Headwater Exploration : Q1 2024 Financial Statements

HEADWATER EXPLORATION INC.

Interim Condensed Statements of Financial Position

(unaudited)

	March 31,	December 31,
	2024	2023
(Cdn$ thousands)	$	$
ASSETS
Current assets
Cash and cash equivalents	126,583	146,052
Restricted cash	350	350
Accounts receivable (note 12)	65,792	46,744
Contribution receivable (note 6)	886	1,771
Financial derivative receivable (note 12)	205	3,758
Inventories	997	788
Prepaids and deposits	1,893	1,461
Total current assets	196,706	200,924
Exploration and evaluation assets (note 3)	23,663	17,930
Property, plant and equipment (note 4)	647,506	616,375
Other assets	1,077	1,106
Total assets	868,952	836,335
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued liabilities (note 12)	102,854	73,715
Stock-based compensation payable (note 8)	3,812	2,431
Financial derivative liability (note 12)	2,329	79
Current portion of lease liability	20	34
Current income tax liability	5,626	22,397
Dividend payable	23,729	23,658
Total current liabilities	138,370	122,314
Financial derivative liability (note 12)	53	-
Stock-based compensation payable (note 8)	368	498
Lease liability	815	808
Decommissioning liability (note 5)	42,861	40,951
Repayable contribution (note 6)	11,619	11,405
Deferred income tax liability	49,191	49,861
Total liabilities	243,277	225,837
Shareholders' Equity
Capital stock (note 7)	484,938	483,013
Contributed surplus	18,332	18,970
Retained earnings	122,405	108,515
Total shareholders' equity	625,675	610,498
Total liabilities and shareholders' equity	868,952	836,335
Subsequent events (note 13)

See accompanying notes to the interim condensed financial statements

Approved on behalf of the Board of Directors:
(signed) "Chandra Henry"	(signed) "Neil Roszell"
Chandra Henry, CPA, CA, Director	Neil Roszell, Executive Chairman

1

HEADWATER EXPLORATION INC.

Interim Condensed Statements of Income and

Comprehensive Income

(unaudited)

Three months ended

March 31,

	2024	2023
(Cdn$ thousands, except per share data)	$	$
REVENUE
Sales (note 9)	134,034	104,209
Royalties	(21,844)	(15,332)
Revenue, net of royalties	112,190	88,877
Gains on financial derivatives (note 12)	273	9,243
	112,463	98,120
EXPENSES
Blending and transportation	16,136	18,036
Production	12,459	9,979
General and administrative	2,601	2,063
Stock-based compensation	2,723	1,615
Depletion and depreciation	30,528	28,657
	64,447	60,350
Interest income and other expense (note 10)	1,166	1,396
Income before income taxes	49,182	39,166
Income taxes
Current income tax expense	12,233	8,572
Deferred income tax (recovery) expense	(670)	615
	11,563	9,187
Net income and comprehensive income	37,619	29,979
Net income per share (note 7)
Basic	0.16	0.13
Diluted	0.16	0.13

See accompanying notes to the interim condensed financial statements

2

HEADWATER EXPLORATION INC.

Interim Condensed Statements of Cash Flows

(unaudited)

	Three months ended
	March 31,
Cash flow related to the following activities:	2024	2023
(Cdn$ thousands)	$	$
OPERATING
Net income	37,619	29,979
Items not involving cash:
Unrealized losses (gains) on financial derivatives (note 12)	5,841	(2,003)
Stock-based compensation	2,723	1,615
Depletion and depreciation	30,528	28,657
Income tax expense	11,563	9,187
Non-cash finance charges	500	294
Settlement of decommissioning liability (note 5)	(95)	-
Income taxes paid	(29,004)	(15,942)
Change in non-cash operating working capital (note 11)	(4,628)	8,414
Cash flows provided by operating activities	55,047	60,201
FINANCING
Payment of lease liability	(22)	(197)
Proceeds from exercise of stock options & warrants (note 7)	35	743
Dividends paid	(23,658)	(23,392)
Proceeds from repayable contribution (note 6)	709	-
Cash flows used in financing activities	(22,936)	(22,846)
INVESTING
Capital expenditures - property, plant and equipment (note 4)	(46,175)	(53,735)
Capital expenditures - exploration and evaluation (note 3)	(19,092)	(15,759)
Government grant (note 6)	177	-
Change in non-cash investing working capital (note 11)	13,510	11,537
Cash flows used in investing activities	(51,580)	(57,957)
Change in cash and cash equivalents	(19,469)	(20,602)
Cash and cash equivalents, beginning of period	146,052	175,447
Cash and cash equivalents, end of period	126,583	154,845

See accompanying notes to the interim condensed financial statements

3

HEADWATER EXPLORATION INC.

Interim Condensed Statements of Changes in Shareholders' Equity

(unaudited)

						Total
		Capital		Contributed	Retained	shareholders'
	Notes	stock	Warrants	surplus	earnings	equity
(Cdn$ thousands)		$	$	$	$	$
Balance at January 1, 2023		479,157	2	17,312	46,864	543,335
Exercise of stock options	7	2,354	-	(1,616)	-	738
Exercise of warrants	7	7	(2)	-	-	5
Stock-based compensation	8	-	-	1,205	-	1,205
Reclassification to stock-based	8	-	-	(563)	-	(563)
compensation payable
Net income		-	-	-	29,979	29,979
Dividends declared	7	-	-	-	(23,539)	(23,539)
Balance at March 31, 2023		481,518	-	16,338	53,304	551,160
Balance at January 1, 2024		483,013	-	18,970	108,515	610,498
Exercise of stock options	7	1,925	-	(1,890)	-	35
Stock-based compensation	8	-	-	1,252	-	1,252
Net income		-	-	-	37,619	37,619
Dividends declared	7	-	-	-	(23,729)	(23,729)
Balance at March 31, 2024		484,938	-	18,332	122,405	625,675

See accompanying notes to the interim condensed financial statements

4

HEADWATER EXPLORATION INC.

Notes to the Interim Condensed Financial Statements

(unaudited)

As at and for the three months ended March 31, 2024 and 2023

(All tabular amounts in thousands, unless otherwise stated)

1. NATURE OF OPERATIONS

Headwater Exploration Inc. ("Headwater" or the "Company") is a Canadian resource company engaged in the exploration for and development and production of petroleum and natural gas in Canada. Headwater is a public company existing under the Alberta Business Corporations Act with common shares listed on the Toronto Stock Exchange ("TSX") under the symbol "HWX".

Headwater's principal place of business is located at 1400, 215 - 9th Avenue S.W., Calgary, Alberta, T2P 1K3 and its registered office is located at 2400, 525 - 8th Avenue S.W., Calgary, Alberta, T2P 1G1.

2. BASIS OF PREPARATION

These unaudited interim condensed financial statements have been prepared in accordance with IAS 34 - Interim Financial Reporting as issued by the International Accounting Standards Board ("IASB"). The unaudited interim condensed financial statements do not include all information required for annual financial statements and should be read in conjunction with the Company's audited financial statements for the year ended December 31, 2023. These unaudited interim condensed financial statements have been prepared following the same accounting policies as the Company's audited financial statements for the year ended December 31, 2023, except for the below.

The IASB issued amendments to IAS 1 "Presentation of financial statements" re: classification of liabilities as current or non-current which is effective for annual periods beginning on or after January 1, 2024. The amendment clarifies that the classification of liabilities as current or non-current should be based on rights that are in existence at the end of the reporting period.

These amendments to IAS 1 did not have a material impact on the Company's financial statements.

The timely preparation of these financial statements requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amount of assets, liabilities, income and expenses. Actual results may differ materially from these estimates. Significant judgments, estimates and assumptions made by management in these financial statements are outlined in the audited financial statements for the year ended December 31, 2023.

These unaudited interim condensed financial statements were approved and authorized for issue by the Board on May 9, 2024.

5

3. EXPLORATION AND EVALUATION ("E&E") ASSETS

The following table reconciles the movements of the Company's E&E assets for the periods:

	March 31, 2024 December 31, 2023
$		$
Balance, beginning of period	17,930	42,872
Additions	19,092	28,556
Dispositions (1)	-	(3,750)
Transfers to PP&E	(13,359)	(49,748)
Balance, end of period	23,663	17,930

(1) Relates to the sale of a gross overriding royalty. No gain or loss was recorded related to the sale.

The Company concluded there are no indicators of impairment for its E&E assets as at March 31, 2024.

4. PROPERTY, PLANT AND EQUIPMENT ("PP&E")

The following table reconciles the movements of the Company's PP&E assets for the periods:

		Oil and gas
		properties	Corporate	Total
Cost	$	$		$
Balance at December 31, 2022		835,220	2,835	838,055
Additions		213,179	38	213,217
Transfers from E&E		49,748	-	49,748
Government grant		(2,474)	-	(2,474)
Changes in decommissioning liability		7,425	-	7,425
Balance at December 31, 2023		1,103,098	2,873	1,105,971
Additions (1)		46,569	6	46,575
Transfers from E&E		13,359	-	13,359
Changes in decommissioning liability		1,696	-	1,696
Balance at March 31, 2024		1,164,722	2,879	1,167,601
Accumulated depletion, depreciation and impairment
Balance at December 31, 2022		367,717	2,296	370,013
Depletion or depreciation expense		119,510	73	119,583
Balance at December 31, 2023		487,227	2,369	489,596
Depletion or depreciation expense		30,482	17	30,499
Balance at March 31, 2024		517,709	2,386	520,095
Net book value at December 31, 2023		615,871	504	616,375
Net book value at March 31, 2024		647,013	493	647,506

1. Includes capitalized general and administrative expenses of $1.0 million and capitalized stock-based compensation of $0.4 million.

The Company concluded there are no indicators of impairment for its PP&E assets as at March 31, 2024.

6

5. DECOMMISSIONING LIABILITY

The following table reconciles the movements of the Company's decommissioning liability for the periods:

	March 31, 2024	December 31, 2023
	$	$
Balance, beginning of period	40,951	32,343
Additions	2,696	12,975
Settlements	(95)	-
Change in estimate (1)	(1,000)	(5,550)
Accretion (note 10)	309	1,183
Balance, end of period	42,861	40,951
Key assumptions
Risk free rate	3.3%	3.0%
Inflation rate	1.8%	1.6%

1. Relates to changes in the inflation rate and risk-free rate. Of this amount, a $2.6 million upward revision is a result of an increase in the inflation rate over the period from 1.6% at December 31, 2023 to 1.8% at March 31, 2024 and a $3.6 million downward revision is a result of an increase in the risk-free rate over the period from 3.0% at December 31, 2023 to 3.3% at March 31, 2024.

The Company has estimated the net present value of its total decommissioning liabilities to be $42.9 million as at March 31, 2024 (December 31, 2023 - $41.0 million). The total future inflated and undiscounted amount of estimated cash flows required to settle these obligations is $110.3 million (December 31, 2023 - $97.4 million). Management estimates the settlement of these obligations will occur over the next 25 to 40 years.

6. REPAYABLE CONTRIBUTION (NRCan ERF)

In 2022 and 2023, the Company received approval of a total of four claims pursuant to a repayable contribution agreement with the Department of Natural Resources Canada ("NRCan"), under the Emissions Reduction Fund ("ERF") Onshore Program. As at March 31, 2024, all funds were received by the Company, with the exception of one holdback amount of $0.9 million (December 2023 - $1.8 million) which has been recorded as a short-term receivable, and subsequent to March 31, 2024, was collected.

The Company has recognized a repayable contribution of $14.2 million, undiscounted, and $11.6 million discounted as at March 31, 2024 (December 31, 2023 - $14.2 million and $11.4 million respectively), with respect to claims submitted to the ERF and confirmed by NRCan. The Company discounts the repayable contribution at a weighted average interest rate of 7.7%. The repayable portion of the funds received are to be repaid as follows: 10% on June 30, 2025, 33% on June 30, 2026, and 57% on June 30, 2027.

	March 31, 2024	December 31, 2023
	$	$
Balance, beginning of period	11,405	6,720
Repayable contribution	-	4,195
Interest (note 10)	214	490
Balance, end of period	11,619	11,405

The Company is in compliance with all terms and conditions of the repayable contribution agreement.

7

7.	CAPITAL STOCK
a)	Issued and outstanding
		March 31, 2024	December 31, 2023
		Number of		Number of
		shares	Amount	shares	Amount
			$		$
	Balance, beginning of period	236,580	483,013	233,920	479,157
	Exercise of stock options	710	1,925	2,654	3,849
	Exercise of warrants	-	-	6	7
	Balance, end of period	237,290	484,938	236,580	483,013

Stock Options

During the three months ended March 31, 2024, 1.3 million stock options were exercised for 0.7 million common shares on a cashless basis, and 33 thousand stock options were exercised for 33 thousand common shares for total proceeds of $35 thousand. Contributed surplus related to the options exercised of $1.9 million was transferred to capital stock.

During the three months ended March 31, 2023, 1.6 million stock options were exercised for 1.1 million common shares on a cashless basis, and 0.4 million stock options were exercised for 0.4 million common shares for total proceeds of $0.7 million. Contributed surplus related to the options exercised of $1.6 million was transferred to capital stock.

b) Per share amounts

Basic per share amounts are calculated using the weighted average number of shares outstanding. The Company uses the treasury stock method to determine the impact of dilutive securities. The reconciling items between basic and diluted average common shares outstanding are stock options, RSUs, PSUs and accrued dividends on RSUs and PSUs.

	Three months ended
	March 31,
	2024	2023
Weighted average shares outstanding
Basic	235,742	234,069
Diluted	237,552	236,279

c) Dividends

On November 3, 2022, Headwater announced its inaugural quarterly cash dividend of $0.10 per common share ($0.40 per common share annualized). The first dividend was paid on January 16, 2023, to shareholders of record at the close of business on December 30, 2022. In 2023, Headwater declared $94.4 million related to its quarterly cash dividend.

On March 7, 2024, Headwater declared a cash dividend of $0.10 per common share. The dividend was paid on April 15, 2024, to shareholders of record at the close of business on March 29, 2024.

8

8. STOCK-BASED COMPENSATION

1. Share awards

The Company has an awards plan (the "Awards Plan") which provides for grants of restricted share units ("RSUs") and performance share units ("PSUs") to officers, employees and consultants of the Company. Generally, one third of the RSUs will vest on each of the first, second and third anniversaries of the date of grant and all PSUs will vest on the third anniversary of the date of grant, unless otherwise determined by the Board of Directors. RSUs are cash settled and PSUs are equity settled.

RSUs (Cash Settled)
The following table summarizes the changes in the RSU liability for the periods:
	March 31,	December 31,
	2024	2023
Balance, beginning of period	1,188	-
Reclassified from contributed surplus	-	563
Increase in liability/fair value adjustment (1)	656	968
Payout	(620)	(343)
Balance, end of period	1,224	1,188
Current portion of stock-based compensation payable	856	690
Long-term portion of stock-based compensation payable	368	498

(1) Includes dividend adjustment.

The RSU liability as at March 31, 2024 of $1.2 million is based on a fair value of $7.67 per RSU which is the Company's closing share price on March 31, 2024.

The following table summarizes the changes in the number of outstanding RSUs for the periods:

	March 31,	December 31,
	2024	2023
Outstanding, beginning of period	377	179
Granted	202	274
Forfeited	(8)	(22)
Exercised	(108)	(54)
Outstanding, end of period	463	377

PSUs (Equity Settled)

The following table summarizes the changes in the number of outstanding PSUs for the periods:

	March 31,	December 31,
	2024	2023
Outstanding, beginning of period	1,917	838
Granted	827	1,082
Forfeited	-	(3)
Outstanding, end of period	2,744	1,917

For the three months ended March 31, 2024, with respect to RSUs and PSUs outstanding, the Company recorded gross stock-based compensation expense of $1.8 million and capitalized stock-based compensation expense of $0.4 million.

9

b) Deferred share units ("DSUs")

The Company has a DSU plan (the "DSU Plan") which provides for grants of DSUs to non-management directors. Each DSU vests on the date of grant; however, settlement of the DSU occurs when the individual ceases to be a director of the Company. DSUs are to be settled in cash or by payment in common shares acquired through the facilities of the TSX. It is the intention of the Company to settle DSUs in cash.

The following table summarizes the changes in the DSU liability for the periods:

	March 31,	December 31,
	2024	2023
	$	$
Balance, beginning of period	1,741	825
Increase in liability/fair value adjustment (1)	1,215	916
Balance, end of period	2,956	1,741
Current portion of stock-based compensation payable	2,956	1,741

(1) Includes dividend adjustment.

The DSU liability as at March 31, 2024 of $3.0 million is based on a fair value of $7.67 per DSU which is the Company's closing share price on March 31, 2024.

The following table summarizes the changes in the number of outstanding DSUs for the periods:

	March 31,	December 31,
	2024	2023
Outstanding, beginning of period	264	141
Granted	102	123
Outstanding, end of period	366	264

c) Stock options

The Company has an old and new stock option plan (the "Option Plans") under which options to purchase common shares of the Company may be granted to directors, officers, employees and consultants of the Company. The Company does not intend to grant any further options under the Option Plans.

The following table summarizes the changes in the outstanding stock options for the periods:

	Three months ended		Year ended
		March 31, 2024	December 31, 2023
		Weighted		Weighted
	Number of	average	Number of	average
	options	exercise price	options	exercise price
Options outstanding, beginning of period	2,508	$ 3.88	6,086	$ 2.74
Forfeited or expired	-	-	(8)	$ 2.39
Exercised (1)	(1,356)	$ 3.53	(3,570)	$ 1.94
Options outstanding, end of period	1,152	$ 4.29	2,508	$ 3.88
Options exercisable, end of period	1,014	$ 4.25	1,383	$ 3.60

1. The Company's weighted average share price, at the date of exercise, for stock options exercised during the three months ended March 31, 2024 was $7.31 per common share (three months ended March 31, 2023 - $6.21 per common share).

There were no stock options granted in three months ended March 31, 2024, or in the year ended December 31, 2023.

10