ITEM 1. BUSINESS
Earth Energy Reserves, Inc. was incorporated in the State of Nevada on February 12, 2002 as Wiltex First, Inc. On March 10, 2005, Earth Energy filed a certificate of amendment with the State of Nevada changing its name to Asian American Business Development Company. On March 13, 2006, Earth Energy filed a certificate of amendment with the State of Nevada changing its name to Earth Energy Reserves, Inc.
On December 16, 2005, Earth Energy elected to be regulated as a Business Development Company as that term is defined in Section 54 of the Investment Company Act. As a BDC, Earth Energy was subject to the laws and regulations contained in the Investment Company Act of 1940. As a BDC, Earth Energy became subject to significant regulation of its activities.
On February 10, 2006, the board of directors unanimously approved a proposal to withdraw Earth Energy's election to be treated as a BDC as soon as practicable, so that it might again conduct business as a regular company rather than as a BDC subject to the Investment Company Act.
Our current business plan has changed the nature of Earth Energy's business from investing, reinvesting, owning, holding, or trading in investment securities to an independent oil and gas company focused on the acquisition, drilling and production of oil and gas in the United States. We are particularly focused on the application of contemporary under-balanced horizontal drilling technology in developing unconventional gas resources, primarily coal bed methane (CBM) gas reservoirs. The board of directors believed that BDC regulation would be inappropriate for such activities.
Our principal geophysical areas of interest are Louisiana, Texas, Oklahoma, New Mexico, Arkansas, Alabama, West Virginia and Wyoming.
Our Business Strategy
Unconventional natural gas is located in areas where the permeability of the surrounding rock is too low to permit standard drilling techniques. As a result, extraction of this gas remained unprofitable until recently, when extraction technology evolved to the point where unconventional gas resources are now commercially viable. We believe unconventional gas will comprise an increasingly larger market share of the U.S. domestic natural gas market. In addition, according to NYMEX commodity futures prices, natural gas prices are forecasted to rise during the next several years as the country recovers from the recession that began in late 2007. We believe that these factors indicate that now the timing is optimal to acquire attractive unconventional natural gas resources on favorable terms.
The key elements of our business strategy are to:
- Acquire unexplored or overlooked leaseholds located in unconventional gas areas (in particular, CBM gas reserve areas) that hold low-risk promise of large and wide-spread accumulations of natural gas reserves.
- Target select producing unconventional gas fields that we identify as under-developed by their current operator and that we believe we can achieve well-above average returns by re-developing these fields.
- Focus on cost efficiency and strive to keep development costs as low as possible, with a goal of reaching one-fourth of the current industry standard.
We seek to be a low-cost developer of unconventional gas fields by applying the latest multi-lateral horizontal drilling methods, in combination with non-damaging under-balanced drilling techniques. We will aim to optimize capital efficiency as we develop the full reserve potential of each field. While our horizontal applications are presently more proven for CBM reservoirs, we may consider shale gas resources as well.
We conduct an initial screening of each potential leasehold whereby we determine whether a horizontal well will likely recover 16 times the reserves per well at only four times the capital investment of a vertical well. If the potential leasehold exceeds this threshold, we will undertake further investigation in order to evaluate whether the property meets our strategic and financial criteria.
We intend to control our overhead expenses and up-front costs in seismic data, hardware, software, geological and geophysical overhead and prospect generation. We also intend to outsource our geological, geophysical, reservoir engineering and land functions and to maintain tight control over general and administrative expenses.
Planned Property Acquisition. On July 26, 2011, Earth Energy entered into a letter of intent with a large mineral owner to enter an oil and gas lease of 71,900 acres in northern Louisiana for exploration and production of Coal Bed Methane reservoirs, known internally as the “NOLA-B” Project. The Company anticipates consummating the lease by October 26, 2011, with drilling to be initiated as soon as practical, but no later than one year from the lease date. An initial lease bonus payment of $719,000 will be paid by the Company upon signing of the lease.
On May 3, 2011, the Company entered into a letter of intent with an energy company to purchase various interests in producing oil and gas leases located in the state of Louisiana, internally known as the “NOLA-A” Project. Until the definitive purchase agreement is executed by both companies, either company may terminate the negotiations regarding this proposed transaction, with or without cause. The estimated purchase price is $1,050,000, subject to customary closing settlement adjustments. The Company anticipates signing the binding Purchase and Sale Agreement with the Seller on or about September 30, 2011, with closing anticipated at October 31, 2011.
In August 2010, the Company entered into a letter of intent with an energy company to purchase various interests in producing oil and gas leases located in the state of Louisiana, internally known as the “NOLA-C” Project, along with placing $100,000 earnest money deposit with the seller. On June 7, 2011, the negotiations and letter of intent were terminated, with the Company receiving a full refund of the $100,000 deposit. While the negotiations are presently in the terminated state, the Company is hopeful that the seller will in the future resume negotiations on what the Company considers an attractive acquisition candidate.
On April 21, 2011, the Company entered a letter of intent with an investment banking firm to secure an $8 million mezzanine debt facility to be used for the acquisition of the NOLA-A and NOLA-B properties, and early drilling operations on those properties. Presently, the institutional mezzanine lender is performing due diligence on the Company and the Properties, with anticipated closing of the debt facility in late October 2011.
Investing Activities. For the year ended June 30, 2011, the registrant did not undertake any investing activities.
Marketing and Pricing
Our future revenues will be derived principally from the sale of CBM natural gas. As a result, our revenues will be determined, to a large degree, by prevailing market prices for the gas. We intend to sell our gas under contractual arrangements or on the spot market at prevailing market prices. The price for gas is based on supply and demand, and we cannot accurately predict or control the price we may receive for our production.
Price decreases would adversely affect our revenues, cash flow, profits and the value of our reserves. Historically, and particularly in recent times, these commodity prices have fluctuated widely. Among the factors that can cause this volatility are:
- The domestic and foreign supplies of oil and gas,
- Overall economic conditions,
- Product demand,
- Weather conditions,
- The price and availability of competitive fuels,
- Political and economic conditions in the Middle East and other
producing regions,
- The level of oil and gas imports,
- Domestic and foreign governmental regulations,
- Potential price controls, and
- Environmental issues.
We may enter into hedging arrangements to reduce our exposure to decreases in the prices of oil and gas. Hedging arrangements may expose us to risk of financial loss in circumstances where:
- There is a change in the expected differential between the hedge price and the actual price of gas;
- Our production and/or sales are less than expected; and/or
- The counter party to the hedging contract defaults on its contractual obligations.
In addition, hedging arrangements may limit the benefit we would receive from increases in the prices of our production. On the other hand, we may choose not to engage in hedging transactions in the future. As a result, we may be more adversely affected by changes in prices than producers who engage in hedging transactions.
Competition
We will compete with numerous other companies in virtually all facets of our business. Our competitors in the exploration, development, acquisition and production business include major integrated companies as well as numerous large and small independents, including many that have significantly greater financial resources and in-house technical personnel.
Government Regulations
- Federal Income Tax. Federal income tax laws significantly affect oil and gas operators. The principal provisions that will affect us are those that permit us to deduct as incurred, rather than to capitalize and amortize, our intangible drilling and development costs and to claim 15% depletion on a portion of our oil and gas production.
- Environmental Matters. Oil and gas operations are subject to extensive federal regulation and, with respect to federal leases, to interruption or termination by governmental authorities on account of environmental and other considerations such as the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) also known as the “Super Fund Law.” The trend towards stricter standards in environmental legislation and regulation could increase our costs and others in the industry. Oil and gas lessees are subject to liability for the costs of clean-up of pollution resulting from a lessee’s operations, and may also be subject to liability for pollution damages. We intend to obtain insurance against costs of clean-up operations, but we have no such insurance at this time and it is unlikely that we will be able to fully insure against all such risks. A serious incident of pollution may also result in the Department of the Interior requiring lessees under federal leases to suspend or cease operation in the affected area.
The Oil Pollution Act of 1990 and regulations hereunder impose a variety of regulations on “responsible parties” related to the prevention of oil spills and liability for damages resulting from such spills in United States waters. The OPA assigns liability to each responsible party for oil removal costs and a variety of public and private damages. While liability limits apply in some circumstances, a party cannot take advantage of liability limits if the spill was caused by gross negligence or willful misconduct or resulted from violation of federal safety, construction or operating regulations.
Few defenses exist to the liability imposed by the OPA. In addition, to the extent we acquire offshore leases and those operations affect state waters, we may be subject to additional state and local clean-up requirements or incur liability under state and local laws. The OPA also imposes ongoing requirements on responsible parties, including proof of financial responsibility to cover at least some costs in a potential spill. We cannot predict whether the financial responsibility requirements under the OPA amendments will adversely restrict our proposed operations or impose substantial additional annual costs to us or otherwise materially adversely affect us.
Our operations will be subject to numerous federal, state and local laws and regulations controlling the discharge of materials into the environment or otherwise relating to the protection of the environment. Such laws and regulations, among other things, impose absolute liability on the lessee for the cost of clean-up of pollution resulting from a lessee’s operations, subject the lessee to liability for pollution damages, may require suspension or cessation of operations in affected areas, and impose restrictions on the injection of liquids into subsurface aquifers that may contaminate groundwater. Such laws could have a significant impact on our operating costs, as well as the oil and gas industry in general. Federal, state and local initiatives to further regulate the disposal of oil and gas wastes are also pending in certain jurisdictions, and these initiatives could have a similar impact on us. Our operations will also be subject to additional federal, state and local laws and regulations relating to protection of human health, natural resources, and the environment pursuant to which we may incur compliance costs or other liabilities.
Other Laws and Regulations. Various laws and regulations often require permits for drilling wells and also cover spacing of wells, the prevention of waste of gas and oil including maintenance of certain gas/oil ratios, rates of production and other matters. The effect of these laws and regulations, as well as other regulations that could be promulgated by the jurisdictions in which we have production, could be to limit the number of wells that could be drilled on our properties and to limit the allowable production from the successful wells completed on our properties, thereby limiting our revenues.
Employees
As of October 13, 2011, we had four employees, including the chairman of the board of directors, president and chief executive officer, vice president of investor relations and vice president of administration-interim CFO.
We intend to use the services of independent consultants and contractors to perform various professional services, including reservoir engineering, land, legal, accounting, environmental and tax services. [One Geologic Consultant, one engineering consultant and one accounting clerk are thus engaged on part-time Independent Contractor (1099) basis.]We will also seek alliances in the areas of geological and geophysical services and prospect generation, evaluation and prospect leasing. We intend to rely on third parties to drill, produce and market our gas and oil. We believe that by limiting our personnel costs, we should be able to better control total costs and retain project management flexibility.
We intend to add full time management and operations personnel in the future, as our business strategy is implemented.
ITEM 1A.
ITEM 1A. RISK FACTORS
Not applicable
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable
ITEM 2.
ITEM 2. PROPERTIES
Our corporate headquarters office is located at 621 17th Street, Suite 1640, Denver, CO 80293 These offices are approximately 2,357 square feet. These premises are leased on a 30 month basis commencing in August 2010 for the average monthly lease payment of $2,884.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The registrant is not involved in any legal proceedings at this date.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
For the year ended June 30, 2011 no matters were submitted to a vote of the registrant’s security holders, through the solicitation of proxies.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Item 5(a)
a) Market Information. The registrant’s common stock is not traded over the counter. We may apply for the listing of our common stock within the next twelve months.
b) Holders. At October 13, 2011, there were approximately 100 shareholders of the registrant.
c) Dividends. Holders of the registrant's common stock are entitled to receive such dividends as may be declared by its board of directors. No dividends on the registrant’s common stock have ever been paid, and the registrant does not anticipate that dividends will be paid on its common stock in the foreseeable future.
d) Securities authorized for issuance under equity compensation plans.
Not applicable.
e) Performance graph. Not applicable.
f) Sale of unregistered securities. In 2011, the Company sold 504,800 Series 2 units at $1.25 per unit to accredited investors in a Private Placement Memorandum. Each unit consisted of one common share and one Class B Warrant to purchase one share of the Company’s common stock at an exercise price of $1.75 per common share and one Class C Warrant to purchase one share of the Company’s common stock at $2.25 per share. The warrants were immediately exercisable for a term of three years.
As of June 30, 2011, the Company recorded proceeds of $393,089 net of fees of $421 from stock sales and recorded another $237,500 in common stock subscriptions. Cash proceeds from the common stock subscriptions were received by the Company subsequent to year end.
These securities were sold pursuant to an exemption from registration under Rule 506, Regulation D of the Securities Act of 1933 to accredited investors.
Item 5(b) Use of Proceeds. Not applicable.
Item 5(c) Purchases of Equity Securities by the issuer and affiliated purchasers. None.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable to a smaller reporting company.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Trends and Uncertainties. We intend to be an independent oil and natural gas company engaged in the acquisition, drilling and production of oil and natural gas in the United States. Our future operations may be adversely affected by our competitors, fluctuating oil prices, changing foreign political environments and any prolonged recessionary periods.
Capital and Source of Liquidity. We are evaluating and pursuing several acquisitions in conventional oil and gas reservoirs, with the intent to maintain diversification in our asset portfolio.
We believe that there will be sufficient capital from recent equity financing and the proposed equity and debt financing to conduct operations for the next twelve months.
Presently, proceeds of Earth Energy's equity financing and cash comprise all of the total cash necessary to conduct operations. Any proposed acquisitions will determine the amount of additional financing necessary to continue operations.
We are currently pursuing equity financing. The board of directors shall determine the amount and type of any additional financing necessary as our financial situation dictates.
Investing Activities. For the year ended June 30, 2011, the registrant made a deposit on the purchase of oil and gas property of $100,000. Negotiations on this property were terminated June 7, 2011 and the $100,000 deposit was refunded in full to the Company. As a result, the registrant had net cash used by investing activities of $0 for the year ended June 30, 2011.
For the six months ended June 30, 2010 and the year ended December 31, 2009, the registrant did not pursue any investing activities.
Financing Activities. For the year ended June 30, 2011, we sold common stock for cash in the amount of $393,089, received proceeds from subscriptions receivable of $965,000 and re-purchased and retired Series A Preferred Stock of $90,611. As a result, we had net cash flows from financing activities of $1,267,478 for the year ended June 30, 2011.
For the six months ended June 30, 2010, we sold common stock for $486,000. We re-purchased and retired Series A Preferred Stock of $15,000. As a result, we had net cash flows from financing activities of $471,000 for the six months ended June 30, 2010.
During the year ended December 2009, we sold common stock for $45,000.
Results of Operations. We have had only minimal revenue since inception. Until completion of our recent private offering, most of our expenses have been paid by Galaxy Partners Ltd. Corp, a company controlled by James Hogue, an officer, director and principal shareholder of Earth Energy and through the sale of our common stock. For the year ended June 30, 2011, six months ended June 30, 2010, and year ended December 31, 2009, Earth Energy received no revenues. For the year ended June 30, 2011, the registrant had general and administrative expenses of $507,129 compared to $208,460 for the six month period in 2010, or the $95,696 for the year ended December 31, 2009.
The expenses for the year ended June 30, 2011 consisted of salaries, stock based compensation, and the expense of hiring a geologist. For the year ended June 30, 2011, Earth Energy had salary expenses of $689,133 with stock based compensation valued at $2,001,233, compared to the total salary and stock based compensation of $0 for both the six months ended June 30, 2010 and the year ended December 31, 2009. Additionally, Earth Energy had geologist costs of $147,444, compared to $0 for the six months ended June 30, 2010 and the year ended December 31, 2009. The substantial increase in salaries and stock based compensation was due to the addition of four employees, compensation to our officers and directors and severance payments to a former officer and director.
Plan of Operation. We have developed an operating strategy that is based on acquiring underdeveloped oil and gas properties that include or are adjacent to existing active production, and are thus, lower risk but with attractive rates of return on the development potential. We have elected directors and appointed and hired officers and consultants with substantial experience in unconventional gas production, including coal bed methane reservoirs, plus the expertise in horizontal wellbore drilling, and we have correspondingly pursued several acquisitions in this arena. We are also evaluating and pursuing several acquisitions in conventional oil and gas reservoirs, with the intent to maintain diversification in our asset portfolio. We have a bias towards desiring to be the operator of the properties we are acquiring but are not exclusively against acquiring non-operated positions in oil and gas assets.
Earth Energy may experience problems; delays, expenses and difficulties sometimes encountered by an enterprise in Earth Energy's stage, many of which are beyond Earth Energy's control. These include, but are not limited to, unanticipated problems relating to additional costs and expenses that may exceed current estimates and competition.
Earth Energy is not delinquent in any of its obligations even though Earth Energy has generated no operating revenues. Earth Energy intends to pursue our business plan utilizing cash made available from the private sale of our securities and future operations. Our management is of the opinion that the proceeds of the sales of its securities and future revenues will be sufficient to pay our expenses for the next twelve months.
Earth Energy is pursuing financing for its operations and seeking additional private investments. In addition, Earth Energy is seeking to expand its revenue base. Failure to secure such financing or to raise additional equity capital and to expand its revenue base may result in the Corporation not being able pay its obligations.
Recent Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board issued Accounting Standards Update 2010-06, “Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements.” This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in Accounting Standards Codification 820.
ASU 2010-06 amends
ASC 820 to now require: (1) a reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and (2) in the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements. In addition, ASU 2010-06 clarifies the requirements of existing disclosures. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early application is permitted. The Company will comply with the additional disclosures required by this guidance upon its adoption in January 2010.
In June 2009, the FASB issued guidance under ASC 105, “Generally Accepted Accounting Principles.” This guidance established a new hierarchy of GAAP sources for non-governmental entities under the FASB Accounting Standards Codification. The Codification is the sole source for authoritative U.S. GAAP and supersedes all accounting standards in U.S. GAAP, except for those issued by the SEC. The guidance was effective for financial statements issued for reporting periods ending after September 15, 2009. The adoption had no impact on the Company’s financial position, cash flows or results of operations.
In August 2009, the FASB issued ASU No. 2009-05, “Fair Value Measurements and Disclosures (Topic 820) - Measuring Liabilities at Fair Value,” related to fair value measurement of liabilities. This update provides clarification that in circumstances in which a quoted price in an active market for an identical liability is not available, a reporting entity is required to measure fair value using one or more valuation techniques. This guidance is effective for the first reporting period beginning after issuance
In April 2009, the FASB updated its guidance under ASC 820, “Fair Value Measurements and Disclosures,” related to estimating fair value when the volume and level of activity for an asset or liability have significantly decreased and identifying circumstances that indicate a transaction is not orderly. The guidance was effective for interim and annual reporting periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. The adoption of this guidance did not have any impact on the Company’s results of operations
Also in April 2009, the FASB updated its guidance under ASC 825, “Financial Instruments,” which requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This guidance also requires those disclosures in summarized financial information at interim reporting periods. The guidance was effective for interim reporting periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009.
On December 31, 2008, the SEC published final rules and interpretations updating its oil and gas reporting requirements. Many of the revisions are updates to definitions in the existing oil and gas rules to make them consistent with the Petroleum Resource Management System, which is a widely accepted standard for the management of petroleum resources that was developed by several industry organizations. Key revisions include the ability to include nontraditional resources in reserves, the use of new technology for determining reserves, permitting disclosure of probable and possible reserves, and changes to the pricing used to determine reserves based on a 12-month average price rather than a period end spot price. The average is to be calculated using the first day-of-the-month price for each of the 12 months that make up the reporting period. The new rules are effective for annual reports for fiscal years ending on or after December 31, 2009. Early adoption is not permitted.
In the opinion of management, these statements will have no material effect on the financial statements of the registrant.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
EARTH ENERGY RESERVES, INC.
Index to the Financial Statements
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Balance Sheets, June 30, 2011 and 2010
Statements of Operations for the Year Ended June 30, 2011, Six Months Ended June 30, 2010, and the Year Ended December 31, 2009
Statements of Changes of Stockholders' Equity for the Year ended December 31, 2009, Six Months Ended June 30, 2010, and the Year Ended June 30, 2011
Statements of Cash Flows for the Year Ended June 30, 2011, Six Months Ended June 30, 2010, and the Year Ended December 31, 2009
Notes to Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Earth Energy Reserves, Inc.
Estes Park, Colorado
We have audited the accompanying balance sheets of Earth Energy Reserves, Inc. as of June 30, 2011 and 2010, and the related statements of operations, changes of stockholders’ equity, and cash flows for the year ended June 30, 2011, the six month period ended June 30, 2010 and the year ended December 31, 2009. Earth Energy Reserves, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Earth Energy Reserves, Inc. as of June 30, 2011 and 2010, and the results of its operations and its cash flows for the year ended June 30, 2011, the six month period ended June 30, 2010 and the year ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has generated minimal revenues from operations, has an accumulated deficit and a working capital deficiency at June 30, 2011, which raises substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. These financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/KWCO, PC
KWCO, PC
Odessa, Texas
October 13, 2011
EARTH ENERGY RESERVES, INC.
BALANCE SHEETS
EARTH ENERGY RESERVES, INC.
STATEMENTS OF CASH FLOWS (Continued)
EARTH ENERGY RESERVES, INC.
NOTES TO FINANCIAL STATEMENTS
June 30, 2011 and 2010
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Earth Energy Reserves, Inc., (the “Company”) formerly Asian American Business Development Company was incorporated in the State of Nevada on February 12, 2002 as Wiltex First, Inc. On March 10, 2005, the Company filed a certificate of amendment with the State of Nevada changing its name to Asian American Business Development Company and on March 13, 2006, the Company's name was changed to Earth Energy Reserves, Inc.
On August 11, 2010, the Company changed its fiscal year to June 30. These financial statements include the audited financial statements for the years ended December 31, 2009 and June 30, 2011, and the six month transition period ended June 30, 2010.
A related company owned by the major shareholder and the major shareholder of the Company, have managed and financed the Company since inception.
Purpose
In July 2007, the management of the Company made the decision to concentrate its efforts to enter the oil and gas industry. The Company intends to become an independent oil and natural gas company engaged in the acquisition, drilling and production of oil and gas, with areas of interest primarily in Texas, Oklahoma, Louisiana, Montana, and Wyoming. In 2007 the Company purchased two oil and gas leases and recognized its first oil revenues in November 2007. Subsequently, these leases were either sold or impaired. Currently the Company is negotiating the purchase of oil and gas leases in Louisiana.
Basis of Presentation
The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States for annual and transitional financial information and with the instructions to Form 10-K and Article 3 and 3-A of Regulations S-X.
Income Taxes
The Company provides for income taxes by utilizing the asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the period in which the differences are expected to effect taxable income.
Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
EARTH ENERGY RESERVES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2011 and 2010
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Use of Estimates and Assumptions
Management uses estimates and assumptions in preparing financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenue and expenses. Actual results could vary from the estimates used.
Net Loss Per Common Share
Diluted net (loss) earnings per share reflects the potential dilution of securities by adding common stock equivalents, including warrants in the weighted-average number of common shares outstanding for a period, if dilutive. All potentially dilutive securities have been excluded from the computation, as their effect is anti-dilutive for the year ended June 30, 2011, the six month transition period ended June 30, 2010 and for the years ended December 31, 2009.
Cash and Cash Equivalents
The Company considers any highly liquid investments with maturities of three months or less on the date of purchase to be cash equivalents. The Company had no cash equivalents at June 30, 2011 or 2010.
Concentration of Credit Risk and Fair Value of Financial Instruments
The Company maintains cash balances at financial institutions, which at times exceed federally insured amounts. The Company has not experienced any losses in such accounts.
The carrying amounts of financial instruments including cash, and accrued expenses approximate their fair values at June 30, 2011 and 2010.
In 2008, the Company adopted ASC 820 to increase consistency and comparability in fair value measurements and to expand disclosures about fair value measurements. ASC 820 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.
ASC 820 applies under other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements.
ASC 820 specifies a valuation hierarchy based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s own assumptions. These three types of inputs have created the following fair value hierarchy:
EARTH ENERGY RESERVES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2011 and 2010
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Level 1
Quoted prices in active markets for identical assets or liabilities.
Level 2
Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted price for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market date.
Level 3
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
The following table summarizes our financial assets and liabilities measured and reported in the Company’s statement of financial position at fair value as of June 30, 2011 and 2010 segregated among the appropriate levels within the fair value hierarchy:
Quoted Prices in
Active Markets for Identical Assets
Significant Other Observable Inputs
Significant Unobservable Inputs
(Level 1)
(Level 2)
(Level 3)
As of June 30, 2010:
Common Stock Issued for Rent
$ -
$25,000
$ -
As of June 30, 2011:
Stock Based Compensation
$ -
$2,001,233
$ -
The common shares issued for rent expense were priced at $1.00 per share which represented the current selling price of such shares to new investors.
Revenue Recognition
Oil, gas, and natural gas liquid revenues are recognized when the products are sold and delivery to the purchaser has occurred.
Oil and Gas Properties
The Company has adopted the full cost method of accounting for oil and gas properties. Accordingly, all costs associated with acquisition, exploration, development of oil and gas reserves, including directly related overhead costs and related asset retirement costs, are capitalized.
All capitalized costs of oil and gas properties, including the estimated future costs to develop proved reserves, are amortized on the unit-of-production method using estimates of proved reserves. Investments in unproved properties and major development projects are not amortized until proved reserves associated with the projects can be determined or until impairment occurs. If the results of an assessment indicate that the properties are impaired, the amount of the impairment is added to the capitalized costs to be amortized.
EARTH ENERGY RESERVES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2011 and 2010
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
In addition, the capitalized costs are subject to a “ceiling test”, which basically limits such costs to the aggregate of the “estimated present value,” discounted at a 10 percent interest rate of future net revenues from proved reserves, based on current economic and operating conditions, plus the lower of cost or fair market value of unproved properties.
Sales of proved and unproved properties are accounted for as adjustments of capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas, in which case the gain or loss is recognized in income.
Abandonments of properties are accounted for as adjustments of capitalized costs with no loss recognized.
Reclassification
Certain previously reported financial information has been reclassified to conform to the current year’s presentation. The impact of such reclassification was not significant to the prior years’ overall presentation.
Impairment of Long-Lived Assets
The Company adheres to guidance under ASC 360 in accounting for the impairment or disposal of long-lived assets. The guidance evaluates the carrying value of its oil and gas leases and equipment whenever a change in circumstances indicates that the carrying value may not be recoverable from the undiscounted future cash flows. If impairment exists, the net book values are reduced to fair values as warranted.
Stock Based Compensation
The Company records stock-based compensation in accordance with Share-Based Payments of the FASB Accounting Standards Codification, which requires the measurement and recognition of compensation expense based on estimated fair values for all shared-based awards made to employees and directors, including stock options and common stock issuances.
Share-Based Payments requires companies to estimate the fair value of the share-based awards on the date of grant using an option-pricing mode. The Company uses the Black-Scholes option-pricing model as its method of determining fair value. This model is affected by the Company’s stock price as well as assumptions regarding a number of subjective variables. These subjective variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. The value of the portion of the award that is ultimately expected to vest is recognized as an expense in the statement of operations over the requisite service period.
All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable.
EARTH ENERGY RESERVES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2011 and 2010
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Recent Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06, “Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements.” This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in Accounting Standards Codification (“ASC”) 820. ASU 2010-06 amends ASC 820 to now require: (1) a reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and (2) in the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements. In addition, ASU 2010-06 clarifies the requirements of existing disclosures. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early application is permitted. The Company has complied with the additional disclosures required by this guidance upon its adoption in January 2010.
In June 2009, the FASB issued guidance under ASC 105, “Generally Accepted Accounting Principles.” This guidance established a new hierarchy of GAAP sources for non-governmental entities under the FASB Accounting Standards Codification. The Codification is the sole source for authoritative U.S. GAAP and supersedes all accounting standards in U.S. GAAP, except for those issued by the SEC. The guidance was effective for financial statements issued for reporting periods ending after September 15, 2009. The adoption had no impact on the Company’s financial position, cash flows or results of operations.
In August 2009, the FASB issued ASU No. 2009-05, “Fair Value Measurements and Disclosures (Topic 820) - Measuring Liabilities at Fair Value,” related to fair value measurement of liabilities. This update provides clarification that in circumstances in which a quoted price in an active market for an identical liability is not available, a reporting entity is required to measure fair value using one or more valuation techniques. This guidance is effective for the first reporting period beginning after issuance.
In April 2009, the FASB updated its guidance under ASC 820, “Fair Value Measurements and Disclosures,” related to estimating fair value when the volume and level of activity for an asset or liability have significantly decreased and identifying circumstances that indicate a transaction is not orderly. The guidance was effective for interim and annual reporting periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. The adoption of this guidance had no impact on the Company’s results of operations.
Also in April 2009, the FASB updated its guidance under ASC 825, “Financial Instruments,” which requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This guidance also requires those disclosures in summarized financial information at interim reporting periods. The guidance was effective for interim reporting periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. The adoption of this guidance had no impact on the Company’s results of operations.
EARTH ENERGY RESERVES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2011 and 2010
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)
Recent Accounting Pronouncements
On December 31, 2008, the SEC published final rules and interpretations updating its oil and gas reporting requirements. Many of the revisions are updates to definitions in the existing oil and gas rules to make them consistent with the Petroleum Resource Management System, which is a widely accepted standard for the management of petroleum resources that was developed by several industry organizations. Key revisions include the ability to include nontraditional resources in reserves, the use of new technology for determining reserves, permitting disclosure of probable and possible reserves, and changes to the pricing used to determine reserves based on a 12-month average price rather than a period end spot price. The average is to be calculated using the first day-of-the-month price for each of the 12 months that make up the reporting period. The new rules are effective for annual reports for fiscal years ending on or after December 31, 2009. Early adoption is not permitted.
In the opinion of management, these topics have no impact on the financial statements of the Company.
NOTE 2: GOING CONCERN
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which contemplates continuation of the Company as a going concern. Since inception, the Company has incurred net operating losses. The future success of the Company will depend on its ability to attain additional capital, or to find an acquisition to add value to its present shareholders and ultimately, upon its ability to attain future profitable operations.
NOTE 3: RELATED PARTY TRANSACTIONS
In March 2010, the Company issued 138,191 of its Series A Preferred Stock in settlement of outstanding related party debt of $129,411 plus accrued interest of $8,780. In the six month period ended June 30, 2010, 15,000 shares of Series A Preferred Stock were re-purchased at $1.00 per share. There were 90,611 shares of the Series A Preferred Stock re-purchased at $1.00 per share during the year ended June 30, 2011. The preferred shares were issued to the Company’s majority shareholder and an entity wholly owned by that same shareholder. The preferred shares were valued and are redeemable at $1 per share. Valuation of these shares was based on the subscription price of common shares sold. The following is a detail of that transaction:
Note Payable Related Party
Majority Shareholder
Accrued Majority Shareholder
Series A Preferred Stock
Balance, December 31, 2009
$96,960
$32,450
$5,192
Accrued Interest at 8%
-
-
3,589
Related Party Debt Converted to Series A Preferred Stock
$96,960
$32,450
$8,781
$138,191
=======
======
======
=======
EARTH ENERGY RESERVES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2011 and 2010
NOTE 4: FEDERAL INCOME TAXES
Total income tax benefit is less than the amount computed by multiplying the loss before income taxes by the statutory federal income tax rate. The reasons for the difference and the related tax effects for the year ended June 30, 2011, the six month period ended June 30, 2010 and for the year ended December 31, 2009 are:
Tax benefit at statutory rates of 34%
$1,137,074
$72,861
$38,770
Non-deductible expense
(34,000)
(8,500)
-
Change in valuation allowance
(1,103,074)
(64,361)
(38,770)
Net income tax benefit
$ -
$ -
$ -
========
======
======
The components of the deferred tax assets are as follows:
June 30,
June 30,
December 31,
Deferred Tax Assets
Net Operating Loss Carryforward
$1,463,517
$342,169
$277,808
Other
-
18,274
18,274
Total Deferred Tax Assets
1,463,517
360,443
296,082
Less Valuation Allowance
(1,463,517)
(360,443)
(296,082)
$ -
$ -
$ -
========
=======
=======
The Company has no deferred tax liabilities.
At June 30, 2011, the Company had federal income tax net operating loss carryforwards of approximately $1,463,000 to offset future taxable income, which begins to expire in 2024; therefore, there was no income tax expense or payable as of June 30, 2011.
NOTE 5: STOCKHOLDERS’ EQUITY
The Company had the following stock transactions during the year ended June 30, 2011:
Effective July 1, 2010 and with shareholder approval, the Company entered into a quasi-reorganization (also referred to as a corporate adjustment). As a result of the quasi-reorganization all prior period losses charged to retained deficit were eliminated against additional paid-in capital. A quasi-reorganization requires that retained earnings be dated for ten years after the quasi-reorganization takes place.
EARTH ENERGY RESERVES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2011 and 2010
NOTE 5: STOCKHOLDERS’ EQUITY-(Continued)
The following is the effect of the quasi-reorganization of the Company at July 1, 2010:
Prior to Quasi-Reorganization
Adjustment
Subsequent to Quasi-Reorganization
Series A Preferred Stock
$ 12
$ -
$ 12
Common Stock
1,107
-
1,107
Additional Paid-In Capital
7,248,354
6,058,126
1,190,228
Retained Deficit
6,058,126
6,058,126
-
Total Stockholders' Equity
$1,191,347
$ -
$1,191,347
=========
========
=========
In 2011, the Company sold 504,800 Series 2 units at $1.25 per unit to accredited investors in a Private Placement Memorandum. Each unit consisted of one common share and one Class B Warrant to purchase one share of the Company’s common stock at an exercise price of $1.75 per common share and one Class C Warrant to purchase one share of the Company’s common stock at $2.25 per share. The warrants were immediately exercisable for a term of three years.
As of June 30, 2011, the Company recorded proceeds of $393,089 net of fees of $421 from stock sales and recorded another $237,500 in common stock subscriptions. Cash proceeds from the common stock subscriptions were received by the Company subsequent to year end.
100,000 shares of the Company’s common stock were issued to a former employee of the Company pursuant to an employee agreement. The shares vested at July 1, 2010 and were valued at $99,022 using the Black-Scholes pricing model with a volatility of 147.89%. The same employee was granted 8,331 options valued at $4,430 using the same Black-Scholes pricing model with a volatility of 147.89%.
Stock based employee compensation has been recorded in the amount of $2,001,233.
The Company had the following stock transactions during the six month period ended June 30, 2010.
Issued 101,982 shares of the Company’s common stock in settlement of accrued compensation of $75,000 plus accrued interest $26,982.
Issued 138,191 shares of Company’s Series A Preferred Stock in settlement of outstanding related party debt of ($129,411) plus accrued interest ($8,780). The shares were issued to the Company’s majority shareholder and an entity which is one hundred percent (100%) owned by the majority shareholder. The preferred shares are redeemable at the option of the Company in the future at $1.00 per share.
The Company repurchased and retired 15,000 shares of its Series A Preferred Stock. The preferred shares were re-purchased at $1.00 per share.
The Company issued 25,000 of its Series 1 units for office rent valued at $1.00 per unit ($25,000). Each unit consists of one common share and one warrant to purchase one common share at an exercise price of $1.50 per common share.
EARTH ENERGY RESERVES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2011 and 2010
NOTE 5: STOCKHOLDERS’ EQUITY-(Continued)
In order to raise additional capital in 2010, the Company sold 1,466,000 Series 1 units at $1 per unit to accredited investors. Each unit consisted of one common share and one warrant to purchase one common share at an exercise price of $1.50 per common share. The warrants were immediately exercisable for a term of three years.
As of June 30, 2010, the Company recorded proceeds of $501,000 from stock sales and recorded another $965,000 in common stock subscription. Cash proceeds from the common stock subscriptions were received by the Company subsequent to year end.
Stock Based Compensation
On July 1, 2010, the Company awarded 4,300,000 shares of the Company’s common stock and 1,183,331 options to purchase the Company’s common stock as incentives pursuant to employment agreements for several of its key employees, officers, and directors. These shares and options vest as follows:
Years Ended July 31
Shares
Options
100,000
258,333
100,000
158,333
100,000
158,334
2,666,000
100,000
2015-2019
1,334,000
500,000
4,300,000
1,175,000
=======
=======
The stock options and common shares were valued using the Black-Scholes pricing model with a volatility of 147.89%, a risk-free interest rate of .22%, a five year expected life and no expected annual dividend. For the year ended June 30, 2011 stock-based compensation was valued at $1,507,331 for the common shares and $493,902 for the stock options for the year ended July 31, 2011. There was no stock-based compensation expense for the six-month period ended June 30, 2010.
Warrants
When the Company sells common stock to investors, each investor receives three year warrants to purchase an equal number of shares of the Company’s common stock. Warrants issued in 2009 and 2010 have an exercise price of $1.50. Class B warrants issued in 2011 have an exercise price of $1.75 and Class C warrants also issued in 2011 have an exercise price of $2.25.
EARTH ENERGY RESERVES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2011 and 2010
NOTE 5: STOCKHOLDERS’ EQUITY-(Continued)
The following is a summary of warrant activity:
Number of Warrants
Warrants Outstanding, December 31, 2008
542,000
Issuances
45,000
Expirations
(482,000)
Warrants Outstanding, December 31, 2009
105,000
Issuances
1,491,000
Expirations
(10,000)
Warrants Outstanding, June 30, 2010
1,586,000
Issuances
1,009,600
Expirations
(25,000)
Warrants Outstanding, June 30, 2011
2,570,600
Warrants issued in 2007 expired in 2010 and warrants issued in 2008 expired in 2011. Warrants issued in 2009, 2010 and 2011 expire in 2012, 2013, and 2014, respectively.
NOTE 6: STOCK OPTION PLAN
On May 1, 2005, the Board of Directors adopted the Company's 2005 non-statutory stock option plan ("Plan") whereby the Company reserved 5,000,000 of its authorized but un-issued common stock for issuance under the Plan. As of June 30, 2011, 2010, and December 31, 2009, no stock options were granted under the Plan.
NOTE 7: SUBSEQUENT EVENTS
On May 3, 2011, the Company entered into a letter of intent with an energy company to purchase various interests in producing oil and gas leases located in the state of Louisiana, internally known as the “NOLA-A” Project. Until the definitive purchase agreement is executed by both companies, either company may terminate the negotiations regarding this proposed transaction, with or without cause. The estimated purchase price is $1,050,000, subject to customary closing settlement adjustments. The Company anticipates signing the binding Purchase and Sale Agreement with the Seller on or about September 30, 2011, with closing anticipated at October 31, 2011.
On July 26, 2011 the Company entered into a letter of intent with a large mineral owner to enter an oil and gas lease of 71,900 acres in northern Louisiana for exploration and production of Coal Bed Methane reservoirs, known internally as the “NOLA-B” Project. The Company anticipates consummating the lease by October 26, 2011, with drilling to be initiated as soon as practical, but no later than one year from the lease date. An initial lease bonus payment of $719,000 will be paid by the Company upon signing of the lease.
EARTH ENERGY RESERVES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2011 and 2010
NOTE 7: SUBSEQUENT EVENTS (continued)
In August 2010, the Company entered into a letter of intent with an energy company to purchase various interests in producing oil and gas leases located in the state of Louisiana, internally known as the “NOLA-C” Project, along with placing $100,000 earnest money deposit with the seller. On June 7, 2011, the negotiations and letter of intent were terminated, with the Company receiving a full refund of the $100,000 deposit. While the negotiations are presently in the terminated state, the Company is hopeful that the seller will in the future resume negotiations on what the Company considers an attractive acquisition candidate.
On April 21, 2011, the Company entered a letter of intent with an investment banking firm to secure an $8 million mezzanine debt facility to be used for the acquisition of the NOLA-A and NOLA-B properties, and early drilling operations on those properties. Presently, the institutional mezzanine lender is performing due diligence on the Company and the Properties, with anticipated closing of the debt facility in late October 2011.
On July 15, 2011, the Company engaged the services of Heritage Fincorp to act as Managing Broker Dealer in the raising of $15 million (with optional extension to a $30 million offering) in equity, via Private Placement. The July 1, 2011 Private Placement Memorandum offers the Company’s Series 3 Units, consisting of one common share of the Company’s Stock and two warrants to purchase shares of stock. Series 3 Units are priced at $1.50 each, with an initial 10 million Units offered, with optional extension to 20 million Units.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures:
Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of June 30, 2011. Based on this evaluation, our chief executive officer and chief principal financial officer have concluded such controls and procedures to be effective as of June 30, 2011 to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms and to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting:
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is the process designed by and under the supervision of Steven A. Kranker, Principle Executive Officer, and Doyle Pennington, the Interim Principal Financial Officer. It is their responsibility to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external reporting in accordance with accounting principles generally accepted in the United States of America. Mr. Kranker and Mr. Pennington have evaluated the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control over Financial Reporting - Guidance for Smaller Public Companies.
Mr. Kranker and Mr. Pennington assessed the effectiveness of our internal control over financial reporting as of June 30, 2011, and concluded that it is effective for the reasons discussed above.
This annual report does not include an attestation report of the registrant’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the registrant’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the registrant to provide only management’s report in this annual report.
Evaluation of Changes in Internal Control over Financial Reporting:
Steven A. Kranker, Principle Executive Officer, and Doyle Pennington, the Interim Principal Financial Officer, have evaluated changes in our internal controls over financial reporting that occurred during the year ended June 30, 2011. Based on that evaluation, Mr. Kranker and Mr. Pennington, or those persons performing similar functions, did not identify any change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Important Considerations:
The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, there can be no assurance that any system of disclosure controls and procedures or internal control over financial reporting will be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS, CONTROL
PERSONS AND CORPORATE GOVERANCE; COMPLIANCE WITH
SECTION 16(a) OF THE EXCHANGE ACT
Our management consists of:
Name
Title
Term
James E. Hogue, age 75
Chairman of the Board
Inception to Present
Chief Executive Officer, Controller, Chief Financial Officer
Inception to June 30, 2010
James R. Phillips, age 63
Vice President, Secretary/ Treasurer and Director
Inception to present
Steven A. Kranker, age 50
Chief Executive Officer, President and Director
July 1, 2010 to present
Doyle Pennington, age 66
Interim Chief Financial V.P. of Administration and Investor Relations and Director
July 1, 2010 to present
James E. Hogue, Chairman and President
Mr. Hogue has served as chairman of Earth Energy since inception. He has over 40 years experience in the petroleum industry, prior to founding Earth Energy Reserves. He is currently President of Galaxy Partners Limited Corp, an advisory service to public companies. From 1996 to 1999 he was President, Chief Operating Officer and a Director of Cotton Valley Resources Corporation, a publicly traded oil and gas exploration and production company. Mr. Hogue earlier served as an officer of several energy companies: Martex Oil and Gas, Inc (President), Mayco Petroleum, Inc (President and Founder), Union Crude Oil Company (President), and Hogue Diamond Drill Bit Manufacturing Company (President), as well as relevant experience employed with Sargent Diamond Bit, Inc. (Core Engineer) and Leatherwood Company (Driller).
James R. Phillips, Jr., Vice President, Secretary, Treasurer and Director
Mr. Phillips has served as Secretary/Treasurer of the Company since March 2005. Prior to joining us, from 1984 to 2005, Mr. Phillips was a financial consultant, registered investment advisor at E. F. Hutton and Raymond James and Associates, Inc., Waco, Texas. Mr. Phillips holds numerous business registrations and licenses, including Registered Securities Representative, Registered Investment Advisor, Securities Licenses Series Seven, Series Six, Series 24, Insurance and Annuities. Mr. Phillips graduated from Texas Tech University with a Bachelor of Business Administration in Finance and Banking.
Steven A. Kranker, Chief Executive Officer, President and Director
Mr. Kranker has over 25 years of broad oil and gas experience with major and large independent E&P companies in roles of increasing responsibility. Prior to joining EER, he served as the Corporate Engineering Manager for Forest Oil Corp., with expertise in acquisition and divestiture evaluation, petroleum property optimization and valuation studies, SEC reserve reporting and associated bank credit facilities. Mr. Kranker was responsible for the oil and gas reserves and economic evaluations in $4 billion in acquisition transactions and $3 billion in divestitures during the past five years, with recent emphasis on the assessment of horizontal drilling in unconventional gas plays. Previous service includes Senior Reservoir Engineer in numerous locations with exposure to a variety of petroleum reservoirs with Brunei Shell Petroleum, Arco Alaska, Maxus Exploration, Conoco and Shell. He holds a Bachelor of Science degree in Petroleum Engineering from the Colorado School of Mines.
Doyle Pennington, Vice President of Administration and Investor Relations and Director.
Mr. Pennington specializes in strategic planning and management of domestic and international special projects for non-profit organizations. He has worked for agencies of the Southern Baptist Convention and other non-profit organizations including the Religious Heritage of America Foundation, Mission America Coalition, the Consortium for Global Education, the International Evangelism Association, Touch the World Ministries, Global Resources Ministries, and the National Christian Foundation. Mr. Pennington has established mission funds to ten state conventions and has managed and coordinated numerous projects and special events for various agencies of the Southern Baptist Convention. He has been a hotel owner-operator of Holiday Inns and apartment complexes, and has developed, owned and managed commercial real estate properties for many years. Mr. Pennington holds a BBA from the University of Mississippi.
All directors hold office until the completion of their term of office, which is not longer than three years, or until their successors have been elected and have been qualified. All officers are appointed annually by the board of directors and, subject to existing employment agreements, serve at the discretion of the board. Currently, directors receive no compensation.
Committees of the Board of Directors
Concurrent with having sufficient members and resources, Earth Energy’s board of directors will establish an audit committee, investment committee and a compensation committee. The audit committee will review the results and scope of the audit and other services provided by the independent auditors and review and evaluate the system of internal controls. The investment committee will review and approve all investments in excess of $25,000 and assist in determining the carrying values of portfolio investments. The compensation committee will manage the stock option plan and review and recommend compensation arrangements for the officers.
No final determination has yet been made as to the memberships of these committees or when we will have sufficient members to establish committees.
All directors will be reimbursed by Earth Energy for any expenses incurred in attending directors' meetings provided that Earth Energy has the resources to pay these fees. Earth Energy will consider applying for officers and directors liability insurance at such time when it has the resources to do so.
Stock Option Plan
On May 1, 2005, the board of directors adopted Earth Energy 2005 non-statutory stock option plan whereby Earth Energy reserved 5,000,000 of its authorized but un-issued common stock for issuance under the Plan. As of June 30, 2011, no stock options were granted under the plan.
Section 16(a) Beneficial Ownership Reporting Compliance
Under Section 16(a) of the Securities Exchange Act of 1934, as amended, an officer, director, or greater-than-10% shareholder of the registrant must file a Form 4 reporting the acquisition or disposition of registrant's equity securities with the Securities and Exchange Commission no later than the end of the second business day after the day the transaction occurred unless certain exceptions apply. Transactions not reported on Form 4 must be reported on Form 5 within 45 days after the end of the registrant's fiscal year. Such persons must also file initial reports of ownership on Form 3 upon becoming an officer, director, or greater-than-10% shareholder. To our knowledge, based solely on a review of the copies of these reports furnished to it, our officers, directors and 10% control persons have not complied with applicable Section 16(a) filing requirements during the years ended June 30, 2011. The officers, directors and 10% control persons have represented that the required reports will be filed on or before October 20, 2011.
Code of Ethics Policy
We have not yet adopted a code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions.
Corporate Governance
There have been no changes in any state law or other procedures by which security holders may recommend nominees to our board of directors. In addition to having no nominating committee for this purpose, we currently have no specific audit committee and no audit committee financial expert. Based on the fact that our current business affairs are simple, any such committees are excessive and beyond the scope of our business and needs.
Indemnification
The registrant shall indemnify to the fullest extent permitted by, and in the manner permissible under the laws of the State of Nevada, any person made, or threatened to be made, a party to an action or proceeding, whether criminal, civil, administrative or investigative, by reason of the fact that he is or was a director or officer of the registrant, or served any other enterprise as director, officer or employee at the request of the registrant. The board of directors, in its discretion, shall have the power on behalf of the registrant to indemnify any person, other than a director or officer, made a party to any action, suit or proceeding by reason of the fact that he/she is or was an employee of the registrant.
Insofar as indemnification for liabilities arising under the Act may be permitted to directors, officers and controlling persons of the registrant, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceedings) is asserted by such director, officer, or controlling person in connection with any securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issues.
INDEMNIFICATION OF OFFICERS OR PERSONS CONTROLLING THE REGISTRANT FOR LIABILITIES ARISING UNDER THE SECURITIES ACT OF 1933, IS HELD TO BE AGAINST PUBLIC POLICY BY THE SECURITIES AND EXCHANGE COMMISSION AND IS THEREFORE UNENFORCEABLE.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
As of June 30, 2010, no officer, director or employee had received any cash compensation, and no director, officer or employee had a contract or commitment to receive annual compensation in excess of $100,000.
Employment Agreement for Steven A. Kranker
In July 2010, we entered into an employment agreement with Mr. Steven A. Kranker, our president and chief executive officer. Mr. Kranker’s employment agreement is a four year term and provides that he will receive:
(1) $260,000 per annum base salary (which amount may be increased or decreased under certain circumstances), plus bonus payments or incentive compensation as may be determined from time to time by our board of directors;
(2) a grant of nonqualified stock options to purchase 1,000,000 shares of our common stock, at an exercise price of $1.00 per share. 100,000 of the options vested on the date of the agreement, and 100,000 of the options will vest on January 1, 2011 and each January 1 thereafter until all such nonqualified stock options are fully vested. If any nonqualified stock options have not vested and Mr. Kranker ceases to be employed by us, the unvested options will fully vest on the date of such termination;
(3) 4,000,000 Earth Energy common shares, fully paid and nonassessable, for a purchase price of $400, payable in cash at the time of issue, which restricted shares shall remain unvested and subject to forfeiture upon termination of Mr. Kranker’s employment unless one of the following events occurs prior to such termination:
(a) Mr. Kranker continues to be employed by us on February 1, 2013, in which event 665,000 shares will vest on that date and become nonforfeitable, with the remaining shares vesting in equal installments of 667,000 shares on the first day of every third month thereafter so long as Mr. Kranker continues to be employed by us; or
(b) Our common shares are traded on a national stock exchange and the average reported closing price of our common shares on the principal stock exchange or other market is $5.00 or more for 20 consecutive trading days, in which event (i) 50% of the shares will become vested and nonforfeitable on that date, and (ii) the remaining 50% of the shares will become vested and nonforfeitable on the January 1 immediately following the date on which the first 50% of the shares vested. Upon Mr. Kranker’s termination or demotion coincident with a change of control, all unvested shares shall immediate become vested and nonforeitable.
Effective July 1, 2010, the Company entered into an offer of employment letter with its Executive Vice President and Chief Financial Officer.
The offer of employment letter provides for the following:
1. Beginning base salary of $125,000 per year until the Company has successfully raised $5 million in capital, at which time the salary will be raised to $175.000.
2. An initial grant of 2,000,000 shares of restricted Company common stock to vest over a four year period.
3. A grant of nonqualified stock options for 75,000 shares of Company stock with an exercise price of $1.00 expiring in ten years. Options vest quarterly over three years of service.
Effective October 28, 2010, William A. Sikora was no longer an officer of the Company. As of that date, Mr. Sikora had been awarded 100,000 vested shares and 8,331 stock options, with the balance of the prior grants being forfeited upon his departure.
Effective July 1, 2010, the Company entered into an offer of employment letter with its Chairman of the Board. The terms of the offer of employment letter provide for an annual salary of $175,000 and a grant of 75,000 nonqualified stock options. Stock options have a 10 year expiration, a $1.00 exercise price, and a 3 year vesting schedule.
Effective July 1, 2010, the Company entered into an offer of employment letter with the Vice President of Administration. The offer of employment letter provides for an annual salary of $120,000, 50,000 nonqualified stock options, and a grant of 200,000 shares of the Company’s restricted common shares to be earned over a 2 year vesting schedule. Stock options have a 10 year expiration, a $1.00 exercise price, and a 3 year vesting schedule.
Board of Directors Compensation. Currently board members receive no special compensation for meetings or time incurred. Director liability insurance may be provided to all members of the board of directors.
Outstanding Equity Awards
The following table sets forth the outstanding stock options to the registrant's officers and directors:
Option Awards
In July 2010, we issued incentive stock options to purchase 1,250,000 common shares to our officers and directors.
Outstanding Equity Awards at October 13, 2011
Name
Number of Securities Underlying Unexercised Options/ Exercisable
Number of Securities Underlying Unexercised Options/ Unexercisable
Option Exercise Price
Option Expiration Date
James E. Hogue
75,000
-
1.00
-
James Phillips
50,000
-
1.00
-
Steven A. Kranker
1,000,000
-
1.00
(1)
W.A. Sikora
8,313
-
1.00
Doyle Pennington
50,000
-
1.00
(1)100,000 of the options vested on date of agreement and 100,000 of the options will vest on January 1, 2011 and each January 1 thereafter until all options are vested.
The registrant does not compensate its directors for their services as such. The registrant reimburses the directors for their reasonable out-of pocket expenses for attending meetings of the board of directors.
ITEM 12.
ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS
The following table sets forth certain information regarding the beneficial ownership of common shares as of October 13, 2011 by: (i) each current director and nominee for director; (ii) all executive officers and current directors of Earth Energy as a group; and (iii) all stockholders known by Earth Energy to be beneficial owners of more than five percent of the outstanding common shares or preferred shares. The information in this table is based solely on a review by Earth Energy of its capital stock transfer records and on publicly available filings made with the SEC by or on behalf of the stockholders listed below, and is based on 11,669,782 outstanding common shares.
Name and Address of Beneficial Owner
Number of Shares Beneficially Owned
Percent of Class
James E. Hogue
671 Heinz Parkway
Estes Park, CO 80517
4,000,000
36.20%
James R. Phillips
6801 Sanger Avenue
Suite 101
Waco, TX 76710
1,540,000
13.90%
Steven Kranker(1)
621 17th Street
Denver, CO 80293
0.00%
Doyle Pennington(2)
2850 Wildwood Lane
Estes Park, CO 80517
101,000
0.90%
Officers and Directors as a group (4 members)
5,641,000
51.00%
(1)In July 2010, Earth Energy authorized a restricted stock grant to Mr. Kranker of 4,000,000 common shares subject to vesting terms over a four year period and forfeiture in the event of certain employment termination conditions.
(2)In July 2010, Earth Energy authorized a restricted stock grant to Mr. Pennington of 200,000 common shares subject to vesting terms over a four year period and forfeiture in the even of certain employment termination conditions.
Unless otherwise indicated, Earth Energy believes that all persons named in the table have sole voting and investment power with respect to all common shares beneficially owned by them. A person is deemed to be the beneficial owner of securities which may be acquired by such person within 60 days from the date indicated above upon the exercise of options, warrants or convertible securities. Each beneficial owner's percentage ownership is determined by assuming that options, warrants or convertible securities that are held by such person (but not those held by any other person) and which are exercisable within 60 days of the date indicated above, have been exercised.
Warrants. There are 2,570,600 warrants issued and outstanding at June 30, 2011, held by approximately 100 warrant holders. The Class B warrants enable holders to purchase common stock at $1.75 per share at any time prior to expiration, and Class C warrants enable holders to purchase common stock at $2.25 per share. 45,000 warrants expire in 2012, 1,491,000 warrants expire in 2013, and 1,009,600 warrants expire in 2014.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
In March 2010, the Company issued 138,191 of its Series A Preferred Stock in settlement of outstanding related party debt of $129,411 plus accrued interest of $8,780. In the six month period ended June 30, 2010, 15,000 shares of Series A Preferred Stock were re-purchased at $1.00 per share. There were 90,611 shares of the Series A Preferred Stock re-purchased at $1.00 per share during the year ended June 30, 2011. The preferred shares were issued to the Company’s majority shareholder and an entity wholly owned by that same shareholder. The preferred shares were valued and are redeemable at $1 per share. Valuation of these shares was based on the subscription price of common shares sold. The following is a detail of that transaction:
Note Payable Related Party
Majority Shareholder
Accrued Majority Shareholder
Series A Preferred Stock
Balance, December 31, 2009
$96,960
$32,450
$5,192
Accrued Interest at 8%
-
-
3,589
-----------
------------
----------
Related Party Debt Converted to Series A Preferred Stock
$96,960
$32,450
$8,781
$138,191
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Director Independence
Earth Energy’s board of directors consists of James Hogue, James Phillips, Steven Kranker, Doyle Pennington. None of the directors are independent as such term is defined by a national securities exchange or an inter-dealer quotation system. For the year ended June 30, 2011, the six months ended June 30, 2010 and for year ended December 31, 2009, there were no transactions with related persons other than as described in the section above entitled “Item 11. Executive Compensation”.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
Audit Fees. For the year ended June 30, 2011, the six months ended June 30, 2010, and the year ended December 31, 2009, we incurred aggregate fees and expenses of approximately $66,864, $49,738 and $27,293 respectively, from Killman, Murrell & Company, PC. Such fees included work completed for our annual audits and for the review of our financial statements included in our Forms 10-Q.
Tax Fees. For the year ended June 30, 2011, the six months ended June 30, 2010 and the year ended December 31, we did not incur any aggregate tax fees and expenses from Killman, Murrell & Company, PC for professional services rendered for tax compliance, tax advice, and tax planning.
All Other Fees. For the year ended June 30, 2011, the six months ended June 30, 2010 and the year ended December 31, 2009, we did not incur any other fees from Killman, Murrell & Company, PC.
The board of directors, acting as the Audit Committee considered whether, and determined that, the auditor's provision of non-audit services was compatible with maintaining the auditor's independence. All of the services described above for the six months ended June 30, 2010, fiscal years 2009 and 2008 were approved by the board of directors pursuant to its policies and procedures.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) List of Financial statements included in Part II hereof
Balance Sheets, June 30, 2011 and 2010
Statements of Operations for the year ended June 30, 2011, the six months ended June 30, 2010, and the year ended December 31, 2009.
Statements of Stockholders’ Equity for the year ended December 31, 2009, six months ended June 30, 2010, and year ended June 30, 2011
Statements of Cash Flows for the year ended June 30, 2011, the six months ended June 30, 2010, and the year ended December 31, 2009.
Notes to the Financial Statements
(a)(2) List of Financial Statement schedules included in Part IV hereof: None
(a)(3) Exhibits
The following of exhibits are filed with this report:
Exhibits
Exhibit 31 - Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32 - Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS** XBRL Instance Document
101.SCH** XBRL Taxonomy Extension Schema Document
101.CAL** XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF** XBRL Taxonomy Extension Definition Linkbase Document
101.LAB** XBRL Taxonomy Extension Label Linkbase Document
101.PRE** XBRL Taxonomy Extension Presentation Linkbase Document
All above mentioned exhibits filed herewith
**XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, Earth Energy has duly caused this Report to be signed on its behalf by the undersigned duly authorized person.
Date: October 13, 2011
Earth Energy Reserves, Inc.
/s/Steven A. Kranker
By: Steven A. Kranker, Principal Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of Earth Energy and in the capacities and on the dates indicated.
/s/Steven A. Kranker
Principal Executive Officer
10/13/11
Steven A. Kranker
Director
/s/Doyle Pennington
Interim Principal Financial Officer
10/13/11
Doyle Pennington
/s/James E. Hogue
Chairman of the Board
10/13/11
James E. Hogue
/s/James R. Phillips, Jr.
Director
10/13/11
James R. Phillips, Jr.