10-Q 1 form10-q.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(MARK ONE)

 

[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended May 31, 2019

 

[  ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                     to

 

Commission file number 000-53520

 

DISCOVERY ENERGY CORP.

(Exact Name of Registrant as Specified in Its Charter)

 

Nevada   98-0507846
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

One Riverway Drive, Suite 1700, Houston, Texas 77056

(Address of principal executive offices)

 

713-840-6495

(Registrant’s telephone number)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [  ] Accelerated filer [  ]
       
Non-accelerated filer [X] Smaller reporting company [X]
       
    Emerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

 

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 151,940,396 as of July 19, 2019.

 

 

 

   
 

 

PART I FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

Discovery Energy Corp.

Consolidated Balance Sheets

(Unaudited)

 

   May 31, 2019   February 28, 2019 
Assets          
Current Assets          
Cash  $123,633   $405,908 
Prepaid expenses   116,696    23,246 
Tax receivable   354    1,311 
Total Current Assets   240,683    430,465 
Oil and gas property – not subject to amortization (successful efforts method)   2,883,915    2,883,915 
Other assets   34,580    35,730 
Total Assets  $3,159,178   $3,350,110 
           
Liabilities and Shareholders’ Deficit          
Current Liabilities          
Accounts payable and accrued liabilities  $1,606,367   $1,409,658 
Accounts payable – related parties, net   396,687    149,190 
Total Current Liabilities   2,003,054    1,558,848 
           
Convertible debentures payable, net of debt discount   3,560,596    3,182,027 
Total Liabilities   5,563,650    4,740,875 
           
Commitments and Contingencies          
           
Shareholders’ Deficit          
Preferred stock – 10,000,000 shares authorized, zero issued and outstanding   -    - 
Common stock – 500,000,000 shares authorized, $0.001 par value – 151,940,396 and 148,240,396 shares issued and outstanding, respectively   151,940    148,240 
Additional paid-in capital   19,160,665    18,059,682 
Accumulated other comprehensive income   159,137    76,205 
Accumulated deficit   (21,876,214)   (19,674,892)
Total Shareholders’ Deficit   (2,404,472)   (1,390,765)
Total Liabilities and Shareholders’ Deficit  $3,159,178   $3,350,110 

 

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

 

 1 
 

 

Discovery Energy Corp.

Consolidated Statements of Operations and Comprehensive Loss

For the Three Months Ended May 31, 2019 and 2018

(Unaudited)

 

   Three Months Ended   Three Months Ended 
   May 31, 2019   May 31, 2018 
Operating Expenses          
General and administrative  $1,629,636   $327,082 
Exploration costs   26,925    93,447 
Total operating expenses   1,656,561    420,529 
           
Operating loss   (1,656,561)   (420,529)
           
Other Income (Expense)          
Interest expense   (545,349)   (781,962)
Miscellaneous income   687    282 
Gain (loss) on foreign currency transactions   (99)   1,251 
           
Other income (expenses)   (544,761)   (780,429)
           
Net loss  $(2,201,322)  $(1,200,958)
           
Loss per common share – basic and diluted  $(0.01)  $(0.01)
Weighted average number of common shares outstanding – basic and diluted   150,130,613    143,040,396 
           
Comprehensive Income (Loss)          
Net loss  $(2,201,322)  $(1,200,958)
Other comprehensive income (loss) – gain (loss) on foreign currency translation   82,932    89,584 
Total comprehensive loss  $(2,118,390)  $(1,111,374)

 

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

 

 2 
 

 

Discovery Energy Corp.

Consolidated Statements of Shareholders’ Equity (Deficit)

For the Three Months Ended May 31, 2019 and 2018

(Unaudited)

 

   Common Stock   Additional       Accumulated
Other
  

Total

Shareholders’

 
   Number  

Par

Value

  

Paid-In

Capital

  

Accumulated

Deficit

  

Comprehensive

Income

  

Equity

(Deficit)

 
Balance, February 28, 2019   148,240,396   $148,240   $18,059,682   $(19,674,892)  $76,205   $(1,390,765)
Share-based compensation   3,700,000    3,700    736,300    -    -    740,000 
Warrant modification expense   -    -    364,683    -    -    364,683 
Gain on foreign currency translation   -    -    -    -    82,932    82,932 
Net loss   -    -    -    (2,201,322)   -    (2,201,322)
                               
Balance, May 31, 2019   151,940,396   $151,940   $19,160,665   $(21,876,214)  $159,137   $(2,404,472)

 

   Common Stock   Additional       Accumulated
Other
  

Total

Shareholders’

 
   Number  

Par

Value

  

Paid-In

Capital

  

Accumulated

Deficit

  

Comprehensive

Income

  

Equity

(Deficit)

 
Balance, February 28, 2018   143,040,396   $143,040   $4,520,275   $(19,516,772)  $4,756   $(14,848,701)
Modified retroactive adjustment for derivative liability   -    -    12,544,607    3,627,512    -    16,172,119 
Gain on foreign currency translation   -    -    -    -    89,584    89,584 
Net loss   -    -    -    (1,200,958)   -    (1,200,958)
                               
Balance, May 31, 2018   143,040,396   $143,040   $17,064,882   $(17,090,218)  $94,340   $212,044 

 

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

 

 3 
 

 

Discovery Energy Corp.

Consolidated Statements of Cash Flows

For the Three Months Ended May 31, 2019 and 2018

(Unaudited)

 

   Three Months Ended
May 31, 2019
   Three Months Ended
May 31, 2018
 
Cash flows from operating activities          
Net loss  $(2,201,322)  $(1,200,958)
Adjustments to reconcile net loss to net cash used in operating activities:          
Amortization of debt discount   378,569    336,676 
Interest expense related to derivative liabilities in excess of debt   -    295,662 
Stock-based compensation   740,000    - 
Warrant modification expense   364,683    - 
Foreign currency transaction (gain) loss   99    (1,251)
Changes in operating assets and liabilities:          
Prepaid expenses   (93,450)   (39,220)
Tax receivable   957    (661)
Accounts payable and accrued liabilities   197,760    140,561 
Accounts payable – related party, net   247,497    30,267 
Net cash used in operating activities   (365,207)   (438,924)
           
Cash flows from financing activities          
Proceeds from issuance of convertible debentures   -    350,000 
Net cash flows provided by financing activities   -    350,000 
           
Effect of foreign currency translation on cash   82,932    89,584 
           
Change in cash during the period   (282,275)   660 
           
Cash, beginning of the period   405,908    261,141 
           
Cash, end of the period  $123,633   $261,801 
           
Supplemental disclosures:          
Interest paid  $-   $- 
Income taxes paid  $-   $- 
           
Noncash investing and financing activities:          
Modified retroactive adjustment for derivative liabilities  $-   $16,172,119 

 

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

 

 4 
 

 

Discovery Energy Corp.

Notes to the Consolidated Financial Statements

 

1. Nature of Operations

 

The principal business of Discovery Energy Corp. (“Company”) is the exploration and development of the 584,651 gross acres (“Prospect”) in South Australia covered by Petroleum Exploration License PEL 512 (“License”). In May 2012, the Company incorporated a wholly-owned Australian subsidiary, Discovery Energy SA Ltd., for the purpose of acquiring a 100% working interest in the License. On May 25, 2016, its status changed from a public to a private legal entity and its name to Discovery Energy SA Pty Ltd. (“Subsidiary”). To date, the Company has not determined whether or not the Prospect, which overlies portions of the Cooper and Eromanga basins, contains any crude oil and/or natural gas reserves that are economically recoverable. While the Company’s present focus is on the Prospect, it may consider pursuing other attractive crude oil and/or natural gas exploration opportunities.

 

2. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited interim consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and the rules of the U.S. Securities and Exchange Commission (“SEC”).

 

Principles of Consolidation

 

These consolidated financial statements include the accounts of the Company and the Subsidiary. Inter-company transactions and balances have been eliminated upon consolidation.

 

Use of Estimates

 

The preparation of these financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of these financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid instruments with a maturity of three months or less at the time of acquisition to be cash equivalents. The Company maintains its cash in bank accounts which, at times, may exceed federally insured limits as guaranteed by the Federal Deposit Insurance Corporation. As of May 31, 2019, all the Company’s cash balances were insured. The Company has not experienced any losses on such accounts.

 

Oil and Gas Property and Exploration Costs

 

The Company is in the exploration stage of evaluating the Prospect and has not yet realized any revenues from its operations. It applies the successful efforts method of accounting for crude oil and natural gas properties. Under this method, exploration costs such as exploratory geological and geophysical costs, delay rentals and exploratory overhead are expensed as incurred. Costs to acquire mineral interests in crude oil and/or natural gas properties, drill and equip exploratory wells that find proved reserves and drill and equip development wells are capitalized. Acquisition costs of unproved leaseholds are assessed for impairment during the holding period and transferred to proven crude oil and/or natural gas properties to the extent associated with successful exploration activities. Significant undeveloped leases are assessed individually for impairment, based on the Company’s current exploration plans, and a valuation allowance is provided if impairment is indicated. Capitalized costs from successful exploration and development activities associated with producing crude oil and/or natural gas leases, along with capitalized costs for support equipment and facilities, are amortized to expense using the unit-of-production method based on proved crude oil and/or natural gas reserves on a field-by-field basis, as estimated by qualified petroleum engineers.

 

Long-lived Assets

 

The carrying values of long-lived assets are reviewed on a regular basis for the existence of facts or circumstances that may suggest impairment. The Company recognizes impairment when the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Impairment losses, if any, are measured as the excess of the carrying amount of the asset over its estimated fair value.

 

Fair Value of Financial Instruments and Derivative Financial Instruments

 

The carrying amounts of cash, receivables, accounts payable, accrued liabilities and shareholder loans approximate their fair values due to the short maturity of these items. Certain fair value estimates may be subject to and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect these estimates. The Company does not hold or issue financial instruments for trading purposes, nor does it utilize derivative instruments in the management of its foreign exchange, commodity price, and/or interest rate market risks.

 

 5 
 

 

Income Taxes

 

Deferred income taxes are reported for timing differences between items of income or expense reported in these financial statements and those reported for income tax purposes. The Company uses the asset/liability method of accounting for income taxes. Deferred income taxes and tax benefits are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases, and for tax loss and credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company provides a valuation allowance for deferred taxes for the estimated future tax effects attributable to temporary differences and carry-forwards when realization is not more likely than not.

 

The Tax Cuts and Jobs Act of 2017 was signed into law on December 22, 2017. The law includes significant changes to the U.S. corporate income tax system, including a federal corporate rate reduction from 34% to 21%. In accordance with ASC 740, the impact of a change in the tax law is recorded in the period of enactment.

 

The Company accounts for uncertain income tax positions by recognizing in the financial statements, the impact of a tax position, if that position is more likely than not of being sustained on examination by taxation authorities, based on the technical merits of the position.

 

Foreign Currency Translation

 

The Company’s functional and reporting currency is the United States dollar. Monetary assets and liabilities denominated in foreign currencies are translated using exchange rates prevailing at the balance sheet date. Non-monetary assets are translated at historical exchange rates, and revenue and expense items at average rates of exchange prevailing during the period. Differences resulting from translation are presented in equity as accumulated other comprehensive income (loss). Gains and losses arising on settlement of foreign currency denominated transactions or balances are included in the determination of income. Foreign currency transactions are primarily undertaken in Canadian and Australian dollars. The Company has not, to the date of these financial statements, entered into derivative instruments to offset the impact of foreign currency fluctuations.

 

Fair Value Considerations

 

Historically, the Company followed Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” as amended by FASB Financial Staff Position (“FSP”) No. 157 and related guidance. These provisions relate to the Company’s financial assets and liabilities carried at fair value and the fair value disclosures related to financial assets and liabilities. ASC 820 defines fair value, expands related disclosure requirements, and specifies a hierarchy of valuation techniques based on the nature of the inputs used to develop the fair value measures. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, assuming the transaction occurs in the principal or most advantageous market for that asset or liability.

 

There are three levels of inputs to fair value measurements - Level 1, meaning the use of quoted prices for identical instruments in active markets; Level 2, meaning the use of quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active or are directly or indirectly observable; and Level 3, meaning the use of unobservable inputs. The Company uses Level 1 inputs for its fair value measurements whenever there is an active market, with actual quotes, market prices, and observable inputs on the measurement date. The Company uses Level 2 inputs for fair value measurements whenever there are quoted prices for similar securities in an active market or quoted prices for identical securities in an inactive market. The Company uses observable market data whenever available.

 

In accordance with ASC 815-40-25 and ASC 815-10-15 “Derivatives and Hedging” and ASC 480-10-25 “Liabilities-Distinguishing Liabilities from Equity”, the embedded derivative associated with the convertible note payable and warrant were accounted for as liabilities during the term of the related note payable and warrant as of February 28, 2018.

 

In July 2017, the FASB issued Accounting Standards Update (“ASU”) 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features. These amendments simplify the accounting for certain financial instruments with down round features. The amendments require companies to disregard the down round feature when assessing whether the instrument is indexed to its own stock, for purposes of determining liability or equity classification. The standard was adopted as of March 1, 2018.

 

Loss Per Share

 

Basic Earnings Per Share (“EPS”) is computed by dividing net income (loss) available to common shareholders (numerator) by the weighted average number of shares outstanding (denominator) during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. In computing diluted EPS, the average stock price for the period is used to determine the number of shares assumed to be purchased from the exercise of stock options and/or warrants. Diluted EPS excludes all dilutive potential shares if their effect is anti-dilutive.

 

 6 
 

 

For the quarters ended May 31, 2019 and 2018, the following share equivalents related to convertible debt and warrants to purchase shares of common stock were excluded from the computation of diluted net loss per share, as the inclusion of such shares would be anti-dilutive.

 

   Quarter Ended   Quarter Ended 
Common Shares Issuable for:  May 31, 2019   May 31, 2018 
Convertible debt   51,054,769    47,169,554 
Stock warrants   19,125,000    19,125,000 
    70,179,769    66,294,554 

 

Comprehensive Income (Loss)

 

The Company recognizes currency translation adjustments as a component of comprehensive income (loss).

 

Recent Accounting Pronouncements

 

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”). ASU 2016-15 will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017. The new standard will require adoption on a retrospective basis unless it is impracticable to apply, in which case it would be required to apply the amendments prospectively as of the earliest date practicable. The Company adopted this standard on March 1, 2019, and determined that it had no receipts or payments meeting the criteria of the ASU. Therefore, the adoption had no impact on the Company’s May 31, 2019 consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”. The new lease guidance supersedes Topic 840. The core principle of the guidance is that entities should recognize the assets and liabilities that arise from leases. Topic 840 does not apply to leases to explore for or use minerals, oil, natural gas and similar nonregenerative resources, including the intangible right to explore for those natural resources and rights to use the land in which those natural resources are contained. In July 2018, the FASB issued ASU No. 2018-11, “Leases (Topic 842): Targeted Improvements”, which provides entities with an alternative modified transition method, for which, comparative periods, including the disclosures related to those periods, are not restated.

 

In addition, the Company elected practical expedients provided by the new standard whereby, the Company has elected to not reassess its prior conclusions about lease identification, lease classification, and initial direct costs and to retain off-balance sheet treatment of short-term leases (i.e., 12 months or less and does not contain a purchase option that the Company is reasonably certain to exercise). As a result of the short-term expedient election, the Company has no leases that require the recording of a net lease asset and lease liability on the Company’s consolidated balance sheet or have a material impact on consolidated earnings or cash flows as of May 31, 2019. Moving forward, the Company will evaluate any new lease commitments for application of Topic 842.

 

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features. These amendments simplify the accounting for certain financial instruments with down round features. The amendments require companies to disregard the down round feature when assessing whether the instrument is indexed to its own stock, for purposes of determining liability or equity classification. The Company adopted the standard as of March 1, 2018.

 

The Company does not anticipate that the adoption of other recently issued accounting pronouncements will have a significant impact on its financial statements.

 

3. Going Concern

 

These financial statements were prepared on a going concern basis, which implies that the Company will continue to realize its assets and discharge its liabilities in the normal course of business. The Company has not generated revenues since inception, and is unlikely to generate earnings in the immediate or foreseeable future. The continuation of the Company as a going concern is dependent upon the ability of the Company to obtain necessary equity or debt financing to continue operations, successfully develop the Prospect and/or obtain producing properties, with a goal of attaining profitable operations. The Company is currently attempting to complete a significant financing, and in this connection might (a) place a significant amount of additional Debentures similar to those described below, (b) secure an alternative financing arrangement, possibly involving the Company’s equity securities, or (c) some combination of (a) and (b). The Company has no assurance that it will be able to raise significant additional funds to develop the Prospect or the additional funds needed for general corporate purposes.

 

As of May 31, 2019, the Company had not generated any revenues and had an accumulated loss of $21,876,214 since inception. These factors raise substantial doubts regarding the Company’s ability to continue as a going concern. These financial statements do not include any adjustments related to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

 

 7 
 

 

4. Oil and Gas Properties

 

The License covers 584,651 gross acres in the State of South Australia. The License grants a 100% working interest in the preceding acreage, which overlies portions of the Cooper and Eromanga basins.

 

On October 26, 2012, a 100% interest in the License was officially issued to the Subsidiary.

 

On May 19, 2014, the Company received notice from the Government of South Australia that it had issued certain modifications to the License and had suspended the License for a period of six months. Such a suspension functions like an extension. Under the amended License, the Company is required to drill 7 exploratory wells rather than 12, as originally required. The 7 required wells must be drilled in years 3, 4, and 5 (2, 2, and 3 wells, respectively). The amount of required 2D seismic was also reduced to 62 miles (100 km.) in year 3 from 155 miles (250 km.) in year 2 but the total 3D seismic work guarantee increased to 193 sq. miles (500 sq. km.) from 154 sq. miles (400 sq. km.). However, the 3D seismic survey requirement is spread over three years with 39 sq. miles (100 sq. km.) in year 2, 77 sq. miles (200 sq. km.) in year 3 and 77 sq. miles (200 sq. km.) in year 4. Subsequent to this modification and suspension, the Company received two additional six-month suspensions, one in February 2015 and one in July 2015 (this additional suspension commenced upon the conclusion of the suspension received in February 2015). In February 2016, the Company received a third additional suspension, which was for one year and which commenced upon the conclusion of the suspension received in July 2015. Combined, these three additional suspensions amount to an accumulated total suspension of two years.

 

On June 22, 2016, the Company terminated the February 2016 License suspension in preparation for a 3D seismic survey (the “Survey”) that was comprised of approximately 69 sq. miles (179 sq. km.) on the southwest portion of the Prospect. After archaeological and environmental reviews of the survey area, fieldwork by the seismic contractor began on July 26, 2016. The Survey and field work were completed on October 30, 2016 and the License was suspended again on November 1, 2016.

 

In July 2017, the License suspension was lifted in order to conduct a Work Area Clearance Survey (“WAC”) of several potential drill sites located in the southern portion of the License. After completing the Survey, the Company requested and received three additional six-month suspensions, one in July 2017, one in June 2018 and one in February 2019 resulting in a new expiration date of October 28, 2021.

 

As a result of the activities, modifications and suspensions described above, the remaining work commitments are now as follows:

 

  * Year 3 ending October 28, 2019 - 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 28, 2020 - Shoot 3D seismic data totaling at a minimum approximately 77 sq. miles (200 sq. km.) and drill two wells.
     
  * Year 5 ending October 28, 2021 - Drill three wells.

 

In four transactions, the Company acquired portions of the royalty interest associated with the PEL 512 License so that the Company now owns an aggregate 5.0% royalty interest, while the previous holders of the original 7.0% royalty interest continue to hold a 2.0% royalty interest.

 

5. Related Party Transactions

 

As of May 31, 2019 and February 28, 2019, the Company owed $396,687 and $149,190, respectively, to certain Company directors for reimbursement of expenses paid on behalf of the Company.

 

On November 1, 2017, but effective as of March 1, 2017, the Company entered into a consulting agreement with Keith Spickelmier, the Company’s Chairman of the Board, to provide certain consulting services to the Company. The Company paid a consulting fee for the three months ended May 31, 2019 of $20,000.

 

During fiscal year 2019, the Company entered into a verbal consulting agreement with an affiliated entity owned by Keith McKenzie, the Company’s Chief Executive Officer. Initially, varying amounts of consulting fees were paid depending on the type and amount of services provided. Since September 2018, a set monthly fee of $5,000 has been paid.

 

On April 15, 2019, the Board of Directors of the Company approved an award of shares of the Company’s common stock to several of the Company’s officers, each of whom is also a director of the Company. In approving these awards, each director abstained from participating in the consideration and approval of such director’s own award. The shares were awarded for services provided to the Company as officers over the past seven years, and were made pursuant to the Company’s 2012 Equity Incentive Plan. The awarded shares were fully vested at the time of the award and can be immediately sold, subject to applicable federal securities law restrictions on such sales. The following table provides information about the officers receiving an award and the number of shares awarded:

 

 8 
 

 

Name of Officer   Offices Held   Number of Award Shares
Keith D. Spickelmier   Chairman of the Board   1,250,000
Keith J. McKenzie   Chief Executive Officer   500,000
William E. Begley   President, Chief Financial Officer

and Chief Operating Officer

  750,000

 

The fair value of these shares was $500,000 based on the market price of $0.20 per share on the grant date.

 

6. Convertible Debentures Payable

 

From May 27, 2016 through May 31, 2019, the Company issued eleven rounds (I thru XI) of senior secured convertible debentures, the proceeds of which have funded the initial 3D seismic survey with respect to the Prospect, the interpretation of seismic data acquired, expenses associated with the seismic survey, costs associated with the debenture issuances, and general and administrative expenses. The debentures are secured by virtually all of the Company’s assets owned, directly or indirectly, but for the License. As discussed elsewhere, the Company may in the future sell additional senior secured convertible debentures having the same terms as those currently outstanding. The table below provides a summary of the senior secured convertible debentures issued through May 31, 2019 and related debt discount and amortization details.

 

Round   Issue
Date
  Maturity
Date
  Interest
Rate
    Conversion
Price
    Principal
Amount
    Debt
Discount
    Debentures,
net of Debt
Discount
 
Outstanding as of February 28, 2019:                                        
I   May 27, 2016   May 27, 2021     8 %   $ 0.16     $ 3,500,000     $ 3,500,000          
II   Aug 16, 2016   May 27, 2021     8 %   $ 0.16       200,000       199,999          
    Aug 16, 2016   May 27, 2021     8 %   $ 0.16       250,000       250,000          
III   Dec 30, 2016   May 27, 2021     8 %   $ 0.16       287,500       237,587          
IV   Feb 15, 2017   May 27, 2021     8 %   $ 0.16       1,000,000       1,000,000          
V   Mar 31,2017   May 27, 2021     8 %   $ 0.16       200,000       200,000          
VI   Jul 5, 2017   May 27, 2021     8 %   $ 0.20       137,500       137,500          
    Jul 5, 2017   May 27, 2021     8 %   $ 0.16       150,000       150,000          
VII   Sept 19, 2017   May 27, 2021     8 %   $ 0.16       400,000       400,000          
    Sept 19, 2017   May 27, 2021     8 %   $ 0.16       100,000       82,125          
VIII   Oct 10, 2017   May 27, 2021     8 %   $ 0.20       137,500       72,806          
IX   Jan 3, 2018   May 27, 2021     8 %   $ 0.20       137,500       137,500          
X   April 2, 2018   May 27, 2021     8 %   $ 0.20       137,500       137,500          
XI   May 16, 2018   May 27, 2021     8 %   $ 0.20       212,500       212,500          
Amortized discount as of February 28, 2019                             (3,049,544 )        
Balance as of February 28, 2019                     6,850,000       3,667,973     $  3,182,027

 

Activity for the three months ended May 31, 2019:                                        
Amortization of discount for the quarter ended May 31, 2019                             (378,569 )        
Balance as of May 31, 2019                   $ 6,850,000     $ 3,289,404     $ 3,560,596  

 

The Company recognized $378,569 and $336,676 in debt discount amortization debt discount amortization during the three months ended May 31, 2019 and 2018, respectively.

 

7. Derivative Liabilities

 

Historically, the Company accounted for certain instruments as derivative instruments in accordance with FASB ASC 815-40, Derivative and Hedging – Contracts in Entity’s Own Equity. This was due to the debentures and related warrants issued by the Company containing a price-reset provision. The Company measured its derivative liability at fair value and recognized the derivative value as a current liability and recorded the derivative value on its consolidated balance sheet. Changes in the fair values of the derivative were recognized as earnings or losses in the current period in other income (expenses) on the consolidated statement of operations and other comprehensive income (loss).

 

As of March 1, 2018, the Company early adopted ASU 2017-11, which revised the guidance for instruments with price-reset provisions. As such, the Company treats outstanding warrants as free-standing equity-linked instruments that are recorded to equity in the consolidated balance sheet as of March 1, 2018.

 

The impact of the adoption was as follows:

 

Derivative liabilities  $(16,172,119)
      
Additional paid-in capital   12,544,607 
Accumulated deficit   3,627,512 
Total stockholders’ deficit  $16,172,119 

 

 9 
 

 

8. Commitments and Contingencies

 

Office Lease

 

Change in Accounting Policy. The Company adopted ASU No. 2016-02, “Leases (Topic 842)” and ASU NO. 2018-11, “Leases (Topic 842): Targeted Improvements”, March 1, 2019, using the alternative modified transition method, for which, comparative periods, including the disclosures related to those periods, are not restated as of March 1, 2019. Refer to Note 2 – Summary of Significant Accounting Policies above for additional information.

 

The Company leases virtual office space in Houston, Texas, with a 6-month term ending June 30, 2019 for $161 per month and has a remaining obligation as of May 31, 2019 of $161. The lease has been renewed for another six months ending December 31, 2019 for $193 per month. The Subsidiary leases virtual office space in Melbourne, Australia, on a month-to-month basis for AU$175. The Company’s server space is also leased on a month-to-month basis for CA$800 inside the office of Keith McKenzie, an officer and director of the Company.

 

For the three months ended May 31, 2019 and 2018, the Company incurred lease expense of $2,725 and $2,673, respectively, for the combined leases.

 

9. Shareholders’ Deficit

 

During the three months ended May 31, 2019, the Company issued 3,700,000 shares of its common stock for services at a price of $0.20 per share to certain officers, board members, employees and professional service providers, based on the stock price on the date of grant with a total grant date fair value of $740,000 (of which 2,500,000 shares were issued to the certain related parties as discussed in Note 5).

 

Warrants

 

The table below presents information about the Company’s outstanding warrants as of February 28, 2019 and May 31, 2019. Pursuant to debenture agreements dated May 27, 2016 and August 16, 2016, warrants to purchase 13,875,000 shares of the Company’s common stock had an original expiration date of May 27, 2019. On May 27, 2019, the Company entered into agreements to extend the related expiration dates to July 27, 2019. As a result of the modification, the Company recorded additional expense of approximately $365,000 for the incremental fair value of the warrants, calculated using the Black-Scholes option-pricing model. Variables used in the Black-Scholes option-pricing model include: (1) risk free interest rate of 2.35%, (2) expected life of 2 months, (3) expected volatility of 80%, and (4) zero expected dividends.

 

No expense was recorded by the Company for the incremental fair value of the warrants due to the early adoption of ASU 2017-11 as noted in Footnote 2.

 

Warrant activity during the three months ended May 31, 2019

 

           Weighted 
           Average 
       Weighted   Remaining 
   Number of   Average   Term 
   Warrants   Exercise Price   (Years) 
Outstanding at February 28, 2019   19,125,000   $0.20    0.49 
Expired/Cancelled   -           
Outstanding as of May 31, 2019   19,125,000   $0.20    0.36 
Exercisable at May 31, 2019               

 

The intrinsic value of warrants outstanding at May 31, 2019 and February 28, 2019 was $191,250 and $-0-, respectively.

 

 10 
 

 

Item 2. Management’s Discussion and Analysis.

 

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 the Company 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 the Company’s other Securities and Exchange Commission filings. The following discussion should be read in conjunction with the Company’s financial statements and related notes thereto included elsewhere in this report.

 

General

 

Discovery Energy Corp. (the Company” or “Discovery) was incorporated under the laws of the state of Nevada on May 24, 2006 under the name “Santos Resource Corp”. The Company’s current business is the exploration and development of the 584,651 gross acres (914 square miles) area in South Australia (“Prospect”) held under Petroleum Exploration License PEL 512 (“License”). 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. 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”). Although the Company’s primary focus is on the exploration and development of the Prospect, the Company has received information about, and has had discussion regarding, possible acquisition of or participation in, other crude oil and/or natural gas opportunities. None of these discussions has led to any agreement in principle. Nevertheless, given an attractive opportunity and its ability to consummate the transaction, the Company could acquire one or more other crude oil and/or natural gas properties, or participate in one or more other crude oil and/or natural gas opportunities.

 

Historical Milestones

 

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 (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 $8,441,228 as of the date of this Report. Interest will continue to be accrued until such time as the Debentures are repaid or converted. Among other uses, the proceeds from the Debentures enabled us to undertake required seismic work. In conjunction with certain issuances of Debentures, warrants (“Warrants”) were issued that give the holder the right to purchase up to a maximum of 19,125,000 shares of the Company’s common stock, par value $0.001 per share 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 3D Survey”) covering an approximately 69 square mile (179 square kilometers) section of the southwest portion of the Prospect. The Nike 3D Survey was completed at a “turnkey price” of approximately $2,379,000.
     
  * The raw data from the Nike 3D 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 presentations to potential sources of significant capital. Technical analysis is on-going.

 

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Current Primary Activities

 

The Company’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 commitment as described below, and develop the Prospect.

 

The License is subject to a five-year work 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. To date, no comments from the government have been received, and management understands that the overseeing government agency is required by law to furnish comments within 30 days after the reports are filed. Moreover, such agency has extended and modified the work commitment a number of times since the filing of the reports, and has been very accommodating with the Company’s requests to it.

 

Over the last several years, a number of extensions and modifications of the work commitment have been granted. The current remaining work commitment is as follows:

 

  * Year 3 ending October 28, 2019 - 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 28, 2020 - Shoot 3D seismic data totaling at a minimum approximately 77 sq. miles (200 sq. km.) and drill two wells.
     
  * Year 5 ending October 28, 2021 - Drill three wells.

 

Management realizes that the Company will not be able to complete the Year 3 requirements of the work commitment by the current deadline for doing so. Accordingly, management intends to seek a further extension of the work commitment in a timely manner such that the Company does not default on its Year 3 requirements. While the Australian authorities have historically accommodated the Company in this regard, no assurance can be given that the needed extension will be granted. If such an extension is not granted, the Company and its stockholders could be materially and adversely affected in ways that are discussed in the section captioned “Liquidity and Capital Resources - Consequences of a Financing Failure” below.

 

The Company needs a significant amount of capital to fulfill its obligations under the work commitment. Moreover, the Debentures mature in May 2021, and the Company will need to raise additional funds or generate sufficient revenues through Hydrocarbon 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 operation 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, 2019 and 2018 are summarized in the table below:

 

  

Three Months Ended

May 31, 2019

  

Three Months Ended

May 31, 2018

 
Revenue  $-   $- 
Operating expenses   (1,656,561)   (420,529)
Other income (expenses)   (544,761)   (780,429)
Net income (loss)  $(2,201,322)  $(1,200,958)

 

Operating expenses for the three-month periods ended May 31, 2019 and 2018 are outlined in the table below:

 

  

Three Months Ended

May 31, 2019

  

Three Months Ended

May 31, 2018

 
Stock-based compensation expense  $740,000   $- 
General and administrative   524,953    327,082 
Warrant modification expense   

364,683

    - 
Exploration costs   26,925    93,447 
Total Operating Expenses  $1,656,561   $420,529 

 

 12 
 

 

Results of Operations for the Three-Month Periods Ended May 31, 2019 and 2018

 

Revenues. The Company did not earn any revenues for either the quarter ended May 31, 2019, or the similar period in 2018. 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, 2019 increased by approximately $1,236,000 (294%), compared to those incurred during the quarter ended May 31, 2018. During the quarter ended May 31, 2019, stock-based compensation expense totaled $740,000, compared to $0 for the quarter ended May 31, 2018. During the quarter ended May 31, 2019, warrant modification expense totaled approximately $365,000, compared to $0 for the quarter ended May 31, 2018. Professional fees increased 98% to approximately $315,000 for the quarter ended May 31, 2019, due to an increase in consulting fees related to the Company’s preparations for drilling and financing for those efforts, compared to approximately $159,000 for the quarter ended May 31, 2018. These expense increases were partially offset by a 71% decrease in exploration costs, reflecting the completion of most geological and geophysical analysis activities in the quarter ended May 31, 2018.

 

Other Income (Expense). Other income (expense) consists primarily of interest expense related to the Debentures (which will be settled in shares of common stock, not cash). The Company had other expenses of approximately $545,000 for the quarter ended May 31, 2019, compared to other expenses of approximately $780,000 for the quarter ended May 31, 2018, a decrease of 30% primarily due to a reduction in debt discount expense of approximately $297,000 incurred in the quarter ended May 31, 2018 with the issuance of the last two debentures.

 

Net Loss. The Company had a net loss of approximately $2,201,000 for the quarter ended May 31, 2019, compared to a net loss of approximately $1,201,000 for the quarter ended May 31, 2018. Loss per common share, on both a basic and fully diluted basis, was ($0.01) for quarter ended May 31, 2019, compared to ($0.01) in quarter ended May 31, 2018.

 

Cash Flow for the Three-Month Periods Ended May 31, 2019 and 2018

 

Cash Used in Operating Activities: Operating activities for the quarter ended May 31, 2019 used cash of $365,207, compared to $438,924 for the quarter ended May 31, 2018, primarily due to a 71% decrease in exploration costs due to the completion of most geological and geophysical analysis activities in the quarter ended May 31, 2018.

 

Cash Used in Investing Activities: No cash was used for investing activities during the quarter ended May 31, 2019 and the quarter ended May 31, 2018.

 

Cash Provided by Financing Activities: There was no cash provided by financing activities for the quarter ended May 31, 2019. Financing activities totaled $350,000 during the quarter ended May 31, 2018 due to the Texican purchase of its remaining additional Debentures with an aggregate original principal amount of $350,000.

 

Off-Balance Sheet Arrangements

 

The Company 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, members of management provided short-term bridge funding. These advances were repaid out of proceeds from the Debenture financings described below.

 

Debenture Financing. Since May 2016, the Company has 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 were issued that give the holder the right to purchase up to a maximum of 19,125,000 Common Shares at an initial per-Common Share exercise price of $0.20.

 

 13 
 

 

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 May 27, 2021.
     
  * We are not entitled to prepay the Debentures prior to their maturity.
     
  * The Debentures are convertible, in whole or in part, into Common Shares at the option of Holder, 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 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.

 

Each of the Warrants includes the following features:

 

  * The initial per-Common 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 Common 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 extended expiration date of July 27, 2019 with respect to 13,875,000 warrant shares, February 15, 2020 with respect to 3,750,000 warrant shares, or September 19, 2020 with respect to 1,500,000 warrant shares.
     
  * 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 this right. However, a representative of the largest holder of the Debentures may be added to the Company’s Board of Directors soon at the request of the Company.

 

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.

 

The proceeds from the Debenture placements were generally used to fund the acquisition, processing and interpretation of the Nike 3D 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 Rincon Energy, LLC pursuant to a geophysical consulting agreement.

 

 14 
 

 

Equity Placements. Subsequent to the start of the Debenture placements, the Company continued certain private capital raising transactions involving the Company’s Common Shares. Beginning in November 2016 and concluding in August 2018, the Company closed on a series of placements of its Common Shares in which an aggregate of 6.9 million Common Shares were issued for an aggregate purchase price of $1,380,000.

 

Available Cash. As of May 31, 2019, the Company had cash of approximately $124,000 and had negative working capital of approximately $1,762,000. As of July 14, 2019, the Company had approximately $45,000 of cash on-hand. Management believes that the cash on hand, as of the preceding date, will be sufficient to finance general and administrative expenses through August 31, 2019. However, this amount of cash will be insufficient to allow the Company to fulfill its 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 $1.0 million through a private placement of its common shares. If successful in raising $1.0 million in the private placement, it is estimated that the related net proceeds will be sufficient to finance general and administrative activities through June 2020. 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. Furthermore, as previously stated, the funds from the private placement will not be sufficient to satisfy the work commitment for future years in any meaningful way.

 

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 3D 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 2019 and October 2021, it is estimated that the Company will need to raise an additional $23 million to have sufficient capital to meet the remaining work commitments specified in the License and to fund operations. Net revenues produced from successful 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 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 cost 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 the 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 future 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 the work commitment is described in the following paragraph.

 

The interpretation and analysis of the Nike 3D 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 resumed and continues its 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. Significant positive cash flow will be 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.

 

 15 
 

 

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 Common 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 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 obligations and capital raising activities.

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of management, including the principal executive officer and principal financial officer, the evaluation of the effectiveness of the design and operation of disclosure controls and procedures pursuant to Exchange Act Rule 13a 15(e) and Rule 15d 15(e) as of the end of the period covered by this quarterly report was completed. Based on this evaluation, the principal executive officer and principal financial officer have determined that the lack of segregation of accounting duties as a result of limited personnel resources is a material weakness and an ineffective element of the Company’s financial procedures. Therefore, the principal executive officer and principal financial officer believe that disclosure controls and procedures are not effective to ensure that information required to be disclosed by the Company in the reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and that disclosure and controls designed to ensure that information required to be disclosed in Company filings or submitted under the Exchange Act is accumulated and communicated to management, including the principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

Limitations on Effectiveness of Controls and Procedures

 

Company management, including the Chief Executive Officer and Chief Financial Officer do not expect that disclosure control procedures and/or internal controls will prevent all potential errors and/or all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, but not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include, but are not limited to, the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by the actions or inactions of one or more individuals and/or by management override of various controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving stated goals under all potential future conditions. Over time, controls could become inadequate due to changes in internal and/or external conditions, or a deterioration in the degree of staff and/or systems compliance with the standards, policies and procedures of the Company.

 

Changes in Internal Controls over Financial Reporting

 

There have been no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II OTHER INFORMATION

 

Item 6. Exhibits.

 

The following exhibits are filed with this Quarterly Report or are incorporated herein by reference:

 

Exhibit    
Number   Description
     
31.01   Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
31.02   Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
32.01   Certification Pursuant to 18 U.S.C. Section 1350, as pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.02   Certification Pursuant to 18 U.S.C. Section 1350, as pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema
101.CAL   XBRL Taxonomy Extension Calculation Linkbase
101.DEF   XBRL Taxonomy Extension Definition Linkbase
101.LAB   XBRL Taxonomy Extension Labels Linkbase
101.PRE   XBRL Taxonomy Extension Presentation Linkbase

 

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SIGNATURES

 

In accordance with the requirements of the Exchange Act, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  DISCOVERY ENERGY CORP.
  (Registrant)
     
  By: /s/ Keith J. McKenzie
    Keith J. McKenzie,
    Chief Executive Officer
    (Principal Executive Officer)
     
  By: /s/ William E. Begley
    William E. Begley,
    Chief Financial Officer
    (Principal Financial Officer and Principal Accounting Officer)

 

July 22, 2019

 

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