Kereco Energy Ltd. announces first quarter 2008 results
CALGARY, May 14 /CNW/ - Kereco Energy Ltd. ("Kereco") or the ("Company")
is pleased to announce operational and financial results for the three months
ended March 31, 2008.
FINANCIAL AND OPERATING HIGHLIGHTS
FINANCIAL Three months ended
($000s, unless otherwise March 31, March 31,
indicated) 2008 2007 % Change
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Petroleum and natural gas sales $ 29,109 $ 43,035 (32)
Funds flow from operations 12,799 21,974 (42)
Per share - basic ($) 0.22 0.39 (44)
Per share - diluted ($) 0.22 0.38 (42)
Net earnings (loss) (269) (1,934) 86
Per share - basic ($) (0.01) (0.03) 67
Per share - diluted ($) (0.01) (0.03) 67
Capital expenditures
Exploration and development 20,082 31,047 (35)
Net acquisitions and
dispositions net of
transaction costs (167,359) - (100)
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Total (147,277) 31,047 (574)
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Bank debt - (179,576) 100
Cash & short term investments 70,042 - 100
Working capital deficiency(1) (8,369) (7,233) (16)
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Total (net debt)/cash balance(2) 61,673 (186,809) 133
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Shareholders' equity 384,025 493,104 (22)
Common shares outstanding at
the end of period (000s)
Basic 58,446 56,505 1
Diluted 63,423 63,914 (1)
Weighted average common shares
outstanding (000s)
Basic 58,538 56,505 4
Diluted(3) 58,538 56,505 4
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OPERATING HIGHLIGHTS(4)
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Average daily production
Natural gas (mcf/day) 8,507 25,292 (66)
Crude oil and NGLs (bbls/day) 2,714 4,216 (36)
Barrels of oil equivalent (boe/day) 4,131 8,431 (51)
Average selling prices(5)
Natural gas ($/mcf) 7.85 8.06 (3)
Crude oil and NGLs ($/bbl) 90.96 62.14 46
Barrels of oil equivalent ($/boe) 75.91 55.24 37
Well events (No.)
Gross 7.0 13.0 (46)
Net 7.0 9.9 (29)
Success (%) 86 77 12
Undeveloped land (000s of acres)
Gross 59 345 (83)
Net 50 233 (79)
Average working interest (%) 85 68 25
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(1) Excluding financial derivative contracts.
(2) Net debt - excludes debt associated with the $70 million principal
amount of convertible debentures issued June 25, 2007.
(3) Excludes anti-dilutive incremental options and warrants of 193,608
for the first quarter 2008 and 1,002,800 for the first quarter of
2007.
(4) References in this report to boe refer to barrel of oil equivalent
whereby natural gas volumes have been converted at a rate of
six thousand cubic feet of natural gas to one barrel of oil. See
"Management's Discussion and Analysis" on page five.
(5) Average selling prices are net of transportation costs and excluding
financial derivatives.
MESSAGE TO SHAREHOLDERS
Kereco Energy Ltd. ("KCO") is pleased to provide our results for the
first quarter of 2008 as well as to provide an update and outlook for the
balance of the year. The key focus for Kereco in the first quarter of 2008
was to finalize the corporate repositioning and establish the foundations for
our go forward plan to achieve an annualized 15 percent growth in value of
reserves and net present value over a 3 to 5 year period of time.
To accomplish this we have developed a four part execution strategy
comprised of:
1. Continue to optimize and efficiently grow the value of our Sturgeon
Lake light oil property. This includes continued low risk infill
development drilling of the asset's numerous sizeable oil in place
reservoirs, modest small "E" exploration, and strengthening already
robust product netbacks through revenue enhancement and operating
cost reduction. We have a minimum of four years worth of development
and optimization opportunities based on our current technical and
business assessments and a track record of adding light oil reserves.
2. Development of the EOR opportunities at Sturgeon Lake including our
Montney waterflood project and our Leduc tertiary recovery project.
3. Utilizing our capital resources established through the
aforementioned asset disposition process to strategically and
opportunistically aggregate hydrocarbon in place projects where
technology can be utilized to manage up recovery factors.
4. Kereco intends to focus on achieving operational excellence and
maintaining disciplined capital spending combined with prudent
capital structure management and enhancement as it relates to both
internally generated activity and the acquisition of new
opportunities.
Consistent with the above plan, the repositioning process concluded
with the closing of the final property disposition on January 14,
2008. Kereco has a much stronger balance sheet with net cash of
$62 million and an undrawn $100 million bank facility and is now well
positioned to take advantage of both internal and external new
opportunities as they arise.
Kereco also achieved a number of operational objectives during the first
quarter of 2008, setting the stage for continued value growth. Notably, we
further expanded the Sturgeon Lake water handling system to facilitate
efficient and cost effective management of the upcoming 2008 Leduc oilwell
development program. We successfully drilled two Montney horizontal light
oilwells utilizing the multistage fracture technology, thereby commencing the
Triassic A pool waterflood project. We acquired two key sections of land
adjacent to our existing Montney A pool where we map an additional six
horizontal development locations bringing our total inventory of horizontal
Montney prospects to 20. Finally, we made a new, Gilwood, light oil pool
discovery at our Narrows property establishing a new development and
exploration area for 2009.
On May 1, 2008 the Company made an offer to purchase all of the issued
and outstanding 4.75% Convertible Unsecured Subordinated Debentures of Kereco
Energy Ltd. The offer will remain open for acceptance until 2:00 pm on June 4,
2008.
With respect to the previously announced normal course issuer bid, the
Company has repurchased to date 468,535 shares at an average cost of $4.04 per
share.
OUTLOOK
Kereco is optimistic and well positioned to execute on a disciplined
program focused on adding long term value. Our industry is experiencing
extremely strong commodity prices which combined with Kereco's 70 percent
weighting to light oil production results in top quartile operating and cash
flow netbacks. With these strong cash flows, a healthy balance sheet, long
reserve life index light oil base asset, stabilized execution costs, and a
greater availability of acquisition opportunities, we are confident and
enthused about achieving our long term value growth objectives.
For the full year 2008, our newly focused company is targeting growth in
value initiatives in both capital and operational activity on our assets as
well as through the aggregation of additional properties into our company
through acquisitions. With the financial flexibility we currently enjoy, we
contemplate expanding our capital expenditures for the year to between
$60 million and $70 million either on our existing asset base or on the
acquisition of additional assets. Kereco does not presently participate in the
full pricing potential due to the out of the money 2008 commodity financial
derivative contracts on oil and natural gas. Utilizing commodity price
assumptions of $120/bbl WTI and AECO $9.50/mcf, excluding the financial
derivative contracts in place, would result in an estimated incremental
$0.34/share cash flow this year. Although this will not be realized in the
current 2008 year, it clearly demonstrates the future cash generation
potential of the Company's asset in subsequent periods. We continue to
forecast funds flow of $58 to $63 million from our average 2008 production of
between 4,000 to 4,200 boe/day at this time.
We would also like to thank each of our three departing Directors; Barry
Heck, Brian Krausert, and Peter Kurceba for their past assistance and guidance
of Kereco. Your insights and knowledge have been truly beneficial to
management, our staff, and our shareholders.
Thank you on behalf of the Board and Management for your continued
support and interest in our new Cadence Energy Inc. (previous Kereco Energy
Ltd).
On behalf of the Board of Directors,
Grant B. Fagerheim
President and Chief Executive Officer
May 13, 2008
MANAGEMENT'S DISCUSSION AND ANALYSIS
The following management's discussion and analysis ("MD&A") should be
read in conjunction with the unaudited consolidated interim financial
statements for the three months ended March 31, 2008, and the audited
consolidated financial statements and MD&A for the years ended December 31,
2007 and 2006 contained in the 2007 consolidated financial statements of
Kereco and is based on information to May 12, 2008. The reader should be aware
that historical results are not necessarily indicative of future performance.
Additional information relating to Kereco can be found at www.sedar.com.
Funds flow from operations, which is determined before changes in
non-cash working capital, is used by us as a key measure of performance. Funds
flow from operations does not have a standardized meaning prescribed by
Canadian Generally Accepted Accounting Principles ("GAAP") and therefore may
not be comparable with the calculation of similar measures for other
companies. Funds flow from operations as presented is not intended to
represent operating profits for the period nor should it be viewed as an
alternative to cash provided by operating activities, net earnings or other
measures of financial performance calculated in accordance with GAAP. Funds
flow from operations per share is calculated using the same share bases which
are used in the determination of earnings per share.
Net debt, which is determined as bank debt and working capital (comprised
of accounts receivable, prepaid expenses and accounts payable and accrued
liabilities) is used by us as a key indicator of the financial position of the
Company. Net debt does not have a standardized meaning prescribed by Canadian
Generally Accepted Accounting Principles ("GAAP") and therefore may not be
comparable with the calculation of similar measures for other companies.
The financial data contained herein has been prepared in accordance with
GAAP, and unless otherwise indicated, all comments in this report are in
thousands of Canadian dollars. In conformity with Canadian Securities
Administrators National Instrument 51-101, natural gas volumes have been
converted to equivalent barrels of oil ("boe") using a conversion ratio of six
thousand cubic feet ("mcf") to one boe. This ratio is based on an energy
equivalency conversion method primarily applicable at the burner tip and does
not represent a value equivalency at the wellhead. Readers are cautioned that
boes may be misleading, particularly if used in isolation.
FORWARD-LOOKING INFORMATION
Certain information set forth in this disclosure, including management's
assessment of the future plans and operations of Kereco, contains
forward-looking statements. By their nature, forward-looking statements are
subject to numerous risks and uncertainties, some of which are beyond our
control, including the impact of general economic conditions, industry
conditions, changes in laws and regulations including the adoption of new
environmental laws and regulations and changes in how they are interpreted and
enforced, volatility of commodity prices, currency fluctuations, interest rate
volatility, imprecision of reserve estimates, environmental risks, competition
from other industry participants, the lack of availability of qualified
personnel or management, stock market volatility and ability to access
sufficient capital from internal and external sources, market valuations with
respect to announced transactions and the final valuations thereof and
obtaining required approvals of regulatory authorities. Readers are cautioned
that the assumptions used in the preparation of such information, although
considered reasonable at the time of preparation, may prove to be imprecise
and, as such, undue reliance should not be placed on forward looking
statements. The actual results, performance or achievement of Kereco could
differ materially from those expressed in, or implied by, these
forward-looking statements and, accordingly, no assurance can be given that
any of the events anticipated by the forward looking statements will transpire
or occur, or if any of them do so, what benefits that Kereco will derive
therefrom. Except as required by law, Kereco disclaims any intention or
obligation to update or revise any forward-looking statements, whether as a
result of new information, future events or otherwise.
BASIS OF PRESENTATION
Kereco is a Calgary-based intermediate light oil and natural gas
exploration, development and production company whose key business activities
are focused in north western Alberta. Kereco began operations as an oil and
gas exploration and production company on January 18, 2005 with the conveyance
of oil and gas properties from Ketch Resources Ltd. ("Ketch"). Our strategy is
to create value primarily through the generation and drilling of exploration
and development prospects as well as through the exploitation and production
of existing reserves, otherwise referred to as organic value added growth. In
addition, we seek strategic acquisitions which add to our production, reserves
and growth potential. We target areas and prospects that we believe can result
in meaningful reserve and production additions on a per share basis.
RESULTS OF OPERATIONS
Production over the first quarter of 2008 averaged 4,131 boe/day
(8,507 mcf/day of natural gas and 2,714 bbls/day of crude oil and NGLs) down
51 percent from the 8,431 boe/day (25,292 mcf/day of natural gas and
4,216 bbls/day of crude oil and NGLs) averaged in the first quarter of 2007.
This reduction in production is a result of the property dispositions which
were completed in the fourth quarter of 2007 and January 14, 2008. Exploration
and development expenditures in the first quarter of 2008 were $20.0 million.
The $20.0 million capital program included drilling seven well events which
resulted in one cased gas well, four cased oil wells and one salt water
disposal well and one dry hole (87 percent success). One gas well and one oil
well were completed in our Peace River Arch area in Alberta and three oil
wells and one salt water disposal well were completed in our Sturgeon area.
Selected Quarterly Information
2008 2007
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($000s, except per share amounts) Q1 Q4 Q3 Q2
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Revenues (net of royalties) 22,660 37,987 33,485 38,051
Funds flow from operations 12,799 21,560 23,345 22,299
Per share - basic ($) 0.22 0.37 0.40 0.39
Per share - diluted ($) 0.22 0.37 0.40 0.38
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Net earnings (loss) (269) (4,383) (122,643) 2,547
Per share - basic ($) (0.01) (0.08) (2.12) 0.04
Per share - diluted ($) (0.01) (0.08) (2.12) 0.04
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Total assets 530,890 639,799 697,275 806,637
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Bank debt - 80,193 150,713 151,892
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2007 2006
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($000s, except per share amounts) Q1 Q4 Q3 Q2
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Revenues (net of royalties) 34,150 31,461 24,152 22,984
Funds flow from operations 21,974 20,592 17,422 16,690
Per share - basic ($) 0.39 0.40 0.49 0.49
Per share - diluted ($) 0.38 0.39 0.48 0.48
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Net earnings (loss) (1,934) (234) 7,006 7,765
Per share - basic ($) (0.03) (0.01) 0.20 0.23
Per share - diluted ($) (0.03) (0.01) 0.19 0.22
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Total assets 784,570 767,411 391,933 364,342
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Bank debt 179,576 188,673 84,695 74,284
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Significant events and variances that have occurred over the last eight
quarters are as follows:
1) On October 19, 2006, Kereco acquired Chamaelo Exploration Ltd.
("Chamaelo"), resulting in subsequent increases in revenues and funds
flow. The acquisition did also result in a significant increase in
depletion, depreciation and amortization which has negatively
impacted net earnings since that point.
2) During the third quarter of 2007, Kereco's production at Sturgeon
Lake was down for over one month as a result of a scheduled
turnaround, resulting in a negative impact on revenues that quarter.
In addition, the entire balance of goodwill was written off in the
third quarter of 2007, resulting in a large net loss.
3) In the fourth quarter of 2007, Kereco completed 3 separate
dispositions of assets for total net proceeds of $71.3 million. These
proceeds reduced both bank debt and total assets in the quarter.
4) On January 14, 2008, Kereco completed an additional disposition of
assets for proceeds of $166.8 million plus an additional $3.0 million
in adjustments to March 31, 2008 related to these property
dispositions. When combined with the fourth quarter 2007
dispositions, the result is also lower revenues and funds flow from
operations in the quarter. These proceeds eliminated bank debt and
reduced total assets in the quarter.
FUNDS FLOW FROM OPERATIONS
Funds flow from operations decreased 42 percent in the first quarter of
2008 to $12.8 million, or $0.22 per share on a diluted basis from
$22.0 million, or $0.38 per share on a diluted basis for the first quarter of
2007, largely as a result of lower production volumes due to the disposal of
assets resulting from the repositioning process which was completed with the
final disposition on January 14, 2008.
Three months ended March 31
($000s) 2008 2007
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Cash provided by operating activities 4,509 25,093
Change in non-cash working capital 8,290 (3,119)
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Funds flow from operations 12,799 21,974
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Net Operating Income
Three months ended March 31
($000s, except per share amounts) 2008 2007
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Natural gas sales 6,340 18,845
Crude oil and NGLs sales 22,769 24,190
Transportation (570) (1,119)
Realized financial derivative gain (loss) (2,630) 1,004
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Total net sales 25,909 42,920
Royalty expenses (6,449) (8,885)
Operating expenses (4,870) (8,431)
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Net operating income 14,590 25,604
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Per share - Basic ($) 0.25 0.45
- Diluted ($) 0.25 0.45
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OPERATING NETBACKS
Three months ended March 31
2008 2007
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Boe netback ($/boe)
Sales price 77.43 56.71
Transportation (1.52) (1.47)
Realized gain (loss) on financial derivatives (7.00) 1.32
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Sales price, net of transportation and
realized gain (loss) on financial derivatives 68.91 56.56
Royalty expenses - ($/boe) (17.15) (11.71)
- (%) 22.6 21.2
Operating expenses (12.95) (11.11)
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Netback 38.21 33.74
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Natural gas netback ($/mcf)
Sales price 8.19 9.40
Transportation (0.34) (1.34)
Realized gain on financial derivatives 0 0.09
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Sales price, net of transportation and
realized gain (loss) on financial derivatives 7.85 8.15
Royalty expenses - ($/mcf) (1.76) (1.57)
- (%) 22.4 19.50
Operating expenses (1.95) (1.84)
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Netback 4.14 4.74
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Crude oil and NGL netback ($/bbl)
Sales price 92.20 63.76
Transportation (1.24) (1.62)
Realized gain (loss) on financial derivatives (10.65) 2.10
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Sales price, net of transportation realized
gain (loss) on financial derivatives 80.31 64.24
Royalty expenses - ($/bbl) (20.59) (13.79)
- (%) 22.6 22.2
Operating expenses (13.62) (11.19)
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Netback 46.10 39.26
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PETROLEUM AND NATURAL GAS SALES
Production for the first quarter of 2008 averaged 4,131 boe/day and net
realized prices of $75.91/boe resulted in revenues of $29.1 million, a
51 percent decrease in production and a 37 percent increase in realized prices
compared to the first quarter of 2007 which had production of 8,431 boe/day
and net realized prices of $55.24/boe. Production decreases in the first
quarter of 2008 compared to the first quarter of 2007 were a result of the
corporate repositioning process which resulted in four separate asset
dispositions, the final of which closed on January 14, 2008 and the reduction
of the associated sales and production volumes from that point forward in the
quarter.
Average price realizations for the first quarter of 2008, net of
transportation costs, were $75.91/boe ($7.85/mcf for natural gas, $90.96/bbl
for crude oil and NGLs). Comparatively, average price realizations for the
first quarter of 2007, net of transportation costs, were $55.24/boe ($8.06/mcf
for natural gas, $62.14/bbl for crude oil & NGLs). The change in price
realizations tracked changes in the underlying commodity prices over these
periods. WTI crude oil averaged U.S. $97.95/bbl for the first quarter of 2008,
sixty-nine percent higher than U.S.$58.12/bbl averaged in the first quarter of
2007. These increases in WTI were mitigated to a degree by the increased value
in the Canadian dollar over this period which increased to an exchange rate of
1.00 for the first quarter of 2008 compared to 1.17 for the for the first
quarter of 2007. The average daily index AECO natural gas price ($Cdn/mcf) was
$7.90/mcf for the first quarter of 2008, seven percent higher than $7.38/mcf
from the first quarter of 2007, and the average monthly index AECO natural gas
price was $7.13/mcf for the first quarter of 2008, four percent lower than
$7.46/mcf from the first quarter of 2007. We market a relatively even mix of
our natural gas at both AECO daily index and at AECO monthly index pricing.
Financial derivative contracts in place (see note 12 to the consolidated
financial statements for further details) resulted in realized losses of
$2.6 million ($7.00/boe) for the quarter compared to gains of $1.0 million
($1.32/boe) for the three months ended March 31, 2007. This increase in losses
is attributable to the crude oil financial derivative contracts which were put
in place in the middle of 2007.
All of our production is sold within Canada, and revenues are received in
Canadian dollars. The commodities we produce and sell are sensitive to both
worldwide (crude oil) and North American (natural gas) price fluctuations as
well as fluctuations in the Canada/U.S. exchange rate. The commodity price
increases realized in first quarter 2008 compared to first quarter 2007 were
offset somewhat by an increase in the value of the Canadian dollar versus the
U.S. dollar over historical levels, which negatively impacted our price
realizations. The average Canada/U.S. exchange rate remained relatively static
at 1.00 for the first quarter of 2008 compared to 1.17 for the first quarter
of 2007.
Realized Financial Derivatives
On an ongoing basis we enter into several financial and physical
commodity contracts to assist in minimizing exposure to commodity prices.
These activities resulted in losses of $2.6 million ($2.6 million on crude
oil) in the first quarter of 2008 compared to a gain of $1.0 million
($0.8 million on crude oil and $0.2 million on natural gas) in the first
quarter of 2007. This increase in losses is attributable to the crude oil
financial derivative contracts which were put in place in the middle of 2007.
Transportation Costs
Transportation costs increased to $1.52/boe for first quarter of 2008
compared to $1.47/boe for the first quarter of 2007. Transportation costs
decreased 36 percent to $0.6 million for the first quarter of 2008 compared to
$1.1 million for the first quarter of 2007, based on decreased sales volumes
over the two periods.
Royalties
Our royalty burdens are predominantly Crown, along with some overriding,
freehold and net profits interest royalties ("other royalties"). For the first
quarter of 2008, average royalty rates increased slightly to 22.6 percent
(Crown royalties of 19.8 percent and other royalties of 2.8 percent) compared
to 21.2 percent (Crown royalties of 17.8 percent and other royalties of
3.4 percent) for the first quarter of 2007 reflecting the royalty burden of
the remaining properties held by Kereco. Kereco's overall corporate royalty
rate is expected to be maintained at the first quarter 2008 rate throughout
the year.
CASH COSTS
Cash costs (operating, general and administrative and interest) increased
to $17.79/boe in the first quarter of 2008 compared to $15.94/boe in the first
quarter of 2007. There was an increase in costs on a per boe basis in all
three categories driven largely by the effects of general and administrative
costs and operating costs relative to the reduced production base in the
quarter following the repositioning process. Year to date cash costs are
expected to be maintained at this level or decrease slightly as continued cost
control initiatives are implemented during 2008.
Operating Costs
Operating costs on a per boe basis increased in the first quarter of 2008
to $12.95/boe ($1.95/mcf for natural gas and $13.62/bbl for crude oil and
NGLs) compared to first quarter of 2007 costs of $11.11/boe ($1.84/mcf for
natural gas and $11.19/bbl for crude oil and NGLs). Operating costs are
largely influenced by power costs, repair and maintenance at Sturgeon Lake and
the ability to attract third party volumes for processing through our Sturgeon
Lake Plant. The increase in costs per boe over these respective periods is
largely attributable to the lower production volumes than expected for the
first quarter, and higher maintenance costs associated with our Sturgeon Lake
property with work being performed on several wells and a reduction in third
party processing income in the quarter. We also continue to have approximately
70 percent of the electrical power load required for Sturgeon Lake fixed at a
rate of $65.50 per KWh for most of 2008 compared to the average market price
of $76.95 per KWh for the quarter. Sulphur sales at Sturgeon Lake, which is a
by-product of the production process, increased in value in the quarter and
$0.5 million in sulphur sales recoveries were netted against operating costs
in the quarter. Operating costs are expected to be in the $12.00/boe range for
the remainder of 2008.
General and Administrative Expenses
General and Administrative ("G&A") costs increased 142 percent on a boe
basis to $3.48/boe for the first quarter of 2008 from $1.44/boe in the first
quarter of 2007. As a result of the repositioning process we maintained an
adequate level of staff to manage the growth of the Company. This, in
combination with the lower production base results in the higher operating
costs per boe compared to the first quarter of 2007. We feel that Kereco is
adequately staffed for our 2008 activities. Total general and administrative
expenses are expected to average between $3.00 to $3.50/boe for the year.
Interest Expense and Interest Income
Interest expense decreased to $1.8 million in the first quarter of 2008
compared to $2.6 million in the first quarter of 2007. This decrease is
largely the result of the completion of the repositioning process which
eliminated our debt balance as of January 15, 2008. The $1.8 million in
interest expense is comprised of $0.8 million in accrued interest related to
the 4.75% convertible debentures, $0.2 million in interest on our bank line
which was drawn up to January 14, 2008, and $0.8 million in non-cash accretion
expense related to the convertible debentures. Offsetting this is $0.5 million
in interest income from the short term cash equivalent investments of
$65 million in one month Banker's Acceptances. On a per boe basis, cash
interest expense net of interest income decreased to $1.36/boe in the first
quarter of 2008 compared to $3.39/boe in the first quarter of 2007. Total
interest expense for the remainder of the year is dependent upon our positive
cash balance, bank draws and is also dependent upon whether the offer to
acquire the outstanding convertible debentures, which were mailed out on
April 28, 2008, is accepted as discussed in note 7 in the notes to the
consolidated financial statements.
NET EARNINGS
A net loss of $0.3 million ($0.01) per diluted share was realized in the
first quarter of 2008 compared to a net loss of $1.9 million ($0.03) per
diluted share in the first quarter of 2007. These losses on earnings are
largely attributable to the increased depletion, depreciation and accretion
expense and the unrealized loss on financial derivatives as described below.
Depletion, Depreciation and Accretion ("DD&A")
Depletion, depreciation and accretion ("DD&A") amounted to $12.2 million,
or $32.32/boe in the first quarter of 2008 compared to $19.4 million or
$25.53/boe for the first quarter of 2007. The DD&A rate increased in the first
quarter of 2008 as a result of adjustments to the depletable capital base and
the associated reserves following the closing of the final property
disposition from the corporate repositioning process in addition to the
capital expenditures added to the depletable asset pool over the quarter,
relative to the proven reserves added. These cumulative additions to the
depletable pools, relative to period end estimated reserves, result in the
increased DD&A rate per boe over the two respective periods. The DD&A rate for
2008 will be approximately $32.00 per boe, prior to incorporating any 2008
activities.
Stock-Based Compensation Expense
Stock-based compensation for the first quarter of 2008 was a recovery of
$0.1 million compared to a $1.0 million expense in the first quarter of 2007.
The recovery recognized in the first quarter of 2008 is largely a result of
the cancellation of 1.9 million options, resulting from the staff departures
concurrent with the repositioning process, net of the regular stock based
compensation expense that needs to be recognized. In the first quarter of
2007, 2.4 million options of non-insiders of the company were cancelled and
1.5 million new options were granted and an additional 2.2 million options
were granted in June of 2007. Stock-based compensation expense continues to be
recognized on the cancelled options over their original life as well as
additional expense for the incremental fair value of the replacement options
granted. See note 11 to the consolidated financial statements for more
details.
The Board of Directors has approved the conditional cancellation of the
currently outstanding options to be replaced with the adoption of a new stock
option plan. The Board of Director's has also approved the conditional
adoption of a share unit plan. Both plans are to be voted upon at the
Company's Annual General Meeting to be held May 14, 2008. If adopted these
changes will impact the stock based compensation expense expected to be
realized for the remainder of 2008.
Unrealized (Gains)/Losses on Financial Instruments
The effect of financial instruments amounted to an unrealized loss of
$2.0 million in the first quarter of 2008 compared to an unrealized loss of
$5.2 million for the first quarter of 2007. These financial instruments
include our financial and physical commodity contracts as well as our
electrical power purchase contract. Any physical commodity contracts and our
electrical power purchase contract were included as financial instruments in
accordance with the new accounting standards for Financial Instruments. The
majority of the gains or losses on financial derivatives are from financial
commodity contracts which are based upon the commodity benchmarks of (WTI) for
oil and (AECO) for natural gas. The losses reflected to date are a result of
the strong WTI oil price increase at the end of March 2008. Accounting
standards require that the change in the fair value ("mark to market") of
these positions be included in earnings on each balance sheet date. See
note 11 in the notes to the consolidated financial statements for additional
details.
Taxes
Total tax recovered for the year to date at March 31, 2008 was
$1.8 million (March 31, 2007: recovery of $1.7 million). This results in an
effective tax rate of 87 percent for the year to date in 2008, which is
largely influenced by a portion of the convertible debenture interest expense
that is non-deductible, as well as rate difference between the statutory rate
and Kereco's effective rate.
Income Tax Pools
At March 31, 2008, the Company had the following estimated tax pools and
non-capital losses that can be used to offset otherwise taxable income in
future periods:
(millions) March 31, 2008
-------------------------------------------------------------------------
Canadian oil and gas property expense ("COGPE") 76.5
Canadian development expense ("CDE") 111.7
Canadian exploration expense ("CEE") 4.4
Undepreciated capital costs ("UCC") 71.8
Non-capital losses carried forward 7.5
-------------------------------------------------------------------------
Total pools and losses 271.9
Share issue costs 11.2
-------------------------------------------------------------------------
Total pools, losses and share issue costs 283.1
-------------------------------------------------------------------------
-------------------------------------------------------------------------
The reduction in pools from the fourth quarter of 2007 reflects the $169.8
million property disposition and the distribution of the Kereco partnership
income of February 1, 2007 to January 31, 2008 in the quarter.
LIQUIDITY AND CAPITAL RESOURCES
Capital Resources
Three months ended March 31
(000s) 2008 2007
-------------------------------------------------------------------------
Funds flow from operations 12,799 21,974
Working capital (11,465) (231)
Bank debt (80,193) (9,097)
Cash and cash equivalents (70,042) -
Business combination and transaction costs (2,458) (413)
Proceeds from property dispositions 169,817 -
Proceeds from the exercise of options or warrants 2,898 521
Proceeds from share issuances (1,274) 18,293
-------------------------------------------------------------------------
Total capital resources 20,082 31,047
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Bank Debt
At March 31, 2008 the Company had in place a syndicated committed credit
facility, in the amount of $100 million, with two major Canadian Chartered
Banks and the Canadian branch of a major international bank. Interest on this
facility is charged at monthly rates and borrowings can be made in Canadian or
U.S. dollars. Borrowings can also be made by way of prime rate advances or
Banker's Acceptances which attract interest at increments to prime based on
the Company's debt/cash flow ratio, calculated utilizing the two most recent
fiscal quarters. The Company has provided a $500 million demand fixed and
floating charge debenture as collateral for the facility.
As at March 31, 2008, this banking facility was undrawn (December 31,
2007, $80.2 million). In January 2008 the entire amount of the outstanding
bank debt balance was repaid in full which resulted in the classification of
the outstanding amount on the balance sheet as a current liability at
December 31, 2007. At March 31, 2008 the Company was in a positive cash
position having $65 million invested in one month Banker's Acceptances earning
3.52% interest as well as a balance of $5.0 million in cash holdings. In April
2008 the credit facility was renewed at $100 million following the
finalization of the year end banking review.
Working Capital
We ended the quarter with a working capital deficiency of $8.4 million
which is comprised of accounts payable and accrued liabilities of
$36.8 million and accounts receivable and prepaid expenses of $28.4 million.
Accounts receivable mainly consist of monthly revenue which is predominantly
collected on the twenty-fifth day of the month following the month of
production as well as joint venture receivables from partners with whom we
conduct joint operations. Accounts payable and accrued liabilities consist of
payments owing for capital, operating and general and administrative
activities. Capital intensive periods will tend to create situations of a
working capital deficiency. We constantly monitor our working capital position
in conjunction with our undrawn bank credit lines.
Following the final property disposition which closed on January 14,
2008, the Company was left with a positive cash and short term investments of
$70.0 million resulting in a positive net debt position of $61.7 million. We
anticipate that the expected funds flow for the year and the undrawn banking
facility will be more than adequate to fund the upcoming year's expected
capital program and operating commitments and convertible debentures without
requiring utilization of the undrawn credit facility. We will continue to
monitor all aspects and make changes to our plans if required.
Convertible Debentures
On June 25, 2007, the Company issued $70 million of convertible unsecured
subordinated debentures which mature on June 30, 2012 and bear interest at
4.75% (the "Debentures"). The interest is payable semi-annually in arrears on
June 30 and December 31 each year. The first interest payment was made on
December 31, 2007. Each debenture can be converted into common shares of the
Corporation at the option of the holder at any time prior to the close of
business on June 29, 2012 at a conversion price of $10.00 per common share.
The Debentures are not redeemable by the Corporation prior to June 30, 2010.
On or after June 30, 2010 and prior to June 30, 2012, the Debentures may be
redeemed at the option of the Corporation, in whole or in part at a redemption
price equal to 100% of the principal amount of the Debentures to be redeemed
plus accrued and unpaid interest to, but excluding, the redemption date
provided that the Current Market Price (as defined in the Short Form
Prospectus filed in conjunction with the offering) is at least 125% of the
Conversion Price.
The Debentures are classified as debt and equity with the equity portion
representing the fair value of the conversion feature of the Debentures. As
the Debentures are converted, a portion of the debt and equity amounts are
transferred to share capital. The debt balance accretes over the life of the
Debentures using the effective interest rate method to the amount owing on
maturity and the increases in the debt balance are reflected as non-cash
interest expense in the consolidated statement of cash flows. The Debentures
are designated as Other Liabilities and the transaction costs associated with
the issuance of the Debentures are netted against the carrying value of the
Debentures and are accreted over the life of the Debentures using the
effective interest rate method.
During the first quarter of 2008, the Board of Directors has resolved to
make a formal offer to acquire all of the outstanding Debentures at a price of
$950 per $1,000 Debenture. Debenture holders will not be entitled to receive
accrued and unpaid interest on the Debentures which is payable after the
expiry time of the offer. The offer was mailed on April 29, 2008 and is open
to acceptance until June 4, 2008 2:00 pm Eastern Daylight time. The offer will
be subject to a minimum tender of 90% of the outstanding Debentures and other
customary conditions.
Share Capital
Three months ended Year ended
March 31, December 31,
2008 2007
-------------------------------------------------------------------------
Weighted average shares outstanding
Basic 58,538,213 57,469,293
Options and warrants(1) - -
-------------------------------------------------------------------------
Diluted 58,538,213 57,469,293
Common shares outstanding at period end
-------------------------------------------------------------------------
Basic 58,445,835 57,839,731
Options and warrants 4,977,648 7,766,452
-------------------------------------------------------------------------
Diluted 63,423,483 65,606,183
-------------------------------------------------------------------------
-------------------------------------------------------------------------
(1) Anti-dilutive incremental options and warrants in the amount of
193,608 for the three months ended March 2008 and 808,142 for the
twelve months ended December 31, 2008 are excluded from the
weighted average diluted shares outstanding.
As at May 12, 2008, Kereco had 58,300,000 shares outstanding, reflecting
the cancellation of 468,535 common shares following the normal course issuer
bid repurchases and the issuance of 928,804 common shares due to warrants
exercises in the quarter.
Normal Course Issuer Bid
In January, 2008 the Company announced its intention to initiate a normal
course issuer bid ("NCIB") to repurchase up to 5,339,424 of its issued and
outstanding common shares (representing approximately 10 percent of the
58,184,217 outstanding common shares as of January 15, 2008, net of 4,789,977
common shares held by insiders as held in escrow) through the facilities of
the Toronto Stock Exchange ("TSX"). The bid commenced on January 18, 2008 and
will terminate on January 17, 2009 or such earlier time as the bid is
completed or terminated at the option of Kereco. 322,700 shares have been
purchased up to March 31, 2008 at an average cost of $3.95. Subsequent to
March 31, 2008, 145,835 shares have been repurchased at an average cost of
$4.26 up to May 12, 2008.
CAPITAL EXPENDITURES
During the first quarter of 2008, we incurred $20.0 million in net
capital expenditures itemized as follows:
Three months ended March 31
($000s) 2008 2007
-------------------------------------------------------------------------
Land 557 503
Geological and geophysical 373 680
Drilling and completions 15,170 22,566
Facilities and equipment 3,490 5,051
Office and corporate costs 56 1,976
Capitalized general and administrative costs 436 271
-------------------------------------------------------------------------
Total exploration and development 20,082 31,047
-------------------------------------------------------------------------
Transaction costs - repositioning process 2,458 -
Property acquisitions and dispositions (169,817) -
-------------------------------------------------------------------------
Total capital expenditures (147,277) 31,047
-------------------------------------------------------------------------
-------------------------------------------------------------------------
We drilled 7.0 (7.0 net) well events during the first quarter of 2008
which resulted in one gas well (1.0 net) and four oil wells (4.0 net)
comprised of one (1.0 net) gas well and one (1.0 net) oil well in the Peace
River Arch area, and three (3.0 net) oil wells and one (1.0 net) salt water
disposal well in the Sturgeon area. This amounted to $15.3 million in drilling
and completion expenditures for the year to date. Related equipping costs and
facility costs amounted to $3.5 million. $0.6 million was also spent on land
resulting in an increase in our undeveloped land position to 50,000 net
undeveloped acres at March 31, 2008. $0.4 million was spent on seismic.
CONTRACTUAL OBLIGATIONS
On February 16, 2007, we issued 2,250,000 flow-through common shares for
proceeds of $19.4 million before issue costs of $1.0 million which will
require us to incur $19.4 million of flow-through share eligible CEE, as
defined in the Canadian Income Tax Act, by December 31, 2008. As of March 31,
2008 approximately $18.7 million in qualifying CEE expenditures related to
this flow-through share commitment have been incurred. We have also executed
separate contracts with two large drilling contractors for the exclusive use
of two specific drilling rigs. One contract is a three year contract which
commenced in December of 2006 and requires us to utilize the rig for a minimum
of 225 days per year. If not utilized we are obligated to pay a minimum $5,800
rate per day. A second drilling contract (which was for two years, commenced
June 1, 2007 and required Kereco to utilize the rig for a minimum of 225 days
per year for two years with a minimum rate per day of $4,785) was terminated
on March 11, 2008 and replaced with a new service rig contract. The new
contract will commence on June 1, 2008 and requires us to utilize the rig for
a total of 7,200 hours at a rate of $645 per hour. There is no timeframe by
which this rig capacity needs to be utilized by. If we are unable to utilize
the rig, a liability of $200 of per unutilizable hour will result. Therefore
the minimum payments under the service rig contract will be $1,440,000.
During 2007, the Company signed a nine year office lease which commences
on February 15, 2008. Average annual payments under the lease will be
$1.5 million. Kereco is currently in negotiations to sub-lease this nine year
office lease.
Kereco has also fixed the price on approximately seventy percent of its
electricity requirements for a period which commenced on February 1, 2006 and
which ends on December 31, 2008.
Following are the future minimum payments required under these drilling,
office and electrical contracts; net of any prepayments:
Drilling Electricity
($000s) contracts Office lease contract
-------------------------------------------------------------------------
2008 $ 975 $ 1,075 $ 1,506
2009 $ 1,196 $ 1,433 $ -
2010-2016 $ - $ 9,962 $ -
Indeterminate $ 1,440 $ - $ -
-------------------------------------------------------------------------
Total $ 3,611 $ 12,470 $ 1,506
-------------------------------------------------------------------------
The Company has other commitments and guarantees in the normal course of
business which are not material, and are therefore not disclosed here.
RISK MANAGEMENT AND HEDGING
We have entered into financial and physical derivative contracts as
outlined in note 11 to the consolidated financial statements. These positions
were undertaken in order to secure pricing on a portion of our future
production and to protect against fluctuations in future commodity prices. We
have not designated any of these financial derivative contracts as hedges and
they have therefore been recorded on the balance sheet as assets or
liabilities with changes in their fair value recorded in net earnings for the
applicable periods.
As an alternative presentation, if Kereco had locked in the volumes
currently hedged at the March 31, 2008 strip pricing for both crude oil and
natural gas, over the term of those hedges, Kereco would actually realize a
net $9.2 million cash loss over the term of the hedges from the oil and
natural gas contracts in place.
The financial and physical derivative contracts entered into up to and
including May 12, 2008 and as listed in note 12 to the Consolidated Financial
Statements result in the following downside price protection and ceiling
prices on future production:
2008 2009
-------------------------------------------------------
Q2 Q3 Q4 Q1 Q2 Q3 Q4
-------------------------------------------------------------------------
Natural Gas
Volume (GJ/day) 2,000 2,000 674 - - - -
Floor price
(AECO CDN $/GJ) 7.63 7.63 7.63 - - - -
Ceiling price
(AECO CDN $/GJ) 8.23 8.23 8.23 - - - -
-------------------------------------------------------------------------
Crude Oil
Volume (bbls/day) 1,500 1,500 1,500 500 500 500 500
Floor price
(WTI US$/bbl) 61.50 61.50 61.50 77.50 77.50 77.50 77.50
Ceiling Price
(WTI US$/bbl) 78.88 78.88 78.88 103.95 103.95 103.95 103.95
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Kereco entered into the 2008 crude oil financial derivative contracts in
June 2007.
NEW ACCOUNTING STANDARDS IN 2007 AND 2008
A) Capital Disclosures
As of January 1, 2008 the Company adopted CICA Handbook section 1535,
"Capital Disclosures", which requires entities to disclose their
objectives, policies and processes for managing capital, and in
addition, whether the entity has complied with any externally imposed
capital requirements.
B) Inventories
As of January 1, 2008 the Company adopted CICA Handbook section 3031,
"Inventories" which did not directly impact the Company's financial
statements.
C) Financial Instruments - Disclosures and Presentation
As of January 1, 2008 the Company adopted CICA Handbook section 3862
- "Financial Instruments - Disclosures" which enhances the disclosure
around a financial instrument's fair value and the qualitative and
quantitative exposure risks around financial instruments. As of
January 1, 2008 the Company also adopted CICA Handbook section 3863 -
"Financial Instruments - Presentation" which addresses the required
disclosures and presentation required for financial instruments.
D) General Standards of Financial Statement Presentation
The CICA has amended section 1400, "General Standards of Financial
Statement Presentation" effective for interim periods beginning on or
after January 1, 2008 to include requirements to assess and disclose
the Company's ability to continue as a going concern. The adoption of
this new section will not have an impact on the financial statements.
ACCOUNTING PRONOUNCEMENTS
A) Goodwill and Intangible Assets and Research and Development Costs
In February 2008, the Canadian Institute of Chartered Accountants
("CICA") issued Section 3064, "Goodwill and Intangible Assets", replacing
Section 3062, "Goodwill and Other Intangible Assets" and Section 3450,
Research and Development costs. Various changes have been made to other
sections of the CICA Handbook for consistency purposes. The new Section will
be applicable to financial statements relating to fiscal years beginning on or
after October 1, 2008. Accordingly, the Company will adopt the new standards
for its fiscal year beginning January 1, 2009. It establishes standards for
the recognition, measurement, presentation and disclosure of goodwill
subsequent to its initial recognition and of intangible assets by
profit-oriented enterprises. Standards concerning goodwill are unchanged from
the standards included in the previous Section 3062. The Company is currently
evaluating the impact of the adoption of this new Section on its consolidated
financial statements. The Company does not expect that the adoption of this
new Section will have a material impact on its consolidated financial
statements.
RELATED PARTY TRANSACTIONS
During 2007 and 2008, Kereco conducted business with a company controlled
by a director of Kereco. These transactions for drilling services were made
under normal business terms and conditions at the same rates as with
non-related parties. Capital additions to property, plant and equipment in the
amount of $857,000 were conducted in 2007. There were no amounts outstanding
at March 31, 2008.
RISK AND UNCERTAINTY
Please refer to the Management's Discussion and Analysis for the year
ended 2007 for a discussion of risks and uncertainties Kereco faces.
The following developments have been added as items of risk and
uncertainty in addition to those stated in the Management's Discussion and
Analysis for the year ended December 31, 2007.
CRITICAL ESTIMATES
Management is required to make judgments and use estimates in the
application of generally accepted accounting principals that have a
significant impact on the financial results of Kereco. Please refer to the
Management's Discussion and Analysis for the year ended 2007 for a discussion
outlining these accounting policies and practices which are critical in
determining Kereco's financial results.
DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL
REPORTING
There are no changes to the disclosure controls and procedures and
internal controls over financial reporting from those disclosed in the
Management's Discussion and Analysis for the year ended December 31, 2007.
OUTLOOK
Kereco is optimistic and well positioned to execute on a disciplined
program focused on adding long term value. Our industry is experiencing
extremely strong commodity prices which combined with Kereco's 70 percent
weighting to light oil production results in top quartile operating and cash
flow netbacks. With these strong cash flows, a healthy balance sheet, long
reserve life index light oil base asset, stabilized execution costs, and a
greater availability of acquisition opportunities, we are confident and
enthused about achieving our long term value growth objectives.
For the full year 2008, our newly focused company is targeting growth in
value initiatives in both capital and operational activity on our assets as
well as through the aggregation of additional properties into our company
through acquisitions. With the financial flexibility we currently enjoy, we
contemplate expanding our capital expenditures for the year to between
$60 million and $70 million either on our existing asset base or on the
acquisition of additional assets. Kereco does not presently participate in the
full pricing potential due to the out of the money 2008 commodity financial
derivative contracts on oil and natural gas. Utilizing commodity price
assumptions of $120/bbl WTI and AECO $9.50/mcf, excluding the financial
derivative contracts in place, would result in an estimated incremental
$0.34/share cash flow this year. Although this will not be realized in the
current 2008 year, it clearly demonstrates the future cash generation
potential of the Company's asset in subsequent periods. We continue to
forecast funds flow of $58 to $63 million from our average 2008 production of
between 4,000 to 4,200 boe/day at this time.
We would also like to thank each of our three departing Directors; Barry
Heck, Brian Krausert, and Peter Kurceba for their past assistance and guidance
of Kereco. Your insights and knowledge have been truly beneficial to
management, our staff, and our shareholders.
Thank you on behalf of the Board and Management for your continued
support and interest in our new Cadence Energy Inc. (previous Kereco Energy
Ltd).
On behalf of the Board of Directors,
Grant B. Fagerheim
President and Chief Executive Officer
May 13, 2008
KERECO ENERGY LTD.
CONSOLIDATED BALANCE SHEETS
As at As at
March 31, December 31,
($000s) (unaudited) 2008 2007
-------------------------------------------------------------------------
ASSETS
Current
Cash and cash equivalents (Note 5) $ 70,042 $ -
Accounts receivable 24,523 39,173
Prepaid expenses 3,856 4,092
Future income taxes (Note 7) $ 2,866 $ 2,486
-------------------------------------------------------------------------
101,287 45,751
Property, plant and equipment, net (Note 4) 429,603 591,918
Deferred charge (Note 4) - 2,130
-------------------------------------------------------------------------
Total assets $ 530,890 $ 639,799
-------------------------------------------------------------------------
-------------------------------------------------------------------------
LIABILITIES
Current
Accounts payable and accrued
liabilities $ 36,748 $ 48,227
Bank debt (Note 5) - 80,193
Advance payment for property
disposition (Note 4) - 17,000
Financial derivative contracts (Note 11) 10,441 8,477
-------------------------------------------------------------------------
47,189 153,897
-------------------------------------------------------------------------
Asset retirement obligation (Note 8) 10,938 13,827
Convertible debentures (Note 6) 54,396 53,600
Future income taxes (Note 7) 34,342 30,824
-------------------------------------------------------------------------
99,676 98,251
-------------------------------------------------------------------------
Total liabilities 146,865 252,148
-------------------------------------------------------------------------
Commitments and guarantees (Note 12)
Contingencies (Note 13)
SHAREHOLDERS' EQUITY
Share capital (Note 9) 447,448 451,110
Contributed surplus (Note 9) 10,509 10,204
Convertible debentures (Note 6) 15,704 15,704
Retained earnings (deficit) (89,636) (89,367)
-------------------------------------------------------------------------
Total shareholders' equity 384,025 387,651
-------------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 530,890 $ 639,799
-------------------------------------------------------------------------
-------------------------------------------------------------------------
The accompanying notes form an integral part of these consolidated
financial statements.
KERECO ENERGY LTD.
CONSOLIDATED STATEMENT OF LOSS, COMPREHENSIVE LOSS AND
RETAINED EARNINGS (DEFICIT)
Three months ended March 31
($000s, except per share amounts) (Unaudited) 2008 2007
-------------------------------------------------------------------------
REVENUE
Petroleum and natural gas sales $ 29,109 $ 43,035
Royalties (6,449) (8,885)
Interest Income 526 -
-------------------------------------------------------------------------
23,186 34,150
-------------------------------------------------------------------------
EXPENSES
Operating 4,870 8,431
Transportation 570 1,119
General and administrative 1,307 1,090
Interest and bank charges (Note 5 & 6) 1,835 2,569
Loss on financial derivatives (Note 11) 4,594 4,216
Depletion, depreciation and
accretion (Notes 4 & 8) 12,151 19,373
Stock-based compensation
(recovery) (Note 9) (58) 957
-------------------------------------------------------------------------
25,269 37,755
-------------------------------------------------------------------------
LOSS BEFORE INCOME TAXES (2,083) (3,605)
-------------------------------------------------------------------------
INCOME TAXES (Note 7)
Future income tax expense
recovery (1,814) (1,671)
-------------------------------------------------------------------------
(1,814) (1,671)
NET LOSS (269) (1,934)
OTHER COMPREHENSIVE INCOME - -
-------------------------------------------------------------------------
COMPREHENSIVE LOSS (269) (1,934)
-------------------------------------------------------------------------
Retained earnings (deficit),
beginning of period (89,367) 37,046
Retained earnings (deficit),
end of period $ (89,636) $ 35,112
-------------------------------------------------------------------------
-------------------------------------------------------------------------
LOSS PER SHARE (Note 9)
Basic $ (0.01) $ (0.03)
Diluted $ (0.01) $ (0.03)
-------------------------------------------------------------------------
-------------------------------------------------------------------------
The accompanying notes form an integral part of these consolidated
financial statements.
KERECO ENERGY LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31
($000s) (Unaudited) 2008 2007
-------------------------------------------------------------------------
OPERATING ACTIVITIES
Net loss $ (269) $ (1,934)
Add items not requiring cash:
Depletion, depreciation and
accretion 12,151 19,373
Future income tax recovery (1,814) (1,671)
Unrealized loss on financial
derivatives 1,964 5,220
Employee common share benefit
plan expense (Note 9) 29 29
Non-cash interest expense on
convertible debentures (Note 6) 796 -
Stock-based compensation
expense (recovery) (Note 9) (58) 957
-------------------------------------------------------------------------
12,799 21,974
Change in non-cash working
capital (Note 10) (8,290) 3,119
-------------------------------------------------------------------------
Cash provided by operating
activities 4,509 25,093
-------------------------------------------------------------------------
FINANCING ACTIVITIES
Issuance of common shares,
net of share issue costs (Note 9) 2,898 18,814
Repurchase of common shares (Note 9) (1,274) -
Bank debt (Note 5) (80,193) (9,097)
Change in non-cash working
capital (Note 10) 139 473
-------------------------------------------------------------------------
Cash provided by financing
activities (78,430) 10,190
-------------------------------------------------------------------------
CASH AVAILABLE FOR INVESTING
ACTIVITIES (73,921) 35,283
-------------------------------------------------------------------------
INVESTING ACTIVITIES
Petroleum and natural gas
expenditures (20,082) (31,047)
Property dispositions net
of transaction costs (Note 4) 167,359 -
Business combination - (413)
Change in non-cash working
capital (Note 10) (3,314) (3,823)
-------------------------------------------------------------------------
Cash used in investing activities 143,963 (35,283)
-------------------------------------------------------------------------
INCREASE IN CASH AND EQUIVALENTS 70,042 -
-------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD $ - $ -
-------------------------------------------------------------------------
-------------------------------------------------------------------------
-------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 70,042 $ -
-------------------------------------------------------------------------
-------------------------------------------------------------------------
The accompanying notes form an integral part of these consolidated
financial statements.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Three months ended March 31, 2008 and 2007
(Unless otherwise stated, tabular amounts presented in these notes are in
thousands of Canadian dollars.) (unaudited)
1. BASIS OF PRESENTATION
The interim consolidated financial statements of Kereco Energy Ltd.
(the "Company" or "Kereco") have been prepared in accordance with
Canadian Generally Accepted Accounting Principles ("GAAP") and are
consistent with the presentation and disclosure in the audited
consolidated financial statements and notes thereto for the year
ended December 31, 2007 except for the changes described in note 2.
"Changes in Accounting Policies". The interim consolidated financial
statements do not conform in all respects to the requirements of GAAP
for annual financial statements. These interim consolidated financial
statements should be read in conjunction with the audited
consolidated financial statements and notes thereto for the year
ended December 31, 2007
2. CHANGES IN ACCOUNTING POLICIES
A) Capital Disclosures
As of January 1, 2008 the Company adopted CICA Handbook section 1535,
"Capital Disclosures", which requires entities to disclose their
objectives, policies and processes for managing capital, and in
addition, whether the entity has complied with any externally imposed
capital requirements. The adoption of this standard resulted in
increased disclosure in the notes to the consolidated financial
statements.
B) Inventories
As of January 1, 2008 the Company adopted CICA Handbook section 3031,
"Inventories" which had no impact on the Company's financial
statements.
C) Financial Instruments - Disclosures and Presentation
As of January 1, 2008 the Company adopted CICA Handbook section 3862
- "Financial Instruments - Disclosures" which enhances the disclosure
around a financial instrument's fair value and the qualitative and
quantitative exposure risks around financial instruments. As of
January 1, 2008 the Company also adopted CICA Handbook section 3863 -
"Financial Instruments - Presentation" which addresses the required
disclosures and presentation required for financial instruments.
D) General Standards of Financial Statement Presentation
The CICA has amended section 1400, "General Standards of Financial
Statement Presentation" effective for interim periods beginning on or
after January 1, 2008 to include requirements to assess and disclose
the company's ability to continue as a going concern. The adoption of
this new section will not have an impact on the financial statements.
3. ACCOUNTING PRONOUNCEMENTS
A) Goodwill and Intangible Assets and Research and Development Costs
In February 2008, the Canadian Institute of Chartered Accountants
("CICA") issued Section 3064, "Goodwill and Intangible Assets",
replacing Section 3062, "Goodwill and Other Intangible Assets" and
Section 3450, Research and Development costs. Various changes have
been made to other sections of the CICA Handbook for consistency
purposes. The new Section will be applicable to financial statements
relating to fiscal years beginning on or after October 1, 2008.
Accordingly, the Company will adopt the new standards for its fiscal
year beginning January 1, 2009. It establishes standards for the
recognition, measurement, presentation and disclosure of goodwill
subsequent to its initial recognition and of intangible assets by
profit-oriented enterprises. Standards concerning goodwill are
unchanged from the standards included in the previous Section 3062.
The Company is currently evaluating the impact of the adoption of
this new Section on its consolidated financial statements. The
Company does not expect that the adoption of this new Section will
have a material impact on its consolidated financial statements.
4. PROPERTY, PLANT AND EQUIPMENT
(000's) As at March 31, 2008 As at December 31, 2007
-------------------------------------------------------------------------
Accumulated Accumulated
Depletion, Net Depletion, Net
and Book and Book
Cost Depreciation Value Cost Depreciation Value
Petroleum and
natural gas
properties $583,995 $156,931 $427,064 $734,411 $145,094 $589,317
Office
equipment &
corporate 3,337 798 $ 2,539 3,282 681 $ 2,601
-------------------------------------------------------------------------
Total $587,332 $157,729 $429,603 $737,693 $145,775 $591,918
-------------------------------------------------------------------------
-------------------------------------------------------------------------
The Company capitalized $0.4 million of indirect general and
administrative overhead for the year to date in 2008 (March 31, 2007
- $0.3 million). $6.2 million of undeveloped land was excluded from
the depletion calculation (March 31, 2007- $50.7 million).
i) Property Disposition and repositioning process
On January 14, 2008 the Company completed the last sale of assets
related to the corporate repositioning process it had embarked upon
on July 18, 2007 for proceeds of $169.8 million net of adjustments.
This includes the original proceeds of $166.8 net of adjustments at
closing in addition to an additional $3.0 million in adjustments at
the end of March 31, 2008. The Company received an advance payment in
the amount of $17.0 million in December 2007 related to this
repositioning process which was settled in January 2008. This
repositioning process also realized deferred charges in the amount of
$2.1 million recorded in December 2007 which have been capitalized to
transaction costs in the first quarter of 2008. An additional
$0.3 million in transaction costs were recognized in the quarter
related to the repositioning process.
5. BANK DEBT, CASH AND CASH EQUIVALENTS
At March 31, 2008 the Company had in place a syndicated committed
credit facility, in the amount of $100 million, with two major
Canadian Chartered Banks and the Canadian branch of a major
international bank. Interest on this facility is charged at monthly
rates and borrowings can be made in Canadian or U.S. dollars.
Borrowings can also be made by way of prime rate advances or Banker's
Acceptances which attract interest at increments to prime based on
the Company's debt/cash flow ratio, calculated utilizing the two most
recent fiscal quarters. The Company has provided a $500 million
demand fixed and floating charge debenture as collateral for the
facility.
As at March 31, 2008, this banking facility was undrawn.
(December 31, 2007, $80.2 million). In January 2008 the entire amount
of the outstanding balance was repaid in full, which resulted in the
classification of the outstanding amount on the balance sheet as a
current liability at December 31, 2007. At March 31, 2008 the Company
was in a positive cash position having $65 million invested in one
month Banker's Acceptances earning 3.52% interest as well as a
balance of $5.0 million in cash holdings. In April 2008 the credit
facility was renewed at $100 million for another annual period under
the same terms and conditions.
6. CONVERTIBLE DEBENTURES
On June 25, 2007, the Company issued $70 million of convertible
unsecured subordinated debentures which mature on June 30, 2012 and
bear interest at 4.75% (the "Debentures"). The interest is payable
semi-annually in arrears on June 30 and December 31 each year. The
first interest payment was made on December 31, 2007. Each debenture
can be converted into common shares of the Corporation at the option
of the holder at any time prior to the close of business on June 29,
2012 at a conversion price of $10.00 per common share. The Debentures
are not redeemable by the Corporation prior to June 30, 2010. On or
after June 30, 2010 and prior to June 30, 2012, the Debentures may be
redeemed at the option of the Corporation, in whole or in part at a
redemption price equal to 100% of the principal amount of the
Debentures to be redeemed plus accrued and unpaid interest to, but
excluding, the redemption date provided that the Current Market Price
(as defined in the Short Form Prospectus filed in conjunction with
the offering) is at least 125% of the Conversion Price.
The Debentures are classified as debt and equity with the equity
portion representing the fair value of the conversion feature of the
Debentures. As the Debentures are converted, a portion of the debt
and equity amounts are transferred to share capital. The debt balance
accretes over the life of the Debentures using the effective interest
rate method to the amount owing on maturity and the increases in the
debt balance are reflected as non-cash interest expense in the
consolidated statement of cash flows. The debentures are designated
as Other Liabilities and the transaction costs associated with the
issuance of the debentures are netted against the carrying value of
the debentures and are accreted over the life of the debentures using
the effective interest rate method.
Following is a reconciliation of the debt and equity components of
the convertible debentures:
Convertible debentures - debt
Issued on June 25, 2007 $ 70,000
Transaction fees and costs (2,525)
Portion allocated to equity - inclusive of transaction
costs (15,519)
Accretion (non cash interest expense) 1,644
---------------------------------------------------------------------
Debt balance as at December 31, 2007 $ 53,600
---------------------------------------------------------------------
Accretion (non cash interest expense) 796
---------------------------------------------------------------------
Debt balance as at March 31, 2008 $ 54,396
---------------------------------------------------------------------
Convertible debentures - equity
Issued on June 25, 2007 $ 15,519
Tax effect of transaction fees and costs 185
Conversion of debentures -
---------------------------------------------------------------------
Equity balance as at December 31, 2007 and
March 31, 2008 $ 15,704
---------------------------------------------------------------------
During the first quarter of 2008, the Board of Directors has resolved
to make a formal offer to acquire all of the outstanding Debentures
at a price of $950 per $1,000 Debenture. Debenture holders will not
be entitled to receive accrued and unpaid interest on the debentures
which is due on June 30, 2008. The offer was mailed on April 29, 2008
and is open to acceptance until June 4, 2008 2:00 pm Eastern Daylight
time. The offer will be subject to a minimum tender of 90% of the
outstanding Debentures and other customary conditions.
7. INCOME TAXES
Total tax recovered for the year to date at March 31, 2008 was
$1.8 million (March 31, 2007: recovery of $1.7 million). This results
in an effective tax rate of 87 percent year to date in 2008, which is
largely influenced by a portion of convertible debenture interest
expense that is non deductible as well as rate differences between
the statutory rate and Kereco's effective rate.
At March 31, 2008, the Company had tax pools and non-capital losses
of approximately $271.9 million, comprised of $4.4 million in
Canadian Exploration Expense (CEE), $76.5 million in Canadian Oil &
Gas Property Expense (COGPE), $111.7 million in Canadian Development
Expense (CDE), and $71.8 million Capital Cost Allowance (CCA) pools
as well as accumulated non-capital losses for income tax purposes of
approximately $7.5 million (December 31, 2007 - $31.9 million) that
can be used to offset otherwise taxable income in future periods.
The remaining non-capital losses, after deductions taken to date,
amount to $7.5 million and expire as follows:
Year of expiry ($millions)
---------------------------------------------------------------------
2010 -
2016 7.5
---------------------------------------------------------------------
7.5
---------------------------------------------------------------------
---------------------------------------------------------------------
In addition to the above losses and tax pools, the Company also has
accumulated capital losses of approximately $21.5 million, (2007 -
$21.5 million).
On February 16, 2007, the Company issued 2,250,000 flow-through
common shares for proceeds of $19.4 million before issue costs of
$1.0 million which will require the Company to incur $19.4 million of
flow-through share eligible Canadian Exploration Expenditures, as
defined in the Canadian Income Tax Act, by December 31, 2008.
Approximately $18.7 million in qualifying flow-through commitment has
been incurred as of March 31, 2008. As of March 31, 2008 the
$19.4 million had been renounced to shareholders and the related tax
impact of $5.0 has been recorded as a reduction to share capital.
8. ASSET RETIREMENT OBLIGATION
The Company has recorded an asset retirement obligation associated
with the present value of the estimated future costs to abandon its
petroleum and natural gas properties. To determine this obligation,
the Company used an inflation rate of two percent and a credit-
adjusted risk-free interest rate of seven percent to discount the
future estimated cash flows of $42.2 million (December 31, 2007:
$50.9 million), which will be paid over a period ranging from two to
forty-five years with the majority of costs being incurred between 12
and 16 years. The March 31, 2008 asset retirement obligation is
comprised of the following:
Balance at December 31, 2007 $ 13,827
---------------------------------------------------------------------
New liabilities added 190
Changes in estimates 59
Accretion of asset retirement obligation 197
Disposition of liabilities (3,335)
---------------------------------------------------------------------
Balance at March 31, 2008 $ 10,938
---------------------------------------------------------------------
9. SHARE CAPITAL
i) Issued and Outstanding Common Shares
Common Shares Amount
Balance at the end of December 31, 2007 57,839,731 $ 451,110
---------------------------------------------------------------------
Exercise of warrants 928,804 2,898
Tax effect of flow through shares - (4,952)
Adjustment to share capital for
warrants exercised - 892
Shares repurchased through normal course
issuer bid (322,700) (2,529)
Amortization of common shares held for
employee benefit plan - 29
---------------------------------------------------------------------
Balance at the end of March 31, 2008 58,445,835 $ 447,448
---------------------------------------------------------------------
ii) Normal Course Issuer Bid
In January, 2008 the Company announced its intention to
initiate a normal course issuer bid ("NCIB") to repurchase up
to 5,339,424 of its issued and outstanding common shares
(representing approximately 10 percent of the 58,184,217
outstanding common shares as of January 15, 2008, net of
4,789,977 common shares held by insiders as held in escrow)
through the facilities of the Toronto Stock Exchange ("TSX").
The bid commenced on January 18, 2008 and will terminate on
January 17, 2009 or such earlier time as the bid is completed
or terminated at the option of Kereco. 322,700 shares have been
purchased up to March 31, 2008 at an average cost of $3.95.
Subsequent to March 31, 2008, 145,835 shares have been
repurchased at an average cost of $4.26 up to May 12, 2008.
iii) Flow-through Common Shares
On February 16, 2007, the Company issued 2,250,000 flow-through
common shares for proceeds of $19.4 million before issue costs
of $1.0 million and the future tax impact and related reduction
to share capital in the amount of $5.0 was recorded in the
first quarter of 2008.
iv) Share Purchase Warrants
In conjunction with the private placement of non-voting shares
to employees, officers and directors on January 18, 2005, each
of the 2,507,692 common shares issued carried with them 0.83
share purchase warrants to purchase in the future one common
share at a price of $3.12 per share. On issuance, the share
purchase warrants were attributed a fair market value totaling
$1.8 million that will be recognized as stock-based
compensation expense over the vesting period of the warrants.
The fair value of $0.96 for each warrant was determined as of
the date they were issued using the Black-Scholes method with
the following assumptions: risk free interest rate -
3.25 percent, expected life - 4 years and volatility -
33 percent and dividend yield - nil. No estimate has been made
for forfeitures as they will be addressed when they occur. At
March 31, 2008 there were a total of 683,183 of these warrants
outstanding which are all exercisable.
In conjunction with the Chamaelo acquisition, 3,740,710
warrants held by previous officers, directors and employees of
Chamaelo were converted at an exchange rate of 0.51 into
1,907,762 (1,847,665 are outstanding at March 31, 2008)
warrants exercisable into Kereco common shares. The weighted
average post conversion exercise price of these warrants is
$10.28 per warrant.
Expiry Date Number of Exercise Contractual Warrants
Warrants Price Life Exercisable
(000s) ($/share) (years) (000s)
---------------------------------------------------------------------
January 18, 2009 683 3.12 0.8 683
May 26, 2009 279 4.12 1.2 279
June 21, 2010 1,569 11.37 2.2 1,569
---------------------------------------------------------------------
2,531 4.17 0.9 2,531
---------------------------------------------------------------------
---------------------------------------------------------------------
v) Stock-Based Compensation
The Company has a stock-based compensation plan under which
options to purchase common shares of the Company have been
granted to employees, officers and directors. Under the plan,
all options awarded have a maximum term of five years, and vest
over a three year period at a rate of one-third per year. At
March 31, 2008 the plan has 5,844,583 shares reserved for
issuance upon the exercise of options, of which 2,446,800 were
granted as at March 31, 2008.
Weighted Weighted
Average Average
Number Of Exercise Contractual
Options Prices Life
(000s) ($/share) (years)
---------------------------------------------------------------------
Balance at December 31, 2007 4,307 6.85 3.9
Granted - - -
Exercised - - -
Expired or cancelled (1,860) 6.9 3.7
---------------------------------------------------------------------
Balance March 31, 2008 2,447 6.80 3.6
---------------------------------------------------------------------
---------------------------------------------------------------------
During 2007, the Company implemented a Stock Appreciation
Rights ("SAR") plan under which rights were granted to officers
of Kereco. Under the plan, all rights granted have a maximum
term of five years, vest over a three year period at a rate of
one-third per year and provide for settlement in cash. In late
March 2007, 439,875 SARs were granted at a price of $5.79 and
in June 2007 853,875 SARs were granted at a price of $5.73.
612,500 SARs were cancelled in the quarter as a result of the
corporate repositioning process leaving 681,250 SARs
outstanding at March 31, 2008 at an average price of $5.75.
Compensation expense for options granted and share purchase
warrants issued by the Company is based on the estimated fair
values at the time of their grants and is recognized as expense
over the vesting periods of the options and share purchase
warrants. Compensation expense for SARs is calculated based
upon the intrinsic value and is recognized as expense over the
vesting periods of the SARs. The Company recognized
$0.1 million non-cash stock-based compensation expense recovery
in 2008 (March 31, 2007 - $1.0 million of expense) with an
equal amount recorded in contributed surplus. No expense was
recognized as stock based compensation expense from the SARs.
$892,000 was transferred out of contributed surplus to share
capital for employee warrants which were exercised in 2008. The
fair value of each option and share purchase warrant has been
determined as at each stock option grant date using a Black-
Scholes model. For the options currently outstanding, the
average terms used are: risk free interest rate - 2.56 percent,
expected life - 4 years, and volatility - 21 percent. The
weighted average fair value of the options outstanding is $2.71
per option. No estimate has been made for expected forfeitures
as they are addressed when they occur.
Additional details on the Company's stock options outstanding
at March 31, 2008 are as follows:
Weighted Weighted
Range of Average Average
Exercise Number of Exercise Contractual Options
Prices Options Price Life Exercisable
($/share) (000s) ($/share) (years) (000s)
---------------------------------------------------------------------
3.84 - 5.73 1,527 5.46 4.2 266
5.90 - 7.24 289 6.52 4.0 47
8.93 - 9.80 316 9.54 1.9 306
10.50 - 11.20 315 10.83 2.2 281
---------------------------------------------------------------------
3.84 - 11.20 2,447 6.80 3.6 900
---------------------------------------------------------------------
---------------------------------------------------------------------
vi) Employee Benefit Plan
During 2005, the Company created an employee benefit plan under
which Kereco common shares have and will from time to time be
purchased on behalf of certain employees. These shares will be
given to certain employees, on the basis of one third per year,
over a period not exceeding three years. To date 23,950 common
shares have been purchased for the plan at an average price of
$14.67 per common share. Of the 23,950 common shares, 14,402
have been issued to certain employees by December 31, 2007 and
9,548 are being held in trust. The purchase of the shares is
recorded as a reduction to shareholder's equity at the
purchased value of the common shares of $0.4 million and will
be amortized to general and administrative expense evenly over
the three year vesting period. At March 31, 2008 $29,000 has
been expensed and recorded to share capital (March 31, 2007:
$29,000).
vii) Cancellation and adoption of a new stock option plan
The Board of Directors has approved the conditional
cancellation of the currently outstanding options to be
replaced with the adoption of a new stock option plan. The
Board of Director's has also approved the conditional adoption
of a share unit plan. Both plans are to be voted upon at the
Company's Annual General Meeting to be held May 14, 2008.
viii) Per Share Amounts
The calculation of basic and diluted net earnings per share is
based on the weighted average number of common shares
outstanding as shown in the table below:
Three months ended March 31
2008 2007
---------------------------------------------------------------
Net loss (269) $ (1,934)
Net loss per share
Basic (0.01) $ (0.03)
Diluted (0.01) $ (0.03)
Weighted average shares outstanding
Basic 58,538,213 56,505,163
Options and warrants(1) - -
---------------------------------------------------------------
Diluted 58,538,213 56,505,163
Common shares outstanding at
period end
---------------------------------------------------------------
Basic 58,445,835 57,752,112
Options and warrants 4,977,648 6,162,247
---------------------------------------------------------------
Diluted 63,423,483 63,914,359
---------------------------------------------------------------
---------------------------------------------------------------
(1) Anti-dilutive incremental options and warrants in the
amount of 193,608 for the three months ended March 2008
(March 2007: 1,002,800) are excluded from the weighted
average diluted shares outstanding.
ix) Contributed Surplus
Amount
Balance at the end of December 31, 2007 $ 10,204
---------------------------------------------------------------
Stock based compensation expense 333
Stock based compensation expenses - reversals
from cancelled options (391)
Warrants exercised (892)
Shares repurchased through normal course issuer bid 1,255
---------------------------------------------------------------
Balance at the end of March 31, 2008 $ 10,509
---------------------------------------------------------------
10. SUPPLEMENTAL CASH FLOW INFORMATION
i) Changes in Non-Cash Working Capital
Three months ended March 31
2008 2007
---------------------------------------------------------------------
Decrease (increase) in non-cash working
capital:
Accounts receivable $ 14,648 $ (8,153)
Prepaid expenses 236 1,377
Advance payment for property disposition (17,000) -
Deferred charge 2,130 -
Accounts payable and accrued liabilities (11,479) 6,545
---------------------------------------------------------------------
Change in non-cash working capital $ (11,465) $ (231)
---------------------------------------------------------------------
Relating to:
Operating activities (8,290) $ 3,119
Financing activities 139 473
Investing activities (3,314) (3,823)
---------------------------------------------------------------------
Change in non-cash working capital (11,465) $ (231)
---------------------------------------------------------------------
---------------------------------------------------------------------
ii) Other Cash Flow Information
Three months ended March 31
2008 2007
---------------------------------------------------------------------
Cash taxes paid - $ -
Cash interest paid 1,039 $ 2,569
---------------------------------------------------------------------
---------------------------------------------------------------------
11. RISK MANAGEMENT & FINANCIAL INSTRUMENTS
The Company's financial instruments are comprised of cash and cash
equivalents, accounts receivable, accounts payable, bank debt,
convertible debentures and financial derivative contracts. These
financial instruments are valued at their appropriate fair values and
are assessed and managed to monitor and control their risk.
All of these financial instruments are recorded at a carrying value
which approximates their fair value. The fair values of cash and cash
equivalents, accounts receivable and accounts payable approximate
their carrying value due to the short terms to maturity. The
Company's bank debt is determined using floating prime rates and
therefore approximates its fair value. The financial derivative
contracts are recorded each balance sheet date at their fair value
using forward curve prices from the financial institutions that the
Company enters into the contracts with. The convertible debentures
are designated as other liabilities as financial instruments and are
recorded at their initial fair values upon inception and subsequently
carried at amortized cost. An independent fair valuation was made of
the debentures as of February 29, 2008, as a result of the offer to
purchase the outstanding debentures as indicated in note 6, which
gave a mid-point valuation of $922.50 per each $1,000 convertible
debenture. This would result in an approximate fair value of
$64,575,000 for the $70,000,000 in outstanding convertible
debentures.
Following are the main financial risks that the Company faces with
these financial instruments:
Credit Risk
Credit risk comes from the exposure the Company faces that a
counterparty to a financial asset will default on payment resulting
in a loss to the Company. Credit risk primarily relates to the
Company's sales receivables with third party marketers, account
receivables from joint venture partners and as well as counterparties
to any financial derivative contracts. The Company generally grants
unsecured credit but routinely assesses the financial strength of its
customers.
The Company sells the majority of its production to large
creditworthy petroleum marketers and all payments are made on the
25th day of the month following the month of production. The Company
historically has not experienced any collection issues with its
petroleum and natural gas marketers and intentionally uses several
marketers in order to diversify this risk. Collection of these
amounts is verified on the 25th day of each month. Financial
derivative contracts are only entered into with credit worthy
chartered banks. These payments or receipts are also distributed, at
the latest, within the first week following the month of production.
Collection of these amounts is verified on the 25th day of each
month.
Joint venture receivables are generated from conducting joint
operating or capital operations with joint venture partners.
Collections from these operations are usually paid within three
months of the joint venture bill being issued to the partner.
Circumstances can arise which extend the terms of collection beyond
this period as specific items on these joint venture billings need to
be resolved between partners. Smaller partners may be cash called to
pay for their share of costs in advance of a project as well. The
Company has the ability to take measures such as withholding
production volumes as recourse for collections on receivables as
well. The Company monitors receivables accounts and actively pursues
collection and payment. If any accounts are considered impaired they
will be charged to an allowance for doubtful accounts. At March 31,
2008 no allowance for doubtful accounts was recorded.
The Company assesses quarterly if there has been any impairment of
the financial assets of the Company. During the three month period
ended March 31, 2008 there was no impairment provision required on
any of the financial assets of the Company due to historical success
of collecting receivables. The Company does not have any significant
credit risk exposure to any single counterparty or any group of
counterparties having similar characteristics.
The maximum exposure to credit risk is represented by the carrying
amount on the balance sheet. There are no material financial assets
that the Company considers past due and at risk of collection.
Liquidity Risk
Liquidity risk entails the potential risk that the Company may not be
able pay for its liabilities including accounts payable, bank debt or
convertible debentures or that the Company may not be able to recover
its cash and cash equivalents.
The Company manages this risk by monitoring its cash position on an
ongoing basis to ensure that it has the liquidity available to match
all of its obligations. The Company is constantly updating its
capital and operating forecasts to monitor its cash, working capital
and net debt position. The credit facility in place with the banks as
discussed in note 5 is also monitored quarterly to ensure that it is
maintained within the parameters of the banking facility
requirements. Following is a list of the liabilities at March 31,
2008 and their due dates:
---------------------------------------------------------------------
Current
Within Within Within
Total one year 1-2 Years 2-5 Years Thereafter
---------------------------------------------------------------------
Accounts
payable and
accrued
liabilities 36,748 36,748 - - -
---------------------------------------------------------------------
Derivative
financial
instruments 10,441 9,716 725 - -
---------------------------------------------------------------------
Convertible
debentures 70,000 - - 70,000 -
---------------------------------------------------------------------
Total 117,189 46,464 725 70,000 -
---------------------------------------------------------------------
---------------------------------------------------------------------
Market Risk
Worldwide factors and local factors lead to market risk for the
Company with aspects such as oil and natural gas commodity prices,
interest rates, electrical prices and commodity prices. Changes in
these factors will have an impact on the Company's valuation of
financial instruments and it will also impact the debt levels of the
Company as well as its earnings and funds flow from operations.
Power Consumption price risk management
The Company has entered into a fixed forward contract to assist in
mitigating its exposure to price swings whereby approximately seventy
percent of its electricity requirements is fixed to
December 31, 2008. This power contract had a fair value gain of
$430,000 at March 31, 2008. Following are the terms of the contract:
---------------------------------------------------------------------
Pricing
Period Volume Type terms
---------------------------------------------------------------------
Electricity
---------------------------------------------------------------------
Jan 1, 2008 - Dec 31, 2008 3.5 MW Fixed Price $65.50/MWh
---------------------------------------------------------------------
Foreign Currency Exchange Risk
The prices received by the Company for the production of crude oil,
natural gas and natural gas liquids are primarily determined in
reference to U.S. dollars but are settled with the Company in
Canadian dollars. The Company's cash flow from commodity sales will
therefore be impacted by fluctuations in foreign exchange rates.
Foreign currency exchange rate risk is the risk that the funds flow
or the fair value of financial instruments will fluctuate as a result
of changes in foreign exchange rates. Sensitivities to foreign
exchange rate risk are monitored by management through its ongoing
forecasting and budgeting practices. The Company had no forward
exchange rate contracts in place as at or during the three months
ended March 31, 2008.
Commodity Price Risk
Most all the Company's revenue is from commodity sales. There is risk
that the associated revenue streams of these commodities will impact
related funds flows as well as the valuation of any commodity based
financial derivative contracts. Sensitivities to commodity price risk
are also monitored by management through its ongoing forecasting and
budgeting practices and monthly mark to market statements. Commodity
price risk is mitigated through the use of financial derivative sales
contracts. The Company's contracts in place as of March 31, 2008 are
as follows:
Oil and Natural Gas Price Risk Management
Pricing
Period Volume Type terms(1)
---------------------------------------------------------------------
Natural Gas
Apr 1, 2008 - Oct 31, 2008 1,000 Financial $7.25 -
GJ/day Collar $8.45
(AECO CDN$/GJ)
Apr 1, 2008 - Oct 31, 2008 1,000 Fixed Collar $8.01
GJ/day (AECO CDN$/GJ)
Crude Oil
Apr 1, 2008 - Dec 31, 2008 1,500 Financial $61.50 -
bbls/day Collar $78.88
(WTI US$/BBL)
Jan 1, 2009 - Dec 31, 2009 500 Financial $77.50 -
bbls/day Collar $103.95
(WTI US$/BBL)
---------------------------------------------------------------------
(1) Collar price indicates minimum floor and maximum ceiling.
These contracts have a fair value in the amount of a loss of
($10,870,000) as of March 31, 2008.
Interest Rate Risk
Interest rate risk is the risk that future cash flows will fluctuate
as a result of changes in market interest rates. The Company is
exposed to interest rate fluctuation on its bank debt which bears a
floating rate of interest based upon prime lending rates. The Company
is also exposed to interest rate fluctuations on its cash balances
which interest income is based upon. The Company had no interest rate
swap or financial contracts in place as at or during the three months
ended March 31, 2008.
Sensitivity Analysis
The following table illustrates the estimated quarterly impact that
would have resulted, for the three months ended March 31, 2008, to
net earnings from changes to commodity prices, interest rates, and
electrical prices as specified. Management uses increments of these
percentage or dollar amount changes internally when assessing and
reporting on risk as an assessment of risk from the reasonably
possible changes in these risk factors.
---------------------------------------------------------------------
($000s) Increase (decrease) in net earnings
---------------------------------------------------------------------
$0.10/GJ increase in AECO price 22
---------------------------------------------------------------------
$0.10/GJ decrease in AECO price (23)
---------------------------------------------------------------------
$1.00 increase in WTI oil prices (325)
---------------------------------------------------------------------
$1.00 weakening in WTI oil prices 351
---------------------------------------------------------------------
1.0 % increase in interest rates (24)
---------------------------------------------------------------------
1.0 % decrease in interest rates 24
---------------------------------------------------------------------
$1.00 increase in the electricity price per mwh 126
---------------------------------------------------------------------
$1.00 decrease in the electricity price per mwh (126)
---------------------------------------------------------------------
---------------------------------------------------------------------
Capital Management
The Company sets appropriate growth targets through investment in
operating and capital projects with the aim of providing value added
growth for shareholders. These objectives are pursued within the
context of a flexible capital structure. The Company's capital
structure is comprised of shareholder's equity, bank debt,
convertible debentures, cash and cash equivalents and working
capital. Consideration will be given to raising equity, buying back
shares, and adjusting its operating or capital expenditure programs
to manage its debt position. A key measure that the Company
constantly monitors its overall net debt and the ratio of it's net
debt to funds flow from operations.
Net debt and Funds Flow from operations are non GAAP financial
measures which are determined as follows: Funds flow from operations,
which is determined as cash provided by operating activities before
changes in non-cash working capital, is used by us as a key measure
of performance. Funds flow from operations does not have a
standardized meaning prescribed by Canadian Generally Accepted
Accounting Principles ("GAAP") and therefore may not be comparable
with the calculation of similar measures for other companies. Net
debt, which is determined as bank debt and working capital (comprised
of cash and cash equivalents, accounts receivable, prepaid expenses
and accounts payable) is used by management us as a key indicator of
the financial position of the Company. Net debt does not have a
standardized meaning prescribed by Canadian Generally Accepted
Accounting Principles ("GAAP") and therefore may not be comparable
with the calculation of similar measures for other companies.
The Company maintains an adequate capital structure to ensure it can
meet all future expenditures and to provide flexibility for its
forthcoming capital and operational programs The bank facility is
based upon the net present value of petroleum reserves which are
assessed twice annually, the most recent having been as of December
31, 2007. As at March 31, 2008 the Company is in a position of having
a positive cash balance and an undrawn bank facility of $100,000,000.
Management has an internal target of maintaining a net debt to
annualized funds flow from operations ratio of under 1:5 - 1:0. The
Company has met this ratio given the Company has at March 31, 2008,
no debt, excluding the convertible debentures, and a positive cash
and cash equivalent balance of $70.0 million.
12. COMMITMENTS AND GUARANTEES
On February 16, 2007, we issued 2,250,000 flow-through common shares
for proceeds of $19.4 million before issue costs of $1.0 million
which will require us to incur $19.4 million of flow-through share
eligible CEE, as defined in the Canadian Income Tax Act, by
December 31, 2008. As of March 31, 2008 approximately $18.7 million
in qualifying CEE expenditures related to this flow-through share
commitment have been incurred. We have also executed separate
contracts with two large drilling contractors for the exclusive use
of two specific drilling rigs. One contract is a three year contract
which commenced in December of 2006 and requires us to utilize the
rig for a minimum of 225 days per year. If not utilized we are
obligated to pay a minimum $5,800 rate per day. A second drilling
contract (which was for two years, commenced June 1, 2007 and
required Kereco to utilize the rig for a minimum of 225 days per year
for two years with a minimum rate per day of $4,785) was terminated
on March 11, 2008 and replaced with a new service rig contract. The
new contract will commence on June 1, 2008 and requires us to utilize
the rig for a total of 7,200 hours at a rate of $645 per hour. There
is no timeframe by which this rig capacity needs to be utilized by.
If we are unable to utilize the rig, a liability of $200 of per
unutilizable hour will result. Therefore the minimum payments under
the service rig contract will be $1,440,000.
During 2007, the Company signed a nine year office lease which
commences on February 15, 2008. Average annual payments under the
lease will be $1.5 million. Kereco is currently in negotiations to
sub-lease this nine year office lease.
Kereco has also fixed the price on approximately seventy percent of
its electricity requirements for a period which commenced on
February 1, 2006 and which ends on December 31, 2008.
Following are the future minimum payments required under these
drilling, office and electrical contracts; net of any prepayments:
Drilling Office Electrical
($000s) contracts lease Contract
---------------------------------------------------------------------
2008 $ 975 $ 1,075 $ 1,506
2009 $ 1,196 $ 1,433 $ -
2010-2016 $ - $ 9,962 $ -
Indeterminate $ 1,440 $ - $ -
---------------------------------------------------------------------
Total $ 3,611 $ 12,470 $ 1,506
---------------------------------------------------------------------
The Company has other commitments and guarantees in the normal course
of business which are not material, and are therefore not disclosed
here.
13. CONTINGENCIES
The Company has been served with two statements of claim totaling
$2.6 million. The Company has not provided for these claims in the
financial statements as it is believed the Company will be successful
in defending all of them. In the unlikely circumstance that the
Company is not successful in defending these claims, there is in
place adequate insurance coverage to mitigate any losses which may
result.
In the first quarter of 2008, the Company reached a favorable
settlement in the amount of $40,000 with respect to a former claim
filed in the amount of $1.0 million.
14. RELATED PARTY TRANSACTIONS
During 2007 and 2008, Kereco conducted business with a company
controlled by a director of Kereco. These transactions for drilling
services were made under normal business terms and conditions at the
same rates as with non-related parties. Capital additions to property
plant and equipment in the amount of $857,000 were conducted in 2007.
There were no amounts outstanding at March 31, 2008.
CORPORATE INFORMATION
Kereco Energy Ltd. is a Canadian energy company engaged in the
exploration, development and production of natural gas and crude oil.
The Company's common shares are listed on the Toronto Stock Exchange
under the trading symbol "KCO".
OFFICERS ENGINEERING CONSULTANTS
Darren W. Dittmer
Controller GLJ Petroleum Consultants Ltd.
Calgary, Alberta
Grant B. Fagerheim
President and
Chief Executive Officer LEGAL COUNSEL
Nathan R. MacBey Burnet Duckworth & Palmer LLP
Vice President, Negotiations Calgary, Alberta
David M. Mombourquette
Vice-President, REGISTRAR AND TRANSFER AGENT
Business Development
Computershare Trust Company of Canada
Kirby J. Wanner Calgary, Alberta
Chief Operating Officer
WARRANT AGENT
DIRECTORS
Valiant Trust Company
Daryl E. Birnie Calgary, Alberta
J. Paul Charron
STOCK EXCHANGE LISTING
Grant B. Fagerheim
Toronto Stock Exchange
Daryl H. Gilbert Trading Symbol "KCO"
Barry M. Heck
HEAD OFFICE
Brian M. Krausert
1100, 530 - 8th Avenue SW
Peter J. Kurceba Calgary, Alberta T2P 3S8
Gerry A. Romanzin Telephone: (403) 290-3400
Facsimile: (403) 290-3447
Grant A. Zawalsky Email: info@kereco.com
Website: www.kereco.com
AUDITORS
Deloitte & Touche LLP
Chartered Accountants
Calgary, Alberta
BANKERS
Bank of Montreal
Calgary, Alberta
Canadian Imperial Bank of Commerce
Calgary, Alberta
Société Générale (Canada Branch)
Calgary, Alberta
ABBREVIATIONS
AECO Alberta Energy Company interconnect with the Nova System
ARTC Alberta Royalty Tax Credit
bbls barrels mmbbls million barrels
bbls/day barrels per day
bcf billion cubic feet
boe barrels of oil equivalent (6mcf = 1bbl)
boe/day barrels of oil equivalent per day
GJ gigajoule
GJ/day gigajoule per day
kWh Kilo watt hour
mbbls thousand barrels
mboe thousand barrels of oil equivalent
mboe/day thousand barrels of oil equivalent per day
Mcf thousand cubic feet
mcf/day thousand cubic feet per day
mmboe million barrels of oil equivalent
mmbtu million British thermal units
mmcf million cubic feet
mmcf/day million cubic feet per day
MWh Mega watt hour
NGLs natural gas liquids
NI Canadian Securities Administrator's National Instrument
WI Working Interest
WTI West Texas Intermediate
%SEDAR: 00021661E
For further information: Grant B. Fagerheim, President and Chief
Executive Officer, Telephone: (403) 290-3401
