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EX-32.1 - EX-32.1 - AMERICAN EAGLE ENERGY Corpv193842_ex32-1.htm
EX-10.2 - EX-10.2 - AMERICAN EAGLE ENERGY Corpv193842_ex10-2.htm
EX-32.2 - EX-32.2 - AMERICAN EAGLE ENERGY Corpv193842_ex32-2.htm
EX-10.3 - EX-10.3 - AMERICAN EAGLE ENERGY Corpv193842_ex10-3.htm
EX-31.2 - EX-31.2 - AMERICAN EAGLE ENERGY Corpv193842_ex31-2.htm
EX-31.1 - EX-31.1 - AMERICAN EAGLE ENERGY Corpv193842_ex31-1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 

 
FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

o 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:  000-50906


 
ETERNAL ENERGY CORP.
(Exact name of registrant as specified in its charter)

Nevada
20-0237026
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

2549 West Main Street, Suite 202, Littleton, Colorado
80120
(Address of principal executive offices)
(Zip Code)

(303) 798-5235
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

(Check one):

Large accelerated filer o
Accelerated filer o
   
Non-accelerated filer o
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:
41,520,000 shares of common stock issued and outstanding at August 13, 2010.

 
 

 
 
ETERNAL ENERGY CORP.
FORM 10-Q
QUARTERLY PERIOD ENDED JUNE 30, 2010

INDEX

A Note About Forward Looking Statements
1
   
PART I - FINANCIAL INFORMATION
 
   
Item 1 - Condensed Financial Statements (Unaudited)
  
   
Condensed Balance Sheets – June 30, 2010 (Unaudited) and December 31, 2009
F-3
   
Condensed Statements of Operations (Unaudited) - For Each of the Three-Month and Six-Month Periods Ended June 30, 2010 and 2009
F-4
   
Condensed Statements of Cash Flows (Unaudited) - For Each of the Three-Month and Six-Month Periods Ended June 30, 2010 and 2009
F-5
   
Notes to the Condensed Financial Statements (Unaudited)
F-7
   
Item 2 - Management’s Discussion and Analysis of Financial Condition or Results of Operations
2
   
Item 4 - Controls and Procedures
6
   
PART II - OTHER INFORMATION
 
   
Item 6 – Exhibits
7
   
Signatures
10

 
 

 
   

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on management’s current expectations. These statements may be identified by their use of words like “plans,” “expect,” “aim,” “believe,” “projects,” “anticipate,” “intend,” “estimate,” “will,” “should,” “could” and other expressions that indicate future events and trends. All statements that address expectations or projections about the future, including statements about our business strategy, expenditures, and financial results, are forward-looking statements. We believe that the expectations reflected in such forward-looking statements are accurate. However, we cannot assure you that such expectations will occur.

Actual results could differ materially from those in the forward looking statements due to a number of uncertainties including, but not limited to, those discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations. Factors that could cause future results to differ from these expectations include general economic conditions; further changes in our business direction or strategy; competitive factors; market uncertainties; and an inability to attract, develop, or retain consulting or managerial agents or independent contractors. As a result, the identification and interpretation of data and other information and their use in developing and selecting assumptions from and among reasonable alternatives requires the exercise of judgment. To the extent that the assumed events do not occur, the outcome may vary substantially from anticipated or projected results, and accordingly, no opinion is expressed on the achievability of those forward-looking statements. No assurance can be given that any of the assumptions relating to the forward-looking statements specified in the following information are accurate, and we assume no obligation to update any such forward-looking statements. You should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report. Except as required by law, we are not obligated to release publicly any revisions to these forward-looking statements to reflect events or circumstances occurring after the date of this report or to reflect the occurrence of unanticipated events.

 
1

 
 

ITEM 1. FINANCIAL STATEMENTS.
   
Eternal Energy Corp.
 
Condensed Financial Statements (Unaudited)
 
As of June 30, 2010 and December 31, 2009 and
For Each of the Three-Month and Six-Month Periods ended June 30, 2010 and 2009

 

 

Eternal Energy Corp.
 
Index to the Condensed Financial Statements (Unaudited)
 
As of June 30, 2010 and December 31, 2009 and
For Each of the Three-Month and Six-Month Periods ended June 30, 2010 and 2009

Condensed Financial Statements of Eternal Energy Corp. (Unaudited):
 
   
Condensed Balance Sheets as of June 30, 2010 (Unaudited) and December 31, 2009
F-3
   
Condensed Statements of Operations for Each of the Three-Month and Six-Month Periods Ended June 30, 2010 and 2009 (Unaudited)
F-4
   
Condensed Statements of Cash Flows for Each of the Three-Month and Six-Month Periods Ended June 30, 2010 and 2009 (Unaudited)
F-5
   
Notes to the Condensed Financial Statements (Unaudited)
F-7

 
F-2

 

Eternal Energy Corp.
 
Condensed Balance Sheets
 
As of June 30, 2010 and December 31, 2009

   
June 30,
       
   
2010
   
December 31
 
   
(Unaudited)
   
2009
 
Current assets:
           
Cash
  $ 4,068,692     $ 1,508,754  
Receivables
    81,061       120,927  
Prepaid expenses
    6,015       46,384  
Spud fees receivable
    -       20,000  
                 
Total current assets
    4,155,768       1,696,065  
                 
Equipment and leasehold improvements, net of accumulated depreciation and amortization of $123,788 and $100,208, respectively
    27,767       49,809  
Oil and gas properties – subject to amortization
    126,029       -  
Oil and gas properties – not subject to amortization
    257,574       412,797  
Assets held for sale
    57,000       57,000  
Marketable securities
    904,324       -  
Deposits
    5,345       5,345  
Deferred tax asset
    -       -  
Total assets
  $ 5,533,807     $ 2,221,016  
                 
Current liabilities:
               
                 
Accounts payable and accrued liabilities
  $ 113,438     $ 138,664  
Accrued oil and gas interests
    -       25,155  
Short-term asset retirement obligation
    -       65,258  
                 
Total current liabilities
    113,438       229,077  
                 
Long-term asset retirement obligation, net of discount of $0, and $36,720, respectively
    -       177,697  
Deferred tax liability
    -       -  
                 
Total liabilities
    113,438       406,774  
                 
Commitments and contingencies (Note 6)
               
                 
Stockholders' equity:
               
Common stock, $.001 par value, 875,000,000 shares authorized, 42,669,000 and 44,550,000 shares issued and outstanding
    42,669       44,550  
Additional paid-in capital
    9,414,654       9,524,308  
Accumulated deficit
    (4,041,572 )     (7,754,616 )
Unrealized gains on equity investments
    4,618       -  
                 
Total stockholders' equity
    5,420,369       1,814,242  
                 
Total liabilities and stockholders' equity
  $ 5,533,807     $ 2,221,016  
  
The accompanying notes are an integral part of the financial statements.
   
 
F-3

 

Eternal Energy Corp.
 
Condensed Statements of Operations (Unaudited)
 
For Each of the Three-Month and Six-Month Periods Ending March 31, 2010 and 2009

   
For the Three-Month Period Ended
   
For the Six-Month Period Ended
 
   
June 30, 2010
   
June 30, 2009
   
June 30, 2010
   
June 30, 2009
 
                         
Oil and gas revenues
  $ 2,999     $ 4,533     $ 74,485     $ 4,533  
Gain on sale of oil and gas properties – subject to amortization, net of costs
    509,934       -       509,934       -  
Gain on sale of oil and gas properties – not subject to amortization, net of costs
    4,735,253       -       4,735,253       -  
                                 
Total revenue
    5,248,186       4,533       5,319,672       4,533  
                                 
Operating expenses:
                               
Oil and gas operating expenses
    -       3,326       -       33,334  
General and administrative
    218,150       167,511       452,402       389,046  
Stock based compensation
    -       89,025       -       199,275  
Professional fees
    84,021       86,586       238,426       223,339  
Depreciation, amortization and depletion expense
    11,801       10,819       28,060       20,052  
                                 
Total operating costs
    313,972       357,267       718,888       865,046  
                                 
Total operating income (loss)
    4,934,214       (352,734 )     4,600,784       (860,513 )
                                 
Interest income
    2,677       16,722       4,372       27,014  
                                 
Income (loss) before taxes
    4,936,891       (336,012 )     4,605,156       (833,499 )
                                 
Provision for income taxes
    (892,112 )     -       (892,112 )     -  
                                 
Net income (loss)
  $ 4,044,779     $ (336,012 )   $ 3,713,044     $ (833,499 )
                                 
Net income (loss) per common share -
                               
Basic
  $ 0.09     $ (0.01 )   $ 0.08     $ (0.02 )
Diluted
  $ 0.09     $ (0.01 )   $ 0.08     $ (0.02 )
Weighted average number of shares outstanding -
                               
Basic
    43,532,612       44,550,000       44,043,152       44,550,000  
Diluted
    44,424,504       44,550,000       46,168,152       44,550,000  
  
The accompanying notes are an integral part of the financial statements.
   
 
F-4

 

Eternal Energy Corp.
 
Condensed Statements of Cash Flows (Unaudited)
 
For Each of the Six-Month Periods Ending June 30, 2010 and 2009

   
2010
   
2009
 
             
Cash flows provided by (used for) operating activities:
           
Net income (loss)
  $ 3,713,044     $ (833,499 )
Adjustments to reconcile net loss to net cash used by operating activities:
               
Non cash transactions:
               
Stock-based compensation
    -       199,275  
Depreciation, depletion and amortization
    28,060       20,054  
Gain on sale of oil and gas properties
    (5,245,187 )        
Changes in operating assets and liabilities:
               
Decrease in prepaid expense
    40,369       3,212  
Decrease in spud fees receivable
    20,000       730,000  
(Increase) decrease in other receivables
    77,366       (20,833 )
Increase in deposits
    -       (16,000 )
Increase in accounts payable and accrued liabilities
    (25,226 )     87,061  
Net cash provided by (used for) operating activities
    (1,391,574 )     169,270  
                 
Cash flows provided by (used for) investing activities:
               
Additions to equipment and leasehold improvements
    (1,538 )     (40,502 )
Additions to oil and gas properties
    (35,682 )     (558,778 )
Proceeds from sale of oil and gas properties
    4,125,000       -  
Purchase of equity investments
    (24,733 )     -  
Net cash provided by (used for) investing activities
    4,063,047       (599,280 )
                 
Cash flows used for financing activities:
               
Repurchase and retirement of shares
    (111,535 )     -  
Net cash used for financing activities
    (111,535 )     -  
                 
Net increase (decrease) in cash
    2,559,938       (430,010 )
Cash - beginning of period
    1,508,754       727,701  
Cash - end of period
  $ 4,068,692     $ 297,691  

 
F-5

 

Eternal Energy Corp.
 
Condensed Statements of Cash Flows (Unaudited)
 
For Each of the Six-Month Periods Ending June 30, 2010 and 2009

Supplemental Disclosure of Cash Flow Information

   
2010
   
2009
 
Cash paid for:
           
Interest
  $ -     $ -  
Income taxes
  $ 892,112     $ -  

 
F-6

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

1.       Description of Business

Eternal Energy Corp. (the “Company”) was incorporated in the state of Nevada in March 2003. The Company engages in the acquisition, exploration, development and producing of oil and gas properties. At June 30, 2010, the Company has entered into participation agreements related to oil and gas exploration projects in the Pebble Beach and Spyglass Prospects, located in Divide County, North Dakota, and Sheridan County, Montana and the Hardy Property, located in southeastern Saskatchewan, Canada.  In addition, the Company owns certain overriding royalty interests in oil and gas leases located in San Juan County, Utah and San Miguel County, Colorado.

2.       Summary of Significant Accounting Policies

Basis of Presentation

These condensed financial statements are presented in United States dollars and have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Securities and Exchange Commission (“SEC”) Form 10-Q and Article 8 of SEC Regulation S-X. The principles for interim financial information do not require the inclusion of all the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. The condensed financial statements included herein are unaudited; however, in the opinion of management, they contain all normal recurring adjustments necessary for a fair statement of the condensed results for the interim periods. Operating results for the three-month and six-month periods ended June 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

Revenue Recognition

The Company records the sale of its interests in prospects as a reduction to the cost pool when the terms of the transaction are final and the sales price is determinable. Spud fee revenue is recognized when drilling commences.  Working interest, royalty and net profit interests are recognized as revenue when oil and gas is sold.

Concentration of Credit Risk

At June 30, 2010, the Company had $3,561,161 on deposit that exceeded United States (FDIC) federally insurance limit of $250,000 per bank. The Company believes this credit risk is mitigated by the financial strength of the financial institutions with which the Company has placed its funds on deposit.

 
F-7

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

Receivables

Receivables are stated at the amount the Company expects to collect. The Company considers the following factors when evaluating the collectability of specific receivable balances: credit-worthiness of the debtor, past transaction history with the debtor, current economic industry trends, and changes in debtor payment terms. If the financial condition of the Company’s debtors were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required.

The Company maintains an estimated allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Changes to the allowance for doubtful accounts made as a result of management’s determination regarding the ultimate collectability of such accounts are recognized as a charge to the Company’s earnings.  Specific receivable balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to receivable. 

At June 30, 2010, the Company has determined that all receivable balances are fully collectible and, accordingly, no allowance for doubtful accounts has been recorded.   

Equipment and Leasehold Improvements

Equipment and leasehold improvements are recorded at cost. Expenditures for major additions and improvements are capitalized and depreciated over the estimated useful lives of the related assets using the straight-line method for financial reporting purposes. The Company uses other depreciation methods (generally accelerated) for tax purposes, where appropriate. The estimated useful lives for significant property and equipment categories are as follows:

Equipment
3 years
Leasehold improvements
lesser of useful life or lease term

When equipment and improvements are retired or otherwise disposed of, the cost and the related accumulated depreciation are removed from the Company's accounts and any resulting gain or loss is included in the results of operations for the respective period.
Expenditures for minor replacements, maintenance and repairs are expensed as incurred.

Oil and Gas Properties

The Company follows the full-cost method of accounting for its investments in oil and gas properties. Under the full-cost method, all costs associated with the exploration of properties are capitalized into appropriate cost centers within the full-cost pool.  Internal costs that are capitalized are limited to those costs that can be directly identified with acquisition, exploration, and development activities undertaken and do not include any costs related to production, general corporate overhead, or similar activities.  Cost centers are established on a country-by-country basis.

 
F-8

 

Eternal Energy Corp.
Notes to the Financial Statements (Unaudited)


As of the end of each reporting period, the capitalized costs of each cost center are subject to a ceiling test, in which the costs shall not exceed the cost center ceiling. The cost center ceiling is equal to i) the present value of estimated future net revenues computed by applying current prices of oil and gas reserves (with consideration of price changes only to the extent provided by contractual arrangements) to estimated future production of proved oil and gas reserves as of the date of the latest balance sheet presented, less estimated future expenditures (based on current costs) to be incurred in developing and producing the proved reserves computed using a discount factor of ten percent and assuming continuation of existing economic conditions; plus ii) the cost of properties not being amortized; plus iii) the lower of cost or estimated fair value of unproven properties included in the costs being amortized; less iv) income tax effects related to differences between the book and tax basis of the properties. If unamortized costs capitalized within a cost center, less related deferred income taxes, exceed the cost center ceiling, the excess is charged to expense and separately disclosed during the period in which the excess occurs.

Asset Retirement Obligations

The Company records asset retirement obligations in the period in which the obligation is incurred and when a reasonable estimate of fair value can be determined. The initial recording of an asset retirement obligation results in an increase in the carrying amount of the related long-lived asset and the creation of a liability.  The portion of the asset retirement obligation expected to be realized during the next 12 month period is classified as a current liability, while the portion of the asset retirement obligation expected to be realized during subsequent periods is discounted and recorded at its net present value.  The discount factor used to determine the net present value of the Company’s asset retirement obligation is 10%, which is consistent with the discount factor that is applied to oil and gas reserves when performing the periodic ceiling tests.

Changes in the noncurrent portion of the asset retirement obligation due to the passage of time are measured by applying an interest method of allocation. The amount of change is recognized as an increase in the liability and an accretion expense in the statement of operations. Changes in either the current or noncurrent portion of the Company’s asset retirement obligation resulting from revisions to the timing or the amount of the original estimate of undiscounted cash flows are recognized as an increase or a decrease to the carrying amount of the liability and the related long-lived asset.   Changes in the current and noncurrent portion of the asset retirement obligation due to the disposal of related long-lived assets are included in the calculation of the gain or loss on the sale of the assets.

 
F-9

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

Treasury Stock

The Company has implemented a stock repurchase program and utilizes the cost method to account for shares reacquired under the program.  Under the cost method, common stock is reduced by the par value of the shares repurchased.  The difference between the total consideration given to reacquire the shares, including any broker commissions or other transaction costs, is recorded as a reduction of additional paid in capital.  The Company immediately retires all repurchased shares.

Fair Value of Financial Instruments
 
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.
 
The Company utilizes the market approach to measure fair value for our financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:
 
Level 1:  Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
 
Level 2:  Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.
 
Level 3:  Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
 
In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as the consideration of counterparty credit risk in its assessment of fair value.
 
The adoption of this statement did not have a material impact on our results of operations and financial condition. The carrying values of our cash, cash equivalents and marketable securities, carried at fair value as of June 30, 2010, are classified in the table below in one of the three categories described above:

 
F-10

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)
 
Fair Value Measurements at June 30, 2010:
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Cash & equivalents
  $ 4,068,692       -       -     $ 4,068,692  
Marketable securities
    904,324       -       -       904,324  
    $ 4,973,016       -       -     $ 4,973,016  

Accounting for Share-Based Compensation

The Company measures compensation cost for all stock-based awards at fair value on the date of grant and recognizes compensation expense in its statements of operations over the service period that the awards are expected to vest. The Company has elected to recognize compensation cost for all options with graded vesting on a straight-line basis over the vesting period of the entire option.

Basic and Diluted Earnings (Loss) Per Share

Basic earnings (loss) per common share is computed by dividing net loss available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share is computed in the same way as basic earnings (loss) per common share except that the denominator is increased to include the number of additional common shares that would be outstanding if all potential common shares had been issued and if the additional common shares were dilutive. Diluted loss per common share for the three-month and six-month periods ended June 30, 2009 is computed in the same way as basic loss per common share, as the inclusion of additional common shares that would be outstanding if all potential common shares had been issued would be anti-dilutive.  See Note 7 for the calculation of basic and diluted weighted average common shares outstanding for the three-month and six-month periods ended June 30, 2010 and 2009.

Income Taxes

The Company follows the liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities are recognized for the future tax benefits and consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax balances. Deferred income tax assets and liabilities are measured using enacted or substantially enacted tax rates expected to apply to the taxable income in the years in which those differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment or substantive enactment.

 
F-11

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

Use of Estimates and Assumptions

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the use of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent obligations in the financial statements and accompanying notes. The Company’s most significant assumptions are the estimates used in the determination of the deferred income tax asset valuation allowance and the allocation of proceeds received from the disposition of certain oil and gas prospects to the remaining prospects included in the Company’s full-cost pool.  The estimation process requires assumptions to be made about future events and conditions, and as such, is inherently subjective and uncertain. Actual results could differ materially from these estimates.

New Accounting Pronouncements

In June 2009, the FASB established the FASB Accounting Standards Codification (the “Codification” or “ASC”) as the official single source of authoritative U.S. generally accepted accounting principles (“GAAP”). All guidance contained in the Codification carries an equal level of authority.  The Codification also includes all relevant SEC guidance organized using the same topical structure in separate sections within the Codification.  The Codification is not intended to change GAAP, but it will change the way GAAP is organized and presented.  Except for the disclosure requirements, the adoption of this statement did not have an impact on the determination or reporting of the Company’s financial statements.  The Company is providing the Codification cross-reference alongside the references to the standards issued and adopted prior to the adoption of the Codification.

In January 2010, the FASB issued Accounting Standards Update 2010-06, Improving Disclosures about Fair Value Measurements (“FASB 2010-06”), which amends ASC 820-10 and requires, among other things, new disclosures regarding the transfers in and out of hierarchy levels 1 and 2 as well as the gross presentation of changes in estimated measurements for level 3 measurements.  In addition, FASB 2010-06 provides clarifying direction with respect to disclosures regarding the various levels of disaggregation and about specific inputs and valuation techniques.  FASB 2010-06 is effective for interim and annual reporting periods beginning after December 31, 2009, except for the gross presentation of level 3 measurement activities, which is effective for fiscal years beginning after December 15, 2010.  The adoption of FASB 2010-06 is not expected to have a material effect on the Company’s financial statements.

ASC 808-10 requires certain income statement presentation of transactions with third parties and of payments between parties to the collaborative arrangement, along with disclosure about the nature and purpose of the arrangement.  ASC 808-10 is effective for the Company’s year beginning January 1, 2009.  The adoption of ASC 808-10 has not had a material impact on the Company’s financial statements.

 
F-12

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

ASC 805 requires an acquiring company to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquired entity at the acquisition date, measured at their fair values as of that date, with limited exceptions.  ASC 805 also requires the acquiring company in a business combination achieved in stages to recognize the identifiable assets and liabilities, as well as the noncontrolling interest in the acquired company, at the full amounts of their fair values.  ASC 805 makes various other amendments to authoritative literature intended to provide additional guidance or to confirm the guidance in that literature to that provided in this Statement.  ASC 805 is effective for the Company’s financial statements beginning January 1, 2009.  The adoption of ASC 805 has not had a material impact on the Company’s financial statements.

ASC 810-10-65 establishes accounting and reporting standards that require the ownership interests in subsidiaries not held by the parent to be clearly identified, labeled and presented in the consolidated statement of financial position within equity, but separate from the parent's equity.  This statement also requires the amount of consolidated net income attributable to the parent and to the non-controlling interest to be clearly identified and presented on the face of the consolidated statement of income.  Changes in a parent's ownership interest while the parent retains its controlling financial interest must be accounted for consistently, and when a subsidiary is deconsolidated, any retained non-controlling equity investment in the former subsidiary must be initially measured at fair value.  The gain or loss on the deconsolidation of the subsidiary is measured using the fair value of any non-controlling equity investment.  The Statement also requires entities to provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. This Statement applies prospectively to all entities that prepare consolidated financial statements and applies prospectively for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (January 1, 2009 for the Company).  The adoption of ASC 810-10-65 has not had a material impact on the Company’s financial statements.

Under ASC 855-10, as under previous practice, an entity must record the effects of subsequent events that provide evidence about conditions that existed at the balance sheet date and must disclose but not record the effects of subsequent events which provide evidence about conditions that did not exist at the balance sheet date. This standard added an additional required disclosure relative to the date through which subsequent events have been evaluated and whether that is the date on which the financial statements were issued. As it relates to the Company, this standard was effective beginning April 1, 2009. The additional disclosures required by this standard are included in Note 10.

In February 2010, the FASB issued Accounting Standards Update 2010-09, Amendments to Certain Recognition and Disclosure Requirements, which amended ASC 855 and which requires issuers of financial statements to evaluate subsequent events through the date on which the financial statements are issued.  FASB 2010-09 defines the term “SEC Filer” and eliminates the requirement that an SEC filer disclose the date through which subsequent events have been evaluated.  This change was made to alleviate potential conflicts between ASC 855-10 and the reporting requirements of the SEC.  FASB 2010-09 is effective immediately, but is not expected to have a material effect on the Company’s financial statements.

 
F-13

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

In January 2010, the FASB issued Accounting Standards Update 2010-03, Oil and Gas Reserve Estimation and Disclosures (“FASB 2010-03”), which amended Extractive Activities – Oil and Gas (Topic 932).  Among other things, FASB 2010-03 expands the definition of oil and gas producing activities and requires companies to use a twelve-month average price, rather than a year-end price, when estimating whether reserve quantities are economical to produce.  In addition, FASB 2010-03 requires separate reserve disclosures for geographical areas that contain more than fifteen percent of an entity's total reserves and provides guidance with respect to the applicability of reporting requirements for equity investments in oil and gas producing entities.  FASB 2010-03 is effective for annual reporting periods ending on or after December 31, 2009.  The adoption of FASB 2010-03 is not expected to have a material effect on the Company’s financial statements.

In April 2010, the FASB issued Accounting Standards Update 2010-14, Amendments to Paragraph 932-10-S99-1 (FASB 2010-14), which amended ASC 932.  FASB 2010-14 revises the definitions of certain definitions contained in SEC Regulation S-X.  FASB 2010-14 is effective for annual reporting periods beginning after December 15, 2009.  The adoption of FASB 2010-14 is not expected to have a material effect on the Company’s financial statements.

3.       Equipment and Leasehold Improvements

The following is a summary of equipment and improvements, at cost, as of June 30, 2010:

Office equipment
  $ 104,046  
Leasehold improvements
    47,509  
Total equipment and improvements
    151,555  
Less: accumulated depreciation
    (123,788 )
Equipment and improvements, net
  $ 27,767  

Depreciation expense for the three-month periods ended June 30, 2010 and 2009 was $11,801 and $10,819, respectively.  Depreciation expense for the six-month periods ended June 30, 2010 and 2009 was $28,060 and $20,054, respectively.

The Company purchased $19,000 of down-hole tools during 2009 and $38,000 of down-hole tools during 2008.  Because the Company no longer possesses exclusive rights to utilize the down-hole gas and water separation technology, the Company has no plans to utilize the tools in the near future.  The Company’s management does not believe that the value of the tools has been impaired and is marketing the tools to other exploration and development companies.  Accordingly, the down-hole tools have been classified as Assets Held for Sale on the Company’s balance sheets as of June 30, 2010 and December 31, 2009.

 
F-14

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

4.       Oil and Gas Properties

As of June 30, 2010 and December 31, 2009, the Company’s cost centers are as follows:

   
June 30, 2010
   
December 31, 2009
 
   
Amortizable
   
Non-Amortizable
   
Amortizable
   
Non-Amortizable
 
United States
  $ -     $ 257,574     $ -     $ 411,751  
Canada
    126,029       -       -       1,046  
Total
  $ 126,029     $ 257,574     $ -     $ 412,797  

Producing Properties

Through various transactions that occurred during 2007, the Company acquired a 75% working interest in the South West Extension of the West Ranch Field (the “South West Extension”), located in Jackson County, Texas.  In August 2009, certain leases included in the West Ranch Field expired and, as a result, the reserves associated with these leases contained in the Glasscock Reservoir are no longer available to the Company.  These leases were pivotal to the implementation of a waterflood program designed to stimulate production throughout the South West Extension.  Because there was no reasonable certainty that the Company would seek to extract the underlying reserves associated with the remaining West Ranch leases, the economic value of these reserves could not be used to evaluate the recoverability of the Company’s investment in the West Ranch property.  Accordingly, the Company fully impaired its full-cost pool, subject to amortization in August 2009.

Because the wells were shut-in, the Company recognized no depletion expense related to the West Ranch property for the three-month and six-month periods ended June 30, 2010 and 2009.

In June 2010, the Company sold its interest in the West Ranch property for $262,500 in cash and the assumption, by the purchaser, of all plugging, abandonment and environmental reclamation liabilities.  Because the Company had fully impaired its investment in the West Ranch Field, and because the West Ranch Field represented the only property in the US cost center of the full-cost pool, subject to amortization, the Company recognized a gain on the transaction of $509,934.

Exploratory Prospects

The Company has entered into participation agreements in a number of exploratory oil and gas properties. Unproven exploratory prospects are excluded from its respective amortizable cost pool. Each prospect’s costs are transferred into the amortization base on an ongoing (well-by-well or property-by-property) basis as the prospect is evaluated and proved reserves are established or impairment is determined. Three exploratory prospects have been abandoned as of June 30, 2010. The Company has a working interest and/or overriding royalty interest in the wells on the remaining prospects, if they are successful. The Company paid certain amounts upon execution of the agreements and is obligated to share in the drilling costs of the exploratory wells. In addition, the Company has agreed to issue shares of its common stock based upon the proven reserves of the property.

 
F-15

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

United States

Steamroller Prospect

The Company currently owns various overriding royalty interests under approximately 20,172 net acres in Utah and Colorado, located within the Steamroller Prospect.  In addition, the Company is entitled to receive an overriding royalty interest on any additional leasehold interest acquired by its working interest partners in an area of mutual interest (“AMI”) between the parties.  The AMI covers approximately 3,571,200 gross acres.

Pebble Beach Prospect

In 2006, the Company entered into a series of agreements that resulted in the acquisition of five percent of the capital stock of Pebble Petroleum, Inc. (“Pebble”), as well as the following rights and interest in the Pebble Beach Prospect:

 
·
A $250,000 spud fee for each of the first eight wells drilled by Pebble;

 
·
A five percent (5%) gross overriding royalty from each well drilled on certain acreage that Pebble holds rights to in SE Saskatchewan, Canada (no capital outlay or other expenses to be required by the Company); and

 
·
A ten percent (10%) working interest in a joint venture with Rover Resources, Inc., (“Rover”), a subsidiary of Pebble; the joint venture will explore and develop certain prospects principally located in Divide County, North Dakota (the Company will pay 10% of all costs incurred).

The last of the eight exploratory wells drilled by Pebble was completed in August 2008.  As of December 31, 2009, the Company had received all but $20,000 of the spud fees related to the initial eight exploratory wells.  The remaining $20,000 of spud fees was collected in March 2010.

In April 2010, the Company sold its working interest in approximately 700 net acres located within the Pebble Beach Prospect to Rover Resources for cash consideration totaling $1 million.  Pursuant to full-cost accounting guidelines, the Company allocated a portion of the gross gain from the sale ($277,355) to the remaining property in the US cost center of the full-cost pool, not subject to amortization, based on the relative fair market values of the properties at the time of the sale, and recognized a net gain on the sale of $722,645.

 
F-16

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

As of June 30, 2010, the Company still owns a 10% working interest in approximately 2,800 net acres located within the Pebble Peach Prospect.  The carrying value of the Company’s interest in the Pebble Beach prospect totaled $31,355 as of June 30, 2010.  Management is currently in the process of developing its exploration strategy relative to the remaining acreage within the Pebble Beach Prospect.  No definite timetable has been established for exploratory drilling activities within the Pebble Beach Prospect, nor does the Company expect that a determination will be made on the ultimate viability of the Pebble Beach Prospect within the next twelve months.

Spyglass Prospect

In June 2010, the Company sold 50% of its working interest in the Hardy Prospect to American Eagle Energy Inc. in exchange for a 50% working interest in approximately 6,851 net acres located within Divide County, North Dakota (the “Spyglass Prospect”).  The Company reclassified 50% of the carrying value of its investment in the Hardy Prospect ($126,029) to the Spyglass Prospect at the time of the sale.  Because no proven reserves have been identified, the Spyglass Prospect has been assigned to the full-cost pool that is not subject to amortization as of June 30, 2010.  Management is currently in the process of developing its exploration strategy relative to the Spyglass Prospect.  No definite timetable has been established for exploratory drilling activities within the Spyglass Prospect, nor does the Company expect that a determination will be made on the ultimate viability of the Spyglass Prospect within the next twelve months.

Impairment Reviews

All of the Company’s oil and gas properties are evaluated for impairment on a quarterly basis.  There were no impairments evident at June 30, 2010.

Canada

In June 2008, the Company acquired a five percent working interest in an additional prospect located in Saskatchewan, Canada for $1,046.  The Company fully impaired its investment in the Canada Prospect in June 2010 citing a lack of proven reserves and no definitive exploration plans relative to the Canadian Prospect.  The impairment was netted against the aforementioned gains from the sale of oil and gas properties, not subject to amortization.

Hardy Property

In April 2010, the Company sold certain gross overriding royalty interests in property located in southeastern Saskatchewan to Ryland Oil Corporation (“Ryland”).  Proceeds from the sale of the gross overriding royalty interest included cash consideration of $2.9 million, 2,145,883 shares of Ryland’s common stock, valued at $874,973 and an assignment of Ryland’s 100% working interest in approximately 4,480 net acres located in Saskatchewan (the “Hardy Property”), which included related equipment valued at approximately $238,681.  Because the gross overriding royalty interests sold represented the only property in the Canadian cost center of the full-cost pool, not subject to amortization, the Company recognized a gain on the full value of the sales proceeds received, totaling $4,013,654.

 
F-17

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

The Hardy Property contains one existing oil well that was shut-in as of June 30, 2010 due to mechanical issues.  However, the area in which the Hardy well is located is known to contain proven oil and gas reserves.  The Company intends to re-enter the Hardy well during the third quarter of 2010 in an attempt to restore the well to production.

5.       Asset Retirement Obligation

As of December 31, 2009, the Company had recorded an aggregate asset retirement obligation associated with its investment in the West Ranch Field in the amount in the amount of $242,955.  The asset retirement obligation represented estimated discounted future plugging and abandonment costs associated with each of the thirty wells located within the Southwest Extension of the West Ranch Field.  The estimated liability was based on the assumption that the wells would have to be plugged and abandoned over a three-year period.

The following table summarized the estimated plugging liability by year in which, in the absence of production, the respective wells were projected to be plugged and abandoned:

   
Amount
 
2010
  $ 65,258  
2011
    93,225  
2012
    121,193  
Gross amount of liability
    279,676  
Discount factor
    (32,241 )
Net present value of asset retirement obligation
  $ 247,435  

As discussed in Note 4, the Company sold its interest in the West Ranch Field in June 2010.  Pursuant to the terms of the sale agreement, the purchaser assumed all future plugging liabilities associated with the West Ranch wells.  Accordingly, the Company has removed its asset retirement obligation from its books and considered the extinguishment of this debt in calculating the gross gain realized on the sale.  As of June 30, 2010, the Company has not recorded any asset retirement obligations related to its newly acquired Hardy Property nor its unproven prospects.

 
F-18

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

6.       Commitments and Contingencies

Drilling Obligations

The Company has an option to fund its share of future exploratory drilling costs related to its 10% working interest in the Pebble Beach Prospect should any exploratory wells be proposed by the other working interest owner.

Employment Agreements

In August 2009, the Company renewed its two-year employment agreement with its Vice President of Engineering.  The financial terms of the renewed employment agreement are substantially the same as the previous employment agreements, which provide for annual compensation of $144,000.

In October 2009, the Company amended its employment agreement with its Chief Financial Officer to extend the contract through September 1, 2010.  The employment agreement provides for annual compensation in the amount of $138,000.

Effective November 1, 2009, the Company renewed its two-year employment agreement with its President and Chief Executive Officer.  The financial terms of the renewed employment agreement are substantially the same as the previous employment agreements, which provide for annual compensation of $174,000.

Lease Obligation

In June 2007, the Company executed an agreement to lease certain office equipment from Banc of America leasing.  The lease agreement expired in June 2010.

Effective January 1, 2009, the Company entered into an agreement to lease its current office space.  The new lease has a term of 36 months and expires in December 31, 2011. Future lease payments related to the Company’s office and equipment leases are as follows:

   
Amount
 
2010
  $ 31,268  
2011
    64,140  
2012
    -  
2013
    -  
2014
    -  
Total
  $ 95,408  

Gross office rent expense for each of the three-month periods ended June 30, 2010 and 2009 was $19,418.  Gross office rent expense for each of the six-month periods ended June 30, 2010 and 2009 was $38,837.  Copier lease expense totaled $1,237 and $1,264 for the three-month periods ended June 30, 2010 and 2009.  Copier lease expense totaled $2,056 and $2,387 for the six-month periods ended June 30, 2010 and 2009

 
F-19

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

7.       Earnings (Loss) Per Share

The following is a reconciliation of the number of shares used in the calculation of basic loss per share and diluted loss per share for the three-month and six-month periods ended June 30, 2010 and 2009:

   
For the Three-Month
   
For the Six-Month
 
   
Period Ended June 30,
   
Period Ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Net income (loss)
  $ 4,044,779     $ (336,012 )   $ 3,713,044     $ (833,499 )
Weighted-average number of common shares outstanding
    43,532,612       44,550,000       44,043,152       44,550,000  
Incremental shares from the assumed exercise of dilutive stock options
    891,892       33,333       2.125.000       -  
Diluted common shares outstanding
    44.424.504       44,583,333       46.168.152       44,550,000  
Basic earnings (loss) per share
  $ 0.09     $ (0.01 )   $ 0.08     $ (0.02 )
Diluted earnings (loss) per share
  $ 0.09     $ (0.01 )   $ 0.08     $ (0.02 )

The following securities were not included in the computation of diluted net loss per share as their effect would have been anti-dilutive:
   
2010
   
2009
 
Stock Options
    -       5,543,800  

8.       Equity Transactions

Stock Repurchases

In March 2010, the Company’s Board of Directors authorized implementation of a stock repurchase program, pursuant to which the Company may repurchase up to $500,000 of its then outstanding common shares at prevailing market prices.  During the three-month and six-month periods ended June 30, 2010, the Company repurchased and retired 1,788,000 and 1,881,000 shares, respectively, of its previously issued and outstanding common stock at an average price of $0.06 per share.  The aggregate cost associated with the repurchase of these shares was $111,504.  As of June 30, 2010, the Company has 42,669,000 shares of common stock outstanding.  As discussed in Note 10, the Company has continued to repurchase shares subsequent to June 30, 2010.

 
F-20

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

Issuance and Cancellation of Restricted Stock and Cancellation of Stock Options

In September 2009, the Company announced that it had granted 6,500,000 restricted shares of common stock to its directors and officers in exchange for the return and cancellation of 5,393,800 unexercised options to purchase shares of common stock.  In October 2009, the Company’s board of directors rescinded the grant of the restricted common shares, effective on the original grant date.  Because the restricted stock certificates were never delivered to the intended recipients, management has determined that the title to the shares never transferred.  Accordingly, no stock-based compensation has been recorded in connection with the issuance of the restricted shares.  The stock options remained cancelled.

Issuance of Stock Options

In October 2009, the Company granted 6,000,000 options to purchase shares of the Company’s common stock to its directors and officers.  The stock options have a five-year life, vest immediately and have an exercise price of $0.05, which exceeded the volume weighted average closing price of the Company’s common stock for the five-day period preceding the grant.  The Company accounted for the new stock option grant as a modification of the previously outstanding stock options and immediately recognized stock-based compensation expense of $145,190 associated with the new grant and the remaining $67,071 of unamortized stock-based compensation associated with the original stock options.  There were no additional stock options granted during the six-month period ended June 30, 2010.  Accordingly, the Company did not recognize any stock-based compensation expense for the six-month period then ended.

A summary of stock option activity for the year ended December 31, 2009 and the six-month period ended June 30, 2010 is presented below:
               
Weighted
 
         
Weighted
   
Average
 
         
Average
   
Remaining
 
         
Exercise
   
Contract
 
   
Options
   
Price
   
Term
 
                   
Outstanding at December 31, 2008
    5,543,800     $ 0.46    
3.1 years
 
Options forfeited
    (5,543,000 )   $ 0.05       -  
Options granted
    6,000,000     $ 0.05       -  
Outstanding at December 31, 2009 and June 30, 2010
    6,000,000     $ 0.05    
4.3 years
 
                         
Exercisable at June 30, 2010
    6,000,000     $ 0.05    
4.3 years
 

 
F-21

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

The assumptions used in the Black-Scholes option pricing model for the stock options granted during the year ended December 31, 2009 were as follows:

Risk-free interest rate
    2.37 %
Expected volatility of common stock
    101 %
Dividend yield
  $ 0.00  
Expected life of options
 
5 years
 
Weighted average fair market value of options granted
  $ 0.03  

Shares Reserved for Future Issuance

As of June 30, 2010, the Company has reserved 6,000,000 shares for future issuance upon exercise of outstanding options.

9.       Income Taxes

For the six-month period ended June 30, 2009, the Company incurred a net operating loss and, accordingly, no provision for income taxes was recorded.  In addition, no benefit for income taxes was recorded due to the uncertainty of the realization of any tax assets.

The Company has recognized net income of $3,713,044 for the six-month period ended June 30, 2010.  However, as discussed below, the Company has sufficient net operating loss carryforwards (“NOL’s”) to offset any current year taxable income.  As a result, the Company has not recognized any US income tax expense for the current period.

As of December 31, 2009, the Company had cumulative net loss carryforwards (“NOL’s”) of approximately $6,453,000 available to offset future US taxable earnings.  The NOL’s, if not utilized, will begin to expire in 2023.

In June 2010, the Company remitted $892,112 to the Canadian Revenue Agency in June 2010 in connection with the sale of certain gross overriding royalty interests.  A foreign tax credit related to the payment of the Canadian taxes is available to reduce future US tax liabilities, once the Company’s NOL’s have expired or fully utilized.

   
June 30,
       
   
2010
   
December 31
 
   
(Unaudited)
   
2009
 
Tax effect of NOL’s
  $ 957,000     $ 2,194,020  
Estimated foreign tax credits
    892,000       -  
Total deferred tax assets
    1,849,000       2,194,000  
Less: Valuation allowance
    (1,849,000 )     (2,194,000 )
Net deferred tax assets
  $ -     $ -  

 
F-22

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

Prior to recognizing income for the six-month period ended June 30,2010, the Company recognized net losses in each fiscal year since inception.  Based on the Company’s history of net losses, management believes that it is more likely than not that the net deferred tax assets will not be fully realizable.  Accordingly, the Company has provided for a full valuation allowance against its net deferred tax assets as of June 30, 2010.

A reconciliation between the amount of income tax (benefit) expense for the six-month periods ended June 30, 2010 and 2009, determined by applying the applicable US statutory income tax rates, is as follows:

   
2010
   
2009
 
Net income (loss) before taxes
  $ 3,713,044     $ (833,499 )
US statutory tax rate
    34 %     34 %
Estimated tax expense (benefit)
    1,262,435       (283,390 )
Provision for deferred taxes
    (1,262,435 )     283,390 )
Net income tax expense (benefit)
  $ -     $ -  

10.     Asset and Royalty Purchases by Ryland Oil Corporation

In November 2009, the Company entered into a letter agreement (the “Letter Agreement”) with Ryland Oil Corporation (“Ryland”), a Canadian oil and gas company whose shares are listed on the TSX Venture Exchange, whereby Ryland proposed to acquire all of the then-outstanding shares of the Company’s common stock in exchange for approximately 17,793,000 shares of Ryland’s common stock, at a ratio of 0.352 shares of Ryland stock for every 1.000 share of the Company’s stock.

On March 26, 2010, the Company and Ryland mutually agreed to terminate the Letter Agreement and, instead, entered into two new asset purchase agreements whereby the Company agreed to sell to Ryland its interest in certain acreage located in North Dakota, as well as its gross overriding royalty interest in certain lands located in Saskatchewan.  The material terms of each agreement were as follows:

 
1.
Purchase and Sale Agreement – Effective April 1, 2010, the Company sold its ten percent working interest in approximately 700 net acres located in North Dakota to Rover for $1 million cash.
 
 
2.
Purchase of Royalty Agreement – Effective April 1, 2010 the Company sold to Ryland all of its gross overriding royalty interest in approximately 264,000 net acres within an area of mutual interest located in southeastern Saskatchewan for $2.9 million in cash, 2,145,883 shares of Ryland’s common stock, which were valued at approximately $874,973 and an assignment of Ryland’s 100% working interest in approximately 4,480 net acres located in Saskatchewan (the “Hardy Prospect”) and related machinery, valued at $238,681.
 
 
F-23

 

Eternal Energy Corp.
 
Notes to the Financial Statements (Unaudited)

11.     Subsequent Events

During the period from July 1 through August 13, 2010, the Company repurchased an additional 1,149,000 shares of its previously outstanding common stock on the open market pursuant to its stock repurchase program.  The aggregate consideration paid for these shares totaled approximately $87,000, resulting in an average repurchase price of $0.076 per acquired share.

 
F-24

 
     

THE FOLLOWING PRESENTATION OF OUR MANAGEMENT'S DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND OTHER FINANCIAL INFORMATION INCLUDED ELSEWHERE IN THIS REPORT.

A Note About Forward-Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on current management's expectations. These statements may be identified by their use of words like “plans,” “expect,” “aim,” “believe,” “projects,” “anticipate,” “intend,” “estimate,” “will,” “should,” “could” and other expressions that indicate future events and trends. All statements that address expectations or projections about the future, including statements about our business strategy, expenditures, and financial results are forward-looking statements. We believe that the expectations reflected in such forward-looking statements are accurate. However, we cannot assure you that such expectations will occur.
 
Actual results could differ materially from those in the forward looking statements due to a number of uncertainties including, but not limited to, those discussed in this section. Factors that could cause future results to differ from these expectations include general economic conditions, further changes in our business direction or strategy, competitive factors, oil and gas exploration uncertainties, and an inability to attract, develop, or retain technical, consulting or managerial agents or independent contractors. As a result, the identification and interpretation of data and other information and their use in developing and selecting assumptions from and among reasonable alternatives requires the exercise of judgment. To the extent that the assumed events do not occur, the outcome may vary substantially from anticipated or projected results, and accordingly, no opinion is expressed on the achievability of those forward-looking statements. No assurance can be given that any of the assumptions relating to the forward-looking statements specified in the following information are accurate, and we assume no obligation to update any such forward-looking statements. You should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report, except as required by law; we are not obligated to release publicly any revisions to these forward-looking statements to reflect events or circumstances occurring after the date of this report or to reflect the occurrence of unanticipated events.

Industry Outlook

The petroleum industry is highly competitive and subject to significant volatility due to numerous market forces. Crude oil and natural gas prices are affected by market fundamentals such as weather, inventory levels, competing fuel prices, overall demand and the availability of supply.

 
2

 

Oil prices cannot be predicted with any certainty and have significantly affected profitability and returns for upstream producers. Historically, the WTI price has averaged approximately $47 per barrel over the past ten years. However, during that time, the industry has experienced wide fluctuations in prices. While local supply/demand fundamentals are a decisive factor affecting domestic natural gas prices over the long term, day-to-day prices may be more volatile in the futures markets, such as on the NYMEX and other exchanges, making it difficult to forecast prices with any degree of confidence. Over the last ten years, the NYMEX gas price has averaged approximately $5.67 per mcf.

Results of Operations for the Three-Month Period Ended June 30, 2010 vs. 2009

We began receiving royalty payments associated with our 5% gross overriding royalty interest in certain properties located in Saskatchewan, Canada in April 2009.  As a result, we recognized $4,533 of oil and gas sales revenue for the three-month period ended June 30, 2009.  Revenues from our overriding royalty positions would continue to grow throughout the remainder of 2009 as additional wells were drilled in the area.  In April 2010, we sold our gross overriding royalty interest in the Saskatchewan property to Ryland Oil Corporation (“Ryland”).  Consequently, we only recognized $2,999 of oil and gas sales revenue during the three-month period ended June 30, 2010.  We do not anticipate recognizing any further oil and gas sales revenue from the Saskatchewan property during the remainder of 2010.  We may or may not recognize additional oil and gas sales revenues during the remainder of 2010, depending on whether or not we can successfully drill producing wells in any of our other properties.

In April 2010, we sold our 5% gross overriding royalty interest in certain lands located in southeastern Saskatchewan to Ryland.  As a result of the sale, we received cash consideration of $2,900,000, shares of Ryland’s common stock valued at $874,973 as of the date of closing, and a 100% working interest in approximately 4,480 net acres, also located in southeastern Saskatchewan (the “Hardy Project”), valued at $238,681.   Because we have no other properties in the Canadian cost center of our full-cost pool, not subject to amortization, we recognized a full gain on the sale totaling $4,013,654.

Also in April 2010, we sold our 10% working interest in approximately 7,000 gross acres (700 net acres) located in Divide County, North Dakota, to Rover Resources Inc., a wholly owned subsidiary of Ryland.  Proceeds from the sale of the 700 acres totaled $1,000,000 in cash.  We allocated a portion of the proceeds to reduce our 10% working interest in the remaining approximate 28,000 gross acres (2,800 net acres) that we own in Divide County and recognized a gain on the sale of the 700 acres, totaling $277,355.

In June 2010, we sold our 75% working interest in the West Ranch property.  Cash proceeds from the sale totaled $262,500.  In addition, the purchaser agreed to assume all plugging and abandonment liabilities related to the West Ranch wells, which totaled $247,434.  Because we had fully impaired our investment in the West Ranch property, and because we have no other properties in the US cost center of our full-cost pool, subject to amortization, we recognized a full gain on the sale totaling $509,934.

 
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As a result of these transactions, we recognized aggregate gains from the sale of certain oil and gas assets totaling $5,245,187 for the three-month period ended June 30, 2010.

Falling oil prices and increasing production costs caused us to shut-in our West Ranch wells in June 2009.  The wells remained shut-in until the West Ranch property was sold in June 2010.  As a result, we did not recognize any oil and gas operating expenses for the three-month period ended June 30, 2010, compared to $3,326 of oil and gas operating expenses that were incurred during the same period in 2009.

General and administrative expenses increased from $167,511 for the three-month period ended June 30, 2009 to $218,150 for the three-month period ended June 30, 2010, primarily as a result of additional consulting fees incurred during 2010 related to the evaluation of the Hardy Project and land services received in connection with our new Hardy Project holdings.  In addition, prior to October 2009, we provided shared CFO services to Roadrunner Oil & Gas, Inc. (“Roadrunner”), for which Roadrunner paid us amounts ranging from $3,000 to $4,000 per month.  Fees received from Roadrunner reduced our gross salaries expense by $10,000 for the three-month period ended June 30, 2009.  Because the shared CFO services arrangement terminated in October 2009, we recognized no such savings for the three-month period ended June 30, 2010.

Stock-based compensation expense for the three-month period ended June 30, 2009 totaled $89,025.  In September 2009, we cancelled all of our then-outstanding stock options in connection with the issuance of restricted shares to the option holders.  In October 2009, we rescinded the issuance of the restricted shares and granted new stock options to the previous option holders.  Pursuant to accounting rules, the granting of the new options was treated as a modification of the terms of the cancelled options.  All stock-based compensation attributable to the newly issued options was fully recognized at the time of grant.  Further, all remaining, unamortized stock-based compensation of the cancelled options was also recognized.  As a result, no stock-based compensation expense was recognized during the three-month period ended June 30, 2010, as all compensation related to our outstanding stock options had already been recognized.

Professional fees for the three-month period ended June 30, 2010 decreased by $2,565 from the same period in 2009.

Depreciation, depletion and amortization expense for the three-month period ended June 30, 2010 increased by $982 from the same period in 2009 primarily due to the normal accretion of our asset retirement obligations.  We wrote off our remaining asset retirement obligations in June 2010 in connection with the sale of the West Ranch property.

Interest income for the three-month period ended June 30, 2010 totaled $2,677, compared to $16,722 for the three-month period ended June 30, 2009.  The decrease is due to reduced interest rates available for the Company’s excess cash, as well as the fact that the Company’s North Sea deposits were invested in long-term investments during 2009, as required by law.  The Company collected the deposits in November 2009.   Since that time, the funds previously held on deposit were invested at normal money-market rates, which are lower that the rates previously received when the funds were invested in longer-term maturity instruments.

 
4

 

In June 2010, we remitted $892,112 in foreign taxes to the Canadian Revenue Agency in connection with our sale of the Saskatchewan gross overriding royalties.  .  The payment of the Canadian taxes created a foreign tax credit, which would be available to reduce the Company’s US tax liability on future earnings, once the Company’s net operating loss carryforwards have expired or been fully utilized.

Results of Operations for the Six-Month Period Ended June 30, 2010 vs. 2009

Oil and gas revenues associated with our 5% gross overriding royalty interest in certain properties located in Saskatchewan totaled $74,485 for the six-month period ended June 30, 2010, compared to $4,533 for the first six months of 2009.  In April 2010, we sold our gross overriding royalty interest in the Saskatchewan property to Ryland.  We do not anticipate recognizing any further oil and gas sales revenue from the Saskatchewan property during the remainder of 2010.  We may or may not recognize additional oil and gas sales revenues during the remainder of 2010, depending on whether or not we can successfully drill producing wells in any of our other properties.

As noted above, we sold our 5% gross overriding royalty interest in certain lands located in southeastern Saskatchewan, as well as our working interests in 700 net acres in North Dakota and our West Ranch property during the six-month period ended June 30, 2010.  Aggregate gains recognized on the sales totaled $5,245,187.  We did not sell any properties during 2009.

Falling oil prices and increasing production costs caused us to shut-in our West Ranch wells in June 2009.  The wells remained shut-in until the West Ranch property was sold in June 2010.  As a result, we did not recognized any oil and gas operating expenses for the six-month period ended June 30, 2010, compared to $33,334 of oil and gas operating expenses that were incurred during the same period in 2009.

General and administrative expenses increased from $389,046 for the six-month period ended June 30, 2009 to $452,402 for the six-month period ended June 30, 2010, primarily as a result of the following:
 
 
·
Amounts received from Roadrunner for shared CFO services and office space rental effectively reduced our 2009 general and administrative expenses by $37,400.  We did not provide such services or sublease any office space to Roadrunner in 2010.

 
·
Filing fees for the period increased by $10,175 as a result of filing responses to questions received from the SEC as well as multiple Form 8-K’s related to the sales transactions with Ryland.

 
·
Consulting fees for the period increased by $17,947 from 2009 to 2010, primarily as a result of additional landman and operational services being contracted.
 
 
5

 

Stock-based compensation expense for the six-month period ended June 30, 2009 totaled $199,275.  We did not recognize any stock-based compensation expense during the six-month period ended June 30, 2010 as all compensation related to our outstanding stock options has already been recognized.

Professional fees for the six-month period ended June 30, 2010 increased by $15,087 from the same period in 2009.  The increase is primarily due to incurring $49,850 in 2010 to obtain a fairness opinion related to the potential merger with Ryland.  This amount was partially offset by a reduction of legal fees due to the favorable settlement of our then-litigation with Zavanna Corp. in July 2010.

Depreciation, depletion and amortization expense for the six-month period ended June 30, 2010 increased by $8,008 from the same period in 2009 primarily due to the normal accretion of our asset retirement obligations.  We wrote off our remaining asset retirement obligations in June 2010 in connection with the sale of the West Ranch property.

Interest income for the six-month period ended June 30, 2010 totaled $4,372, compared to $27,014 for the six-month period ended June 30, 2009.  As discussed above, the interest rates available to the Company for its short-term investments had declined significantly since the middle of 2009.

In June 2010, we remitted $892,112 in foreign taxes to the Canadian Revenue Agency in connection with our sale of the Saskatchewan gross overriding royalties.  The payment of the Canadian taxes created a foreign tax credit, which would be available to reduce the Company’s US tax liability on future earnings, once the Company’s net operating loss carryforwards have expired or been fully utilized.


As of June 30, 2010, our assets totaled $5,533,807, which included cash balances of $4,068,692 and investments in marketable securities valued at $904,324.  As of June 30, 2010, we have working capital totaling $4,042,330 available to us to fund operations and potential drilling activities.

We also own working interests in prospective oil and gas leases located in North Dakota and southeastern Saskatchewan which could be liquidated, in part or in total, if necessary, to fund future operations.

Off-Balance Sheet Arrangements

The Company had no off-balance sheet arrangements at June 30, 2010.

ITEM 4T. CONTROLS AND PROCEDURES.

The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s "disclosure controls and procedures" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report.  Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2010.  There has been no change in the Company’s internal control over financial reporting during the quarter ended June 30, 2010, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 
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ITEM 6. EXHIBITS.

Exhibit
 
Description of Exhibit
     
3(i).1
 
Articles of Incorporation filed with the Nevada Secretary of State on July 25, 2003. (Incorporated by reference to Exhibit 3.1 of our Form 10-SB filed August 18, 2004.)
     
3(i).2
 
Certificate of Change filed with the Nevada Secretary of State effective November 7, 2005. (Incorporated by reference to Exhibit 3(i).2 of our Current Report on Form 8-K filed November 9, 2005.)
     
3(i).3
 
Articles of Merger filed with the Nevada Secretary of State effective November 7, 2005. (Incorporated by reference to Exhibit 3(i).3 of our Current Report on Form 8-K filed November 9, 2005.)
     
3(ii).1
 
Bylaws, adopted July 18, 2003. (Incorporated by reference to Exhibit 3.2 of our Form 10-SB filed August 18, 2004.)
     
3(ii).2
 
Amendment No. 1 to Bylaws, adopted November 4, 2005. (Incorporated by reference to Exhibit 3(ii) of our Current Report on Form 8-K filed November 9, 2005.)
     
10.1
 
Agreement and Plan of Merger between Golden Hope Resources Corp. (renamed Eternal Energy Corp.) and Eternal Energy Corp., filed with the Nevada Secretary of State effective November 7, 2005. (Incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed November 9, 2005.)
     
10.2*
 
Purchase and Sale Agreement by and between Eternal Energy Corp., PNP Petroleum I, LP., Cibolo Energy Operating, Inc. and Century Assets Corporation, dated June 25, 2010.
     
10.3*
 
Letter Agreement between Eternal Energy Corp. and American Eagle Energy Inc. dated June 18, 2010.
     
10.4
 
Reserved for future use.
     
10.5
 
Reserved for future use.
     
10.6
 
Letter Agreement by and between Eternal Energy Corp. and International Frontier Resources Corporation. (Incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed December 5, 2005.)
     
10.7
 
Reserved for future use.
     
10.8
 
Reserved for future use.
     
10.9
 
Letter Agreement by and between Eternal Energy Corp. and International Frontier Resources Corporation Relating to Quad 41 and Quad 42 dated January 30, 2006. (Incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed February 3, 2006.)
     
 
Amended and Restated Letter Agreement by and between Eternal Energy Corp. and International Frontier Resources Corporation Relating to Quad 14 dated January 30, 2006. (Incorporated by reference to Exhibit 10.2 of our Current Report on Form 8-K filed February 3, 2006.)
     
10.11
 
Reserved for future use.
     
10.12
 
Reserved for future use.
     
10.13
 
Reserved for future use.
     
10.14
 
Reserved for future use.
     
10.15
 
Reserved for future use.
     
10.16
 
Letter Agreement effective as of May 19, 2006, by and among Eternal Energy Corp., International Frontier Resources Corporation, Palace Exploration Company Limited, Oilexco Incorporated, and Challenger Minerals (North Sea) Limited (Incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed May 23, 2006).
     
 
Letter Agreement dated October 15, 2006, by and among Eternal Energy Corp., Fairway Exploration, LLC, Prospector Oil, Inc., and 0770890 B.C. Ltd. (Incorporated by reference to Exhibit 10.17 of our Registration Statement on Form 10-KSB filed April 16, 2007).

 
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10.18**
 
Letter Agreement dated October 26, 2006, by and among Eternal Energy Corp., Fairway Exploration, LLC, Prospector Oil, Inc., 0770890 B.C. Ltd., and Rover Resources Inc. (Incorporated by reference to Exhibit 10.18 of our Registration Statement on Form 10-KSB filed April 16, 2007).
     
10.19
 
Letter Agreement dated February 28, 2007, by and among Eternal Energy Corp., Pebble Petroleum Inc., Emerald Bay Holdings Ltd., and Heartland Resources Inc. (Incorporated by reference to Exhibit 10.19 of our Registration Statement on Form 10-KSB filed April 16, 2007).
     
10.20
 
Agreement To Terminate DGWS Option (Incorporated by reference to Exhibit 10.20 of our Quarterly Report on Form 10-Q filed May 15, 2009).
     
10.21
 
Amended and Restated Employment Agreement by and between Eternal Energy Corp. and Craig Phelps dated August 1, 2007 (Incorporated by reference to Exhibit 10.21 of our Quarterly Report on Form 10-Q filed May 15, 2009).
     
10.22
 
Employment Agreement by and between Eternal Energy Corp. and Kirk A. Stingley dated June 2, 2008 (Incorporated by reference to Exhibit 10.22 of our Quarterly Report on Form 10-Q filed May 15, 2009).
     
10.23
 
Amended and Restated Employment Agreement by and between Eternal Energy Corp. and Bradley M. Colby dated November 1, 2009 (Incorporated by reference to Exhibit 10.23 of our   ).
     
10.24
 
First Amendment to the Amended and Restated Employment Agreement by and between Eternal Energy Corp. and Craig H. Phelps dated August 1, 2009 (Incorporated by reference to Exhibit 10.24 of our Quarterly Report on Form 10-Q filed November 23, 2009).
     
10.25
 
First Amendment to the Employment Agreement by and between Eternal Energy Corp. and Kirk. A. Stingley dated October 30, 2009 (Incorporated by reference to Exhibit 10.25 of our Form Quarterly Report on Form 10-Q filed November 23, 2009).
     
10.26
 
Form Of Letter Agreement dated November 25, 2009, between the Registrant and Ryland Oil Corporation in respect of a potential acquisition of the registrant (Incorporated by reference to Exhibit 10.26 of our Current Report on Form 8-K filed March 10, 2010).
     
10.27
 
Lease Agreement dated January 2, 1009 by and between Eternal energy Corp. and Oakley Ventures, LLC (Incorporated by Reference to Exhibit 10.27 of our Annual Report on Form 10-K filed March 23, 2010).
     
10.28
 
Purchase and Sale Agreement by and between Eternal Energy Corp. and Ryland Oil Corporation dated March 26, 2010 (Incorporated by reference to Exhibit 10.28 of our Current Report on Form 8-K filed March 29, 2010).
     
10.29
 
Purchase of Royalty Agreement by and between Eternal Energy Corp. and Ryland Oil Corporation dated March 26, 2010 (Incorporated by reference to Exhibit 10.29 of our Current Report on Form 8-K filed March 29, 2010).
     
10.29a
 
Amending Agreement to the Ryland/Eternal Royalty Purchase Agreement by and between Eternal Energy Corp. and Ryland Oil Corporation dated April 20, 2010 (Incorporated by reference to Exhibit 10.29a of our Current Report on Form 8-K filed March 29, 2010).
     
10.30
 
Termination Agreement (of the US Pebble Acquisition Agreement) by and between Eternal Energy Corp., Fairway Exploration LLC, Prospector Oil, Inc., Pebble Petroleum Inc. and Rover Resources Inc. dated April 29, 2010.
     
10.31
 
Termination Agreement (of the Canadian Pebble Acquisition Agreement) by and between Eternal Energy Corp., Fairway Exploration LLC, Prospector Oil, Inc. and Pebble Petroleum Inc. dated April 29, 2010.
     
10.32
 
Termination Agreement (of the US Prospect Acquisition Agreement) by and between Eternal Energy Corp., Fairway Exploration LLC, Prospector Oil, Inc., Pebble Petroleum Inc., Rover Resources Inc., Steven Swanson, Richard L. Findley, Thomas G. Lantz and Ryland Oil Corporation dated May 11, 2010.
     
10.33
 
Termination Agreement (of the Canadian Prospect Acquisition Agreement) by and between Eternal Energy Corp., Fairway Exploration LLC, Prospector Oil, Inc., Pebble Petroleum Inc., Steven Swanson, Richard L. Findley, Thomas G. Lantz and Ryland Oil Corporation dated May 11, 2010.
     
10.34
 
Termination of Management Services Agreement by and between Eternal Energy Corp., Ryland Oil Corporation and Brad Colby dated December 1, 2009.

 
8

 

10.35
 
Amendment to the Consulting Agreement by and between Eternal Energy Corp., Rover Resources Inc. and Brad Colby dated April 1, 2010.
     
31.1*
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act
     
31.2*
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act
     
32.1*
 
Certification pursuant to Section 906 of the Sarbanes-Oxley Act
     
32.2*
 
Certification pursuant to Section 906 of the Sarbanes-Oxley Act


*
Filed herewith.
**
Portions omitted pursuant to a request for confidential treatment.

 
9

 


In accordance with the requirements of the Exchange Act, the registrant caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

ETERNAL ENERGY CORP.
 
   
(Registrant)
 
   
August 13, 2010
/s/ Bradley M. Colby
 
Bradley M. Colby
 
President and Chief Executive Officer

 
10