CAUTIONARY STATEMENT FOR FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements are based on current expectations and projections
about future events. These forward-looking statements are subject to known and
unknown risks, uncertainties and assumptions about Discovery that may cause
actual results, levels of activity, performance or achievements to be materially
different from any future results, levels of activity, performance or
achievements expressed or implied by such forward-looking statements. In some
cases, forward-looking statements can be identified by the use of terminology
such as "may," "might," "should," "could," "would," "expect," "plan,"
"anticipate," "believe," "estimate," "continue," or the negative of such terms
or other similar expressions. Factors that might cause or contribute to such a
discrepancy include, but are not limited to, those described in Discovery's
other Securities and Exchange Commission filings. The following discussion
should be read in conjunction with Discovery's financial statements and related
notes thereto included elsewhere in this report.
Discovery Energy Corp. (the "Company") was incorporated under the laws of the
state of Nevada on May 24, 2006 under the name "Santos Resource Corp". The
current business of the Company is the exploration and development of the
584,651 gross acres (914 sq. miles) area in South Australia ("Prospect") held
under Petroleum Exploration License PEL 512 ("License"). The Prospect is located
in the "Western Flank" area, which is the southwest Permian edge of the Cooper
and Eromanga Basins, the most prolific producing onshore region in Australia.
There are three separate acreage blocks in the Prospect: West (~400,000 acres),
South (~181,000 acres) and Lycium (~4,000 acres). In May 2012, the Company
incorporated a wholly owned Australian subsidiary, Discovery Energy SA Ltd.
("Subsidiary"), for the purpose of acquiring a 100% working interest in the
License. In May 2016, the Subsidiary's legal entity status changed from public
to private and its name changed to Discovery Energy SA Pty Ltd. The Company is
in the initial exploration phase of determining whether or not the Prospect
contains economically recoverable volumes of crude oil, natural gas and/or
natural gas liquids (collectively "Hydrocarbons"). Although the Company's
current focus is primarily on the Prospect, management from time-to-time
exchanges information with other industry participants regarding additional
investment opportunities in Australia.
Recent Developments and Events
Coronavirus Pandemic. In December 2019, a novel strain of coronavirus,
SARS-CoV-2, which causes coronavirus disease 2019 ("COVID-19"), surfaced in
Wuhan, China. Since then, SARS-CoV-2 and COVID-19 spread to many countries,
including the U.S. The COVID-19 pandemic led to the implementation of various
responses, including government-imposed quarantines, travel restrictions and
other public health safety measures. It resulted in a significant spike in
unemployment and a concomitant decline in economic activity in the U.S. and many
other countries, and any future outbreak of a health epidemic or other adverse
public health developments may have similar effects. Although the effects of the
COVID-19 pandemic had been lessening in the U.S. and other parts of the world
overall, these effects recently started worsening again in the U.S. and
elsewhere, creating renewed uncertainty regarding the future. The current
COVID-19 pandemic could continue to, and future similar epidemics or pandemics
could also, materially and adversely impact our ability to finance and conduct
our business once it becomes operational, and could materially and adversely
impact our operations, financial condition and results.
Severe Hydrocarbons Price Decline. Another recent development occurring more or
less simultaneously with the COVID-19 pandemic is a Hydrocarbons price war that
began in early March 2020. At the time that this event started on March 8, 2020,
the price of Brent crude was $45.27 per barrel, which was already down from a
recent high of $68.91 on January 6, 2020. Such price declined to a low of $19.33
on April 21, 2020. On July 10, 2020, the posted price of Brent crude was $43.17.
Prices of Hydrocarbons are volatile and entail certain risks. The Company has no
assurance that the price of Hydrocarbons will recover to adequate levels or that
the Company will not be harmed by prolonged low levels of Hydrocarbon prices.
To date, the Company has achieved the following milestones:
* On October 26, 2012, the License was granted to the Subsidiary.
After the License grant, the Company's primary focus was on
completing a financing to raise sufficient funds so that the Company
could undertake a required proprietary seismic acquisition program.
After exploring a number of possible financings, the precipitous
decline in crude oil prices starting in the summer of 2014 delayed
the Company's ability to successfully complete a financing of the
type being sought.
* In May 2016, the Company completed its first closing under a
financing arrangement pursuant to which the Company issued to two
investors Senior Secured Convertible Debentures due May 27, 2021
(each a "Debenture" and collectively the "Debentures"). To date, the
Company has issued a total of 14 Debentures having an aggregate
original principal amount of $6,850,000. The Debentures are due and
payable on or before May 27, 2021. Interest on the Debentures to
date has been accrued and added to principal, thereby increasing the
outstanding balance on the Debentures to approximately $9,139,000 as
of June 30, 2020. Interest will be accrued until such time as the
Debentures are repaid or converted. Among other uses, the proceeds
from the Debentures enabled the Company to undertake required
seismic work. In conjunction with certain issuances of Debentures,
warrants ("Warrants") were issued that grant the holder the right to
purchase up to a maximum of 19,125,000 common shares at an initial
per-share exercise price of $0.20. For more information about the
Debentures and the Warrants, see the section captioned "Liquidity
and Capital Resources - Financing History and Immediate, Short-Term
Capital Needs - Debenture Financing" below.
* On October 30, 2016, fieldwork was completed on the Company's
proprietary Nike 3D seismic survey (the "Nike Survey") covering an
approximately 69 sq. mile (179 sq. km.) section of the western
portion of the South Block of the Prospect and directly on trend and
in close proximity to mature producing oilfield and recent
discoveries on the blocks to the north. The Nike Survey was
completed at a "turnkey price" of approximately $2.4 million.
* The raw data from the Nike Survey was converted to analytical
quality information, processed and interpreted by the Company's
geophysical advisor. Interpretation of the processed data included
advanced technical analysis by specialized consultants. This
technical work identified an inventory of more than 30 leads judged
to be potential areas of crude oil accumulations. The Company has
prioritized these initial prospective locations for presentation to
potential sources of significant capital. Technical analysis is
* In June 2017, the Company completed the archeological and
environmental field surveys of seven prospective drilling locations
as required by applicable laws and regulations. It subsequently
filed reports on these surveys with the South Australian government;
no material issues were identified at any of the prospective
* In addition to the amounts raised pursuant to the Debentures
arrangements, since the Company adopted its current business plan,
the Company has raised funds totaling approximately $4.3 million
through private placements of the Company's common shares.
* In several transactions to date, the Company (through the
Subsidiary) purchased portions of an original 7.0% royalty interest
relating to the Prospect retained by the party that, in effect,
transferred and sold the License to the Company. As a result, the
Company (through the Subsidiary) now owns an aggregate 5.0% royalty
interest, while the previous holder of the original 7.0% royalty
interest continues to hold a 2.0% royalty interest. The aggregate
purchase price for the aggregate 5.0% royalty interest was $540,500.
Current Primary Activity
Discovery's current primary activity is to complete either a major financing or
a major joint venture relationship, or both, so that it can execute the
remaining work on the Prospect's five-year work commitment (the "Commitment") as
described below, and develop the Prospect.
The License is subject to a Commitment, which imposes certain financial
obligations on the Company. In management's view, the geotechnical work
completed in Years 1 and 2 of the Commitment was sufficient to satisfy the
License requirements for those two years. Required reports in connection with
these activities were timely filed.
Over the last several years, a number of extensions and modifications of the
Commitment have been granted. The current remaining Commitment is as follows:
* Year 3 ending October 28, 2020 - Shoot 2D seismic data totaling at
least approximately 62 miles (100 km.) and shoot 3D seismic data
totaling at a minimum approximately 77 sq. miles (200 sq. km.) and
drill two wells.
* Year 4 ending October 29, 2021 - Shoot 3D seismic data totaling a
minimum of approximately 77 sq. miles (200 sq. km.) and drill two
* Year 5 ending October 29, 2022 - Drill three wells.
Discovery does not believe that it will be able to complete its Year 3
Commitment obligations by their due date of October 28, 2020. Accordingly, the
Company expects to seek an extension of such obligations prior to the due date.
While the Company has to date been successful in obtaining such extensions, it
has no assurance that any further extensions will be obtained. The failure to
obtain the required extension will materially and adversely impact the Company.
See the section captioned "Liquidity and Capital Resources - Consequences of a
Financing Failure" below.
Discovery needs a significant amount of capital to fulfill its obligations under
the Commitment. Moreover, the Debentures mature in May 2021, and the Company
will need to raise additional funds or generate sufficient revenues through
Hydrocarbons production to timely repay the Debentures. The Company's capital
requirements and financing activities are described in the section captioned
"Liquidity and Capital Requirements" below. The success of the initial phase of
the Company's plan of operations depends upon the Company's ability to obtain
additional capital or enter into a suitable joint venture arrangement in order
to acquire additional seismic data and successfully drill Commitment wells.
Failure to obtain required additional capital or enter into a suitable joint
venture arrangement will materially and adversely affect the Company and its
stockholders in ways that are discussed in the section captioned "Liquidity and
Capital Resources - Consequences of a Financing Failure" below. The Company
cannot provide assurance that it will obtain the necessary capital and/or enter
into a suitable joint venture agreement.
Results of Operations
Results of operations for the three-month periods ended May 31, 2020 and 2019
are summarized in the table below:
Three Months Ended Three Months Ended
May 31, 2020 May 31, 2019
Revenue $ - $ -
Operating expenses (407,738 ) (1,656,561 )
Other income (expenses) (590,073 ) (544,761 )
Net income (loss) $ (997,811 ) $ (2,201,322 )
Operating expenses for the three-month periods ended May 31, 2020 and 2019 are
outlined in the table below:
Three Months Ended Three Months Ended
May 31, 2020 May 31, 2019
Stock-based compensation expense $ - $ 740,000
General and administrative 404,888 524,953
Warrant Modification Expense - 364,683
Exploration costs 2,850 26,925
Total Operating Expenses $ 407,738 $ 1,656,561
Results of Operations for the Three-Month Periods Ended May 31, 2020 and 2019
Revenues. The Company did not earn any revenues in either of the comparative
quarter years. Sales revenues are not anticipated until such time as the
Prospect has commenced commercial production of Hydrocarbons. As the Company is
presently in the exploration stage of its operations, no assurance can be
provided that commercially exploitable levels of hydrocarbons on the Prospect
will be discovered, or if such resources are discovered, that the Prospect will
commence commercial production.
Operating Expenses. Total operating expenses incurred during the quarter ended
May 31, 2020 decreased by approximately $1,250,000 (75%), compared to those
incurred during the quarter ended May 31, 2019. The decrease is primarily due to
the absence of any stock-based compensation or warrant modification expense for
the quarter ended May 31, 2020, while the Company had such expenses of
approximately $740,000 and $365,000, respectively, for the quarter ended May 31,
2019. Other cost reductions included:
* $63,000 - Travel related expenses (as travel was curtailed to avoid exposure
to COVID-19 virus)
* $57,000 - Professional and General and Administrative (paid to 3rd party
* $24,000 - Exploration (due to reduced activity in Australia)
Net Income (Loss). The Company had a net loss of $997,811 for the quarter ended
May 31, 2020, compared to a net loss of $2,201,000 for the quarter ended May 31,
2019. The primary driver of this change is attributable to the absence of
stock-based compensation expense and warrant modification expense in the quarter
ended May 31, 2020, compared to the quarter ended May 31, 2019. Loss per common
share, on both a basic and fully diluted basis, was $0.01 in the first quarter
of each of fiscal 2021 and fiscal 2020.
Cash Flows for the Three-Month Periods Ended May 31, 2020 and 2019
Cash Used in Operating Activities: Operating activities for the three months
ended May 31, 2020 used cash of $174,521, versus $365,207 for the three months
ended May 31, 2019, primarily due to a decrease travel, use of third party
providers and exploration activities as further described above, in the three
months ended May 31, 2020.
Cash Used in Investing Activities: No cash was used for investing activities
during each of the three month periods ended May 31, 2020 and May 31, 2019.
Cash Provided by Financing Activities: Financing activities totaled $168,750
during the three months ended May 31, 2020, resulting from the private placement
of 250,000 common shares at $0.20 per common share for gross proceeds of
$50,000, and proceeds from a Paycheck Protection Program loan in the amount of
$118,750. There was no cash provided by financing activities for the three-month
period May 31, 2019.
Off-Balance Sheet Arrangements
Discovery has no off-balance sheet arrangements.
Liquidity and Capital Resources
Financing History and Immediate, Short-Term Capital Needs
Early Financings. From January 2012 through May 27, 2016, business activities
were financed primarily through private placements of common shares. During that
period, several rounds of equity financing were conducted which raised total
"seed" capital in the amount of $2,723,750 resulting in the issuance of
19,657,501 common shares. Moreover, from time to time, officers and directors of
the Company provided short-term bridge funding. These advances were repaid out
of proceeds from the Debenture financings described below.
Debenture Financing. Beginning in May 2016 and continuing through August 2018,
the Company relied on a series of placements of Debentures (debt instruments
convertible into common shares). The 14 Debentures comprising this series were
issued pursuant to a Securities Purchase Agreement executed on May 27, 2016.
Debentures having an aggregate original principal amount of $6,850,000 have been
placed. In conjunction with certain Debentures, warrants ("Warrants") were
issued that grant to the holder the right to purchase from the Company up to a
maximum of 19,125,000 common shares at an initial per-share exercise price of
Each of the Debentures includes the following features:
* The Debentures bear interest at the rate of eight percent (8%) per
annum, compounded quarterly. However, upon the occurrence and during
the continuance of a stipulated event of default, the Debentures
will bear interest at the rate of twelve percent (12%) per annum.
* Interest need not be paid on the Debentures until the principal
amount of the Debentures becomes due and payable. Instead, accrued
interest is added to the outstanding principal amount of the
Debentures quarterly. Nevertheless, the Company may elect to pay
accrued interest in cash at the time that such interest would
otherwise be added to the outstanding principal amount of the
* The principal amount of and accrued interest on the Debentures are
due and payable in a single balloon payment on or before May 27,
* We are not entitled to prepay the Debentures prior to their
* The Debentures are convertible, in whole or in part, into Common
Shares at the option of holders, at any time and from time to time.
The conversion price for Debentures having an aggregate original
principal amount of $5,887,500 is $0.16, while the conversion price
for a Debenture with an original principal amount of $962,500 is
$0.20. All conversion prices are subject to certain adjustments that
are believed to be customary in transactions of this nature,
including so-called "down round" financing adjustments. The Company
is subject to certain liabilities and liquidated damages for its
failure to honor timely a conversion of the Debentures, and these
liabilities and liquidated damages are believed to be customary in
transactions of this nature.
* The holders of the Debentures are entitled to have them redeemed
completely or partially upon certain events (such as a change of
control transaction involving the Company or the sale of a material
portion of the Company's assets) at a redemption price equal to 120%
of the then outstanding principal amount of the Debenture and 100%
of accrued and unpaid interest on the outstanding principal amount
of this Debenture, plus all liquidated damages and other amounts due
thereunder in respect of the Debenture.
* The Debentures feature negative operating covenants, events of
defaults and remedies upon such events of defaults that are believed
to be customary in transactions of this nature. One of the remedies
upon an event of default is the Debenture holders' ability to
accelerate the maturity of the Debenture such that all amounts owing
under the Debenture would become immediately due and payable. The
Debenture holders would then be able to resort to the collateral
securing the Debentures, if the Company did not pay the amount
outstanding, which is likely to be the case.
* The Debentures are secured by virtually all of the Company's assets
owned directly or indirectly but for the License, which is held by
the Company's Australian subsidiary, Discovery Energy SA Pty Limited
(the "Subsidiary"). Moreover, the Company has separately guaranteed
the Debentures and has pledged all of its stock in the Subsidiary to
secure such guarantee. The essential effect of these security
arrangements is that, if the Company defaults on or experiences an
event of default with respect to the Debentures, the holders of the
Debentures could exercise the rights of a secured creditor, which
could result in the partial or total loss of nearly all of the
Company's assets, in which case its business could cease and all or
substantially all stockholders' equity could be lost. For more
information about this, see the section captioned "Consequences of a
Financing Failure" below.
Each of the Warrants includes the following features:
* The initial per-share exercise price of the Warrants is $0.20 and is
subject to certain adjustments that are generally believed to be
customary in transactions of this nature. Subject to certain
exceptions, the exercise price of the Warrants involves possible
adjustments downward to the price of any common shares or their
equivalents sold by the Company during the term of the Warrants for
less than the then applicable exercise price of the Warrants. Upon
the adjustment of the exercise price, the number of shares issuable
upon exercise of the Warrants is proportionately adjusted so the
aggregate exercise price of the Warrants remains unchanged.
* All of the Warrants are currently exercisable and remain so until
their expiration date of August 31, 2020 with respect to 17,625,000
warrant shares, or September 19, 2020 with respect to 1,500,000
* The Company is subject to certain liabilities and liquidated damages
for failure to honor timely an exercise of the Warrants, and these
liabilities and liquidated damages are believed to be customary in
transactions of this nature.
The largest holder of the Debentures has the right to have elected to the
Company's Board of Directors one nominee, but this holder has not yet exercised
the right to nominate or have one director elected.
Moreover, persons holding a majority of the outstanding Debentures have the
right to require the Company to register with the SEC the resale of the shares
into which Debentures can be converted, the shares that can be acquired upon the
exercise of the Warrants and possibly other shares owned by such persons as
The proceeds from the Debenture placements were generally used to fund the
acquisition, processing and interpretation of the Nike Survey data and payment
of the Company's and the Debenture holders' expenses associated with the
placements. A portion of these proceeds were used to retire all of the then
outstanding indebtedness (including the amounts owed to Liberty Petroleum for
allowing us to be issued the License in its place, and loans made by
management), and to acquire a 5.0% overriding royalty interest relating to the
Prospect. Funds were also used for payment of general and administrative
expenses. In addition to the preceding, a portion of the proceeds was used to
pay a geophysical advisor.
More Recent Equity Placements. Subsequent to the start of the Debentures
placements, the Company continued certain private capital raising transactions
involving the Company's common shares. Beginning in November 2016 and concluding
in March 2020, the Company closed on a series of private placements of its
common shares in which an aggregate of 8.8 million shares were issued for an
aggregate purchase price of $1,830,000.
Paycheck Protection Program Loan. In connection with the Payroll Protection
Program established by the Coronavirus Aid, Relief, and Economic Security Act,
the Company borrowed the sum of approximately $118,750. In due course, the
Company intends to apply for the forgiveness of this indebtedness to the maximum
extent permitted by applicable law.
Available Cash. As of July 10, 2020, the Company had cash of approximately
$20,000, and had negative working capital of about $3,300,000. Management
believes that the cash on hand, as of the preceding date, will be sufficient to
finance general and administrative expenses through September 30, 2020 although
no assurance of this can be provided. However, this amount of cash will be
insufficient to allow the Company to fulfill work commitment obligations in a
timely manner. A plan for financing these obligations is discussed below.
Management intends to finance all of the general and administrative expenses
beyond available cash on hand by undertaking to raise up to $10.0 million
through a private placement of common shares. If successful in raising $10.0
million in the private placement, it is estimated that the related net proceeds
will be sufficient to finance both general and administrative expenses, and a
number of work commitment obligations through December 2022. However, no
assurance can be given that the amounts will be adequate. Moreover, no assurance
can be provided of successfully raising any additional funds for this purpose.
Long-Term Capital Needs
The five-year work commitment relating to the License imposes certain
obligations on the Company. The work requirements of the first two years, which
included geotechnical studies and the Nike Survey, have been completed and
reports and certain work materials have been submitted as required by the South
Australian government. Going forward, additional funds will be required to meet
the seismic and drilling obligations of License Years 3, 4 and 5. Working
capital will also be needed to satisfy general and administrative expenses.
Between July 2020 and October 2022 (the month in which the Company's work
commitments are currently required to be completed), the Company estimates that
it will need to raise an additional $20.0 million to have sufficient capital to
meet the remaining work commitments specified in the License and to fund
operations. Net revenues produced from successful oil wells could provide some
of the funds required to meet these capital needs. However, no assurance can be
given that this or any other amount of financing will be obtained or that any
oil revenue will be earned.
If successful with the early wells, work will continue with a full development
plan, the scope of which is now uncertain but will be based on technical
analysis of seismic data, field drilling and log reports, production history and
costs estimates. However, all of the preceding plans are subject to the
availability of sufficient funding and the receipt of all governmental
approvals. Without sufficient available funds to undertake these tasks,
additional financings or a joint venture partner will be required.
Failure to procure a joint venture partner or raise additional funds will
preclude the Company from pursuing its business plan, as well as exposing the
Company to the loss of the License, as discussed below. Moreover, if the
business plan proceeds as just described, but the initial wells do not prove to
hold producible reserves, the Company could be forced to cease its initial
exploration efforts on the Prospect.
Major Financing Efforts and Other Sources of Capital
The Company's capital strategy for most of its past four fiscal years has been,
and continues to be, to attempt to engage in a single major capital raising
transaction to provide sufficient funds to satisfy its capital needs for a
number of years to come. While management did not completely abandon this
strategy, the Company did shift its emphasis in an effort to try to engage in
one or more smaller capital raising transactions to provide sufficient funds to
satisfy ongoing and future capital needs. During a two-year period beginning in
May 2016, the Company completed a series of placements of its Debentures having
an aggregate original principal amount of $6,850,000. The Company's plan for
financing its general and administrative expenses is described in the section
captioned "Financing History and Immediate, Short-Term Capital Needs" above. The
Company's plan for financing its work commitments is described in the following
The interpretation and analysis of the Nike Survey resulted in an inventory of
more than 30 leads judged to be potential areas of crude oil accumulations.
These initial prospective locations were prioritized and the results are being
presented to prospective investors with a view to securing the capital to
commence the Company's initial drilling program. The Company needs to complete a
major capital raising transaction to continue moving its business plan forward.
In the interim, the Company is continuing efforts to raise comparably smaller
amounts to cover general and administrative expenses. The Company has no
assurance that it will be able to raise any required funds. The Company has been
and is also exploring efforts to secure one or more joint venture partners.
Sales from production as a result of successful exploration and drilling efforts
would provide the Company with incoming cash flow. The proved reserves
associated with production would most likely increase the value of the Company's
rights in the Prospect. This, in turn, should enable the Company to obtain bank
financing (after the wells have produced for a period of time to satisfy the
lenders requirements). Both of these results would enable the Company to
continue with its development activities. Positive cash flow is a critical
success factor for the Company's plan of operation in the long run. Management
believes that, if the Company's plan of operation successfully progresses (and
production is realized) as planned, sufficient cash flow and debt financing will
be available for purposes of properly pursuing its plan of operation, although
the Company can make no assurances in this regard.
Finally, to reduce its cash requirements, the Company might attempt to satisfy
some of its obligations by issuing common shares, which would result in dilution
in the percentage ownership interests of the Company's existing stockholders and
could result in dilution of the net asset value per share of the Company's
Consequences of a Financing Failure
If required financing is not available on acceptable terms, the Company could be
prevented from satisfying its work commitment obligations or developing the
Prospect to the point that the Company is able to repay the Debentures, which
become due in May 2021. Failure to satisfy work commitment obligations could
result in the eventual loss of the License and the total loss of the Company's
assets and properties. Failure to timely pay the Debentures could result in the
eventual exercise of the rights of a secured creditor and the possible partial
or total loss of the Company's assets and properties. Failure to procure
required financing on acceptable terms could prevent the Company from developing
the Prospect. If any of the preceding events were to occur, the Company could be
forced to cease its operations, which could result in a complete loss of
stockholders' equity. If additional financing is not obtained through an equity
or debt offering, the Company could find it necessary to sell all or some
portion of the Prospect under unfavorable circumstances and at an undesirable
price. However, no assurance can be provided that the Company will be able to
find interested buyers or that the funds received from any such partial sale
would be adequate to fund additional activities. Future liquidity will depend
upon numerous factors, including the success of the Company's exploration and
development program, satisfactory achievement of License commitment's and
capital raising activities.
The Company has experienced no obvious impact from the COVID-19 pandemic with
respect to Liquidity and Capital Resources. However, the result of the pandemic
may create greater uncertainty or challenges in the Company's ability to raise
capital. For further risk discussion, see the risk factor captioned "PANDEMICS
OR DISEASE OUTBREAKS (SUCH AS THE NOVEL CORONAVIRUS, ALSO KNOWN AS THE COVID-19
VIRUS) COULD MATERIALLY AND ADVERSELY AFFECT US IN A VAREITY OF WAYS" in the
Company's Annual Report on Form 10-K for the Company's fiscal year ended
February 29, 2020.
© Edgar Online, source Glimpses