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS 123(R), "Share-Based Payment,"
which is a revision of SFAS No. 123, Accounting for Stock-Based
Compensation. SFAS 123(R) is effective for public companies for interim
or annual periods beginning after June 15, 2005, supersedes APB Opinion
25, Accounting for Stock Issued to Employees, and amends SFAS 95,
Statement of Cash Flows.
SFAS 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro-forma disclosure is no longer
an alternative. The new standard will be effective for the company,
beginning August 1, 2005. The Company has not yet completed their
evaluation but expects the adoption to have an effect on the financial
statements similar to the pro-forma effects reported above.
In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary
Assets, which changes the guidance in APB 29, Accounting for Nonmonetary
Transactions. This Statement amends APB 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have
commercial substance. A nonmonetary exchange has commercial substance if
the future cash flows of the entity are expected to change significantly
as a result of the exchange. SFAS 153 is effective during fiscal years
beginning after June 15, 2005. The Company does not believe the adoption
of SFAS 153 will have a material impact on the Company's financial
statements.
The Securities and Exchange Commission has issued Staff Accounting
Bulletin (SAB) No. 106 regarding the application of SFAS 143, "Accounting
for Asset Retirement Obligations," on oil and gas producing entities that
use the full cost accounting method. It states that after adoption of
SFAS 143, the future cash outflows associated with settling asset
retirement obligations that have been accrued on the balance sheet should
be excluded from the present value of estimated future net cash flows
used for the full cost ceiling test calculation. SAB No. 106 will be
effective for the Company once the Company has proved reserves and will
exclude the future cash flows from settling asset retirement obligations
in its ceiling test computation upon having proved reserves.
NOTE 3 - PROPERTY AND EQUIPMENT
OIL AND GAS PROPERTIES
At February 28, 2005, the Company's oil and gas properties consist of oil
and gas lease acquisition costs and capitalized drilling, completion and
facility costs. The Company had no proved reserves and all properties are
considered to be unevaluated.
As of February 28, 2005, the Company has acquired interests in 222
natural gas wells in the Powder River Basin either through acquisition or
drilling. Twenty-four wells have had initial production but due to the
lack of sufficient production history, proved reserves have not been
determined. The remaining wells are in various stages of completion or
awaiting hook up to pipelines.
10
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3 - PROPERTY AND EQUIPMENT (CONTINUED)
UNEVALUATED PROPERTIES
At February 28, 2005 and November 30, 2004 the Company's unevaluated oil
and gas properties consist of costs incurred in the following areas:
February 28, 2005 November 30, 2004
Oil and gas properties - full cost method
United States $ 42,199,279 $ 37,405,620
Europe 85,909 85,909
------------ -------------
$ 42,285,188 $ 37,491,529
============ =============
The Company's oil and gas expenditures to date, have consisted of
acquisition costs to purchase, lease or otherwise acquire properties,
costs to drill complete and equip wells and costs to construct gathering
systems and production facilities. The Company has realized initial
production from twenty-two wells. Due to the relatively short production
history, the Company does not have sufficient production information by
which reserves can be estimated. The Company has no proved reserves at
February 28, 2005 and all oil and gas property costs relate to
unevaluated properties.
NOTE 4 - NOTES PAYABLE
During the three months ended February 28, 2005 the Company paid in cash
the remaining note payable balance owed to the President of Pannonian,
$15,946.
OTHER
In connection with the January 2004 acquisition of oil and gas properties
from DAR LLC, the company issued a promissory note to DAR in the amount
of $2,600,000. The note called for interest at a rate of 6% per annum and
for principal payments of $1,000,000 on January 14, 2005 and $1,600,000
on June 24, 2005.
On January 19, 2005, the Company entered into an amendment to the
agreement with DAR whereby for the payment of $100,000 by January 21,
2005, the payment schedule was revised as follows:
Due on or before March 1, 2005 $500,000
Due on or before August 19, 2005 1,600,000
Due on or before January 13, 2006 500,000
NOTE 5 - CONVERTIBLE NOTES PAYABLE
In August and October 2004, the Company completed two tranches of a
private offering of Senior Secured Convertible Notes and Warrants (the
"Notes"). 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
11
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5 - CONVERTIBLE NOTES PAYABLE (CONTINUED)
convertible into 10,695,187 shares of the Company's common stock based on
a conversion price of $1.87 per share. 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 (the "Warrants").
The Company was required to pay total accrued interest as of January 14,
2005. The Company notified the holders of the Notes (the "Holders") that,
in accordance with the terms of the Convertible Notes, the payment of
accrued interest due on January 14, 2005, would be made in shares of the
Company's Common Stock instead of cash. The Holders converted the accrued
interest totaling $863,440 into 722,567 shares of Common Stock at various
conversion rates. The Company recognized additional interest expense of
$121,658 on the conversions, representing the difference between the
market price of the stock and the conversion rates at the respective
conversion dates.
The fair value of the warrants, estimated as of the issue date under the
Black-Scholes pricing model, resulted in a discount to the notes of
$4,336,316. Amortization of the discount of $866,943 is included in
interest expense for the three months ended February 28, 2005.
Deferred financing costs associated with the notes in the amount of
$1,648,218 have been capitalized and are being amortized over the life of
the notes. For the three months ended February 28, 2005 amortization of
financing costs of $292,127 was recorded as interest.
NOTE 6 - STOCKHOLDERS' EQUITY
COMMON STOCK
During the three months ended February 28, 2005, the Company issued
shares of its common stock as follows:
o 305,656 shares issued in conjunction with the cashless exercise of
508,475 Series "A" warrants associated with the convertible debentures
dated September 24, 2003.
o 271,377 shares issued in conjunction with the cashless exercise of
508,475 Series "B" warrants associated with the convertible debentures
dated October 3, 2003.
o 635,594 shares for $451,272 cash for the exercise of 635,594 of
warrants at an exercise price of $0.71 per share.
o 722,567 shares issued to Holders of Senior Secured Convertible Notes
in connection with the conversion of $863,440 of accrued interest at
various conversion rates, ranging from $1.16 to $1.29 per share.
12
GALAXY ENERGY CORPORATION
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 7 - STOCK OPTION PLAN
The Company adopted the 2003 Stock Option Plan (the "Plan"), as amended.
Under the Plan, stock options may be granted at an exercise price not
less than the fair market value of the Company's common stock at the date
of grant. Options may be granted to key employees and other persons who
contribute to the success of the Company. The Company has reserved
6,500,000 shares of common stock for the plan. At February 28, 2005 and
February 29, 2004, options to purchase 2,025,000 and 3,380,000 shares
were available to be granted pursuant to the stock option plan.
In December 2004 the Company granted certain employees and consultants
options to purchase a total of 925,000 shares of the Company's common
stock for a term 10 years at the closing price of the common stock on the
dates of grant. The options vest over terms of two to five years.
On January 1, 2005, the Company granted each of the Company's outside
directors options to purchase 12,500 shares of the Company's common stock
for a term 10 years at the closing price of the common stock on the date
of grant. The options were vested upon grant.
NOTE 8 - SUBSEQUENT EVENTS
a) The Company notified the Holders that in accordance with the terms
of the Convertible Notes, the principal and interest payment due
on March 1, 2005, totaling $1,148,402, would be made part in cash,
$474,217, and the balance, $674,185, in shares of the Company's
Common Stock. On March 1, 2005, holders converted $674,185 into
433,671 shares of Common Stock at a conversion rate of $1.55 per
share.
b) On March 2, 2005, the Company entered into a Lease Acquisition and
Development Agreement (the "Agreement") with two non-related
parties to acquire an initial 58-1/3% working interest in
unevaluated oil and gas properties in the Piceance Basin in
Colorado, by depositing $7,000,000 in escrow. In connection with
the Agreement the Company entered into a Participation Agreement
with a related party, to acquire all or a portion of the remaining
41-2/3% working interest in the subject properties. Jointly, the
Company and the Related Party have an obligation under the
Agreement to drill one well by November 1, 2005 and nine
additional wells by August 22, 2006.
Funding for the Company's share of acquisition and project costs
has been financed through a private placement of senior
subordinated convertible notes. On March 1, 2005, Galaxy entered
into Securities Purchase Agreements with several accredited
investors pursuant to which Galaxy agreed to sell, and the
Investors agreed to purchase, in the aggregate, up to $7,695,000
principal amount of Senior Subordinated Convertible Notes and
three-year warrants to purchase 1,637,234 shares of common stock
at $1.88 per share. The notes may be converted by the holders into
shares of common stock at a price of $1.88 per share.
c) On April 4, 2005, the Company agreed in principle, subject to
completion and execution of definitive documentation, to terms of
a senior secured convertible note financing in the aggregate
principal amount of $10,000,000. The notes would be secured by a
security interest in all of the assets of the Company and the
domestic properties of its subsidiaries. Such security interest
would rank equally with that of the senior secured convertible
notes issued by the Company on August 19, 2004 and October 27,
2004 (the "2004 Notes"). The investors of the proposed financing
are the holders of 100% of the 2004 Notes. The notes would be
senior to the convertible note financing completed in March 2005.
The notes and related documents would have terms substantially
similar to the 2004 Notes and related documentation.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
This report contains forward-looking statements. You should review our
cautionary note about forward-looking statements at the end of this section.
Management believes the completion of its fiscal quarter ended February
29, 2004 marked the completion of its first phase of its business plan. The
goals of the first phase were to obtain promising oil and gas properties in the
Powder River Basin of Wyoming and Montana and adequate funding to pay for those
properties and commence drilling operations. To accomplish those goals, we
needed to build our corporate infrastructure and make the investing public aware
of our presence. We believed that by so doing, we could raise the capital we
needed from the sale of our securities and use shares of our common stock to pay
for property acquisitions.
Our goal for the second phase of our business plan, which commenced
March 1, 2004, was to determine the potential of our properties. We believed
that by so doing, we could develop a plan to secure additional funding for what
is hoped to be development drilling projects. During the second half of the
fiscal year ended November 30, 2004, we raised additional funding for our coal
bed methane development program in the Powder River Basin of Wyoming. We also
raised additional funds to diversify our property position and acquire oil and
gas properties in the Piceance Basin of Colorado in March 2005.
Our tasks now are to establish reserves on our properties and to place
our properties into production. We had interests in 153 completed wells and 70
wells in various stages of completion as of April 7, 2005. While we recorded our
first revenues from natural gas sales during the fiscal year ended November 30,
2004, we expect to generate significantly more revenues during the current
fiscal year. We anticipate that these revenues, while significantly larger than
in fiscal 2004, will not be sufficient to fund completely our planned operations
and commitments. Accordingly, we will continue to raise funds from external
sources, such as the sale of equity and/or debt securities. We believe, however,
that our recent property acquisition in the Piceance Basin, as well as the
results from our drilling operations in the Powder River Basin, will enhance our
ability to obtain such financing on suitable terms
RESULTS OF OPERATIONS
During the three months ended February 28, 2005 we recorded natural gas
sales volumes of 28,935 mcf compared to zero sales volumes in the same period in
2004. We recorded $111,877 of natural gas sales and $172,137 of lease operating
and production tax expense on the sales volumes for the quarter ending February
2005 compared to natural gas sales of zero and lease operating and production
tax expense of zero during the same period in 2004. Depreciation, depletion and
amortization ("DD&A") expenses associated with the gas sales were $52,951 or
$1.83 per mcf during our quarter ending February 28, 2005 compared with zero
DD&A expenses during the same period of 2004. Because the production history of
the producing wells is not sufficient to enable us to recognize proved reserves,
we calculated DD&A on the basis of costs incurred on producing wells and the
estimated productive life of the wells.
We recorded interest income earned on cash deposits in commercial banks
of $36,560 during the quarter ending February 28, 2005 compared to $13,337
during the same period in 2004. The cash deposits resulted from our financing
and fund raising activities during our fiscal year ending November 30, 2004.
14
For the quarters ended February 28, 2005 and 2004, we recorded general
and administrative costs of $1,255,511 and $676,424, respectively. Significant
expenses in the quarter ending February 28, 2005 included: salaries and benefits
of $247,288; professional and consulting fees of $253,288; travel and
entertainment, primarily related to financing activities, of $166,846; legal
expenses of $129,324; investor relations of $185,502; office lease and expenses
of $146,890 and directors fees of $46,500. Comparative amounts for the same
period in 2004 were: salaries and benefits of $73,303; professional and
consulting fees of $165,685; travel and entertainment primarily related to
financing activities of $88,430; legal expenses of $143,112; investor relations
of $104,973; office lease and expenses of $47,667 and directors fees of $13,500.
The increases in the quarter ending February 28, 2005 compared to the previous
year's period reflect our significantly higher level of operational activity,
including managing the completion of wells and construction of facilities in the
Powder River Basin during the quarter. Also during the 2005 quarter, the Company
devoted significant efforts and expenditures to additional financing activities
resulting in increased legal, consulting and investor relations expenses.
We recorded $68,904 of DD&A expenses in the quarter ending February 28,
2005 compared to $1,335 in the previous year's quarter. The increase reflects
depreciation of furniture and equipment of $12,509 in the quarter ending
February 28, 2005 versus $1,335 in the previous year's period, DD&A of oil and
gas properties of $52,951 in the quarter ending February 28, 2005 compared to
$-0- in the previous year's period, and depreciation and accretion of the asset
retirement obligation of $3,444 in the quarter ending February 28, 2005 versus
$-0- in the previous year's period.
We recorded interest and financing costs of $2,035,355 in the quarter
ending February 28, 2005 compared to $771,924 in the previous year's period. The
expense for this quarter is comprised of interest on the convertible notes and
other notes payable of $754,628, the amortization of the discount on the
convertible notes of $866,943, amortization of deferred financing costs of
$292,127, respectively, and the value of the discount on the shares issued to
noteholders upon conversion of accrued interest as of January 14, 2005, in the
amount of $121,658. The expense in last year's quarter ending February 28, 2004
is comprised of interest on 7% convertible debentures and other notes payable of
$108,012 and $65,580 of amortization of deferred financing costs, and
amortization of the discount on convertible debentures of $595,696.
Our loss for the quarter ended February 28, 2005 of $3,383,470
increased the accumulated deficit as of that date to $16,934,235. The equivalent
numbers for the quarter ending February 28, 2004 were $1,436,346 and $5,156,007,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
FINANCING ACTIVITIES. Since inception, the Company has funded its
activities through the sale of convertible debentures, convertible notes, common
stock, and the exercise of warrants, raising net proceeds of $40,572,872 through
February 28, 2005, of which $451,272 was raised during the three-month period
then ended through the exercise of warrants.
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.
15
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 terms of
the warrants, the exercise price has been reset and these warrants are currently
exercisable at $1.54 per share. 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
terms of the warrants, the exercise price has been reset and these warrants are
currently exercisable at $1.54 per share. 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 and warrants. Gross proceeds from
the initial tranche were $15,000,000, while gross proceeds from the second
tranche 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 of our assets, and are convertible into 10,695,187 shares of
our common stock based on a conversion price of $1.87 per share. We paid accrued
interest on the principal amount of the notes on January 14, 2005 and became
obligated to pay monthly principal installments of $833,333 plus accrued
interest as of March 1, 2005. At our option, and assuming the satisfaction of
certain conditions, we may pay the monthly installments in cash or through a
partial conversion of the notes into shares of our common stock at a conversion
rate equal to the lesser of $1.87 or 93% of the then current market price. Note
purchasers received three-year warrants to purchase 5,194,806 shares of common
stock at $1.54 per share.
In March 2005, we entered into an agreement to acquire an initial
58-1/3% working interest in 4,000 net undeveloped mineral acres in the Piceance
Basin in Colorado. Funding for our share of acquisition and project costs was
financed through a private placement of $7,695,000 in senior subordinated
convertible notes and warrants. The unsecured notes are due June 1, 2007 and may
be converted by the holders into shares of common stock at a price of $1.88 per
share. The note holders also received three-year warrants to purchase 1,637,234
shares of common stock at $1.88 per share. We have agreed to register the shares
underlying the notes and warrants.
On April 4, 2005, we agreed in principle, subject to completion and
execution of definitive documentation, to terms of a senior secured convertible
note financing in the aggregate principal amount of $10,000,000. This financing
has a term of five years, but holders will have the right to have the notes
repaid at any time after three years and also in March 2007 if any of the notes
discussed in the previous paragraph are then outstanding, unless certain
circumstances exist. These notes will be secured by a security interest in all
of our assets and the domestic properties of our subsidiaries. Such security
interest will rank equally with that of the senior secured convertible notes
issued by the Company on August 19, 2004 and October 27, 2004 (the "2004
Notes"). The investors in this proposed financing are the holders of 100% of the
2004 Notes. The notes will be senior to the convertible note financing discussed
in the previous paragraph. The notes and related documents are expected to have
terms substantially similar to the 2004 Notes and related documentation.
OPERATING AND INVESTING ACTIVITIES. Our financing activities described
above have provided sufficient cash for our operating and investing activities.
From inception through February 28, 2005, we used $34,983,816 for operating and
investing activities, of which $5,549,695 was spent during the three-month
period then ended. We had $5,399,478 of cash at February 28, 2005. In
comparison, we expended $3,839,044 for operating and investing activities during
the three months ended February 28, 2004, and had $12,681,995 of cash at
February 28, 2005.
16
WORKING CAPITAL DEFICIENCY. At February 28, 2005, we had a working
capital deficiency of $9,209,110, compared to a working capital deficiency of
$626,108 at November 30, 2004. Included in the working capital deficiency at
February 28, 2005 was $8,766,214 of convertible note payments due in the next
twelve months. A total of $1,148,401.83 was due under the notes on March 1,
2005. This included a principal repayment of $833,333 plus interest at 12.5% for
the period from January 14, 2005 to March 1, 2005. In order to maximize the cash
we have available for our drilling operations, we elected to pay such amount
with $474,217.13 in cash and the remainder in converted stock. Such conversion
was made by the noteholders on March 1, 2005 and a total of 433,671 shares of
common stock were issued to the noteholders on that date. Likewise, In order to
maximize the cash we have available for our drilling operations, we elected to
make the first payment due under the convertible notes - an interest payment of
$857,740 for the period from the issuance of the notes through January 14, 2005
- - through the conversion of shares under the terms of the notes rather than with
cash. The total of such interest amount was converted into 722,567 common shares
at various conversion rates based upon the trading price of our common stock as
required under the terms of the notes.
We may, subject to certain conditions, continue to make payment of the
amounts due on the convertible notes in shares of common stock rather than cash.
We intend to closely monitor the trading volume and price of our common stock
throughout the life of the convertible notes to determine the optimum repayment
mix of cash and common stock. At February 28, 2005, we had initial production
from 22 wells. We plan to utilize our available cash to complete and connect to
pipelines up to 44 additional wells during the first part of the current fiscal
year. Management believes that natural gas production from these wells will
generate revenues sufficient to service the cash portion of the debt repayment
schedule, if any.
We are addressing our working capital deficiency through the sale of
our common stock and debt securities. During the three months ended February 28,
2005, we received $451,272 from the exercise of 635,594 warrants at a price of
$0.71 per share. In March 2005, we entered into an agreement to acquire a
working interest in the Piceance Basin in Colorado. Funding for our share of
acquisition and project costs was financed through a private placement of
$7,695,000 in senior subordinated convertible notes and warrants as described
above under the Liquidity and Capital Resources section. In April, 2005, we
agreed in principle to terms of a senior secured convertible note financing in
the aggregate principal amount of $10,000,000 as described above under the
Liquidity and Capital Resources section. During March and April 2005, we
received $141,675 from the exercise of 178,438 warrants at prices ranging from
$0.71 to $1.54 per share.
Management believes these transactions are an indication of our ability
to generate additional capital to meet our obligations during the next year.
However, our drilling program for the coming year will require additional
capital and will require us to raise additional funds by selling equity
securities, issuing debt, selling assets, or engaging in farm-outs or similar
types of arrangements. Any financing obtained through the sale of our equity
will likely result in additional dilution to our stockholders. If we are forced
to sell assets to meet our operating and capital requirements, we may not
realize the full market value of the assets and the sales price could be less
than our carrying value of the assets.
SCHEDULE OF CONTRACTUAL OBLIGATIONS
The following table summarizes our obligations and commitments to make
future payments under our notes payable, operating leases, employment contracts
and consulting agreement for the periods specified as of February 28, 2005.
17
- --------------------------------------------------------------------------------------------------------------------
PAYMENTS DUE BY PERIOD
-----------------------------------------------------------------
MORE
LESS THAN 1 3-5 THAN 5
CONTRACTUAL OBLIGATIONS (1)TOTAL YEAR 1-3 YEARS YEARS YEARS
- --------------------------------------------------------------------------------------------------------------------
Convertible Notes Payable (2)
Principal $20,000,000 $ 10,000,000 $10,000,000 -- --
Interest 3,623,836 2,938,014 685,822 -- --
Notes payable and accrued interest 2,816,998 2,816,998 -- -- --
- --------------------------------------------------------------------------------------------------------------------
Office Leases 101,541 34,463 67,078 -- --
- --------------------------------------------------------------------------------------------------------------------
TOTAL $26,542,375 $15,789,475 $10,752,900
- --------------------------------------------------------------------------------------------------------------------
(1)This table excludes the costs of drilling obligations in our European
permits, as we have not determined that we will conduct those
operations. 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 an
interest rate of 11.75% from August 19, 2004 through October 4, 2004;
12% from October 4, 2004 through January 4, 2005, 12.5% through March
2, 2005 and 12.75% thereafter.
PLAN OF OPERATION
In addition to the above obligations, at February 28, 2005, we intended
to utilize our available cash for the following capital expenditures on our oil
and gas projects:
(1) $3,876,000 for operations to complete existing wells, to
construct necessary production and gathering facilities and
infrastructure to commence gas production in the Leiter,
Buffalo Run, Pipeline Ridge, Horse Hill, Dutch Creek, Glasgow
and West Recluse areas of Wyoming; and
(2) $60,000 to complete participation in a 16 well pilot program
including related permitting costs, in Montana.
As of April 4, 2005, we have completed approximately one-half of the
work identified above leaving $1,800,000 yet to be spent as described.
Our ability to complete all the drilling activities described above and
to meet our commitments and obligations is dependent upon the success of the
drilling program and the amount of cash flow generated from the sale of oil and
gas from the wells drilled. We continue to pursue funding and industry
participation alternatives to ensure our ability to continue to acquire
additional acreage and complete additional drilling activity. In addition, we
believe our ability to fund our activities and meet our commitments is dependent
upon the trading volume and price of our common stock. If our stock trades at
prices above the exercise prices of outstanding warrants and conversion prices
of outstanding debt securities, we may be able to obtain cash through the
exercise of warrants and pay our debt obligations with the issuance of our
stock.
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
18
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.
Depletion of exploration and development costs and depreciation of
production equipment is provided 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. Should this comparison indicate an excess carrying value, the excess is
charged against earnings. At February 28, 2005, and 2004, there were no proved
reserves. Costs of oil and gas properties are considered unevaluated at February
28, 2005 and 2004.
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. Our asset retirement obligations ("ARO") relate primarily to the
plugging, dismantlement, removal, site reclamation and similar activities of our
oil and gas properties. Prior to adoption of this statement, such obligations
were accrued ratably over the productive lives of the assets through its
depreciation, depletion and amortization for oil and gas properties without
recording a separate liability for such amounts.
From inception through February 28, 2005, we, through acquisition and
drilling, acquired working interests in 222 natural gas wells. A limited number
of these wells had initial gas production during the period,
19
and the others are in various stages of completion and hook up at February 28,
2005. We adopted the provisions of SFAS 143 to record the ARO associated with
all wells in which we own an interest on the date such obligation arose.
Depreciation of the related asset, and accretion of the ARO on wells from which
production has commenced, has been calculated using our estimate of the life of
the wells, based upon the lives of comparable wells in the area. The amounts
recognized upon adoption are based upon numerous estimates and assumptions,
including future retirement costs, future recoverable quantities of oil and gas,
future inflation rates and the credit-adjusted risk-free interest rate.
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
Options that we may grant to employees under our stock option plan are
accounted for by using the intrinsic method under APB Opinion 25, Accounting for
Stock Issued to Employees (APB 25). In October 1995, the Financial Accounting
Standards Board (FASB) issued Statement No.123, Accounting for Stock-Based
Compensation (SFAS123), which defines a fair value based method of accounting
for stock options. The accounting standards prescribed by SFAS 123 are optional
and we have continued to account for stock options under the intrinsic value
method specified in APB 25.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS 123(R), "Share-Based Payment,"
which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation.
SFAS 123(R) is effective for public companies for interim or annual periods
beginning after June 15, 2005, supersedes APB Opinion 25, Accounting for Stock
Issued to Employees, and amends SFAS 95, Statement of Cash Flows.
SFAS 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the income statement based
on their fair values. Pro-forma disclosure is no longer an alternative. The new
standard will be effective for us, beginning August 1, 2005. We have not yet
completed our evaluation but expect the adoption to have an effect on the
financial statements similar to the pro-forma effects reported above.
In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary
Assets, which changes the guidance in APB 29, Accounting for Nonmonetary
Transactions. This Statement amends APB 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have
commercial substance. A nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. SFAS 153 is effective during fiscal years beginning after June
15, 2005. We do not believe the adoption of SFAS 153 will have a material impact
on our financial statements.
The Securities and Exchange Commission has issued Staff Accounting
Bulletin (SAB) No. 106 regarding the application of SFAS 143, "Accounting for
Asset Retirement Obligations," on oil and gas producing entities that use the
full cost accounting method. It states that after adoption of SFAS 143, the
future cash outflows associated with settling asset retirement obligations that
have been accrued on the balance sheet should be excluded from the present value
of estimated future net cash flows used for the full cost ceiling test
20
calculation. SAB No. 106 will be effective for us once we have proved reserves
and will exclude the future cash flows from settling asset retirement
obligations in our ceiling test computation upon having proved reserves
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk relates to changes in the pricing applicable to
the sales of gas production in the Powder River Basin in Wyoming and Montana.
This risk will become more significant to us as our production increases in
these areas. Although we are not using derivatives at this time to mitigate the
risk of adverse changes in commodity prices, we may consider using them in the
future.
ITEM 4. CONTROLS AND PROCEDURES
As required by SEC rules, we have evaluated the effectiveness of the
design and operation of our disclosure controls and procedures at the end of the
period covered by this report. This evaluation was carried out under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer. Based on this
evaluation, these officers have concluded that the design and operation of our
disclosure controls and procedures are effective. There were no changes in our
internal control over financial reporting or in other factors that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
Disclosure controls and procedures are our controls and other
procedures that are designed to ensure that information required to be disclosed
by us in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
SEC's rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure
21
that information required to be disclosed by us in the reports that we file
under the Exchange Act is accumulated and communicated to our management,
including principal executive officer and principal financial officer, as
appropriate, to allow timely decisions regarding required disclosure.
22
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not a party to any pending legal proceedings.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended February 28, 2005, we issued 635,594
shares of common stock upon the exercise of warrants, for proceeds
of $451,271.74; issued 577,033 shares of common stock upon the
"cashless exercise" of warrants; and issued 722,567 shares of
common stock upon conversion of principal and interest due under
convertible notes. No underwriters were used in these stock
transactions. We relied upon the exemption from registration
contained in Rule 506 for the sales of shares, as all of the
purchasers were accredited investors.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
- --------------------------------------------------------------------------------
REGULATION S-K
NUMBER EXHIBIT
- --------------------------------------------------------------------------------
2.1 Agreement and Plan of Reorganization dated as of November 1,
2002 by and among Galaxy Investments, Inc., Dolphin
Acquisition Corporation and Dolphin Energy Corporation (1)
- --------------------------------------------------------------------------------
2.2 Share Exchange Agreement by and between Galaxy Investments,
Inc. and Pannonian International, Ltd. (2)
- --------------------------------------------------------------------------------
3.1 Articles of Incorporation (3)
- --------------------------------------------------------------------------------
3.2 Articles of Amendment to Articles of Incorporation (4)(17)
- --------------------------------------------------------------------------------
3.3 Bylaws (3)
- --------------------------------------------------------------------------------
10.1 Escrow Instructions and Agreement dated as of August 28, 2002
(5)
- --------------------------------------------------------------------------------
10.2 Lease Acquisition and Drilling Agreement dated as of
September 30, 2002, as amended (5)
- --------------------------------------------------------------------------------
23
- --------------------------------------------------------------------------------
REGULATION S-K
NUMBER EXHIBIT
- --------------------------------------------------------------------------------
10.3 Letter agreement among Dolphin Energy Corporation, Harbor
Petroleum, LLC and Florida Energy, Inc. dated March 6, 2003
(5)
- --------------------------------------------------------------------------------
10.4 2003 Stock Option Plan (4)
- --------------------------------------------------------------------------------
10.5 Third Extension Agreement between Pioneer Oil LLC and Dolphin
Energy Corporation dated April 28, 2003 (4)
- --------------------------------------------------------------------------------
10.6 Lease Option and Acquisition Agreement between Dolphin Energy
Corporation and Quaneco, L.L.C. (6)
- --------------------------------------------------------------------------------
10.7 Amendment to Lease Option and Acquisition Agreement between
Dolphin Energy Corporation and Quaneco, L.L.C. dated
September 2, 2003 (7)
- --------------------------------------------------------------------------------
10.8 Fourth Extension Agreement between Pioneer Oil LLC and
Dolphin Energy Corporation dated April 28, 2003 (8)
- --------------------------------------------------------------------------------
10.9 Form of Securities Purchase Agreement dated as of September
24, 2003 between Galaxy Energy Corporation and the Purchaser
named therein (8)
- --------------------------------------------------------------------------------
10.10 Form of 7% Secured Convertible Debenture due September 24,
2005 (8)
- --------------------------------------------------------------------------------
10.11 Form of Common Stock Purchase Warrant Exercisable at $0.71
per Share (8)
- --------------------------------------------------------------------------------
10.12 Form of Common Stock Purchase Warrant Exercisable at $0.83
per Share (8)
- --------------------------------------------------------------------------------
10.13 Letter amending Lease Option and Acquisition Agreement
between Dolphin Energy Corporation and Quaneco, L.L.C. dated
September 22, 2003 (9)
- --------------------------------------------------------------------------------
10.14 Fifth Extension Agreement between Pioneer Oil LLC and Dolphin
Energy Corporation dated September 30, 2003 (9)
- --------------------------------------------------------------------------------
10.15 Option Agreement between Tom Horn, LLC and Dolphin Energy
Corporation dated October 10, 2003 (9)
- --------------------------------------------------------------------------------
10.16 Sixth Extension Agreement between Pioneer Oil LLC and Dolphin
Energy Corporation dated October 16, 2003 (9)
- --------------------------------------------------------------------------------
10.17 Form of Securities Purchase Agreement dated as of December
18, 2003 between Galaxy Energy Corporation and the purchaser
named therein (10)
- --------------------------------------------------------------------------------
10.18 Form of Common Stock Purchase Warrant Exercisable at $2.71
per Share (10)
- --------------------------------------------------------------------------------
10.19 Sale and Escrow Agreement dated December 22, 2003 between
Pioneer Oil, LLC and Dolphin Energy Corporation (11)
- --------------------------------------------------------------------------------
10.20 Share Acquisition Agreement between Pioneer Oil, LLC and
Galaxy Energy Corporation dated December 22, 2003 (11)
- --------------------------------------------------------------------------------
24
- --------------------------------------------------------------------------------
REGULATION S-K
NUMBER EXHIBIT
- --------------------------------------------------------------------------------
10.21 Registration Rights Agreement dated as of December 22, 2003
between Pioneer Oil, LLC and Galaxy Energy Corporation (11)
- --------------------------------------------------------------------------------
10.22 Purchase and Sale Agreement by and between Continental
Industries, LC and DAR, LLC and Galaxy Energy Corporation
dated January 14, 2004 (12)
- --------------------------------------------------------------------------------
10.23 Form of Securities Purchase Agreement dated as of January 15,
2004 between Galaxy Energy Corporation and the Purchaser
named therein (13)
- --------------------------------------------------------------------------------
10.24 Form of Common Stock Purchase Warrant Exercisable at $4.05
per Share (13)
- --------------------------------------------------------------------------------
10.25 Strategic Consulting Agreement Between Brian Hughes and
Dolphin Energy Corporation (14)
- --------------------------------------------------------------------------------
10.26 Securities Purchase Agreement dated August 19, 2004 between
Galaxy Energy Corporation and the Buyers named therein (15)
- --------------------------------------------------------------------------------
10.27 Form of Initial Note (15)
- --------------------------------------------------------------------------------
10.28 Form of Conditional Note (15)
- --------------------------------------------------------------------------------
10.29 Form of Common Stock Purchase Warrant (15)
- --------------------------------------------------------------------------------
10.30 Registration Rights Agreement dated August 19, 2004 between
Galaxy Energy Corporation and the Buyers named therein (15)
- --------------------------------------------------------------------------------
10.31 Security Agreement dated August 19, 2004 among Galaxy Energy
Corporation, Dolphin Energy Corporation, and Pannonian
International, Ltd. and Promethean Asset Management L.L.C. a
Delaware limited liability company, in its capacity as
collateral agent for the Lender (15)
- --------------------------------------------------------------------------------
10.32 Guaranty dated August 19, 2004 by Dolphin Energy Corporation
and Pannonian International, Ltd. in favor of Promethean
Asset Management L.L.C. in its own behalf and in its capacity
as agent for the benefit of the Buyers (15)
- --------------------------------------------------------------------------------
10.33 Form of Mortgage (15)
- --------------------------------------------------------------------------------
10.34 Purchase and Sale Agreement by and among Tower Colombia
Corporation, North Finn, LLC and American Oil & Gas, Inc., as
Sellers and Dolphin Energy Corporation, as Buyer dated July
15, 2004 (16)
- --------------------------------------------------------------------------------
10.35 Coal Bed Methane Participation Agreement dated November 2,
2004 between Dolphin Energy Corporation and Horizon Gas, Inc.
(18)
- --------------------------------------------------------------------------------
10.36 Lease Acquisition and Development Agreement between Dolphin
Energy Corporation (Buyer/Operator) and Apollo Energy LLC and
ATEC Energy Ventures, LLC (Seller/Non-Operator) dated
February 22, 2005 (19)
- --------------------------------------------------------------------------------
25
- --------------------------------------------------------------------------------
REGULATION S-K
NUMBER EXHIBIT
- --------------------------------------------------------------------------------
10.37 Amended Participation Agreement between Marc A. Bruner and
Dolphin Energy Corporation dated March 16, 2005 (20)
- --------------------------------------------------------------------------------
10.38 Securities Purchase Agreement dated March 1, 2005 between
Galaxy Energy Corporation and the Buyers named therein (19)
- --------------------------------------------------------------------------------
10.39 Form of Note (19)
- --------------------------------------------------------------------------------
10.40 Form of Common Stock Purchase Warrant (19)
- --------------------------------------------------------------------------------
10.41 Registration Rights Agreement dated March 1, 2005 between
Galaxy Energy Corporation and the Buyers named therein (19)
- --------------------------------------------------------------------------------
10.42 Subordination Agreement (19)
- --------------------------------------------------------------------------------
16.1 Letter from Wheeler Wasoff, P.C. (17)
- --------------------------------------------------------------------------------
21 Subsidiaries of the registrant (4)
- --------------------------------------------------------------------------------
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
- --------------------------------------------------------------------------------
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
- --------------------------------------------------------------------------------
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of
Chief Executive Officer
- --------------------------------------------------------------------------------
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of
Chief Financial Officer
- --------------------------------------------------------------------------------
- -------------------
(1) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated November 13, 2002, filed December 6, 2002,
file number 0-32237.
(2) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated May 7, 2003, filed May 13, 2003, file number
0-32237.
(3) Incorporated by reference to the exhibits to the registrant's
registration statement on Form 10-SB, file number 0-32237.
(4) Incorporated by reference to the exhibits to the registrant's quarterly
report on Form 10-QSB for the quarter ended May 31, 2003, file number
0-32237.
(5) Incorporated by reference to the exhibits to the registrant's annual
report on Form 10-KSB for the fiscal year ended November 30, 2002, file
number 0-32237.
(6) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated August 5, 2003, filed August 18, 2003, file
number 0-32237.
(7) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated September 2, 2003, filed September 8, 2003,
file number 0-32237.
(8) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated October 7, 2003, filed October 8, 2003, file
number 0-32237.
(9) Incorporated by reference to the exhibits to the registrant's initial
filing of its registration statement on Form SB-2, file number
333-110053, on October 29, 2003.
26
(10) Incorporated by reference to the exhibits to the registrant's amended
current report on Form 8-K dated December 19, 2003, filed December 23,
2003, file number 0-32237.
(11) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated December 22, 2003, filed December 23, 2003,
file number 0-32237.
(12) Incorporated by reference to the exhibits to the registrant's amended
current report on Form 8-K dated January 14, 2004, filed January 20,
2004, file number 0-32237.
(13) Incorporated by reference to the exhibits to the registrant's amended
current report on Form 8-K dated January 15 2004, filed January 16,
2004, file number 0-32237.
(14) Incorporated by reference to the exhibits to post-effective amendment
no. 1 to the registrant's registration statement on Form SB-2, filed
August 2, 2004, file number 333-110053
(15) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated August 19, 2004, filed August 20, 2004, file
number 0-32237.
(16) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated September 30, 2004, filed October 5, 2004,
file number 0-32237.
(17) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated October 22, 2004, filed October 26, 2004, file
number 0-32237.
(18) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated November 2, 2004, filed November 4, 2004, file
number 0-32237.
(19) Incorporated by reference to the exhibits to the registrant's current
report on Form 8-K dated March 1, 2005, filed March 4, 2005, file
number 0-32237.
(20) Incorporated by reference to the exhibits to the registrant's amended
current report on Form 8-K dated March 1, 2005, filed March 21, 2005,
file number 0-32237.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GALAXY ENERGY CORPORATION
April 14, 2005 By: /s/ CARMEN J. LOTITO
---------------------------------------
Carmen J. Lotito
Chief Financial Officer
27