Item
1. Business.
General
Discovery
Energy Corp. (the “Company”) was incorporated under the laws of the state of Nevada on May 24, 2006
under the name “Santos Resource Corp”. The current business of the Company is the exploration and development of the 584,651
gross acres (914 sq. miles) area in South Australia (“Prospect”) held under Petroleum Exploration License PEL
512 (“License”). The Prospect is located in the “Western Flank” area, which is the southwest Permian
edge of the Cooper and Eromanga Basins, the most prolific producing onshore region in Australia. There are three separate acreage blocks
in the Prospect: West (~400,000 acres), South (~181,000 acres) and Lycium (~4,000 acres). In May 2012, the Company incorporated a wholly
owned Australian subsidiary, Discovery Energy SA Ltd. (“Subsidiary”), for the purpose of acquiring a 100% working
interest in the License. In May 2016, the Subsidiary’s legal entity status changed from public to private and its name changed
to Discovery Energy SA Pty Ltd. The Company is in the initial exploration phase of determining whether or not the Prospect contains economically
recoverable volumes of crude oil, natural gas and/or natural gas liquids (collectively “Hydrocarbons”). Although
the Company’s current focus is primarily on the Prospect, management from time-to-time exchanges information with other industry
participants regarding additional investment opportunities in Australia. The Company’s internet address is https://discoveryenergy.com.
Our
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to
Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our website as soon as reasonably
practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”).
The SEC maintains an internet site that contains our public filings with the SEC and other information regarding the Company, at http://www.sec.gov.
Recent
Developments and Events
This
section discusses developments and events during fiscal 2021 that are believed to be significant to the Company.
Extension
of Debentures. On May 27, 2016, the Company entered into a Securities Purchase Agreement with an initial investor (the
“Original Purchaser”) pursuant to which the Company issued to the Original Purchaser some of the Company’s
Senior Secured Convertible Debentures (each a “Debenture” and collectively the “Debentures”).
The Debentures are debt instruments convertible into the Company’s common shares. Eventually a second investor was made a party
to the Securities Purchase Agreement and was also issued Debentures. Thus far, the Company has issued to these two investors a total
of 14 Debentures having an aggregate original principal amount of $6,850,000. Interest on the Debentures to date has been accrued and
added to principal, thereby increasing the outstanding balance on the Debentures to approximately $9,699,000 as of March 31, 2021.
Interest will continue to be accrued until such time as the Debentures are repaid or converted to common shares. The original terms of
the Debentures provided that the principal amount of and accrued interest on the Debentures was due and payable in a single balloon payment
on or before May 27, 2021 (the “Maturity Date”). For more information about the Debentures, see “Item
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Financing
History and Immediate, Short-Term Capital Needs - Debentures Financing” below.
In
conjunction with certain issuances of the Debentures, warrants (“Warrants”) were issued to the Original Purchaser
that grant to it the right to purchase up to an aggregate maximum number of 19,125,000 common shares at an initial per-share exercise
price of $0.20. The Warrants have been amended from time to time to extend their expiration dates (the “Termination Date”).
Prior to the extension discussed below, the Warrants had a Termination Date of February 28, 2021. For more information about the Warrants,
see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital
Resources - Financing History and Immediate, Short-Term Capital Needs - Debentures Financing” below.
On
February 4, 2021, the parties to the Debentures and Warrants entered into an amendment to them providing for the following:
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The
Maturity Date of the Debentures was extended to December 31, 2023.
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The
Termination Date of the Warrants was also extended to December 31, 2023.
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The
Company agreed to issue to the Original Purchaser additional Warrants to purchase 8,752,058 additional common shares at a per-share
exercise price of $0.20, subject to adjustment upon the occurrence of certain customary events. These warrants were issued on May
28, 2021, and have an expiration date of December 31, 2023. These warrants bring the total number of warrant shares that may be
acquired by the Original Purchaser to 27,877,058.
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Management
believes that the extension of the Debentures under favorable terms, and the recent extension of the deadlines for the work commitment
on the Prospect have mitigated many of the issues and concerns affecting the Company caused by the effects of Covid-19 in the U.S. and
Australia.
Suspension
of Work Commitment. On August 13, 2020, the Company received from the Government of South Australia, Department of Energy
and Mining, confirmation that such agency had approved the Company’s application for an additional 12-month suspension of the work
commitment relating to the License. Prior to this further suspension, the Company’s remaining work commitments were due to be completed
by October 29, 2022. The deadlines for the Company’s remaining work commitments are detailed in the section captioned “Item
1. Business - Plan of Operation - Current Primary Activity” below.
Paycheck
Protection Program Loan. In connection with the Paycheck Protection Program established by the Coronavirus Aid, Relief, and
Economic Security Act, the Company borrowed an initial loan during fiscal year 2021 in the amount of $118,750 and a second loan
during fiscal year 2022 in the amount of $120,000. The Company is in the process of applying for the forgiveness of the first draw
to the maximum extent permitted by applicable law. The Company is also planning on applying for forgiveness of the second draw to the
maximum extent permitted.
On-going
Effects of Coronavirus Pandemic. In December 2019, a novel strain of coronavirus, SARS-CoV-2, which causes coronavirus disease
2019 (“COVID-19”), surfaced in Wuhan, China. Since then, SARS-CoV-2 and COVID-19 spread to many countries, including the
U.S. The COVID-19 pandemic led to the implementation of various responses, including government-imposed quarantines, travel restrictions
and other public health safety measures. It resulted in a significant spike in unemployment and a concomitant decline in economic activity
in the U.S., Australia and many other countries, and any future outbreak of a health epidemic or other adverse public health developments
may have similar effects. Although the effects of the COVID-19 pandemic have been lessening in the U.S. and other parts of the world
overall due to (among other things) effective vaccination programs, these effects could start worsening again in the U.S. and elsewhere,
creating renewed uncertainty. The current COVID-19 pandemic could continue to, and future similar epidemics or pandemics could also,
materially and adversely impact our ability to finance and conduct our business once it becomes operational, and could materially and
adversely impact our operations, financial condition and results. See the risk factor captioned “PANDEMICS OR DISEASE OUTBREAKS
(SUCH AS THE NOVEL CORONAVIRUS, ALSO KNOWN AS THE COVID-19 VIRUS) COULD MATERIALLY AND ADVERSELY AFFECT US IN A VAREITY OF WAYS.”
Recovery
in Hydrocarbons Prices. Almost simultaneously with the initial widespread adverse effects from the COVID-19 pandemic, a Hydrocarbons
price war began in early March 2020. At the time that this event started on March 8, 2020, the price of Brent crude was $45.27 per barrel,
which was already down from a recent high of $68.91 on January 6, 2020. Such price declined to a low of $19.33 on April 21, 2020. By
June 2021, the posted price of Brent had recovered to almost $73 per barrel. Hydrocarbons are volatile and entail
certain risks. See the risk factor captioned “HYDROCARBONS ARE COMMODITIES SUBJECT TO PRICE VOLATILITY BASED ON MULTIPLE FACTORS
OUTSIDE THE CONTROL OF PRODUCERS, AND LOW PRICES MAY MAKE PROPERTIES UNECONOMIC.” The Company has no assurance that the price of
Hydrocarbons will remain at adequate levels or that the Company will not be harmed by future prolonged low Hydrocarbon prices.
Historical
Milestones
To
date, the Company has achieved the following milestones:
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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.
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The
Company completed the Debentures and Warrant financing described in “Item 1. Business - Recent Developments and Events - Extension
of Debentures” above. Among other uses, the proceeds from the Debentures enabled the Company to undertake required seismic
work. For more information about the Debentures and the Warrants, see “Item 7. Management’s Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital Resources - Financing History and Immediate, Short-Term Capital
Needs - Debentures Financing” below.
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On
October 30, 2016, fieldwork was completed on the Company’s proprietary Nike 3D seismic survey (the “Nike Survey”)
covering an approximately 69 sq. mile (179 sq. km.) section of the western portion of the South Block of the Prospect and directly
on trend and in close proximity to mature producing oilfields and recent discoveries on the blocks to the north. The Nike Survey
was completed at a “turnkey price” of approximately $2.4 million.
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The
raw data from the Nike Survey was converted to analytical quality information, processed and interpreted by the Company’s geophysical
advisor. Interpretation of the processed data included advanced technical analysis by specialized consultants. This technical work
identified an inventory of more than 30 leads judged to be potential areas of crude oil accumulations. The Company has prioritized
these initial prospective locations for presentation to potential sources of significant capital. Technical analysis is on-going.
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In
June 2017, the Company completed the archeological and environmental field surveys of seven prospective drilling locations as required
by applicable laws and regulations. It subsequently filed reports on these surveys with the South Australian government; no material
issues were identified at any of the prospective drilling sites.
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In
addition to the amounts raised pursuant to the Debentures arrangements, since the Company adopted its current business plan, the
Company has raised funds totaling approximately $4.6 million through private placements of the Company’s common shares.
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In
several transactions to date, the Company (through the Subsidiary) purchased portions of an original 7.0% royalty interest relating
to the Prospect retained by the party that, in effect, transferred and sold the License to the Company. As a result, the Company
(through the Subsidiary) now owns an aggregate 5.0% royalty interest, while the previous holder of the original 7.0% royalty interest
continues to hold a 2.0% royalty interest. The aggregate purchase price for the aggregate 5.0% royalty interest was $540,500 USD.
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Prospect
There
are producing wells on trend and directly north and east of the Company’s South block. A typical Namur well, a primary producing
reservoir in the Western Flank, is drilled to a depth of approximately 5,500 feet. The wellbore is vertical or near vertical and there
is no lateral drilling or hydraulic stimulation required. This high-permeability reservoir combined with a strong aquifer system produces
high flow and recovery rates. Initial production rates typically range from 450 to 940 barrels of oil per day (“BOPD”).
Production is anticipated to be sweet, high gravity (45 degree) crude which is expected to result in premium pricing. As described in
the section captioned “Markets and Marketing” below, markets for the Company’s future production are readily accessible
via existing infrastructure.
Beginning
in 2018, Beach Energy began implementing horizontal drilling techniques targeting the lower permeability McKinlay and Birkhead reservoirs
in the Western Flank. Several wells, with lateral sections of approximately 2,000 feet, were successfully drilled and completed. Initial
production rates ranged from 800 to 2,000 BOPD resulting in an average well productivity improvement of 8.2 times over vertical wells
for 1.5 times the cost. Typically, the time and cost to drill a well decreases and production rates and economics improve as additional
wells are drilled and the increase in knowledge and experience is incorporated into best practices.
Exploration
Activity
Since
2012, the Company has assembled a database that now includes a substantial inventory of data, analyses and technical information on the
Cooper and Eromanga Basins, fields in the Western Flank, operators and operations, all in close proximity to the Prospect. In 2012, an
engineering consultant was engaged to prepare an NI 51-101 compliant report which resulted in the identification of more than 110 seismic
generated leads over approximately 30% of the Prospect. This was complimented by the reinterpretation of approximately 3,200 miles (5,153
km.) of 2D seismic data and the reprocessing and reinterpretation of approximately 55 sq. miles (141 sq. km.) of 3D seismic data from
a survey conducted over the Lake Hope area in the eastern portion of the South block. The data described in the preceding sentence was
acquired in connection with the issuance of the License. In late 2016, the Company conducted the approximately $2.4 million Nike Survey
covering an area of approximately 69 sq. miles (179 sq. km.) located in the western section of the South block and directly on trend
and in close proximity to mature producing oil fields and recent discoveries on blocks to the north. The Company has also undertaken
some “work area clearance” (“WAC”) surveys.
Terms
of the License
In
2012, the Subsidiary received a formal grant of the License from the South Australian Minister for Mineral Resources and Energy. The
License is a “Petroleum Exploration License” (a “PEL”) granting the right to explore for all regulated
resources (including petroleum and any other substance that naturally occurs in association with petroleum) relating to the Prospect,
provided, however, that the License does not permit use of the Prospect as a source of geothermal energy or a natural reservoir for the
purpose of gas storage.
The
Company now holds a 100% working interest in the License, subject to a 10% overriding royalty interest in favor of the State of South
Australia and an aggregate 3% overriding royalty interests in favor of others. In view of these overriding royalty interests, the Company’s
net revenue interest in the License is 87%
The
License is subject to a five-year work commitment as described below. Failure to comply with the work program requirements could lead
to the cancellation of the License. The License also requires that insurance of the types and amounts of coverage that management believes
are reasonable, customary and the industry standard be maintained, and contains provisions regarding environmental matters and liabilities
that management also believes are reasonable, customary and the industry standard.
The
initial term of the License is five years, with two five-year renewal terms, subject to the provisions of the South Australian Petroleum
and Geothermal Energy Act 2000. As discussed herein, the initial five-year term has been suspended a number of times; as a result, this
initial term currently remains in effect. At the end of the initial five-year term of the License and assuming that the Company has met
its obligations, the License can be renewed for a first five-year renewal term, provided, however, that the Company must relinquish one-third
of its acreage or convert all or portions of it to a Petroleum Retention License (a “PRL”). At the end of the
first five-year renewal term, assuming that the Company has met its commitment obligations, the License can be renewed for a second five-year
renewal term, provided, however, that the Company must relinquish one-third of its original acreage or convert all or portions of the
remaining acreage to a PRL. Relevant law requires the South Australian government to grant a PEL with respect to any acreage to be relinquished
if the related licensee submits a reasonable application for renewal of the related license. Management believes that (as a matter of
practice) the South Australian government almost invariably grants renewals, although the Company has no assurance that this will occur
in its case. Any renewal could entail additional requirements, such as additional work commitments. Control over acreage can remain in
effect indefinitely, so long as the licensee converts its license to a Petroleum Production License” (a “PPL”)
and is producing Hydrocarbons from the related acreage. A PPL has requirements somewhat different from a PEL, and the scope of the acreage
in effect “held by production” is limited by applicable law.
Plan
of Operation
Current
Status
The
Company is in the initial phase of its Plan of Operation. To date, field operations have been limited to the successful completion of
seismic and related WAC surveys. Without drilling results, the Company does not have the necessary technical data to prepare estimates
of Hydrocarbon reserves needed to prepare various reports for submission to regulators. The Company cannot provide assurance that it
will find commercially producible volumes of Hydrocarbons.
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 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 relevant 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 Company requests.
Over
the term of the License thus far, a number of extensions and modifications of the work commitment have been granted. The current remaining
work commitment is as follows:
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Year
3 ending October 28, 2021 - 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.
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Year
4 ending October 29, 2022 - Shoot 3D seismic data totaling a minimum of approximately 77 sq. miles (200 sq. km.) and drill two wells.
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Year
5 ending October 29, 2023 - Drill three wells.
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The
Company needs a significant amount of additional capital to fulfill its obligations under the work commitment. Moreover, the Debentures
will mature in December 2023, and the Company will need to raise additional funds or generate sufficient revenues through Hydrocarbon
production to timely repay the Debentures, if they are not converted. 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
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 “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - 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.
Once
the Company is in a position to commence drilling, it intends to engage the services of a third-party contractor. No significant impediments
to procuring the services of one or more qualified contract operators and drillers in connection with the initial phase of the Company’s
Plan of Operation are anticipated. However, a considerable increase in drilling activity in the West Flank area could result in longer
wait times and higher costs to obtain materials and services. The contract operator will be responsible for all regulatory compliance
matters; hiring the drilling contractor, geologist and petroleum engineer to make final decisions relative to the zones to be targeted;
well design; drilling and logging. Should wells comprising the Company’s drilling operations be successful, the operator will then
be responsible for completion operations, production facilities procurement, installation, operations and maintenance, interconnecting
with gathering or transmission pipelines and attending to various administrative matters.
The
Company initially plans to focus on oil-bearing formations, and thus crude oil is most likely to be the Company’s principal product
for the foreseeable future, if the Company is successful in its exploration and production activities. Natural gas is not expected to
be a significant opportunity for the foreseeable future. The Company expects that most of its oil production will be transported through
trucking operations owned by others.
Any
natural gas produced may (depending on the amount produced) be flared or transported through gathering systems and gas pipelines that
are owned by others. Transportation capacity on gas gathering systems and pipelines is occasionally limited and at times unavailable
due to repairs or improvements being made to the facilities or due to use by other gas shippers with priority transportation agreements
or who own or control the relevant pipeline. The Company cannot accurately predict the costs of transporting its natural gas production
until it drills, completes and tests its initial successful wells. The cost of installing infrastructure to deliver the Company’s
natural gas production to Moomba, which, as described below, is the principal transportation center for the area, or elsewhere will vary
depending upon distance traversed, negotiated handling/treating fees, pipeline tariffs and other associated costs. Although issues pertaining
to the Company’s natural gas transportation could adversely affect the Company, the Company does not believe that this will be
the case due to the minor role that any natural gas production is expected to play in the Company’s business.
Markets
and Marketing
The
petroleum industry has been characterized historically by Hydrocarbon prices that fluctuate (sometimes dramatically), and supplier costs
can rise significantly during industry booms. The most recent price decline cycle started in early March 2020 when an oil price war began.
On March 8, 2020, the price of Brent crude was $45.27 per barrel, which was already down from a recent high of $68.91 on January 6, 2020.
Such price declined to a low of $19.33 on April 21, 2020. By March 2021, the posted price of Brent had recovered to almost $70 per barrel.
The Company has no assurance that the price of Hydrocarbons will recover to adequate levels or that the Company will not be harmed by
prolonged low levels of Hydrocarbon prices. Hydrocarbon prices and markets are likely to remain volatile. Sales prices for these commodities
are subject to wide fluctuations in response to relatively minor changes in supply and demand, market uncertainty, and a variety of additional
factors beyond the Company’s control. These factors include:
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international
political conditions (including embargoes, wars and civil unrest, such as the recent unrest in the Middle East);
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the
domestic and foreign supply of Hydrocarbons;
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consumer
demand;
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weather
conditions;
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domestic
and foreign governmental regulations and other actions;
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actions
taken by the Organization of the Petroleum Exporting Countries (“OPEC”);
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technological
advances affecting energy consumption;
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technology
and knowledge advances’ impact seismic, drilling, development and production;
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the
price and availability of alternative fuels;
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epidemics,
pandemics and government action that impedes the ability of companies to undertake their businesses; and
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general
economic conditions.
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Decreases
in Hydrocarbon prices might not only decrease the Company’s future revenues on a per unit basis, but could also reduce the volumes
that the Company could produce economically. A sustained decline in sales prices could materially and adversely affect the Company’s
future business, financial condition, results of operations, liquidity and borrowing capacity, and may require a reduction in the carrying
value of the Company’s assets. While the Company’s future revenues may increase if prevailing prices increase significantly,
exploration and production costs and acquisition costs for additional properties and reserves could also increase. The Company might
enter into hedging arrangements or use derivative financial instruments to hedge in whole or in part the risk associated with fluctuations
in Hydrocarbon prices.
The
Company does not expect to refine any of its production, although it may need to treat or process some of its production to meet the
quality standards of purchasing or transportation companies. Therefore, the Company expects that all or nearly all of its production
will be sold to a relatively small number of customers. Production from the Company’s properties will be marketed in a manner consistent
with industry practices. The Company does not currently have any long-term sales contracts for its future production, but it expects
that it will generally sell any production that it develops pursuant to these types of contracts. The Company does not believe that it
will have any difficulty in entering into long-term sales contracts for its production, although there can be no assurance in this regard.
The
principal Hydrocarbon transportation hub for the Western Flank is located in the vicinity of Moomba. This processing and transportation
center is approximately 37 miles due east of the Prospect’s easternmost boundary and about 40 miles from the Company’s expected
initial drill sites. These sites are located about 20 miles from a privately-owned terminal for trucking oil in Lycium. The Lycium Hub
is also the terminal point for a main Trunk Line with a capacity of 20,000 barrels per day, which delivers oil to the Moomba Processing
Facility. Management believes that the Company has access to an infrastructure sufficient to transports its Hydrocarbon production to
processing facilities or customer markets.
The
availability of a ready market for the Company’s production will depend on a number of factors beyond the Company’s control,
including the availability of other production in the Prospect’s vicinity, the proximity and capacity of Hydrocarbon pipelines,
and fluctuations in supply and demand. Although the effect of these factors cannot be accurately predicted or anticipated, the Company
does not anticipate any unusual difficulty in contracting to sell its production of Hydrocarbons to purchasers at prevailing market prices
and under arrangements that are usual and customary in the industry. However, there can be no assurance that market, economic and regulatory
factors will not in the future materially and adversely affect the Company’s ability to sell its production.
Sales
prices for Hydrocarbon production are negotiated based on factors normally considered in the industry, such as the reported trading prices
for Hydrocarbons on local or international commodity exchanges, distance from wells to pipelines, well pressure, estimated reserves,
commodity quality and prevailing supply conditions. Historically, Hydrocarbon sales prices have experienced high volatility resulting
from changing perceptions throughout the industry centered on supply and demand. The Company cannot predict the occurrence of events
that may affect sales prices or the degree to which such prices will be affected. However, sales prices realized by the Company should
be equivalent to the then current market prices in the geographic region of the Prospect. Typically, crude oil prices in Australia reflect
or are “benchmarked” against European commodity market trading settlement prices, mainly Brent Crude.
The
Company will strive to obtain the best sales prices in the area of its production. The Company’s revenues, profitability and future
growth will depend substantially on prevailing prices. Decreases in the sales prices would likely adversely affect the carrying value
of any proved reserves the Company is successful in establishing and its prospects, revenues, profitability and cash flow.
Competition
The
Company expects to operate in the highly competitive industry of Hydrocarbon exploration, development and production. The Company believes
that the level of competition in these areas will continue and may even intensify. In the areas of Hydrocarbon exploration, development
and production, competitive advantage is gained through superior capital investment decisions, technological innovation and cost management.
The Company’s competitors include major firms and a large number of independent companies. Because the Company expects to have
control over acreage sufficient for its exploration and production efforts for the foreseeable future, the Company does not expect to
compete for the acquisitions of properties for the exploration for Hydrocarbons. However, the Company will compete for the equipment,
services and labor required to explore for, develop and produce its properties and to transport its production. Many of the Company’s
competitors have substantially larger operating staffs and greater financial and other resources. In addition, larger competitors may
be able to absorb the burden of any changes in laws and regulations more easily than the Company can, which would adversely affect its
competitive position. Moreover, most of the Company’s competitors have been operating in the Western Flank for longer periods than
the Company has and they have demonstrated the ability to operate through a number of industry cycles. The impact of this intense competition
cannot currently be determined.
Regulation
The
Company’s operations in South Australia and within the Western Flank are subject to the laws and regulations of the State of South
Australia and the Commonwealth of Australia. The License was granted under the Petroleum and Geothermal Energy Act 2000 (SA) and the
Company’s operations within and with respect to the License are governed by this Act and by the Petroleum and Geothermal Energy
Regulations 2013 (SA). This legislation covers all phases of the Company’s operations including exploration, appraisal, development
and production of Hydrocarbons from the License area. Other legislation which the Company will be required to comply with at various
stages of its operations include: Environment Protection Act 1993 (SA); Aboriginal Heritage Act 1988 (SA); Native Title Act 1994 (SA)
and Native Title Act 1993 (Cth). As its Hydrocarbon exploration and production operations in South Australia proceed, the Company will
provide more detailed information regarding the material features and effects of these laws and regulations and such other legislation
with which the Company will be required to comply.
Employees
As
of the date of this Report, the Company had three full-time employees. Fiscal 2021 was the first time that the Company had employees
since it adopted its current business plan. However, the Company has used a number of consultants and part-time service providers in
the past, including members of the Company’s current management team. The Company’s needs for additional personnel in the
future are uncertain.
Item
1A. Risk Factors.
An
investment in our common shares is highly speculative and involves a high degree of risk. You should carefully consider all of the risks
discussed below, as well as the other information contained in this Annual Report. If any of the following risks develop into actual
events, our business, financial condition or results of operations could be materially and adversely affected and the trading price of
our common shares could decline.
RISKS
RELATING TO OUR COMPANY
WE
ARE AN EARLY-STAGE COMPANY WITH NO PROVED RESERVES, AND WE HAVE A NUMBER OF IMPORTANT MILESTONES THAT WE MUST ACHIEVE.
Our
business plan is to explore, develop and produce crude oil, natural gas and/or natural gas liquid (collectively “Hydrocarbons”)
from a tract of land (the “Prospect”) covered by Petroleum Exploration License (“PEL”) 512 (the
“License”) in the State of South Australia. The Prospect is considered “undeveloped acreage,” which
the U.S. Securities and Exchange Commission (the “Commission”) defines as “lease acreage on which wells
have not been drilled or completed to a point that would permit the production of commercial quantities of Hydrocarbons regardless of
whether such acreage contains proved reserves.” We have no proved reserves. In view of our extremely limited history in the Hydrocarbon
exploration business, an investor may have difficulty in evaluating us and our business, both current and future activities. An investor
must consider our business and prospects in light of the risks, expenses and difficulties frequently encountered by companies in their
early stage of development. For our business plan to succeed, we must successfully undertake most of the following activities:
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Complete
a financing or similar transaction that will provide us with sufficient funds;
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Drill
successful exploratory test wells on the Prospect to determine the presence of Hydrocarbons in commercially viable quantities;
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Develop
the Prospect to a stage at which Hydrocarbons are being produced in commercially viable quantities;
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Contract
with purchasers of our commercial production of Hydrocarbons upon such commencement; and
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Identify
and enter into binding agreements with suitable third parties (such as joint venture partners and contractors) for the Prospect.
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There
can be no assurance that we will be successful in undertaking such activities. Our failure to undertake successfully most of the activities
described above could materially and adversely affect our business, financial condition and results of operations.
WE
HAVE A HISTORY OF LOSSES, AND WE MAY NOT BECOME PROFITABLE.
We
have incurred losses since our inception. For our fiscal year ended February 28, 2021, we incurred net losses of $6,083,713,
of which interest expense, both non-cash and accrued, in the amount of $2,328,346 was a primary driver. As of February 28, 2021,
we had an accumulated deficit of $31,661,738. We expect our losses to continue as we incur significant capital expenditures and
operating expenses to explore for Hydrocarbons on the Prospect. These continuing losses will most likely be greater than current levels.
If our revenues do not increase substantially or if our expenses exceed our expectations, we may never become profitable. There can be
no assurance that our exploration and production activities will produce Hydrocarbons in commercially viable quantities, if any at all.
Moreover, even if we succeed in producing Hydrocarbons, we expect to incur operating losses until such time (if ever) as we produce and
sell a sufficient volume of our commercial production to cover direct production costs as well as corporate overhead. There can be no
assurance that sales of our Hydrocarbon production will ever generate significant revenues, that we will ever generate positive cash
flow from our operations or that (if ever attained) we will be able to sustain profitability in any future period.
WE
ARE SIGNIFICANTLY LEVERAGED.
During
a two-year period beginning in May 2016, we took on a significant amount of debt through the sale of Senior Secured Convertible Debentures
due (each a “Debenture” and collectively the “Debentures”). The amount of this indebtedness
(including principal and accrued interest) was approximately $9,699,000 compounded through March 31, 2021. Our Debentures are secured
by all of our assets owned directly or indirectly but for the License. The use of secured indebtedness to finance our business is referred
to as leveraging. Leveraging increases the risk of loss to us if and to the extent we have insufficient revenue to pay our debt obligations.
In such event, cash from other sources will be required. Our Debentures must be repaid or converted by the holders thereof on or before
December 31, 2023. Unless we generate such cash, we may not have sufficient funds to pay our Debentures and other indebtedness when due.
In such event, we might be required to sell our assets and properties to meet our obligations, or to seek an extension to our Debentures,
or alternative debt or equity financing. If sale, extension or refinancing is not obtained or consummated, we could default in our obligations.
THE
EXERCISE OF SECURED CREDITOR RIGHTS COULD RESULT IN A SIGNIFICANT OR COMPLETE LOSS.
If
we default on our Debentures, the remedy of our Debentures holders would be (among other things) to institute proceedings against our
assets and properties to sell them to satisfy the amounts owed pursuant to our Debentures. This could result in the partial or total
loss of our assets and properties. We have no assurance that, upon the exercise of our Debentures holders’ secured creditor rights,
we would receive a return of anything on our assets and properties. The loss of our assets and properties by the exercise of our Debentures
holders’ secured creditor rights would most likely materially and adversely affect our business, financial condition or assets,
and could result in a total loss to our stockholders.
OUR
DEBENTURES FEATURE CERTAIN OPERATING COVENANTS THAT COULD ADVERSELY AFFECT THE COMPANY.
Our
Debentures contain operating covenants that prohibit us from certain actions (negative operating covenants) and that require us to continually
undertake other actions (affirmative operating covenants). The negative operating covenants could preclude us from taking actions that
we believe to be in the best interests of our stockholders. The affirmative operating covenants will require us to incur continuing costs
and expense and could require us to take actions that we believe are not in our best interests. Moreover, our failure to comply with
either negative operating covenants or affirmative operating covenants would most likely be a default under our Debentures, giving to
our Debentures holders the rights described above.
Pandemics
or disease outbreaks (such as the novel coronavirus, also known as the COVID-19 virus) could materially AND adversely affect us in a
vareity of ways.
Pandemics
or disease outbreaks such as COVID-19 could materially and adversely affect us in a number of ways. First, the current pandemic resulted,
and future pandemics and epidemics could result, in economic downturns that could affect the market for our proposed products. Transport
restrictions related to quarantines or travel bans, or simply declines in customers desire and willingness to travel, due to pandemics
and epidemics have caused, and can be expected to cause when they occur in the future, significant declines in demand for products derived
from crude oil, such as gasoline and jet fuel. Such declines greatly reduce not only the amount of products that can be sold on an aggregate
basis, but also the price received for such products. Such results can be expected to have the following effects:
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harm
our financial results (especially revenues and profits) if and when we enter into commercial production.
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harm
our ability to raise funds (if needed) due to a diminished interest in investing in Hydrocarbon exploration and production companies
in general.
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depress
our stock price, further harming our ability to raise funds.
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Workforce
limitations and travel restrictions resulting from pandemics or disease outbreaks and related government actions may impact many aspects
of our business. We could experience interruptions or delays in receiving supplies of products and services from third parties due to
staffing shortages, production slowdowns or stoppages, disruptions in delivery systems, travel limitations, mass transit disruptions,
and the like. If a significant percentage of persons provided employment and other contractual services to us were unable to work, including
because of illness or travel or government restrictions in connection with pandemics or disease outbreaks, our operations could be materially
and adversely impacted.
Moreover,
the spread of pandemics or disease outbreaks such as the COVID-19 virus may also disrupt logistics necessary to import, export, and deliver
products to us or our customers. Ports and other channels of entry may be closed or operate at only a portion of capacity, as workers
may be prohibited or otherwise unable to report to work, and means of transporting products within regions or countries may be limited
for the same reason.
Currently,
uncertainty exists relating to the potential effect of COVID-19 on our business. Infections may become more widespread, exacerbating
an already challenging environment. The extent to which any pandemic or epidemic impacts our business will depend on future developments,
which are highly uncertain and cannot be predicted with confidence, such as the ultimate geographic spread of the disease, the duration
of the outbreak, travel restrictions and actions to contain the outbreak or treat its impact, such as social distancing and quarantines
or lock-downs in the United States and other countries, business closures or business disruptions and the effectiveness of actions taken
in the United States and other countries to contain and treat the disease.
Also,
the current pandemic, and future pandemics and epidemics could hamper our efforts to provide our investors with timely information and
comply with our filing obligations with the Commission. Of major concern is loss of key staff and/or service providers due to life threatening
health issues.
OUR
OUTSTANDING OBLIGATIONS AND ABILITY TO ISSUE ADDITIONAL COMMON SHARES COULD RESULT IN SIGNIFICANT DILUTION TO STOCKHOLDERS.
Our
Debentures outstanding as of the date of the filing of this Report are convertible into 59,043,869 common shares, and the number
of shares into which these Debentures may be converted is expected to increase in the future. An aggregate of 27,877,058 common shares
can be acquired upon the exercise of the outstanding Warrants. The conversion price of our Debentures and the exercise price of the Warrants
may be less than the then current market price of the common shares at the time of conversion and exercise. Moreover, we have registered
an aggregate of 6,000,000 common shares for issuance pursuant to an equity incentive plan to employees, officers, directors, and outside
consultants to compensate them for services provided or to provide incentives to them. Of these common shares, 1,747,300 are still available
for issuance in the future. Future issuance of additional shares pursuant to the Debentures, Warrants or the equity incentive plan or
otherwise could cause immediate and substantial dilution to the net tangible book value of common shares issued and outstanding immediately
before such transactions. Any future decrease in the net tangible book value of such issued and outstanding shares could materially and
adversely affect the market value of the common shares. Moreover, any common shares issued as described above would further dilute the
percentage ownership of existing stockholders. The terms on which we could obtain additional capital while our Debentures or the Warrants
are outstanding may be adversely affected because of the potential dilution described in this risk factor.
WE
NEED ADDITIONAL CAPITAL TO SATISFY OUR WORK COMMITMENT, TO PROVIDE WORKING CAPITAL AND TO DEVELOP THE PROSPECT, WHICH CAPITAL WE MAY
NOT BE ABLE TO RAISE OR WHICH MAY BE AVAILABLE ONLY ON TERMS UNFAVORABLE TO US.
We
have a work commitment with respect to the Prospect requiring us to expend significant stipulated amounts. We will need additional funds
to satisfy the remainder of the work commitment, which includes the actual drilling of wells. Moreover, we will need working capital
and further funds to explore and develop the Prospect in the manner that we prefer.
We
are actively engaged in efforts to complete a capital raising transaction sufficient for us to complete the third year of the work commitment
and provide additional funds to cover general and administrative costs. In the past, we have used the services of firms that specialize
in capital procurement, but we are currently pursuing our own capital raising initiatives. If funds are not procured pursuant to this
arrangement, we will be constrained to seek alternative financing. We have no assurance that we will be successful in completing a transaction
that will provide us with required funds. Our failure to honor our work commitment could result in our loss of the Prospect. Moreover,
our failure to procure funds needed to develop operations sufficient to generate enough cash to retire our Debentures as they become
due could result in Debentures holders’ eventual exercise of the rights of a secured creditor and the possible loss of all or a
large part of our assets. If either of the preceding events were to occur, we could be forced to cease our current business plan, which
could result in a complete loss to our stockholders. Our future liquidity will depend upon numerous factors, including the success of
our business efforts and our capital raising activities. If we obtain funds through the issuance of equity securities, the following
results will or may occur:
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the
percentage ownership of our existing stockholders will be reduced.
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the
new equity securities could have rights, preferences or privileges senior to those of the holders of our common shares.
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We
have no assurance of our ability to raise funds for any purpose.
THERE
IS SUBSTANTIAL DOUBT AS TO WHETHER WE WILL CONTINUE OPERATIONS WITHOUT ADDITIONAL FINANCING.
Based
on our assessment of the related risk factors (described further below), we believe there is substantial doubt about our ability to continue
to operate as a going concern for the 12 months following the issuance of our February 28, 2021 financial statements. Our independent
registered public accountant has added an emphasis paragraph to its report on our financial statements for the year ended February 28,
2021 regarding our ability to continue as a going concern. Key to this determination is our lack of any historical revenues and our accumulated
deficit of $31,661,738 since inception through February 28, 2021. Since May 2016, we have placed Debentures having an aggregate
original principal amount of $6,850,000. Proceeds from these placements largely financed our business for our fiscal years 2017 and 2018,
and the first half of our fiscal year 2019. Since that time, we have financed our business through private common shares financings.
Notwithstanding the preceding, we still need additional funds. There can be no assurance that we will be successful in securing funding,
becoming profitable, or continuing our business without either a temporary interruption or a permanent cessation.
IF
WE GROW OUR BUSINESS AS PLANNED, WE MAY NOT BE ABLE TO MANAGE PROPERLY OUR GROWTH, AND WE EXPECT OPERATING EXPENSES TO INCREASE, WHICH
MAY IMPEDE OUR ABILITY TO ACHIEVE PROFITABILITY.
If
we are successful in growing our business as we plan, our operations may expand rapidly and significantly. Any rapid growth could place
a significant strain on our management, operational and financial resources. In order to manage the growth of our operations, we will
be required to improve and expand existing operations; to implement new operational, financial and inventory systems, procedures and
controls, including improvement of our financial and other internal management systems; and to train, manage and expand our staffing.
If we are unable to manage growth effectively, our business, results of operations and financial condition will be materially and adversely
affected. In addition, if we are successful in growing our business as we plan, we expect operating expenses to increase, and as a result,
we will need to generate increased revenue to achieve and maintain profitability. These additional costs and expenses could delay our
ability to achieve continuing profitability.
CONDUCTING
BUSINESS INTERNATIONALLY MAY RESULT IN INCREASED COSTS AND OTHER RISKS.
We
plan on operating our business in Australia. Operating internationally exposes us to a number of risks. Examples include a possible downturn
in local economic conditions due to local policy decisions, increases in duties and taxes, and other adverse changes in laws, regulations
and policies affecting our business, or governing the operations of foreign based companies. Additional risks include currency fluctuations,
interest rate movements, imposition of trade barriers, and restrictions on repatriation of earnings. If we are unable to address these
risks adequately, our financial position and results of operations could be adversely affected.
RISKS
RELATING TO OUR INDUSTRY
OIL
AND NATURAL GAS EXPLORATION AND PRODUCTION PRESENT MANY RISKS THAT ARE DIFFICULT TO MANAGE.
Our
Hydrocarbon exploration, development and production activities are subject to many risks that may be unpredictable and are difficult
to manage. In addition, the cost and timing of drilling, completing and operating wells is often uncertain. In conducting exploration
and development activities, the presence of unanticipated pressure or irregularities in formations, miscalculations or accidents may
cause exploration, development and production activities to be delayed or unsuccessful. This could result in a total loss of our investment
in a particular drilling program. If exploration efforts are unsuccessful in establishing proved reserves in a timely manner and exploration
activities cease, the amounts accumulated as unproved costs will be charged against earnings as impairments.
OUR
FOCUS ON EXPLORATION ACTIVITIES EXPOSES US TO GREATER RISKS THAN ARE GENERALLY ENCOUNTERED IN LATER-STAGE HYDROCARBON PROPERTY DEVELOPMENT
BUSINESSES.
If
we are funded, most of our initial activity will involve drilling exploratory test wells on acreage with no proved Hydrocarbon reserves.
While all drilling (whether developmental or exploratory) involves risks, exploratory drilling involves greater risks of dry holes or
failure to find commercial quantities of Hydrocarbons. The economic success of any drilling program will depend on numerous factors,
including the ability to estimate the volumes of recoverable reserves relating to the drilling program, rates of future production, future
commodity prices, investment and operating costs and possible environmental liabilities. All of these factors may impact whether a drilling
program will generate cash flows sufficient to provide a suitable return on investment. If we experience a series of failed drilling
projects, our business, results of operations and financial condition could be materially and adversely affected.
CERTAIN
CURRENT TRENDS COULD MATERIALLY ADVERSELY AFFECT US AND OUR INDUSTRY.
Worldwide
concern over the risks of climate change is growing. This has led to the following developments and could lead to further movement in
the following directions:
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Laws
are being adopted or considered to reduce greenhouse gas emissions, conserve fuel, use fewer Hydrocarbons, and utilize more alternative
energy sources. These laws include cap and trade regimes, carbon taxes, trade tariffs, minimum renewable usage requirements, restrictive
permitting, increased efficiency standards, and incentives or mandates for alternative or renewable energy. Government and other
activist persons are also seeking to promote their climate change agendas indirectly, such as by seeking to reduce the availability
of or increase the cost for, financing and investment in our industry and taking actions intended to promote changes in business
strategy for companies in this industry.
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Consumer
sentiment seems to be shifting against fuel sources that leave a large carbon footprint (such as Hydrocarbons) and in favor of products
that use alternative energy sources. As an example, sales of electric vehicles increased rapidly for most of the second decade of
the 21st century, and this could continue into the future. Even investors (including sovereign wealth, pension, and endowment
funds) are increasingly sensitive to environmental, social, and governance (ESG) matters, opting to divest their holdings of (or
not acquire investments in) companies in our industry. Organizations provide information to investors on corporate governance and
related matters and have developed ratings processes for evaluating companies on their approach to ESG matters. Such ratings are
used by some investors to inform their investment and voting decisions. All of this could have negative impacts on the stock prices
and access to capital markets of companies in our industry.
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In
response to the two points made above, research into new technologies to reduce the cost and increase the use of alternative energy
sources is increasing. These technologies include advanced biofuels and hydrogen, carbon capture and storage, breakthrough energy
efficiency processes, and advanced energy-saving materials.
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The
effect of the actions described above could have the potential to reduce demand for Hydrocarbons, to increase the costs of producing
Hydrocarbons and products based on them (thereby increasing the prices, but reducing the quantity sold, of end-products), to affect adversely
revenues, margins and investment returns or even render certain proposed projects economically unfeasible, and to increase regulatory
compliance costs, as well as shift Hydrocarbon demand toward relatively lower-carbon sources such as natural gas. The full effects of
the current trends (which are beyond our control) create a great deal of uncertainty as to their ultimate impact, and these effects may
not be fully felt for many years to come. Nevertheless, these trends may materially adversely affect our business, financial condition,
results of operations and cash flows.
WE
WILL RELY ON INDEPENDENT EXPERTS AND TECHNICAL OR OPERATIONAL SERVICE PROVIDERS OVER WHOM WE MAY HAVE LIMITED CONTROL.
We
are, and will continue to be, engaging independent contractors to provide us with technical assistance and services. These include the
services of geologists, geophysicists, chemists, landmen, engineers and scientists. We also are and will be relying upon them to analyze
the Prospect and any other future prospects to determine methods in which the Prospect may be developed in a cost-effective manner and
to select drill sites. In addition, we intend to rely on the owners and operators of oil rigs and drilling equipment, and on providers
of oilfield services, to drill and develop our prospects to production. Moreover, if our properties hold commercial quantities of Hydrocarbons,
we would need to rely on third-party gathering, trucking and/or pipeline facilities to transport and purchase our production. Our limited
control over the activities and business practices of these providers, any inability on our part to maintain satisfactory commercial
relationships with them or their failure to provide quality services could materially and adversely affect our business, results of operations
and financial condition.
SHORTAGES
OF RIGS, EQUIPMENT, SUPPLIES AND PERSONNEL COULD DELAY OR OTHERWISE ADVERSELY AFFECT OUR COST OF OPERATIONS OR OUR ABILITY TO OPERATE
ACCORDING TO OUR BUSINESS PLAN.
If
drilling activity increases in the Western Flank, a general shortage of drilling and completion rigs, field equipment and qualified personnel
could develop. As a result, the costs and delivery times of rigs, equipment and personnel could be substantially greater than in previous
years. From time to time, these costs have sharply increased and could do so again. The demand for and wage rates of qualified drilling
rig crews generally rise in response to the increasing number of active rigs in service and could increase sharply in the event of a
shortage. Shortages of drilling and completion rigs, field equipment or qualified personnel could delay, restrict or curtail our exploration
and development operations, which could in turn adversely affect our results of operations.
OUR
REVIEW OF PROPERTIES CANNOT ASSURE THAT ALL DEFICIENCIES OR ENVIRONMENTAL RISKS MAY BE IDENTIFIED OR AVOIDED.
We
plan on undertaking reviews that we believe are consistent with industry practice for our drilling programs. However, these reviews will
often be limited in scope, and may not reveal all existing or potential problems, or permit us to become sufficiently familiar with the
related properties to assess all potential problems. Moreover, we may not perform an inspection on every platform or well, and our inspections
may not reveal all structural or environmental problems. Our license rights with respect to the Prospect contain no indemnification for
environmental liabilities. Accordingly, we will pursue our drilling programs on an “as is” basis, which could require us
to make substantial expenditures to remediate environmental contamination. If a property deficiency or environmental problem cannot be
satisfactorily remedied to warrant commencing drilling operations on a property, we could lose our entire investment in the asset.
WE
MAY NOT BE ABLE TO FULLY INSURE AGAINST ALL RISKS RELATED TO OUR PROPOSED OPERATIONS, WHICH COULD RESULT IN SUBSTANTIAL CLAIMS FOR WHICH
WE ARE UNDERINSURED OR UNINSURED.
We
currently do not have any insurance with regard to our proposed Hydrocarbon exploration and production activities. Prior to commencing
these activities, we do intend to obtain insurance that we believe will be consistent with prevailing industry practices. We have no
assurance that we will be able to obtain such insurance, or if obtained, we will be able to maintain it if costs become prohibitively
expensive. Moreover, we have no assurance that such insurance will cover all risks. Losses and liabilities arising from uninsured and
underinsured events, which could arise from even one catastrophic event, could materially and adversely affect our business, results
of operations and financial condition. Our exploration, drilling and other activities are subject to risks such as:
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fires
and explosions;
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environmental
hazards, such as uncontrollable flows of natural gas, oil, brine, well fluids, toxic gas or other pollution into the environment,
including groundwater contamination;
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abnormally
pressured formations;
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mechanical
failures of drilling equipment;
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personal
injuries and death, including insufficient worker compensation coverage for third-party contractors who provide drilling services;
and
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natural
disasters, such as adverse weather conditions.
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Our
business could be negatively affected by security threats, including cybersecurity threats, and other disruptions.
We
will depend to a meaningful extent on digital technologies to conduct our business. These technologies will relate to seismic, financial,
operating and other data. Cyber incidents have recently increased, and have involved malicious software and attempts to gain unauthorized
access to data and systems. Our technologies, systems, networks, and those of our business partners, may become the target of cyberattacks
or information security breaches that could result in the unauthorized release, misuse, loss or destruction of proprietary and other
information, or other disruption of our business operations. Our implementation of various procedures and controls to monitor and mitigate
security threats and to increase security for our information, facilities and infrastructure may result in increased capital and operating
costs. Moreover, there can be no assurance that such procedures and controls will be sufficient to prevent security breaches from occurring.
Any security breach could likely materially and adversely affect our business, financial condition or results of operation.
OPERATIONAL
IMPEDIMENTS MAY HINDER OUR ACCESS TO HYDROCARBON MARKETS OR DELAY OUR PRODUCTION.
We
expect to deliver Hydrocarbons through trucking systems, gathering systems and pipelines that we do not own. Existing facilities may
not be available to us now or in the future. The marketability of our future production depends in part upon the availability, proximity
and capacity of truck terminals, pipelines, natural gas gathering systems and processing facilities owned by others. Our failure to establish
suitable contractual relationships with respect to our production would materially and adversely affect our business, results of operations
and financial condition. In addition, any significant change in our arrangements with trucking firms, gathering system or pipeline owners
and operators or other market factors affecting the overall infrastructure facilities servicing our properties could adversely impact
our ability to deliver the Hydrocarbons we produce to markets in a satisfactory manner. In some cases, we may be required to shut in
wells, at least temporarily, for lack of a market because of the inadequacy or unavailability of transportation facilities. If that were
to occur, we would be unable to timely realize revenue from those wells until arrangements were made to deliver our production to market.
Moreover, our ability to produce and market Hydrocarbons could be negatively impacted by:
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government
regulations; and
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government
transportation, tax and energy policies.
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HYDROCARBON
RESERVES DECLINE ONCE A PROPERTY BECOMES PRODUCTIVE, AND WE EXPECT TO NEED TO FIND ADDITIONAL RESERVES TO SUSTAIN REVENUE GROWTH.
Even
if we add Hydrocarbon reserves through our exploration activities, our reserves will decline as they are produced. We will be constantly
challenged to add additional reserves through further exploration or further development of our existing properties. There can be no
assurance that our exploration and development activities will be successful in adding new reserves. If we fail to replace reserves,
our level of production and cash flows will be adversely impacted.
WE
EXPECT TO HAVE LIMITED CONTROL OVER ACTIVITIES ON PROPERTIES WE DO NOT OPERATE, WHICH COULD REDUCE OUR PRODUCTION AND REVENUES.
We
expect that we will operate all of our initial wells. However, some of our business activities could be conducted through joint operating
agreements under which we own partial interests in Hydrocarbon properties. In such situation, we may not operate the related properties
and in some cases we may not have the ability to remove the operator in the event of poor performance. As a result, we may have a limited
ability to exercise influence over normal operating procedures, expenditures or future development of underlying properties and their
associated costs. The failure of an operator of our wells to adequately perform operations, or an operator’s breach of the applicable
agreements, could reduce our production and revenues. The success and timing of our drilling and development activities on properties
operated by others therefore depend upon a number of factors outside of our and the operator’s control, including:
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timing
and amount of capital expenditures;
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expertise
and financial resources; and
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inclusion
of other participants.
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HYDROCARBONS
ARE COMMODITIES SUBJECT TO PRICE VOLATILITY BASED ON MULTIPLE FACTORS OUTSIDE THE CONTROL OF PRODUCERS, AND LOW PRICES MAY MAKE PROPERTIES
UNECONOMIC.
Hydrocarbons
are commodities, and, therefore, their prices are subject to wide fluctuations in response to relatively minor changes in supply and
demand. Historically, the markets for Hydrocarbons have been volatile. These markets will likely continue to be volatile in the future.
The prices a producer may expect and its level of production depend on numerous factors beyond its control, such as those described in
“Item 1. Business - Markets and Marketing.” Lower Hydrocarbons prices may not only decrease revenues on a per unit basis,
but also may reduce the volume of Hydrocarbons that can be economically produced. Lower prices will also negatively impact the value
of proved reserves.
COMMODITY
PRICE RISK MANAGEMENT DECISIONS MAY CAUSE US TO FOREGO ADDITIONAL FUTURE PROFITS OR RESULT IN MAKING ADDITIONAL CASH PAYMENTS.
To
reduce our exposure to changes in the prices of Hydrocarbons, we may enter into commodity price risk management agreements for a portion
of our Hydrocarbon production. The agreements that we could enter into generally would have the effect of providing us with a fixed price
for a portion of the expected future Hydrocarbon production over a fixed period of time. Commodity price risk management agreements expose
us to the risk of financial loss, including the following:
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production
is less than expected;
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the
counter-party to the commodity price risk management agreement may default on its contractual obligations to us;
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we
could be required to post additional cash to cover margin requirements, which could materially and adversely affect liquidity;
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we
could be unable to meet additional margin requirements, which could result in the closing of positions thereby leading to a financial
loss as well as the possible loss of the anticipated benefits of the related hedging transactions;
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there
may be a change in the expected differential between the underlying price in the commodity price risk management agreement and actual
prices received; and
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market
prices may exceed the prices for which we are contracted to receive, resulting in the need to make significant cash payments.
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Furthermore,
commodity price risk management arrangements may limit the benefit we would receive from increases in the prices for Hydrocarbons.
OUR
PROPERTIES MAY BE SUBJECT TO SUBSTANTIAL IMPAIRMENT OF THEIR RECORDED VALUE.
The
accounting rules for our properties, for which we establish proved reserves, will require us to review periodically their carrying value
for possible impairment. If Hydrocarbon prices decrease or if the recoverable reserves on a property are revised downward, we may be
required to record impairment write-downs, which would result in a negative impact to our financial position. We also may be required
to record impairment write-downs for properties lacking economic access to markets and must record impairment write-downs for our Prospect
as the license for it expires or when we expect such license to expire without an extension, both of which could also negatively impact
our financial position.
OUR
COMPETITORS INCLUDE LARGER, BETTER-FINANCED AND MORE EXPERIENCED COMPANIES.
The
Hydrocarbon industry is intensely competitive. As an early-stage company, we must compete against larger companies that may have greater
financial and technical resources than we have and substantially more experience in our industry. These competitive advantages may better
enable our competitors to sustain the impact of higher exploration and production costs, Hydrocarbon price volatility, productivity variances
among properties, overall industry cycles and other factors related to our industry. The advantages of our competitors may also negatively
impact our ability to acquire prospective properties, develop reserves, attract and retain quality personnel and raise capital.
CONDUCTING
OPERATIONS IN THE HYDROCARBON INDUSTRY SUBJECTS US TO COMPLEX LAWS AND REGULATIONS, INCLUDING ENVIRONMENTAL REGULATIONS THAT CAN HAVE
A MATERIAL ADVERSE EFFECT ON THE COST, MANNER OR FEASIBILITY OF DOING BUSINESS.
Companies
that explore for and develop, produce and sell Hydrocarbons in Australia are subject to extensive government laws and regulations, including
complex tax laws and environmental laws and regulations, and are required to obtain various permits and approvals from government agencies.
If these permits are not issued or unfavorable restrictions or conditions are imposed on our drilling activities, we may not be able
to conduct our operations as planned. Alternatively, failure to comply with these laws and regulations, including the requirements to
obtain any permits, may result in the suspension or termination of our operations and subject us to administrative, civil and criminal
penalties. Compliance costs can be significant. Further, these laws and regulations could change in ways that substantially increase
our costs and associated liabilities. We cannot be certain that existing laws or regulations, as currently interpreted or reinterpreted
in the future, or future laws or regulations will not harm our business, results of operations and financial condition. For example,
matters subject to regulation and the types of permits required include:
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water
discharge and disposal permits for drilling operations;
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drilling
permits;
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reclamation;
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spacing
of wells;
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occupational
safety and health;
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air
quality, noise levels and related permits;
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rights-of-way
and easements;
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calculation
and payment of royalties;
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gathering,
transportation and marketing of Hydrocarbons;
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taxation;
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waste
disposal; and
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flaring
on-site of unsold natural gas.
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Under
these laws and regulations, we could be liable for:
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personal
injuries;
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property
damage;
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oil
spills;
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*
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discharge
of hazardous materials;
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*
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remediation
and clean-up costs;
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*
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fines
and penalties; and
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*
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natural
resource damages.
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RISKS
RELATING TO OUR MANAGEMENT
WE
DEPEND ON CERTAIN KEY PERSONNEL.
We
rely upon the efforts and skills of our current and expected future management. The loss of the services of any member of management,
including the lack of sufficient time to devote to our operations, could materially and adversely affect our operations. The employment
agreements and consulting agreements that we have entered into with members of management contain no non-competition agreement with us,
and therefore allow the related member of management to terminate his agreement upon 60-days’ notice. As a result, any member of
management may discontinue providing his services to us at any time and for any reason, and even thereafter commence competition with
us. Moreover, we do not currently maintain key man life insurance on any member of management.
OUR
CURRENT MANAGEMENT RESOURCES MAY NOT BE SUFFICIENT FOR THE FUTURE, AND WE HAVE NO ASSURANCE THAT WE WILL BE ABLE TO ATTRACT ADDITIONAL
QUALIFIED PERSONNEL.
There
can be no assurance that the current level of management is sufficient to perform all responsibilities necessary or beneficial for management
to perform. Our future success also depends on our continuing ability to attract, assimilate and retain highly qualified sales, technical
and managerial personnel. Competition for these individuals is intense, and there can be no assurance that we can attract, assimilate
or retain necessary personnel in the future.
OUR
MANAGEMENT OWNS A LARGE PERCENTAGE OF OUR OUTSTANDING SHARES, AND CUMULATIVE VOTING IS NOT AVAILABLE TO STOCKHOLDERS.
Our
current senior management owns approximately 65.05% of our outstanding common shares as of the date of the filing of this Report. Cumulative
voting in the election of directors is not authorized in our First Amended and Restated Articles of Incorporation. Accordingly, it is
not permitted as a matter of law. As a result, the holder or holders of a majority of our outstanding common shares may elect all of
our directors. Management’s large percentage ownership of our outstanding common shares will enable them to maintain their positions
as such and thus their control of our business and affairs.
OUR
OBLIGATION TO INDEMNIFY MEMBERS OF MANAGEMENT COULD REQUIRE US TO PAY THEM FOR LOSSES CAUSED BY THEM, AND LIMITATIONS ON CLAIMS AGAINST
STOCKHOLDERS COULD PREVENT OUR RECOVERY OF SUCH LOSSES FROM THEM.
The
corporation law of Nevada allows a Nevada corporation to indemnify its directors and each of its officers, agents, contractors and/or
employees to the extent that certain standards are met, and our First Amended and Restated Articles of Incorporation permit indemnification
of our directors, and our Bylaws require indemnification of our directors and officers to the maximum extent permitted by law. If the
required standards are met, we could be required to indemnify management for losses caused by them. Further, we may purchase and maintain
insurance on behalf of any such persons whether or not we have the power to indemnify such person against the liability insured against.
Moreover, the corporation law of Nevada allows a Nevada corporation to limit the liability of its directors to the corporation and its
stockholders to a certain extent, and our First Amended and Restated Articles of Incorporation and Bylaws have eliminated the director’s
liability to the maximum extent permitted by law. Consequently, because of the actions or omissions of our management, we could incur
substantial losses and be prevented from recovering such losses from such persons. Further, the U.S. Securities and Exchange Commission
maintains that indemnification for liabilities arising under the Securities Act is against the public policy expressed in the Securities
Act, and is therefore unenforceable.
We
may not have adequate internal controls over financial reporting.
While
we are constantly striving to improve our internal controls over financial reporting, our management has determined that our disclosure
controls, procedures and controls over financial reporting are not sufficiently effective to ensure that information required to be disclosed
by us in the reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”),
is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Commission. Our Board
of Directors has not designated an Audit Committee and we do not have any outside directors. We have implemented a number of disbursing,
accounting and financial statement preparation and review processes, and as a result the financial controls of the Company have been
improved. If we do not have adequate internal accounting controls, we may also be unable to prepare accurate accounts on a timely basis
to meet our continuing financial reporting obligations and we may not be able to satisfy our obligations under applicable securities
laws.
There
may be limitations on the effectiveness of our internal controls, and a failure of our control systems to prevent error or fraud may
materially harm us.
We
do not expect that internal control over financing reporting, even if timely and well established, will prevent all errors and fraud.
A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s
objectives will be 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 their 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, have been detected. Failure of our control
systems to prevent error or fraud could materially and adversely affect our business.
WE
HAVE NOT VOLUNTARILY IMPLEMENTED VARIOUS CORPORATE GOVERNANCE MEASURES, IN THE ABSENCE OF WHICH, STOCKHOLDERS MAY HAVE MORE LIMITED PROTECTIONS
AGAINST INTERESTED DIRECTOR TRANSACTIONS, CONFLICTS OF INTEREST AND SIMILAR MATTERS.
Certain
Federal legislation, including the Sarbanes Oxley Act of 2002, has resulted in the adoption of various corporate governance measures
designed to promote the integrity of corporate management and securities markets. Some of these measures have been adopted in response
to legal requirements. Others have been adopted by companies in response to the requirements of national securities exchanges, such as
the NYSE or the NASDAQ Stock Market, on which their securities are listed. Among the corporate governance measures that are required
under the rules of national securities exchanges are those that address board of directors’ independence, audit committee oversight,
and the adoption of a code of ethics. Although we have adopted a Code of Ethics, we have not yet adopted any of these other corporate
governance measures and, since our securities are not yet listed on a national securities exchange, we are not required to do so. We
have not adopted certain corporate governance measures such as an audit or other independent committees of our Board of Directors because
we do not have sufficient funds available to do so. Possibly if we were to adopt some or all of these corporate governance measures,
stockholders would benefit from somewhat greater assurances that internal corporate decisions were being made by disinterested directors
and that policies had been implemented to define responsible conduct. For example, in the absence of audit, nominating and compensation
committees comprised of at least a majority of independent directors, decisions concerning matters such as compensation packages to our
senior officers and recommendations for director nominees may be made by a majority of directors who have an interest in the outcome
of the matters being decided. Although we intend to bolster our corporate governance capabilities as funds become available for this
purpose, prospective investors should bear in mind our current lack of corporate governance measures in formulating their investment
decisions.
RISKS
RELATING TO OUR COMMON SHARES
OUR
COMMON SHARES HAVE EXPERIENCED LIMITED TRADING.
Our
common shares are quoted on the over-the-counter markets under the name “Discovery Energy Corp.” and the symbol “DENR”.
The volume of trading of our common shares has been extremely limited. There can be no assurance as to the prices at which our common
shares will trade in the future. Until our common shares become more broadly held and orderly markets develop and even thereafter, the
prices of our common shares may fluctuate significantly. Prices for our common shares will be determined in the marketplace and may be
influenced by many factors, including the following:
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*
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The
depth and liquidity of the markets for our common shares;
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*
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Investor
perception of us and the industry in which we participate;
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*
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General
economic and market conditions;
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*
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Responses
to quarter to quarter variations in operating results;
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*
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Failure
to meet securities analysts’ estimates;
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*
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Changes
in financial estimates by securities analysts;
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*
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Changes
in laws, regulations and policies;
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*
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Conditions,
trends or announcements in the Hydrocarbon industry;
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*
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Announcements
of significant acquisitions, strategic alliances, joint ventures or capital commitments by us or our competitors;
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*
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Additions
or departures of key personnel;
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*
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Sales
of our common shares;
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*
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Accounting
pronouncements or changes in accounting rules that affect our financial statements; and
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*
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Other
factors and events beyond our control.
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The market price of our common shares could experience
significant fluctuations unrelated to our operating performance. As a result, a stockholder (due to personal circumstances) may be required
to sell such stockholder’s common shares at a time when our stock price is depressed due to random fluctuations, which are possibly
based on factors beyond our control.
INCREASES
IN THE SALES VOLUME OF OUR SHARES COULD ADVERSELY AFFECT US.
We
have a very thinly traded market for our shares. Future sales of a large number of our shares may have a depressive effect on the price
of our common shares, and might also adversely affect our ability to raise additional capital.
THE
TRADING PRICE OF OUR COMMON SHARES MAY ENTAIL ADDITIONAL REGULATORY REQUIREMENTS, WHICH COULD NEGATIVELY AFFECT SUCH TRADING PRICE.
The
trading price of our common shares historically has been below $5.00 per share. As a result of this price level, trading in our common
shares is subject to the requirements of certain rules promulgated under the Exchange Act. These rules require additional disclosure
by broker dealers in connection with any trades generally involving any non-NASDAQ equity security that has a market price of less than
$5.00 per share, subject to certain exceptions. Such rules require the delivery, before any penny stock transaction, of a disclosure
schedule explaining the penny stock market and the risks associated therewith and impose various sales practice requirements on broker
dealers who sell penny stocks to persons other than established customers and accredited investors (generally institutions). For these
types of transactions, the broker dealer must determine the suitability of the penny stock for the purchaser and receive the purchaser’s
written consent to the transaction before sale. The additional burdens imposed upon broker dealers by such requirements may discourage
broker dealers from effecting transactions in our common shares. As a consequence, the market liquidity of our common shares could be
severely affected or limited by these regulatory requirements.
PROVISIONS
OF OUR ARTICLES OF INCORPORATION AND BYLAWS MAY DELAY OR PREVENT A TAKEOVER, WHICH MAY NOT BE IN THE BEST INTERESTS OF OUR STOCKHOLDERS.
Provisions
of our First Amended and Restated Articles of Incorporation and Bylaws may be deemed to have anti-takeover effects, which include when
and by whom special meetings of our stockholders may be called, and may delay, defer or prevent a takeover attempt. In addition, our
First Amended and Restated Articles of Incorporation authorizes the issuance of up to 10,000,000 shares of preferred stock with such
rights and preferences, as may be determined by our Board of Directors. Of this authorized preferred stock, no shares are currently issued
and outstanding. Our Board of Directors may, without stockholder approval, issue up to 10,000,000 preferred stock with dividends, liquidation,
conversion or voting rights that could adversely affect the voting power or other rights of our common stockholders.
STOCKHOLDERS
HAVE NO GUARANTEE OF DIVIDENDS AND MAY BE CONSTRAINED TO SELL THEIR SHARES TO REALIZE A RETURN ON THEIR INVESTMENT.
The
holders of our common shares are entitled to receive dividends when, as and if declared by the Board of Directors out of funds legally
available therefore. To date, we have paid no cash dividends. Currently, our outstanding Debentures prohibit us from paying dividends
without the consent of our Debentures holders. Even if such a prohibition did not exist, the Board of Directors will most likely not
declare any dividends in the foreseeable future, but will instead retain all earnings, if any, for use in our business operations. As
a result, an investor will probably need to sell some or all of their shares to realize a return on an investment in them, and investors
may not be able to sell such shares at or above the price they paid for them.