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Second Quarter Results
In the second quarter of 2008, the Company averaged approximately 2,360 boe/d of production, with a net back price of $40.88 per boe. The Company also spent approximately $9.5 million on capital projects and land acquisitions.
Northeast British Columbia Operational Update
Sabretooth has finished drilling its first horizontal Montney well at Red Creek. The completion of this well is scheduled for mid September with initial completion results expected by middle to late October. Capital expenditures for the remaining five months of 2008 are projected at $15.0 million and are expected to include expenditures to drill 4 horizontal and 3 vertical wells primarily on Sabretooth's existing assets at Red Creek, Mica and Gunnell/Sahtaneh.
Sabretooth's existing non-conventional Montney undeveloped land holdings total approximately 40,000 net acres, with Sabretooth's Northeast British Columbia Montney land holdings accounting for approximately 84% of that number. Sabretooth will continue to focus its exploration and development efforts on its core Montney land holdings which will provide a solid base for growth for the balance of 2008 and into 2009. Total undeveloped land holdings will be approximately 119,700 net acres once all contemplated assets divestitures are closed.
Asset Rationalization
The Company successfully closed the sale of its West Central assets on July 31, 2008 and expects to close the sale of its Fireweed assets by the middle of August. When the Fireweed asset sale is completed, the Company will have disposed of approximately 545 boe/d of production for total proceeds of $22.5 million. Current production after asset rationalization is approximately 1,900 boe/d.
Credit Facility and Debt
As a result of the asset rationalization, the Company is in the process of negotiating a revised credit facility. The revised credit facility is expected to be approximately $58.0 million and is expected to close by the middle of August. The Company expects that the 2008 capital program will be funded through cash flow from operations and bank facilities.
About Sabretooth Energy
Sabretooth Energy Ltd. is a public oil and gas exploration and development company, located in Calgary, Alberta and carrying out operations in Western Canada. Sabretooth trades on the Toronto Stock Exchange (TSX) under the symbol "SAB".
This news release contains forward-looking statements relating to the Company's plans and other aspects of the Company's anticipated future operations, strategies, financial and operating results and business opportunities. Forward-looking statements typically use words such as "anticipate", "believe", "project", "expect", "plan", "intend" or similar words suggesting future outcomes, statements that actions, events or conditions "may", "would", "could" or "will" be taken or occur in the future, or statements regarding the outlook for petroleum prices, estimated amounts and timing of capital expenditures, the timing, location and extent of future drilling operations anticipated timing and results of construction projects and project tie-ins, estimates of future production, the ability to realize the timing, on investments in ABCP, the terms of the Corporation's new credit facility, loans to be received from National Bank of Canada, if any, operating costs or other expectations, beliefs, plans, objectives, assumptions or statements about future events or performance. Statements regarding reserves are also forward-looking statements, as they reflect estimates as to the expectation that the deposits can be economically exploited in the future.
These statements are based on certain factors and assumptions regarding expected growth, results of operations, performance, business prospects and opportunities, the terms of the Corporation's new credit facility and the ability of the Company to realize on its investments in ABCP. While we consider these assumptions to be reasonable based on information currently available to us, they may prove to be incorrect.
By their nature, forward-looking statements involve numerous risk and uncertainties and other factors that contribute to the possibility that the predicted outcome will not occur, including, without limitation, risks associated with oil and gas exploration, development, exploitation, production, marketing and transportation, loss of markets, volatility of commodity prices, currency fluctuations, imprecision of reserve estimates, environmental risks, competition from other producers, inability to retain drilling rigs and other services, incorrect assessment of the value of acquisitions, failure to realize the anticipated benefits of acquisitions, delays resulting from or inability to obtain required regulatory approvals, the ability to realize on investments in ABCP and ability to access sufficient capital from internal and external sources. Readers are cautioned that the foregoing list of factors is not exhaustive.
Although Sabretooth believes that the expectations represented in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct. As a consequence, actual results may differ materially from those anticipated in the forward-looking statements and you should not unduly rely on forward-looking statements. The forward-looking statements contained in this news release are made as the date of this new release and the Company does not undertake any obligation to update publicly or to revise any of the included forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by applicable securities laws.
The term barrels of oil equivalent or boe may be misleading, particularly if used in isolation. A conversion ratio for gas of 6 mcf: 1 boe is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.
<< Q2 2008 Highlights ------------------------------------------------------------------------- Three Months Six Months Three Months Six Months Ended Ended Ended Ended June 30, June 30, June 30, June 30, 2008 2008 2007 2007 ------------------------------------------------------------------------- Financial ($) Production revenue $ 15,559,000 $ 29,782,000 $ 4,299,000 $ 9,537,000 Realized gain (loss) on hedge $ (2,331,000) $ (2,411,000) $ 215,000 $ 270,000 Unrealized gain (loss) on hedge $ (4,715,000) $(12,698,000) $ 634,000 $ 17,000 Net income (loss) $ (2,486,000) $(13,305,000) $ 141,000 $ 4,055,000 Funds flow from operations $ 6,339,000 $ 14,072,000 $ 2,177,000 $ 4,664,000 ------------------------------------------------------------------------- Production volumes Natural gas (mcf/d) 12,422 14,098 5,140 5,781 Crude oil (bbls/d) 179 229 114 108 Natural gas liquids (bbls/d) 107 116 24 28 Total (boe/d) 2,357 2,695 995 1,100 Sales prices Natural gas ($/mcf) $ 8.91 $ 8.19 $ 7.93 $ 7.87 Natural gas, not including hedges ($/mcf) $ 10.98 $ 9.13 $ 7.47 $ 7.60 Crude oil ($/bbl) $ 125.19 $ 102.31 $ 63.55 $ 64.76 Natural gas liquids ($/bbl) $ 113.55 $ 98.73 $ 65.86 $ 61.45 Total ($/boe) $ 61.67 $ 55.81 $ 49.84 $ 49.25 Netbacks, not including unrealized hedges ($/boe) Price $ 61.67 $ 55.81 $ 49.84 $ 49.25 Royalties (6.29) (6.98) (6.38) (7.90) Transportation (1.53) (1.38) (1.54) (1.57) Operating costs (12.97) (12.12) (13.09) (10.89) ------------------------------------------------------------------------- Total $ 40.88 $ 35.33 $ 28.83 $ 28.89 ------------------------------------------------------------------------- Capital expenditures ($) ------------------------------------------------------------------------- Total capital expenditures $ 9,522,000 $ 22,126,000 $ 6,142,000 $ 20,098,000 ------------------------------------------------------------------------- Land (net acres) Developed 42,035 42,035 10,656 10,656 Undeveloped 171,619 171,619 49,927 49,927 ------------------------------------------------------------------------- Total Land 213,654 213,654 60,583 60,583 ------------------------------------------------------------------------- >>
Management's Discussion and Analysis
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This Management's Discussion and Analysis ("MD & A") of the financial and operating results for Sabretooth Energy Limited ("Sabretooth" or the "Company") should be read in conjunction with the Company's unaudited consolidated financial statements (the "Financial Statements") and related notes for the six months ended June 30, 2008 as well as with the audited consolidated financial statements (the "Annual Financial Statements") for the year ended December 31, 2007.
This MD & A is dated August 6, 2008.
Basis of Presentation
The financial data presented below has been prepared in accordance with Canadian Generally Accepted Accounting Principles ("GAAP"). The reporting and the measurement currency is the Canadian dollar. For the purpose of calculating unit costs, natural gas is converted to a barrel equivalent ("boe") using six thousand cubic feet of natural gas equal to one barrel of oil unless otherwise stated. The term barrels of oil equivalents (BOE) may be misleading, particularly if used in isolation. A BOE conversion ratio for gas of 6 mcf:1 boe is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.
Non-GAAP Measurements
Within the Management Discussion and Analysis references are made to terms commonly used in the oil and gas industry. Netback is not defined by GAAP in Canada and is referred to as a non-GAAP measure. Netbacks equal total revenue less royalties, operating costs and transportation costs calculated on a boe basis. Management utilizes this measure to analyze operating performance. Total boes are calculated by multiplying the daily production by the number of days in the period.
Funds flow from operations is a non-GAAP term that represents net income (loss) adjusted for non-cash items including depletion, depreciation, accretion, future income taxes, stock-based compensation, unrealized hedge gains (losses), asset write-downs and gains (losses) on sale of assets and before adjustments for changes in working capital. The Company evaluates its performance based on earnings and funds flow from operations. The Company considers funds flow from operations a key measure as it demonstrates the Company's ability to generate the cash flow necessary to fund future growth through capital investment and to repay debt. The Company's calculation of funds flow from operations may not be comparable to that reported by other companies. Funds flow from operations per share is calculated using the same weighted average number of shares outstanding used in the calculation of income (loss) per share.
Forward-looking Statements
Certain statements contained within this MD & A constitute forward- looking statements. These statements related to future events or our future performance. All statements other than statements of historical fact may be forward-looking statements. Forward-looking statements are often, but not always, identified by the use of words such as "seek", "anticipate", "budget", "plan", "continue", "estimate", "expect", "forecast", "may", "will", "project", "predict", "potential", "targeting", "intend", "could", "might", "should", "believe", and similar expressions. Forward-looking statements in this MD & A include, but are not limited to, statements with respect to: the potential impact of implementation of the Alberta Royalty Framework on Sabretooth's condition and projected 2008 capital investments; its ability to realize the Company's investments in Asset Backed Commercial Paper ("ABCP") ; projections with respect to growth of natural gas production; the projected impact of land access and regulatory issues; projections relating to the volatility of crude oil prices in 2008 and beyond and reasons therefore; the Company's projected capital investment levels for 2008 and the source of funding therefore; the effect of the Company's risk management program, including the impact of derivative financial instruments; the Company's defence of lawsuits; the impact of the climate change initiatives on operating costs; the impact of Western Canada pipeline constraints; projections that the Company will fully recover from its ABCP. Readers are cautioned not to place undue reliance on forward-looking statements, as there can be no assurance that the plans, intentions or expectations upon which they are based will occur.
By their nature, forward-looking statements involve numerous assumptions, known and unknown risks and uncertainties, both general and specific, that contribute to the possibility that the predictions, forecast, projects and other forward-looking statements will not occur, which may cause the Company's actual performance and financial results in future periods to differ materially from any estimates or projects of future performance or results expressed or implied by such forward-looking statements. These assumptions, risks and uncertainties include, among other things: volatility of and assumptions regarding oil and gas prices; assumptions based upon Sabretooth's current guidance; fluctuations in currency and interest rates; its ability to realize the Company's investment in ABCP; product supply and demand; market competition; risk inherent in the Company's marketing operations, including credit risks; imprecision of reserves estimates and estimates of recoverable quantities of oil, natural gas and liquids from resource plays and other sources not currently classified as proved; the Company's ability to replace and expand oil and gas reserves; the Company's ability to generate sufficient cash flow from operations to meet its current and future obligations; the Company's ability to access external sources of debt and equity capital; the timing and cost of well and pipeline constructions; the Company's ability to secure adequate product transportation; changes in royalty, tax, environmental and other laws or regulations or the interpretations of such laws or regulations; risks associated with existing and potential future lawsuits and regulatory actions made against the Company; and other risks and uncertainties described from time to time in the reports and filings made with securities regulatory authorities by Sabretooth. Statements relating to "reserves" are deemed to be forward-looking statements, as they involve the implied assessment, based on certain estimates and assumptions that the resources and reserves described can be profitably produced in the future.
Financial outlook information contained in this MD & A about prospective results of operations, financial position or cash flows is based on assumptions about future events, including economic conditions and proposed courses of action, based on management's assessment of the relevant information currently available. Readers are cautioned that such financial outlook information contained in this MD & A should not be used for purposes other than for which it is disclosed herein.
Although Sabretooth believes that the expectations represented by such forward-looking statements are reasonable, there can be no assurance that such expectation will prove to be correct. Readers are cautioned that the foregoing list of important factors is not exhaustive. Furthermore, the forward-looking statements contained in this MD & A are made as of the date of this MD & A, and except as required by law Sabretooth does not undertake any obligation to update publicly or to revise any of the included forward-looking statements, whether as a result of new information, future events or otherwise. The forward-looking statements contained in this MD & A are expressly qualified by this cautionary statement.
<< FINANCIAL RESULTS AND HIGHLIGHTS Three months Six months ended June 30, ended June 30, $(000's) 2008 2007 2008 2007 ------------------------------------------------------------------------- Revenue, net of royalties $ 4,209 $ 3,721 $ 26,360 $ 7,965 Funds flow from operations(1) $ 6,339 $ 2,177 $ 14,072 $ 4,664 Net income (loss) $ (2,486) $ 141 $ (13,305) $ 4,055 ------------------------------------------------------------------------- (1) Funds flow from operations is a non-GAAP term that represents net earnings adjusted for non-cash items including depletion and depreciation, accretion, future income taxes, stock-based compensation, unrealized hedge gains (losses), asset write-downs and gains (losses) on sale of assets. The Company evaluates its performance based on earnings and funds flow from operations. The Company considers funds flow from operations a key measure as it demonstrates the Company's ability to generate the cash flow necessary to fund future growth through capital investment and to repay debt. Summary of Funds Flow from Operations Three months Six months ended June 30, ended June 30, ------------------------------------------- $(000's) 2008 2007 2008 2007 ------------------------------------------------------------------------- Cash From Operating Activities (Add back) deduct: $ 5,254 $ (493) $ 9,948 $ 2,737 Net change in non-cash working capital (1,085) (2,670) (4,124) (1,927) Funds flow from operations $ 6,339 $ 2,177 $ 14,072 $ 4,664 ------------------------------------------------------------------------- >>
Revenue
Gas revenue not including the realized loss on derivatives increased 194% from $7,954,000 for the six months ended June 30, 2007 to $23,433,000 for the same period in 2008. The increase in gas sales relates primarily to the 146% increase in production resulting from the acquisition, the successful drilling program, along with a slight increase of Sabretooth's natural gas price by 4%.
Oil sales increased by 236% for the six month period ending June 30, 2008 compared to the same time period in 2007 primarily due to the strengthening of Sabretooth's oil price by 58%. The increase in the oil price was the result of the significant increase in the US$ WTI.
<< Three months Six months ended June 30, ended June 30, ------------------------------------------- $(000's) 2008 2007 2008 2007 ------------------------------------------------------------------------- Natural gas $ 12,407 $ 3,494 $ 23,433 $ 7,954 Realized gain (loss) on hedge contracts (2,331) 215 (2,411) 270 ------------------------------------------------------------------------- Total Natural gas $ 10,076 $ 3,709 $ 21,022 $ 8,224 Oil 2,042 660 4,261 1,270 Natural gas liquids 1,110 145 2,088 313 ------------------------------------------------------------------------- Total Revenue $ 13,228 $ 4,514 $ 27,371 $ 9,807 ------------------------------------------------------------------------- >>
Pricing
Both natural gas and crude oil prices rose during the second quarter. During the first 6 months of 2008 prices at AECO rose 52% from a low of $6.98/Mcf to a high of $10.60/Mcf. Sabretooth realized an average natural gas price of $8.91/Mcf during the three months ended June 30, 2008, an increase of 12% from $7.93/Mcf for the same period in 2007. The AECO daily index for the same time period increased by 44%.
The selling price for oil for the three months ended June 30, 2008, increased from $63.55/bbl to $125.19/bbl and increase of 97%, due to the increase in the US$ WTI benchmark price, partially offset by a stronger Canadian dollar.
<< Three months Six months Average Selling Price(1) ended June 30, ended June 30, ------------------------------------------- 2008 2007 2008 2007 ------------------------------------------------------------------------- Natural gas (per mcf) $ 8.91 $ 7.93 $ 8.19 $ 7.87 Crude Oil (per bbl) $ 125.19 $ 63.55 $ 102.31 $ 64.76 Natural gas liquids (per bbl) $ 113.55 $ 65.86 $ 98.73 $ 61.45 ------------------------------------------------------------------------- Per boe $ 61.67 $ 49.84 $ 55.81 $ 49.25 ------------------------------------------------------------------------- (1) The average selling prices reported are after realized derivative losses and before transportation costs. Three months Six months ended June 30, ended June 30, ------------------------------------------- Benchmark Pricing 2008 2007 2008 2007 ------------------------------------------------------------------------- AECO natural gas - monthly index (CDN$/Mcf) $ 8.83 $ 7.07 $ 8.24 $ 7.03 AECO natural gas - daily index (CDN$/MCF) $ 9.67 $ 6.70 $ 8.62 $ 6.86 WTI Crude Oil (US$/bbl) $ 123.95 $ 64.94 $ 110.91 $ 61.46 Edmonton Par Price (CDN$/bbl) $ 126.38 $ 72.62 $ 112.30 $ 70.19 US$/CDN$ exchange rate $ 0.99 $ 0.93 $ 0.99 $ 0.89 >>
Production
Production increased to 2,357 boe/d in the second quarter of 2008 from 995 boe/d in the second quarter of 2007, primarily due to the 2007 corporate acquisition of Bear Ridge Resources and the successful drilling program, offset by natural declines.
Sabretooth drilled 4 wells (1.8 net) in the second quarter of 2008, focused primarily in the B.C. resource play. Five new wells came on production in the second quarter adding 65 boe/d, which was offset by three wells that paid out in the second quarter decreasing production by 85 boe/d.
Production volumes for the six months ended June 30, 2008 were 490,461 boe and averaged 2,695 boe/d compared to six months ended June 30, 2007 production volumes were 199,140 boe and averaged 1,100 boe/d.
Production volumes for the three months ended June 30, 2008 were 2,357 boe/d compared to the first quarter of 2008 which were 3,032 boe/d. The decrease was due to non-operated plant downtime and natural declines.
<< For the three For the three months ended months ended June 30, 2008 June 30, 2007 ------------------------------------------------------- Total Per day Total Per day ------------------------------------------------------------------------- Natural Gas 1,130,435 mcf 12,422 mcf/d 467,720 mcf 5,140 mcf/d Crude Oil 16,313 bbls 179 bbls/d 10,384 bbls 114 bbls/d NGLs 9,771 bbls 107 bbls/d 2,220 bbls 24 bbls/d ------------------------------------------------------------------------- Total 214,502 boe 2,357 boe/d 90,557 boe 995 boe/d ------------------------------------------------------------------------- For the six For the six months ended months ended June 30, 2008 June 30, 2007 ------------------------------------------------------- Total Per day Total Per day ------------------------------------------------------------------------- Natural Gas 2,565,809 mcf 14,098 mcf/d 1,046,409 mcf 5,781 mcf/d Crude Oil 41,645 bbls 229 bbls/d 19,612 bbls 108 bbls/d NGLs 21,154 bbls 116 bbls/d 5,126 bbls 28 bbls/d ------------------------------------------------------------------------- Total 490,461 boe 2,695 boe/d 199,140 boe 1,100 boe/d ------------------------------------------------------------------------- >>
Royalty Expense
Royalty expense in the second quarter of 2008 was $1,350,000 or 10% of revenue compared to $578,000 or 13% of revenue in the second quarter of 2007. Royalty expense for the first six months of 2008 was $3,422,000 or 13% of revenue compared to $1,572,000 or 16% of revenue for the same period in 2007. Royalty expense as a percentage of revenue is lower in the current quarter which is primarily due to an additional $800,000 of capital cost recovery credits compared to the same time period in 2007.
<< Three months ended Six months ended June 30, June 30, ------------------------------------------- $(000's) 2008 2007 2008 2007 ------------------------------------------------------------------------- Royalties ($) $ 1,350 $ 578 $ 3,422 $ 1,572 ------------------------------------------------------------------------- As a % of revenue 10% 13% 13% 16% Per Unit of Production ($/boe) $ 6.29 $ 6.38 $ 6.98 $ 7.90 ------------------------------------------------------------------------- Transportation Transportation costs for the second quarter of 2008 were $329,000 or $1.53 per boe. For the six months ended June 30, 2008 transportation costs were $675,000 or $1.38 per boe. Transportation costs for the second quarter of 2007 were $140,000 or $1.54 per boe. For the six months ended June 30, 2007 transportation costs were $313,000 or $1.57 per boe. Transportation costs per boe are relatively flat quarter over quarter. Three months ended Six months ended June 30, June 30, ------------------------------------------- $(000's) 2008 2007 2008 2007 ------------------------------------------------------------------------- Transportation $ 329 $ 140 $ 675 $ 313 Per Unit of Production ($/boe) $ 1.53 $ 1.54 $ 1.38 $ 1.57 ------------------------------------------------------------------------- >>
Operating Costs
Operating costs during the second quarter of 2008 were $2,782,000 or $12.97 per boe compared to $1,186,000 or $13.09 per boe for the same time period in 2007. For the six months ended June 30, 2008 operating costs were $5,945,000 or $12.12 per boe compared to $2,168,000 or $10.89 per boe. For the six months ended June 30, 2008, operating costs increased by 174% per boe while production increased 145% per boe/d comparing to the same period in 2007. The increase in operating costs for the second quarter was attributable to lower production while infrastructure costs remained constant.
<< Three months ended Six months ended June 30, June 30, ------------------------------------------- $(000's) 2008 2007 2008 2007 ------------------------------------------------------------------------- Operating Costs ($) $ 2,782 $ 1,186 $ 5,945 $ 2,168 Per Unit of Production ($/boe) $ 12.97 $ 13.09 $ 12.12 $ 10.89 ------------------------------------------------------------------------- Operating Netbacks Sabretooth's netback for the second quarter of 2008 increased from $28.83 in 2007 to $40.88. For the six months ended June 30, 2008 was $35.33 compared to $28.89 in 2007. The increase in the netback for the six months ended June 30, 2008 is primarily due to the higher average selling prices attributable to higher market prices, along with lower royalty rates, and lower transportation costs. Offsetting these increases in the netback were higher operating costs, and increased derivative losses. Three months ended Six months ended June 30, June 30, ------------------------------------------- 2008 2007 2008 2007 ------------------------------------------------------------------------- Production revenue, including realized hedge gains (losses) $ 61.67 $ 49.84 $ 55.81 $ 49.25 Royalty expense (6.29) (6.38) (6.98) (7.90) Transportation (1.53) (1.54) (1.38) (1.57) Operating Costs (12.97) (13.09) (12.12) (10.89) ------------------------------------------------------------------------- Netback, $/boe $ 40.88 $ 28.83 $ 35.33 $ 28.89 ------------------------------------------------------------------------- >>
General and Administrative Expenses
General and administrative ("G & A") expenses for the second quarter of 2008, net of capitalized amounts and recoveries, were $1,452,000 or $6.77 per boe, up 191% compared to $500,000 or $5.53 per boe for 2007. For the three and six months ended June 30, 2008, Sabretooth capitalized approximately $670,000 and $1,161,000 G & A expenses respectively related to exploration and development. The increase in G & A costs per boe is attributable to increased personnel costs during the second quarter coupled with decreased production.
For the six months ended June 30, 2008 G & A expenses were $2,114,000 or $4.31 per boe compared to $1,078,000 or $5.41 per boe in 2007. Overall G & A per boe has decreased by 20% compared to 2007.
<< Three months ended Six months ended June 30, June 30, ------------------------------------------- $(000's) 2008 2007 2008 2007 ------------------------------------------------------------------------- G & A expense $ 1,452 $ 500 $ 2,114 $ 1,078 Per Unit of Production ($/boe) $ 6.77 $ 5.53 $ 4.31 $ 5.41 ------------------------------------------------------------------------- Interest Expense Interest expense for the second quarter was $757,000 compared to $125,000 in 2007. For the six months ended June 30, 2008 interest expense were $1,501,000 compared to $214,000 in 2007. The increase in interest expense was a result of increased bank debt in 2008 due to the Bear Ridge acquisition. Three months ended Six months ended June 30, June 30, ------------------------------------------- $(000's) 2008 2007 2008 2007 ------------------------------------------------------------------------- Interest Expense ($) $ 757 $ 125 $ 1,501 $ 214 Per Unit of Production ($/boe) $ 3.53 $ 1.38 $ 3.06 $ 1.07 ------------------------------------------------------------------------- >>
Depletion, Depreciation and Amortization ("DD & A")
DD & A expense for the second quarter 2008 was $4,991,000 or $23.27 per boe compared to $2,565,000 or $28.32 in 2007. DD & A expense for the six months ended June 30, 2008 was $10,924,000 or $22.27 per boe compared to $5,858,000 or $29.42 for the same time period in 2007.
The per boe decrease in three months ended 2008 compared to the same period in 2007 is mainly due to the proved reserves developed through the Company's capital projects and the Bear Ridge acquisition.
The depletion rate is impacted by the costs to acquire, explore and develop reserves of crude oil and natural gas, known as finding, development and acquisition costs. In the early stages of exploration, capital costs may be recognized before proved reserves are fully booked leading to higher initial depletion rates. In addition higher depletion rates also result as new production often receives lower reserves assignments under National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities ("NI 51-101") due to the naturally unpredictable nature of newer production.
Asset Retirement Obligations
The Company developed four new assets subject to asset retirement obligations during the second quarter of 2008, and eleven new assets for the six months ended June 30, 2008. $64,000 was recognized as an accretion expense for the second quarter of 2008, and $134,000 for the six months ended June 30, 2008. For the six months period in 2007, the Company acquired ten new assets subject to asset retirement obligations. The Company recognized accretion expense of $14,000 for the second quarter of 2007 and $28,000 for the six months ended June 30, 2007. Total asset retirement obligations recognized at June 30, 2008 is $4,275,000.
Stock Based Compensation
The Company recognizes stock based compensation expense for all stock options granted. For the three and six months ended June 30, 2008, Sabretooth recorded $216,000 (2007 - $76,000) and $550,000 (2007 - $145,000) respectively in stock based compensation expense, with a corresponding increase to contributed surplus, for stock options granted.
Common Shares Outstanding
The number of common voting shares outstanding increased by 48,000 during the second quarter of 2008.
In the first quarter of 2008 the Company granted 195,000 stock options exercisable into voting common shares of the Company. These options vest 25% the first, second, third and fourth anniversaries of grant and have a weighted average exercise price of $2.66 per share.
In the first quarter of 2008, 229,000 vested options were repurchased for approximately $104,000. The amount paid to repurchase the options was charged to contributed surplus.
In the second quarter of 2008 the Company granted 500,000 stock options exercisable into voting common shares of the Company. These options vest 25% the first, second, third and fourth anniversaries of grant and have a weighted average exercise price of $2.28 per share.
In the second quarter of 2008, 48,000 vested options were exercised for approximately $100,000. The amount paid to exercise the options was credited to share capital. $15,000 was charged to contributed surplus related to the stock based compensation recognized for the above options in previous periods; the same amount was credited to share capital.
Income Taxes
The Company has non-capital loss carry-forwards, investment tax credit carry-forwards, and Scientific Research and Development expenses available to reduce future years' income for tax purposes. The Scientific Research and Development expenses of approximately $22,704,000 available for carry-forward do not expire. The non-capital loss and investment tax credit carry-forwards expire as follows:
<< Year of expiry Non-capital losses Investment tax credits $(000's) $(000's) ------------------------------------------------------------------------- 2010 $ - $ 930 2011 - 1,280 2012 - 672 2013 - 761 2014 - 338 2025 6,168 - ----------------------------------------------- $ 6,168 $ 3,981 ----------------------------------------------- >>
In addition, the Company has UCC pools of approximately $38,000,000, COGPE pools of approximately $20,000,000, CEE pools of approximately $38,000,000, CDE pools of approximately $10,000,000, and share issuance costs of approximately $4,000,000 which can be used to reduce taxable income in the future.
As at June 30, 2008, $7,993,000 has been recognized as a future income tax asset as the Company believes, based on estimated cash flows from existing reserves, that it is more likely than not to realize these assets.
<< Capital Expenditures Three months ended Six months ended June 30, June 30, ------------------ ----------------- $(000's) 2008 2007 2008 2007 ------------------------------------------------------------------------- Land acquisition costs $ 2,889 $ 172 $ 5,272 $ 2,337 Geological & geophysical 33 634 288 1,557 Drilling, completions & workovers 4,788 3,262 12,681 11,890 Tangible equipment 1,103 1,842 2,539 3,921 Capitalized overhead 673 232 1,309 393 Office furniture & equipment 36 - 37 - ------------------------------------------------------------------------- Total capital expenditures $ 9,522 $ 6,142 $ 22,126 $ 20,098 ------------------------------------------------------------------------- ------------------------------------------------------------------------- >>
Liquidity and Capital Resources
The Company has established three credit facilities with a Canadian chartered bank. Credit Facility A is a $55,000,000 revolving operating demand loan which bears interest at the bank prime rate plus 0% to 1.5%, depending on the Company's debt to cash flow ratio. Credit Facility B is a $5,000,000 non-revolving acquisition/development demand loan, which bears interest at the bank prime rate plus 0.50%. Credit Facility C is a Revolving Demand Credit Agreement in the face amount of $18,000,000 which bears interest at the bank prime rate and will be required to be repaid in full upon the liquidation or refinancing of the Company's Asset Backed Commercial Paper ("ABCP") holdings. All credit facilities are subject to periodic review by the bank and are secured by a general assignment of book debts and a $100,000,000 demand debenture with a first floating charge over all assets of the Company as well a hypothecation/pledge of ABCP. The Company is authorized to access the credit facilities with prior approval of the Board of Directors of the Company (the "Board"). The Company is required to meet certain financial based covenants under the terms of these facilities. As at June 30, 2008, the Company has drawn $39,566,000 on Facility A, $ Nil on Facility B, and $18,000,000 on Facility C. The effective interest rate for the period ended June 30, 2008 was 5.74% (2007 - 5.40%). In the second quarter of 2008, the Company had exceeded a bank covenant which the bank has waived. The waived covenant states that the Company should not hedge more than 70% of its production under the lending agreement. For the three month period ended June 30, 2008, the Company had hedged approximately 81% of its production.
The Company holds ABCP that is valued at $18,003,000 at June 30, 2008. As at June 30, 2008, the Company held Canadian third party ABCP with an original cost of $24,147,000. At the dates the Company acquired these investments, they were rated R1 (High) and backed by R1 (High) rated assets and liquidity agreements. These investments matured during the third quarter of 2007 but, as a result of the liquidity issues in the ABCP market, did not settle on maturity. As a result the Company has classified its ABCP as long-term investments.
On August 16, 2007 an announcement was made by a group representing banks, asset providers and major investors that they had agreed in principle to a long-term proposal and interim agreement to convert the ABCP's into long-term floating rate notes maturing no earlier than the scheduled maturity of the underlying assets. On September 6, 2007, a Pan-Canadian restructuring committee consisting of major investors was formed. The committee was created to propose a solution to the liquidity problem affecting the ABCP and has retained legal and financial advisors to oversee the proposed restructuring process. On March 17, 2008, a court order was obtained through which a restructuring of the ABCP is expected to occur. A meeting of note holders occurred on April 25, 2008 and the restructuring plan was approved.
The ABCP in which the Company has invested has not traded in an active market since mid-August 2007 and there are currently no market quotations available.
The valuation technique used by the Company to estimate the fair value of its investments in ABCP incorporates probability-weighted discounted cash flows considering the best available public information regarding market conditions and other factors that a market participant would consider for such investments. Probability-weighted discount rates of approximately 7.10% and 12.90% were used at June 30, 2008 for the senior AA and subordinated notes respectively for this estimate and an interest rate of 2.7% was used. This evaluation resulted in a reduction of $6,144,000 to the original cost of the ABCP at June 30, 2008. The assumptions used in determining the estimated fair value reflect the public statements made by the Pan-Canadian restructuring committee that it expects the ABCP will be converted into senior AA rated and subordinated unrated long-term floating rate notes with maturities matching the maturities of the underlying assets and bearing market interest rates commensurate with the nature of the underlying assets and their associated cash flows and the credit rating and risk associated with the long-term floating rate notes. The Company estimates that it will receive 87% of the senior AA rated notes (Class A-1 and A-2) and 13% of the subordinated unrated notes (Class B and C). Assumptions have been made as to the long-term interest rates to be received from the long-term floating rate notes. The term of the notes is estimated to be approximately 7 years which approximates the maturity of the assets backing the note. Based on these assumptions, a write-down of $5,932,000 from the estimated fair value at December 31, 2007 was recognized during the period ended June 30, 2008.
The original ABCP in which the Company has invested has an interest rate of 4.52%. At June 30, 2008 there is $697,000 of interest owing to the Company after impairment allowance. If the restructuring is successful, interest will be paid out. A 36% impairment has been used to value the interest receivable.
Continuing uncertainties regarding the value of the assets which underlie the ABCP, the amount and timing of cash flows and the outcome of the restructuring process could give rise to a further change in the value of the Company's investment in ABCP which would impact the Company's earnings. It is reasonably possible, based on existing knowledge, that change in future conditions in the near term could require a material change in the recognized amount. The reduction from the face value could range from $9,000,000 to $5,900,000 based on alternative reasonable assumptions, although given the nature of the information available, the amount ultimately recovered could vary outside these ranges.
On June 24, 2008 the Company's bank provided an additional credit facility to provide liquidity in respect to the ABCP. The Company will receive Restructuring Notes in exchange for the affected ABCP not backed by ineligible assets. The credit facility is structured as follows:
Tranche A: $10,910,339 revolving credit facility, which represents an amount equal to approximately 45% of the face value of the Restructuring Notes.
Tranche B: $7,273,559 revolving credit facility, which represents an amount equal to approximately 30% of the face value of the Restructuring Notes.
The borrowings under the credit facility will be first allocated to Tranche A and the balance will be allocated to Tranche B. The term is for three years with an option to extend the term to seven years on a year by year basis if agreed to by both parties. Interest is payable at the bank prime rate less 1%. The credit facility is secured by the Restructuring Notes and guarantees. The credit facility also provides for a put option allowing the Company to assign to the bank the Restructuring Notes in payment of the capital under Tranche A. The credit facility will become effective once the final approval and implementation of the restructuring plan is complete.
Contractual Obligations
Sabretooth is committed to various contractual obligations and commitments in the normal course of operations and financing activities. These are outlined as follows:
<< 1) Office Leases - The minimum annual net lease payments, exclusive of operating costs are as follows: 2008 $ 83,000 2009 165,000 2010 169,000 2011 143,000 2012 143,000 Thereafter nil ----------- $ 703,000 ----------- 2) Asset Retirement Obligations - Sabretooth is the owner of oil and natural gas wells and related surface equipments and facilities. These assets will have to be abandoned and the surface returned to its natural state. As at June 30, 2008, total estimated undiscounted future cash flows required to settle these obligations is approximately $12,505,000 which is exclusive of salvage values and adjusted for expected inflation. This estimate is subject to change based on amendments to environmental laws and as new information with respect to the Company's operations become available. Sabretooth estimates that the salvage value of its field equipments would offset a portion of its estimated future asset retirement obligations. Sabretooth does not expect to incur significant asset retirement cost obligations within the next five years. 3) Flow-through Qualifying Expenditures - Sabretooth assumed obligations related to the Bear Ridge acquisition from issuance of flow-through common shares to incur approximately $24,000,000 of qualifying expenditures before December 31, 2008 and $12,300,000 before March 31, 2009. Approximately $22,456,000 of qualifying expenditures has been incurred to June 30, 2008. The Company also has 1,050,000 CDE warrants which are exercisable at a price of $3.81 and expire March 31, 2009. If they are exercised the Company would have an obligation to spend $4,000,000 of CDE expenditures. Outstanding Share Data As of the date of this MD & A, Sabretooth had the following securities outstanding: 1) 39,114,000 common voting shares; 2) 3,306,000 stock options; and 3) 1,050,000 warrants. Quarterly Information Financial 2008 2007 ------------------------------------------------------------------------- ($ thousands except per share data) Q2 Q1 Q4 Q3 ------------------------------------------------------------------------- Production Revenues (including gains (losses) on financial commodity contract) $ 8,513 $ 6,160 $ 12,888 $ 8,547 Royalties 1,350 2,072 2,246 1,454 Operating expenses 2,782 3,163 3,647 1,955 Transportation expenses 329 346 521 244 Net income (loss) (2,486) (10,819) 217 (497) Per Share - basic (0.06) (0.28) 0.01 (0.02) Per share - diluted (0.06) (0.28) 0.01 (0.02) Funds flow 6,339 7,733 5,985 3,875 Per Share - basic 0.16 0.19 0.15 0.14 Per share - diluted 0.16 0.19 0.15 0.13 Capital expenditures, net $ 9,522 12,604 12,013 4,112 Acquisition expenditures, net - - - 24,752 ------------------------------------------------------------------------- Total expenditures $ 9,522 $ 12,604 $ 12,013 $ 28,864 ------------------------------------------------------------------------- Financial 2007 2006 ------------------------------------------------------------------------- ($ thousands except per share data) Q2 Q1 Q4 Q3 ------------------------------------------------------------------------- Production Revenues (including gains (losses) on financial commodity contract) $ 5,150 $ 4,686 $ 5,369 $ 7,485 Royalties 578 994 1,290 1,249 Operating expenses 1,186 982 944 965 Transportation expenses 140 173 198 223 Net income (loss) 141 3,914 (646) 699 Per Share - basic 0.01 0.19 (0.03) 0.04 Per share - diluted 0.01 0.18 (0.03) 0.04 Funds flow 2,177 2,487 3,095 3,192 Per Share - basic 0.11 0.12 0.16 0.17 Per share - diluted 0.10 0.12 0.15 0.17 Capital expenditures, net $ 6,142 13,956 12,281 8,633 Acquisition expenditures, net - - - - ------------------------------------------------------------------------- Total expenditures $ 6,142 $ 13,956 $ 12,281 $ 8,633 ------------------------------------------------------------------------- Operations 2008 2007 ------------------------------------------------------------------------- Q2 Q1 Q4 Q3 ------------------------------------------------------------------------- Production Volumes Natural gas (mcf/day) 12,422 15,773 17,303 10,813 Oil (bbl/day) 179 278 325 165 NGLs (bbl/day) 107 125 171 36 Total boe/day 2,357 3,032 3,380 2,003 ------------------------------------------------------------------------- Average selling price Natural gas ($/per mcf) $ 8.91 $ 7.63 $ 6.84 $ 7.12 Oil ($/per bbl) 125.19 87.57 76.55 80.61 NGLs ($/per bbl) 113.55 86.02 75.81 75.89 ------------------------------------------------------------------------- Combined ($per boe) $ 61.67 $ 51.25 $ 46.21 $ 46.91 Royalties ($per boe) 6.29 7.51 7.22 7.89 Operation expense ($per boe) 12.97 11.46 11.73 10.61 Transportation ($per boe) 1.53 1.25 1.68 1.32 ------------------------------------------------------------------------- Netback ($per boe) $ 40.88 $ 31.03 $ 25.58 $ 27.09 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Operations 2007 2006 ------------------------------------------------------------------------- Q2 Q1 Q4 Q3 ------------------------------------------------------------------------- Production Volumes Natural gas (mcf/day) 5,140 6,429 8,308 9,418 Oil (bbl/day) 114 103 49 10 NGLs (bbl/day) 24 32 21 80 Total boe/day 995 1,206 1,454 1,659 ------------------------------------------------------------------------- Average selling price Natural gas ($/per mcf) $ 7.47 $ 7.80 $ 7.09 $ 5.90 Oil ($/per bbl) 63.55 66.14 60.42 69.71 NGLs ($/per bbl) 65.86 57.67 67.11 65.71 ------------------------------------------------------------------------- Combined ($per boe) $ 49.84 $ 48.75 $ 43.96 $ 39.29 Royalties ($per boe) 6.38 9.16 9.64 8.18 Operation expense ($per boe) 13.09 9.05 7.07 6.32 Transportation ($per boe) 1.54 1.60 1.48 1.46 ------------------------------------------------------------------------- Netback ($per boe) $ 28.83 $ 28.94 $ 25.77 $ 23.33 ------------------------------------------------------------------------- ------------------------------------------------------------------------- >>
Financial instruments and risk management
The Company has the following financial instruments:
Cash and cash equivalents are designated as held-for-trading instruments and are measured at fair value. Investment in commercial paper is designated as held-for-trading and is measured at fair value with changes in fair value recognized in earnings. Accounts receivable and deposits are designated as loans and receivables and are measured at amortized cost. Accounts payable and accrued liabilities and bank indebtedness are designated as other financial liabilities and are measured at amortized cost. All risk management assets and liabilities are derivative financial instruments and classified as held-for-trading.
The Company uses various types of derivative financial instruments to manage risks associated with natural gas price fluctuations. These instruments are not used for trading or speculative purposes. Proceeds and costs realized from holding the related contracts are recognized at the time each transaction under a contract is settled. For the unrealized portion of such contracts, the Company utilizes the fair value method of accounting. The fair value is based on an estimate of the amounts that would have been paid to or received from counter parties to settle these instruments given future market prices and other relevant factors. The method requires the fair value of the derivative financial instruments to be recorded at each balance sheet date with unrealized gains or losses on those contracts recorded through net earnings.
An embedded derivative is a component of a contract that affects the terms in relation to another factor. These hybrid contracts are considered to consist of a "host" contract plus an embedded derivative. The embedded derivative is separated from the host contract and accounted for as a derivative only if certain conditions are met. The Company has not identified any embedded derivatives which require separate recognition and measurement.
The nature of these financial instruments and its operations expose the Company to market risk, credit risk and liquidity risk. The Company manages its exposure to these risks by operating in a manner that minimizes these risks. The Board of Directors has overall responsibility for the establishment and oversight of the Company's risk management framework. The Board has established policies in setting risk limits and controls and monitors these risks in relation to market conditions.
a) Market risk
Market risk is the risk that changes in market prices, such as foreign exchange rates, commodity prices, and interest rates will affect the Company's net earnings or the value of financial instruments. These risks are generally outside the control of the Company. The objective of the Company is to mitigate market risk exposures within acceptable limits, while maximizing returns.
Commodity price risk
--------------------
The nature of the Company's operations results in exposure to fluctuations in commodity prices. Management continuously monitors commodity prices and initiates instruments to manage exposure to these risks when it deems appropriate. As a means of managing commodity price volatility, the Company enters into various derivative financial instrument agreements and physical contracts. Collars ensure that the commodity prices realized will fall into a contracted range for a contracted sale volume based on the monthly index price. Monthly gains and losses are determined based on the differential between the AECO daily index and the AECO monthly index when the monthly index price falls in between the floor and the ceiling. Derivative financial instruments are marked-to-market and are recorded on the consolidated balance sheet as either an asset or liability with the change in fair value recognized in net earnings.
The following information presents all positions for the derivative financial instruments outstanding as at June 30, 2008.
<< ------------------------------------------------------------------------- Term Volume Price Basis ------------------------------------------------------------------------- April 1, 2008 to March 31, 2009 3,000 GJ/day $7.04 AECO ------------------------------------------------------------------------- April 1, 2008 to March 31, 2009 6,000 GJ/day $7.08 AECO ------------------------------------------------------------------------- January 1, 2008 to December 31, 2008 3,150 GJ/day $6.50 floor AECO $10.00 ceiling ------------------------------------------------------------------------- >>
Realized losses totalling $2,331,000 for the second quarter ending June 30, 2008 from derivatives was recognized in income (June 30, 2007 - $215,000 realized gain). For the six months ended June 30, 2008, the Company realized losses totalling $2,411,000 (June 30, 2007 - $270,000 realized gain). The fair value of the commodity contracts outstanding at June 30, 2008 were $(11,
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