General
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." Its
current business plan is to explore for and produce Hydrocarbons from a tract of
land (the "Prospect") covered by Petroleum Exploration License (PEL) 512 (the
"License") in the State of South Australia. The business plan was adopted near
the end of fiscal 2012. 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
liquid (collectively "Hydrocarbons"). For information about the milestones that
the Company has achieved to date, see "Item 1. Business." 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.
The Company has experienced losses and negative cash flows since inception, and
it expects to incur such losses and negative cash flows for the foreseeable
future. The Company has an accumulated deficit of $31,661,738 since inception
through February 28, 2021. As of June 1, 2021, the Company had approximately
$15,000 in cash available to meet its operating cash requirements. The Company's
losses (coupled with a limited amount of cash) cause doubt about the Company's
ability to continue as a going concern, and our independent registered public
accountant has added an emphasis paragraph to its report on our financial
statements for the year ended February 28, 2021 regarding our ability to
continue as a going concern. The Company is maintaining an on-going effort to
locate sources of additional funding, without which the Company will not be able
to remain a viable entity. Information about the Company's liquidity situation
and its on-going capital raising activities is given in the section captioned
"Liquidity and Capital Resources" below.
Critical Accounting Policies and Estimates
The Company's discussion and analysis of its financial condition and results of
operations as of February 28, 2021 are based upon its independently audited
financial statements, which have been prepared in accordance with generally
accepted accounting principles in the United States. The preparation of these
financial statements requires that management make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. The estimates are based
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances. These estimates and assumptions provide a
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions, and these differences
may be material. The footnotes to the financial statements contain critical
accounting policies that significantly impact the judgments and estimates used
in the preparation of these financial statements. These policies should be
reviewed to better understand the financial condition and results of operations
of the Company.
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Results of Operations
Results of operations for the fiscal years ended February 28, 2021 and February
29, 2020 are summarized in the table below:
Fiscal Year Fiscal Year
Ended Ended
February 28, 2021 February 29, 2020
Revenue $ - $ -
Operating expenses (3,755,298 ) (3,661,874 )
Other expenses (2,328,415 ) (2,241,259 )
Net loss $ (6,083,713 ) $ (5,903,133 )
Operating expenses for the fiscal years ended February 28, 2021 and February 29,
2020 are summarized in the table below:
Fiscal Year Fiscal Year
Ended Ended
February 28, 2021 February 29, 2020
Stock-based compensation $ - $ 802,500
General and administrative 1,008,532 1,627,008
Warrant modification expense 2,710,166 1,184,366
Exploration costs 36,600 48,000
Total operating expenses $ 3,755,298 $ 3,661,874
Comparison of Fiscal Year Ended February 28, 2021 to Fiscal Year Ended February
29, 2020
Revenues. The Company did not earn any revenues in either of the comparative
fiscal 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 fiscal year
ended February 28, 2021 increased by $93,424 (2.6%), compared to those incurred
during the fiscal year ended February 29, 2020. The Company had stock-based
compensation expense of $802,500 for the fiscal year ended February 29, 2020,
compared to none for the fiscal year ended February 28, 2021. The decrease of
general and administrative expense is primarily due to the pandemic impact on
travel and lower third-party professional service fees. Moreover, third party
professional service fees were higher during the fiscal year ended February 29,
2020 due to certain non-recurring matters during that period, including a
farmout agreement and the corporate approval of a reverse stock split that the
Company ultimately decided not to pursue. The increase in warrant modification
expense is primarily due to the extension of the maturity date of outstanding
warrants to December 31, 2023. As a result of this modification, the Company
recorded additional expense of approximately $2,710,166.
Net Loss. The Company had a net loss of $6,083,713 for the fiscal year ended
February 28, 2021, compared to a net loss of $5,903,133 for the fiscal year
ended February 29, 2020. Loss per common share was $0.04 for the fiscal year
ended February 28, 2021, and $0.04 for the fiscal year ended February 29, 2020.
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Cash Flows for the Fiscal Years Ended February 28, 2021 and February 29, 2020
Cash Used in Operating Activities: Operating activities for the fiscal year
February 28, 2021 used cash of $202,674, compared to $882,037 to the fiscal year
ended February 29, 2020 primarily due to lower travel and third party
professional service fees during the fiscal year ended February 28, 2021, and
timing differences on payables.
Cash Used in Investing Activities: No cash was used for investing activities
during the fiscal year ended February 28, 2021 and February 29, 2020.
Cash Provided by Financing Activities: Financing activities totaled $218,750
during the fiscal year ended February 28, 2021, resulting from the private
placement of 500,000 common shares at $0.20 per common share for gross proceeds
of $100,000, and proceeds from a Paycheck Protection Program loan in the amount
of $118,750. Financing activities totaled $406,250 during the fiscal year ended
February 29, 2020 resulting from the private placement of 1,425,000 common
shares at $0.25 per common share and 250,000 common shares at $0.20 per common
share
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 Debentures financings described below.
Debentures 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 and the extension of the maturity
date of the Debentures, Warrants were issued that give the holder the right to
purchase up to a maximum of 27,877,058 common shares at an initial per-share
exercise price of $0.20.
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
Debentures.
* The principal amount of and accrued interest on the Debentures are due and
payable in a single balloon payment on or before December 31, 2023.
* We are not entitled to prepay the Debentures.
* 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.
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* 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 Debentures holders' ability to accelerate the maturity of the Debentures
such that all amounts owing under the Debentures would become immediately due
and payable. The Debentures 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 Risk Factors
captioned "THE EXERCISE OF SECURED CREDITOR RIGHTS COULD RESULT IN A
SIGNIFICANT OR COMPLETE LOSS" herein.
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 will remain so until their
expiration date of December 31, 2023.
* 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. To date, the holder has not exercised
this right.
Moreover, the holders of the Debentures have the right to require the Company to
register with the SEC the resale of the common shares into which Debentures can
be converted, the common shares that can be acquired upon the exercise of the
Warrants and possibly other Common Shares. This preceding right is generally
referred to as "demand" registration rights. The Company has the obligation to
file a registration statement to effect the registration within certain periods
of time, and the obligation to cause such registration statement to become
effective within certain other periods of time. It will be liable for stipulated
monetary damages if it fails in these obligations. The size of these damages is
significant, although they are believed to be customary. Once a registration
statement is declared effective, the Company must maintain it as effective and
current until such time as the registered common shares are sold or become
eligible to be sold pursuant to an exemption under certain circumstances, which
it believes will never occur. In addition to the Debentures holders' "demand"
registration rights, the Debentures holders have "piggyback" registration rights
whereby they can participate (without a demand) in most registrations that the
Company might proposes.
The proceeds from the Debentures placements were generally used to fund the
acquisition, processing and interpretation of the Nike Survey data and payment
of the Company's and the Debentures 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 Rincon Energy, LLC pursuant to a geophysical consulting agreement.
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COVID-19. The Company initially experienced no material impacts from the
COVID-19 pandemic with respect to liquidity and capital. However, the negative
reaction in financial markets was significant. Initially, the pandemic resulted
in a severe decrease in demand for Hydrocarbons, in particular transportation
fuels. This decrease resulted in a major drop in the price of crude oil and its
resulting impact on financial markets in general and in particular, the energy
industry. Demand has now recovered substantially, crude oil prices have
increased to above $60 per barrel for the next three years based on the forward
curve. Exploration and production operations are recovering and funding is
becoming more widely available. However, the recent increase in infection rates
is concerning though there has, to date, been no negative Hydrocarbon sector
activity impact. 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."
Equity Placements. Subsequent to the start of the Debentures placements, the
Company continued certain private capital raising transactions involving its
common shares. Beginning in November 2016 and concluding in July 2020, the
Company closed on a series of private placements in which an aggregate of
9,075,000 shares were issued for an aggregate purchase price of $1,886,250.
Paycheck Protection Program Loan. In connection with the Paycheck Protection
Program established by the Coronavirus Aid, Relief, and Economic Security Act,
the Company borrowed an initial loan during fiscal year 2021 in the amount of
$118,750 and a second loan during fiscal year 2022 in the amount of $120,000.
The Company is in the process of applying for the forgiveness of the first draw
to the maximum extent permitted by applicable law. The Company is also planning
on applying for forgiveness of the second draw to the maximum extent permitted.
Available Cash. As of June 1, 2021, the Company had cash of approximately
$15,000, and had negative working capital of approximately $1,926,000.
Management believes that the cash on hand, as of the preceding date, will be
sufficient to finance general and administrative expenses through July 31, 2021
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 May 2021 and October 2023 (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 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,
costs estimates and sales prices. 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.
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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 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 has
not completely abandon this strategy, the Company did shift its emphasis in an
effort 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 paragraph.
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 also
re-commenced 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 shares of its 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 existing stockholders.
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 December 2023. 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
commitments and capital raising activities.
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Known Trends
Management believes that it has discerned the following trends relevant to the
Company:
* Oil consumption in 2020 declined by 6.7% to 93 million barrels a day. This was
the largest historical decline in volume terms, and the first recorded decline
since 2009. Consumption fell in most countries, as COVID-19 containment
measures impacted road and air travel and industrial production.
* Oil consumption is forecast to increase by 1.8% in 2021, reaching 95 million
barrels a day. A large proportion of this recovery is due to higher transport
related demand.
* In 2022, consumption is forecast to rise by 3.7% to 99 million barrels a day
(Figure 8.1). Consumption is projected to reach 102 million barrels a day in
2024, before declining marginally to 101 million barrels in 2026.
* Oil prices are forecast to average $61 per barrel in 2021, significantly
higher than 2020, when prices were severely affected by COVID-19. Over the
medium term, prices are projected to remain around $60 a barrel, prices are
projected to average $65 a barrel in 2024, before falling to $62 a barrel in
2025
* Australian oil consumption is forecast to recover to 2018-19 levels in
2021-22. For the rest of the outlook period, Australian oil consumption is
projected to increase marginally, reaching 1.1 million barrels a day by
2025-26.
* The forecast for Australia's crude and condensate export earnings has been
revised up by around $120 million in 2020-21 and $260 million in 2021-22
(nominal terms), due to higher oil price forecasts.
* Australian export earnings (in real terms) are projected to increase from
A$7.7 billion in 2020-21 to A$10 billion in 2025-26, as prices recover.
(Sources: BREE - Resources and Energy Quarterly - March, 2021)
Off-Balance Sheet Arrangements
During the year ended February 28, 2021, the Company had no off-balance sheet
arrangements.
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