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HEVI > SEC Filings for HEVI > Form 10-Q on 12-Sep-2013All Recent SEC Filings

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Form 10-Q for HEAVY EARTH RESOURCES, INC.


12-Sep-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion relates to a discussion of the financial condition and results of operations of Heavy Earth Resources, Inc., a Florida corporation (the "Company") herein used in this report, unless otherwise indicated, under the terms "Registrant," "Heavy Earth," "we," "us" and similar terms and its wholly-owned subsidiaries Deep Core Inc., a Cayman Island exempt company ("Deep Core"), Deep Core's majority-owned Colombian subsidiary, DCX SAS (formerly known as Petropuli SAS) ("DCX"), Deep Core's wholly-owned Barbados subsidiary, Deep Core (Barbados) Inc., and Syncline Technologies, Inc. a Cayman Island exempt Company ("Syncline").

Forward Looking Statements

This following information specifies certain forward-looking statements of management of the company. Forward-looking statements are statements that estimate the happening of future events are not based on historical fact. Forward-looking statements may be identified by the use of forward-looking terminology, such as "may", "shall", "could", "expect", "estimate", "anticipate", "predict", "probable", "possible", "should", "continue", or similar terms, variations of those terms or the negative of those terms. The forward-looking statements specified in the following information have been compiled by our management on the basis of assumptions made by management and considered by management to be reasonable. Our future operating results, however, are impossible to predict and no representation, guaranty, or warranty is to be inferred from those forward-looking statements.

The assumptions used for purposes of the forward-looking statements specified in the following information represent estimates of future events and are subject to uncertainty as to possible changes in economic, legislative, industry, and other circumstances. As a result, the identification and interpretation of data and other information and their use in developing and selecting assumptions from and among reasonable alternatives require the exercise of judgment. To the extent that the assumed events do not occur, the outcome may vary substantially from anticipated or projected results, and, accordingly, no opinion is expressed on the achievability of those forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to:

risks associated with drilling and production programs on the Morichito and La Maye Blocks resulting from geological, technical, drilling, seismic and other unforeseen problems;

unexpected results of exploration and development drilling and related activities on the Morichito and La Maye Blocks;

continued availability of capital and financing to fund exploration and development drilling activities;

increases in operating costs;

availability of skilled personnel;

unpredictable weather conditions;

the impact of political and economic instability in Colombia;

the ability to obtain required approvals of regulatory authorities in Colombia;

senior management's general inexperience in oil and gas operations in Colombia;

members of senior management not being based in Colombia; and

other factors listed from time to time in the Company's filings with the Securities and Exchange Commission.

No assurance can be given that any of the assumptions relating to the forward-looking statements specified in the following information are accurate, and we assume no obligation to update any such forward-looking statements.

Critical Accounting Policies and Estimates.

Our Management's Discussion and Analysis of Financial Condition and Results of Operations section discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to revenue recognition, accrued expenses, financing operations, and contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The most significant accounting estimates inherent in the preparation of our financial statements include estimates as to the appropriate carrying value of certain assets and liabilities which are not readily apparent from other sources. These accounting policies are described at relevant sections in this discussion and analysis and in the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012 and this Quarterly Report on Form 10-Q for the period ended June 30, 2013.


Heavy Earth Resources, Inc. (the "Company"), a Florida corporation, is engaged in the acquisition, exploration, development and production of oil and gas properties. As of June 30, 2013, the Company, through its subsidiaries, owned a 50% participating oil and gas interest in the Morichito Block located in the Llanos Basin, Colombia and a 25% participating interest in the La Maye Block located in the Lower Magdalena Basin, Colombia. On August 28, 2013, the Company entered into the following agreements in connection with its subsidiary, Deep Core, Inc.:

Share Purchase Agreement dated as of the same date (the "Purchase Agreement"), by and between the Company and Black Energy Oil & Gas Corp., a Panamanian company ("Black Energy"); and

Letter agreement dated as of the same date (the "Letter Agreement"), by and between the Company and Deep Core (Barbados) Inc., a Barbados corporation wholly owned by the Company ("Deep Core Barbados"), on the one hand, and DCX SAS on the other hand.

Pursuant to the Purchase Agreement, the Company agreed to sell to Black Energy, and Black Energy agreed to purchase from the Company, the shares of Deep Core Inc., ("Deep Core") held by the Company, representing all of the issued and outstanding share capital of Deep Core (the "Shares"). Deep Core, a Cayman Islands company, owns 99.675% of the issued and outstanding share capital of DCX SAS, a Columbian company ("DCX") that owns a 50% participating interest in the Morichito Block located in the Llanos Basin, Columbia. In addition:

Total consideration for the Shares is $1.5 million in cash (the "Proceeds") plus the assumption of $6 million of existing liabilities as well as all future liabilities of Deep Core.

The Company shall retain a 15% participation interest in the Morichito Block (the "Interest"), to be held by Deep Core Barbados, pursuant to an agreement to be entered into by and between DCX and Deep Core Barbados.

From and after the closing of the Agreement (the "Closing"), Black Energy (and
DCX) shall hold the Interest in trust and for the benefit of Deep Core Barbados until such time that Columbia's National Agency of Hydrocarbons can formally approve the transfer of the Interest to Deep Core Barbados.

From and after the Closing, Black Energy shall cause DCX to commence such exploratory activities at the Morichito Block as set forth in Schedule B of the Agreement, and to pay for all attendant expenses up to $10 million. Expenses in excess thereof, as well as any other expenses, shall be borne by Black Energy and Deep Core Barbados pro rata to their respective participation interests. If Black Energy fails to perform any of its obligations described herein, Black Energy agrees to transfer the Shares back to the registrant upon notice for no additional consideration.

The Company agrees to use the Proceeds to pay for such expenses relating to the Morichito Block that are attributable to the Interest.

At the Closing, Black Energy shall establish an escrow account and deposit 2.5 million Columbian pesos into such account for the payment of debts of DCX as set forth in Schedule A of the Agreement.

The Company has a right of first refusal with respect to any proposed transfer of the Shares, the shares of DCX held by Deep Core, or DCX's participation interest in the Morichito Block. Black Energy shall notify the registrant in writing at least 30 business days prior to the closing of any such transfer, and the registrant shall have 10 business days therefrom to exercise its refusal right.

Pursuant to the Letter Agreement, DCX acknowledges the Interest under the terms of the Purchase Agreement and the rights of the Company thereto.

Second Quarter Highlights

Morichito Block

We completed an advanced 94 square kilometers 3D seismic survey over the northern portion of the Morichito Block, located within producing trends of the prolific Llanos Basin, to define and identify high-impact exploration drilling targets. The 3D seismic survey was completed ahead of schedule and on budget and preliminary analysis has indicated the quality of the data is better than expected. Subsequent to June 30, 2012, we announced the completion of its merging of its new 3D seismic surveys with previous 3D seismic surveys and the fulfillment of its obligations for the relinquishment of 50% of the Morichito Block area in conjunction with a two-year E&P Contract extension from the Colombian ANH.

The work plan's focus is to commence production from the Morichito-5 (M-5) discovery well and engage in negotiations to consummate a possible farm-out agreement to support the long-term development of the Morichito block. Specifically, the Company satisfied the final stage of the six phases of the E&P Contract with the delivery of the new seismic to the ANH. In addition, DCX completed the purchase of key production equipment and facilities required to produce the M-5 discovery well and treat the oil onsite for full time production to commence on completion of the all weather access road.


Morichito-5 Commerciality

In March 2012, DCX submitted to the ANH the request for commerciality for part of the Morichito Block. We have completed an exploration and production work plan aimed at extracting the maximum value from the discovery well (Morichito-5) and underlying targets with a program to realize near-term operating cash flow from production prior to year end 2013.

La Maye Block

The Operator of the La Maye block has been preparing for the testing of the Noelia well. Testing of the well is expected to commence in the third quarter 2013 subject to weather. The Operator recently received approval from the ANH to suspend the contract until September 30, 2013, giving the Operator more time to complete the testing.

Accounts Payable

Upon closing of the Petropuli SPA, certain liabilities and contingent liabilities totaling approximately US$2.2 million were assumed by DCX. There are past vendor obligations included in accounts payable on the consolidated balance sheet in addition to an environmental fine to be levied by the environmental ministry of Colombia related to various activities performed by Petropuli prior to the acquisition by Deep Core. In addition, there is a pending receivable for seismic cost from a partner in the Morichito block that holds a 35% interest in the block.

Additional information related to the Company and its subsidiaries' operations is available on our website at www.heavyearthresources.com. However, the information on our website is not incorporated by reference in this report.

The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements for the period ended June 30, 2013, together with notes thereto, which reflect the operations of our subsidiaries Deep Core and DCX.

Results of Operations

For the Three Months Ended June 30, 2013, as Compared to the Three Months ended June 30, 2012.

Revenues

We had no revenues for the three months ended June 30, 2013 and 2012.

Operating Expenses

For the three months ended June 30, 2013, our total operating expenses were $147,365 which consisted of exploration and lease operating costs of $29,442, depreciation and amortization expense of $2,603, general and administrative expenses of $48,728, legal and professional fees of $47,012. By comparison, for the three months ended June 30, 2012, our total operating expenses were $523,484 which consisted of exploration and lease operating costs of $40,178, depreciation and amortization expense of $1,658, general and administrative expenses of $176,691, and legal and professional fees of $304,957.

Net Loss

For the three months ended June 30, 2013, we had a net loss of $229,365. By comparison, for the three months ended June 30, 2012, we had a net loss of $523,484. We expect to incur net losses for the foreseeable future.


For the Six Months ended June 30, 2013, as Compared to the Six Months ended June 30, 2012.

Revenues

We had no revenues for the six months ended June 30, 2013 and 2012.

Operating Expenses

For the six months ended June 30, 2013, our total operating expenses were $667,032 which consisted of exploration and lease operating costs of $59,459, depreciation and amortization expense of $3,252, general and administrative expenses of $296,089, legal and professional fees of $288,652. By comparison, for the six months ended June 30, 2012, our total operating expenses were $616,362 which consisted of exploration and lease operating costs of $56,235, depreciation and amortization expense of $3,325, general and administrative expenses of $249,308, and legal and professional fees of $307,494.

Net Loss

For the six months ended June 30, 2013, we had a net loss of $783,200. By comparison, for the six months ended June 30, 2012, we had a net loss of $680,979. We expect to incur net losses for the foreseeable future.

Liquidity and Capital Resources

As of June 30, 2013, our total assets were $12,995,809. Our total current assets consist of cash and cash equivalents of $1,434, restricted cash of $444,316, short-term investments of $99,793, inventory of $45,420, and other receivables of $900,863. Restricted cash of $444,316 represents amounts held on account with a fiduciary to guarantee payment to one of DCX's main suppliers for exploration and development activities. Short-term investments of $99,793 include amounts on deposit to be held in excess of the six months that are used as stand-by letters of credit for the Colombian ANH for future exploration and development costs. Inventory of $45,420 consists of barrels of oil extracted during our exploratory testing on the Morichito Block and are stated at the lower of cost or market. Our other receivable of $900,863 consists of amounts due from working interest partners in the Morichito Block for the seismic exploration costs.

As of June 30, 2013, our oil and gas properties of $11,197,464 and property, plant and equipment of $295,849 less accumulated depreciation and amortization of $29,330. Our oil and gas properties of $11,217,043 consist of the net costs incurred for evaluated properties and in exploration and development activities as of June 30, 2013 for our interest in the Morichito Block which includes approximately 57,252 gross acres and our interest in the La Maye Block which includes approximately 68,252 gross acres.

Our total current liabilities of $6,754,308 consists of accounts payable and accrued expenses of $6,623,537, and related party advances payable of $128,041, as of June 30, 2013. A significant portion of the accounts payable on our consolidated balance sheet as of June 30, 2013, includes amounts owed to vendors that provided services to DCX when it was owned by PVE and prior to the acquisition by Deep Core plus seismic costs incurred and not yet paid by a specific partner. DCX is also subject to an environmental fine to be levied by the environmental ministry of Colombia related to various activities that occurred prior to the acquisition by Deep Core. We are negotiating payment of these past obligations and the issues associated with the environmental agency, and we are hopeful that we will be able to obtain favorable resolution of those obligations.

Over the last six months, we have been financing our operations through the previous sale of our securities. Prior to the closing of the Share Exchange, Deep Core issued promissory notes to nine holders in exchange for an aggregate of $3,365,000 in proceeds. On the closing of the Share Exchange, the outstanding principal balance and unpaid accrued interest of those notes converted into shares of our common stock at a conversion price of $0.40 per share.

As of June 30, 2013, we had a cash overdraft of $1,434. We will need additional funds to satisfy our working capital requirements to operate at our current level of activity for the next twelve months. We expect that our future available capital resources will consist primarily of cash on hand, cash generated from our business, if any, and future debt and/or equity financings, if any.


During 2013, we expect that our subsidiaries will continue to incur significant exploration and development costs as we exploit our interests in the Morichito Block and La Maye Block. Our exploration and lease operating costs in the Morichito Block and La Maye Block will be significant and will continue to impact our liquidity. We may also incur additional costs related to any potential acquisition of oil and gas properties or interests in Colombia and other areas of Central and South America. We also expect to incur significant professional fees associated with being a public company as well as significant general and administrative expenses. Those fees will be higher as our business volume and activity increases and will continue to impact our liquidity. Other than the exploration and development costs for the Morichito Block and the La Maye Block, any potential acquisitions costs and anticipated increases in legal and accounting costs and general and administrative expenses, we are not aware of any other known trends, events or uncertainties, which may affect our future liquidity.

Our forecast for the period for which our financial resources will be inadequate to support our operations involves risks and uncertainties and actual results could fail as a result of a number of factors. We must raise additional capital to continue and expand our operations. We cannot guarantee that additional funding will be available on favorable terms, if at all. Any debt financing or other financing of securities senior to common stock that we are able to obtain will likely include financial and other covenants that will restrict our flexibility. Any failure to comply with these covenants would have a negative impact on our business, prospects, financial condition, results of operations and cash flows. Additionally, these alternatives could be highly dilutive to our existing shareholders, and may not provide us with sufficient funds to meet our long-term capital requirements. We have and may continue to incur substantial costs in the future in connection with raising capital to fund our business, including investment banking fees, professional fees and other costs. If the amount of capital we are able to raise from financing activities, together with our revenues from operations, is insufficient to satisfy our capital needs, we will be required to reduce operating costs, which could hinder our future development of the Morichito Block and the La Maye Block.

Off-Balance Sheet Arrangements.

We have no off-balance sheet arrangements.

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