Frontera Resources Regulatory News (FRR)

1 Apr 2008 07:01

Frontera Resources Corporation01 April 2008 FRONTERA RESOURCES CORPORATION Houston, Texas U.S.A. - April 1, 2008 2007 ANNUAL RESULTS Frontera Resources Corporation (London Stock Exchange, AIM Market - Symbol: FRR;OTCQX Market, U.S.A. - Symbol: FRTE), an independent oil and gas exploration andproduction company, today announced its final results for the year ended 31December 2007, in accordance with the requirements for companies listed on OTCQXand the covenants relating to its 10% convertible notes due 2012. 2007 Financial Highlights • Results for the year ended 31 December 2007 reflect a net loss of $19.7 million, or $0.28 per share on a fully diluted basis, in line with the early stage nature of the company's asset portfolio and expenditures required to evaluate the company's undeveloped fields and exploration opportunities. • Working capital position of $46 million at year-end 2007. • Liquidity of and access to shares within U.S. capital markets enhanced through quotation of the shares on U.S. over-the-counter services. 2007 Operational Highlights • Taribani Field Unit - Successfully launched Zone 9 development program through re-completion and new drilling operations at Dino #2 and T-#45 well locations. • Basin Edge Play Unit - Commenced extensive exploration drilling campaign at the "C" Prospect. • Mirzaani Field Area Production Unit - Continued profitable production, with revenues totaling approximately $1.9 million for 2007. • Mirzaani Field Area Exploration Unit - Advanced efforts to farm out the Mirzaani Deep Prospect in order to accelerate drilling of this large prospect situated beneath the existing Mirzaani Field. • Block 12 Area Wide Development Unit - Evolved Frontera's extensive inventory of undrilled prospects and undeveloped fields in anticipation of mid-term and long-term value creation opportunities. The company expects to issue a complete review of its 2007 financial results andoperations prior to its annual meeting of stockholders on May 22, 2007, and tocontinue to issue news releases in the ordinary course of business in theinterim as events warrant. Additional disclosure and financial informationabout the company, including the audited financial statements of the company asof December 31, 2007, can be found at www.fronteraresources.com. Enquiries: Frontera Resources CorporationLiz WilliamsonVice President, Investor Relations and Corporate Communications(713) 585-3216lwilliamson@fronteraresources.com Brunswick Group LLPPatrick Handley / Mark AntelmeLondon: +44 207 4045959 Notes to Editors: 1. Frontera Resources Corporation is an independent Houston, Texas, U.S.A. -based international oil and gas exploration and production company whosestrategy is to identify opportunities and operate in emerging markets around theworld. Frontera has operated in Georgia since 1997 where it holds a 100 percentworking interest in a production sharing agreement with the government ofGeorgia. This gives Frontera the exclusive right to explore for, develop andproduce oil and gas from a 5,060 square kilometer area in eastern Georgia knownas Block 12. For more information, please see www.fronteraresources.com. 2. This release may contain certain forward-looking statements, including,without limitation, expectations, beliefs, plans and objectives regarding thepotential transactions, potential drilling schedule, well results and venturesdiscussed in this release, as well as reserves, future drilling, development andproduction. Among the important factors that could cause actual results todiffer materially from those indicated by such forward-looking statements are:future exploration and development results; availability and performance ofneeded equipment and personnel; seismic data; evaluation of logs and cores fromwells drilled; fluctuations in oil and gas prices; weather conditions; generaleconomic conditions; and the political situation in Georgia and neighboringcountries. There is no assurance that Frontera's expectations will be realized,and actual results may differ materially from those expressed in theforward-looking statements. Frontera Resources Corporation and Subsidiaries Consolidated Financial Statements December 31, 2007 and 2006 Page(s) Report of Independent Auditors............................................ 1 Consolidated Financial Statements Balance Sheets............................................................ 2 Statements of Operations.................................................. 3 Statements of Stockholders' Equity........................................ 4 Statements of Cash Flows.................................................. 5 Notes to Financial Statements............................................. 6-18 Report of Independent Auditors To the Board of Directors ofFrontera Resources Corporation: In our opinion, the accompanying consolidated balance sheets and the relatedconsolidated statements of operations, stockholders' equity and cash flowspresent fairly, in all material respects, the financial position of FronteraResources Corporation and its subsidiaries (the "Company") at December 31, 2007and 2006, and the results of their operations and their cash flows for the yearsthen ended in conformity with accounting principles generally accepted in theUnited States of America. These consolidated financial statements are theresponsibility of the Company's management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits. Weconducted our audits of these statements in accordance with auditing standardsgenerally accepted in the United States of America. Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion. PricewaterhouseCoopers LLPHouston, TexasMarch 25, 2008 Balance Sheets 2007 2006 AssetsCurrent assets Cash and cash equivalents $ 4,945,221 $ 9,927,181 Restricted cash 15,118,786 - Short-term investments 25,600,000 14,823,000 Accounts receivable 73,189 139,107 Inventory 9,293,005 3,124,858 Prepaid expenses and other current assets 1,268,503 267,720 Total current assets 56,298,704 28,281,866Property and equipment, net 1,405,957 1,081,213Oil and natural gas properties, full cost method Properties being depleted 23,750,981 23,750,981 Properties not subject to depletion 55,828,093 27,631,505 79,579,074 51,382,486Less: Accumulated depletion (21,457,846) (21,107,707) Net oil and gas properties 58,121,228 30,274,779Other assets 2,431,254 - Total assets $ 118,257,143 $ 59,637,858 Liabilities and Stockholders' EquityCurrent liabilities Accounts payable $ 3,049,928 $ 566,396 Accrued liabilities 7,760,800 518,004 Current maturities of notes payable - vendor - 3,450,941 Current maturities of notes payable - related party - 51,097 Total current liabilities 10,810,728 4,586,438Convertible notes payable 68,572,500 -Other long-term liabilities 38,595 41,669 Total liabilities 79,421,823 4,628,107Commitments and contingenciesStockholders' equity Common stock 2,821 2,818 Additional paid-in capital 153,107,958 149,499,177 Common stock warrants 1,266 1,266 Treasury stock, at cost (567,832) (567,832) Accumulated deficit (113,708,893) (94,050,228) Accumulated other comprehensive income - 124,550 Total stockholders' equity 38,835,320 55,009,751 Total liabilities and stockholders' equity $ 118,257,143 $ 59,637,858 Statements of Operations 2007 2006 Revenue - crude oil sales $ 1,878,540 $ 758,630 Operating expensesField operating and project costs 3,838,444 1,407,321General and administrative 14,916,927 11,920,999Depreciation, depletion and amortization 703,815 963,678 Total operating expenses 19,459,186 14,291,998 Loss from operations (17,580,646) (13,533,368)Other income (expense)Forgiveness of debt 6,000 2,339,098Interest income 2,507,173 1,698,352Interest expense (4,619,709) (267,958)Other, net 28,517 29,616 Total other income (expense) (2,078,019) 3,799,108 Net loss $ (19,658,665) $ (9,734,260)Loss per shareBasic and diluted $ (0.28) $ (0.15) Number of shares used in calculating loss per shareBasic and diluted 70,423,083 63,113,205 Statements of Stockholders' Equity Common Additional Common Treasury Accumulated Accumulated Total Stock Paid-In Stock Stock Deficit Other Stockholders' Capital Warrants Comprehensive Equity Income Balance at December 31, 2005 $2,178 $142,480,721 $31,151 $(567,832) $(84,315,968) $ 264,360 $ 57,894,610Exercise of common stock warrants 619 3,428,262 (29,885) - - - 3,398,996Exercise of common stock options 21 524,979 - - - - 525,000Compensation expense-common stock options - 3,065,215 - - - - 3,065,215Unrealized gain on marketable securities - - - - - 397,993 397,993Reclassification adjustment for gains on marketable securities included in net loss - - - - - (537,803) (537,803)Net loss - - - - (9,734,260) - (9,734,260)Total comprehensive loss for the year (9,874,070)Balance at December 31, 2006 2,818 149,499,177 1,266 (567,832) (94,050,228) 124,550 55,009,751Exercise of common stock options 1 18,399 - - - - 18,400Conversion of convertible debt 2 99,998 - - - - 100,000Compensation expense-common stock options - 3,490,384 - - - - 3,490,384Unrealized gain on marketable securities - - - - - 53,420 53,420Reclassification adjustment for gains on marketable securities included in net loss - - - - - (177,970) (177,970)Net loss - - - - (19,658,665) - (19,658,665)Total comprehensive loss for the year (19,783,215)Balances at December 31, 2007 $2,821 $153,107,958 $ 1,266 $(567,832)$(113,708,893) $ - $ 38,835,320 Statements of Cash Flows 2007 2006 Cash flows from operating activities Net loss $(19,658,665) $(9,734,260) Adjustments to reconcile net loss to net cash used in operating activities Depreciation, depletion and amortization 703,815 963,678 Gain on sale of asset (19,072) (85,000) Interest income - restricted cash (118,786) - Noncash interest expense 1,672,500 - Debt issuance cost amortization 285,391 - Amortization of warrants - 72,504 Stock based compensation 2,811,649 3,065,215 Forgiveness of debt (6,000) (2,339,098) Changes in operating assets and liabilities: Accounts receivable 65,918 7,193 Inventory (6,168,147) (1,154,730) Prepaid expenses and other current assets (1,000,783) 301,084 Accounts payable 2,489,532 (34,831) Accrued liabilities 7,242,796 (1,342,573) Other long-term liabilities (3,074) 41,669 Net cash used in operating activities (11,702,926) (10,239,149) Cash flows from investing activities Investment in oil and gas properties (28,196,588) (21,701,511) Investment in property and equipment (678,420) (140,081) Restricted cash (5,000,000) 250,000 Restricted short-term investments - 2,950,000 Net redemption (purchase) of short-term investments 14,698,450 15,637,190 Purchase of auction rate securities (51,375,000) - Redemption of auction rate securities 25,775,000 - Proceeds from disposal of property, plant and equipment 19,072 85,000 Net cash used in investing activities (44,757,486) (2,919,402) Cash flows from financing activities Repayments of borrowings (3,502,038) (212,878) Proceeds from convertible debt 66,500,000 - Restricted cash (10,000,000) - Exercise of common stock warrants - 3,186,863 Debt issuance costs (1,537,910) - Exercise of common stock options 18,400 525,000 Net cash provided by financing activities 51,478,452 3,498,985 Net decrease in cash and cash equivalents (4,981,960) (9,659,566) Cash and cash equivalents Beginning of year 9,927,181 19,586,747 End of year $ 4,945,221 $ 9,927,181 Supplemental cash flow information Cash paid for interest $ 2,677,367 $ 121,619 Notes payable used to exercise common stock warrants - 212,133 Noncash debt issuance costs - convertible notes payable 500,000 - Noncash debt issuance costs - stock options 678,735 - Conversion of debt to common stock 100,000 - Issuance of convertible notes payable in lieu of interest payments 1,672,500 - Notes to Financial Statements 1. Nature of Operations Frontera Resources Corporation, a Delaware corporation, and its subsidiaries(collectively "Frontera" or the "Company") are engaged in the development of oiland gas projects in emerging marketplaces. Frontera was founded in 1996 and isheadquartered in Houston, Texas. The Company emphasizes development of reservesin known hydrocarbon-bearing basins, and is attracted to projects that havesignificant exploration upside. Since 2002, the Company has focusedsubstantially all of its efforts on the exploration and development of oilfieldswithin the Republic of Georgia ("Georgia"), a member of the Former SovietUnion. In June 1997, the Company entered into a 25 year production sharing agreementwith the Ministry of Fuel and Energy of Georgia and State Company Georgian Oil("Georgian Oil"), which gives the Company the exclusive right to explore,develop and produce crude oil in a 5500 square kilometer area in eastern Georgiaknown as Block 12, hereafter referred to as the "Block 12 PSA". The Block 12PSA can be extended if commercial production remains viable upon its expirationin June 2022. Under the terms of the Block 12 PSA, the Company is entitled to conductexploration and production activities and is entitled to recover its cumulativecosts and expenses from the crude oil produced from Block 12. Followingrecovery of cumulative costs and expenses from Block 12 production, theremaining crude oil sales, referred to as Profit Oil, are allocated betweenGeorgian Oil and Frontera in the proportion of 51% and 49%, respectively. Under the terms of the Block 12 PSA, Frontera is exempt from all taxes imposedby the government of Georgia, and any taxes imposed on the Company shall be paidby Georgian Oil on behalf of the Company from Georgian Oil's 51% share of ProfitOil. Taxes are defined by the Block 12 PSA to mean all levies, duties,payments, fees, taxes or contributions payable to or imposed by any governmentagency, subdivision, municipal or local authorities within the Government ofGeorgia. 2. Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of Frontera ResourcesCorporation and it's wholly and majority owned subsidiaries. All significantintercompany transactions and accounts have been eliminated in consolidation. Reclassifications Certain reclassifications have been made in prior period financials statementsto conform with current period presentation. Reclassifications have no impacton the Company's financial position, results of operations, or cash flows. Use of Estimates The preparation of the consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates. Estimates of oil and natural gas reserves and their values, future productionrates and future costs and expenses are inherently uncertain for numerousreasons, including many factors beyond the Company's control. Reservoirengineering is a subjective process of estimating underground accumulations ofoil and natural gas that cannot be measured in an exact manner. The accuracy ofany reserve estimate is a function of the quality of data available and ofengineering and geological interpretation and judgment. In addition, estimatesof reserves may be revised based on actual production, results of subsequentexploitation and development activities, prevailing commodity prices, operatingcost and other factors. These revisions may be material and could materiallyaffect the Company's future depletion, depreciation and amortization expenses. The Company's revenue, profitability, and future growth are substantiallydependent upon the prevailing and future prices for oil and natural gas, whichare dependent upon numerous factors beyond its control such as economic,regulatory developments and competition from other energy sources. The energymarkets have historically been volatile and there can be no assurance that oiland natural gas prices will not be subject to wide fluctuations in the future. A substantial or extended decline in oil and natural gas prices could have amaterial adverse effect on the Company's financial position, results ofoperations, cash flows and quantities of oil and natural gas reserves that maybe economically produced. Cash and Cash Equivalents Cash and cash equivalents include all cash balances, money market accounts andcertificates of deposit, all of which have original maturities of three monthsor less. Restricted Cash At December 31, 2007 the Company had approximately $15,119,000 of restrictedcash. Restricted cash in the amount of $5,000,000 serves as collateral for a$5,000,000 line of credit that is used from time to time to support letters ofcredit that provide financial assurance that the Company will fulfill itsobligations with respect to service contracts with certain vendors. Theremaining $10,119,000 is a portion of the proceeds from the convertible debtissuance in May 2007 of approximately $67.0 million, plus related earnedinterest, which is being held in escrow until the Company's stock price meetscertain agreed benchmarks. Assuming no event of default has occurred,$5,000,000 will be released from escrow after the stock price of the shares ofcommon stock has exceeded the conversion price for 20 consecutive trading days;the balance of the escrow account will be released when the stock price of theshares exceeds two times the conversion price for twenty consecutive tradingdays. In February 2008, $5,000,000 of restricted cash related to theconvertible debt was released from escrow after meeting the stock pricebenchmark. See Note 5 for further discussion of the convertible notes. AtDecember 31, 2006, the Company had no cash or cash equivalents restricted as touse or availability. Short-Term Investments Short-term investments consist of Municipal Short Term Auction Rate Securities("M-STARS") and corporate bonds both of which represent funds available forcurrent operations. In accordance with the Statement of Financial AccountingStandards No. 115, Accounting for Certain Investments in Debt and EquitySecurities ("SFAS No. 115"), these M-STARS are classified as available-for-saleand are carried at cost or par value, which approximates the fair market value. These securities have stated maturities beyond three months but are priced andtraded as short-term instruments due to the liquidity provided through theinterest rate mechanism of 7 to 35 days. At December 31, 2007, short-term investments consist of investments in M-STARSwith an estimated fair value of $25,600,000 with no unrealized holding gains orlosses. At December 31, 2006, short-term investments consisted of investmentsin corporate bonds with an estimated fair value of $14,823,000 and netunrealized holding gains in the amount of $124,550 which were included inaccumulated other comprehensive income. Inventory Inventory consists primarily of materials to be used in the Company's foreignoilfield operations and crude oil held in stock tanks. Inventory is valuedusing the first-in, first-out method and is stated at the lower of cost ormarket. Inventory consists of the following: December 31, 2007 2006 Materials and supplies $7,997,192 $1,405,610 Crude oil 1,295,813 1,719,248 $9,293,005 $3,124,858 Property and Equipment Property and equipment are stated at cost. Expenditures for major renewals andbetterments, which extend the original estimated economic useful lives ofapplicable assets, are capitalized. Expenditures for normal repairs andmaintenance are charged to expense as incurred. The costs and relatedaccumulated depreciation of assets sold or retired are removed from theaccounts, and any gain or loss thereon is reflected in operations. Depreciationof property and equipment is computed using the straight-line method over theestimated useful lives of the assets, ranging from three to seven years. Oil and Gas Properties The Company follows the full cost method of accounting for oil and gasproperties. Accordingly, all costs associated with acquisition, exploration,and development of oil and gas reserves, including directly related overheadcosts, are capitalized. All capitalized costs of oil and gas properties, including the estimated futurecosts to develop proved reserves, are depleted on the unit-of-production methodusing estimates of proved reserves. Investments in unproved properties andmajor development projects are not depleted until proved reserves associatedwith the projects can be determined or until impairment occurs. In addition,the capitalized costs are subject to a "ceiling test," which limits such coststo the aggregate of the future net revenues from proved reserves, based oncurrent economic and operating conditions, discounted at a 10% interest rate,plus the lower of cost or fair market value of unproved properties. A ceilingtest calculation is performed at each year-end. No impairment write down wasnecessary for the years ended December 31, 2007 and 2006. Sales or other dispositions of oil and gas properties are accounted for asadjustments of capitalized costs with no gain or loss recognized, unless suchadjustments would significantly alter the relationship between capitalized costsand proved reserves of oil and gas, in which case the gain or loss is recognizedin earnings. Costs Excluded Costs associated with unproved properties related to continuing operations of$55.8 million as of December 31, 2007 are excluded from amounts subject toamortization. The majority of the evaluation activities are expected to becompleted within a three-year period. In addition, the Company's internalengineers evaluate all properties on an annual basis. Costs Excluded by Year Incurred Excluded Year Cost Incurred Costs at Prior December 31, Years 2006 2007 2007 Property acquisition $ - $ - $ - $ - Exploration 5,929,994 21,701,511 28,196,588 55,828,093 Development - - - - Total costs incurred $ 5,929,994 $ 21,701,511 $28,196,588 $55,828,093 Income Taxes The Company follows the provisions of SFAS No. 109, Accounting for Income Taxes,which requires the recognition of deferred tax liabilities and assets for theexpected future tax consequences of events that have been included in thefinancial statements or tax returns. Under this method, deferred taxliabilities and assets are determined based on the difference between thefinancial statements and the tax basis of assets and liabilities using enactedrates in effect for the years in which the differences are expected to reverse. Valuation allowances are established, when appropriate, to reduce deferred taxassets to the amount expected to be realized. The Company accounts for uncertain tax positions in accordance with FASBInterpretation No. 48 ("FIN 48"), Accounting for Uncertainty in Income Taxes. Accordingly, the Company reports a liability for unrecognized tax benefitsresulting from uncertain tax positions taken or expected to be taken in a taxreturn. The Company recognizes interest and penalties, if any, related tounrecognized tax benefits in income tax expense. Revenue Recognition Oil and natural gas revenues are recorded when title passes to the customer, netof royalties, discounts and allowances, as applicable. Oil and natural gas soldis not significantly different from the Company's share of production. Foreign Currency Transactions The financial statements of the foreign subsidiaries are prepared in UnitedStates dollars, and the majority of transactions are denominated in UnitedStates dollars. Gains and losses on foreign currency transactions are theresult of changes in the exchange rate between the time a foreigncurrency-denominated invoice is recorded and when it is ultimately paid and areincluded in operations. Foreign currency transaction gains and losses were notmaterial for the years ended December 31, 2007 and 2006. Foreign Operations Frontera's future revenues depend on operating results from its operations inthe Republic of Georgia. The success of Frontera's operations is subject tovarious contingencies beyond management control. These contingencies includegeneral and regional economic conditions, prices for crude oil, competition andchanges in regulation. Frontera is subject to various additional political andeconomic uncertainties in Georgia which could include restrictions on transferof funds, import and export duties, quotas and embargoes, domestic andinternational customs and tariffs, and changing taxation policies, foreignexchange restrictions, political conditions and regulations. Concentrations of Credit Risk Financial instruments which potentially subject the Company to concentrations ofcredit risk consist principally of cash, short-term investments and accountsreceivable. The Company maintains its cash in bank deposits with various majorfinancial institutions. These accounts, at times, may exceed federally insuredlimits. Deposits in the United States are guaranteed by the Federal DepositInsurance Corporation up to $100,000. The Company monitors the financialcondition of the financial institutions and does not anticipate any losses onsuch accounts. Short-term investments consist of auction rate securities. The auction processresets the applicable interest rates at prescribed calendar intervals and isintended to provide liquidity to the holders of auction rate securities bymatching buyers and sellers in a market context, enabling the holders to gainimmediate liquidity by selling such securities at par, or rolling over theirinvestment. If there is an imbalance between buyers and sellers, there is arisk of a failed auction. Due to recent credit issues experienced by short-termfunding markets, some of these securities have failed at auction subsequent toDecember 31, 2007. An auction failure is not a default, and in some cases itcould reset the applicable interest rates to a higher rate as outlined by thesecurity. The Company does not currently intend to liquidate these investmentsat below par value or prior to a reset date. The Company will assess the fairvalue of these securities at the end of each quarter. Based on the Company'sability to access cash and cash equivalents, expected operating cash flows andother sources of cash, we do not anticipate that any lack of short-termliquidity related to these securities will materially affect the Company'sability to operate the business. For the years ended December 31, 2007 and 2006, 100% of the Company's crude oilsales were to one unrelated customer. Fair Value of Financial Instruments Frontera's financial instruments consist of cash, accounts receivable, accountspayable, a line of credit and notes payables. The fair value of cash, accountsreceivable and accounts payable are estimated to approximate the carrying valuedue to the liquid nature of these instruments. The fair value of the line ofcredit and notes payable was determined based upon discount rates whichapproximate variable interest rates for borrowings of a similar nature. Thefair values of the debt instruments at December 31, 2007 and 2006 wereapproximately $44,589,000 and $3,500,000, respectively. Loss Per Share Basic loss per share amounts are calculated based on the weighted average numberof common stock outstanding during the year. Diluted loss per share arecalculated using the weighted average number of common stock outstanding duringthe year, including the dilutive effect of stock options, warrants andconvertible notes. Basic and diluted loss per share for the years endedDecember 31, 2007 and 2006 are the same since the effect of all common stockequivalents is antidilutive to the Company's net loss per share under SFASNo. 128. Stock-Based Compensation The Company adopted SFAS No. 123R, Share-Based Payment, effective January 1,2006. This statement requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the financial statementsbased on their grant-date fair values. Compensation costs for awards grantedprior to, but not vested, as of January 1, 2006 would be based on the grant dateattributes originally used to value those awards for pro forma purposes underSFAS No. 123. The Company adopted SFAS No. 123R using the modified prospectivetransition method, utilizing the Black-Scholes option pricing model for thecalculation of the fair value of employee stock options. Under the modifiedprospective method, the Company records compensation cost related to unvestedstock awards as of December 31, 2005 by recognizing the unamortized grant datefair value of these awards over the remaining vesting periods of those awardswith no change in historical reported earnings. The Company estimatedforfeiture rates for the year based on our historical experience of approximately 3%. The effect of adoption of the new standard related to stock option planswas an additional expense of $3,065,215 ($0.05 per share, basic and diluted) forthe year ended December 31, 2006. At December 31, 2007, there was $2,735,646 oftotal unrecognized compensation cost related to non-vested stock options. Thiscompensation cost is expected to be recognized over a weighted-average period ofapproximately 0.7 years. The Black-Scholes model incorporates assumptions to value stock-based awards. The risk-free rate of interest is the related U.S. Treasury yield curve forperiods within the expected term of the option at the time of grant. Thedividend yield on our common stock is assumed to be zero as we have historicallynot paid dividends and have no current plans to do so in the future. Theexpected volatility is based on historical volatility of the Company's commonstock. Due to the Company's net operating loss position; there are no anticipatedwindfall tax benefits upon exercise of options. 3. Accrued Liabilities Accrued liabilities consist of the following: December 31, 2007 2006 Accrued payables $ 7,587,780 $365,594Accrued interest - 15,550Accrued benefits 173,020 136,860 $ 7,760,800 $ 518,004 4. Notes Payable Line of Credit During 2006 the Company established a $10,000,000 line of credit with acommercial bank by agreeing to collateralize $15,000,000 of cash and marketablesecurities. The line was primarily set up to support letters of credit issuedby the Company from time to time in support of it's oil and gas operations.During 2007, the line was retired and replaced with a $5,000,000 line of creditcollateralized by $5,000,000 of cash and cash equivalents. The line isprimarily used to support letters of credit issued by the Company from time totime in support of its oil and gas operations. Notes Payable - Related Party Effective December 31, 2001, the Company raised $500,394 through the issuance ofa rights offering consisting of 6% notes payable plus warrants which entitledthe holders to purchase an aggregate of 15,637,329 shares of common stock of theCompany at an exercise price of $0.032 per share. During 2006 the notes becamedue and were retired in full with the exception of one note holder as theCompany was awaiting fund transfer instructions. This note holder was paid infull in January 2007. During 2006 warrant holders exercised warrants to purchase 12,468,741 shares ofcommon stock, for approximately $399,000. Note Payable - Vendor Effective October 1, 2004, the Company converted a $3,450,941 account payable toSaipem S.p.A. ("Saipem") into a note payable for the same amount. Under theterms of the Saipem note payable agreement, the Company agreed to pay Saipemquarterly interest-only payments until September 30, 2007, the maturity date, atwhich date the note was paid in full. During 2006, warrants were exercised to purchase 3,000,000 shares of commonstock for $3,000,000 related to a prior senior note. In February 2008, warrantswere exercised to purchase 377,419 shares of common stock in a cashlessexercise, pursuant to the warrant agreement. After the February 2008 warrantexercise, no warrants remain outstanding. 5. Convertible Notes During May 2007, the Company raised approximately $67.0 million through aprivate placement of convertible unsecured notes due May 2012. The notes wereissued at par and will bear interest at 10%, payable quarterly in arrears incash or in kind at the Company's discretion. The notes are convertible intocommon stock at a conversion price of $1.67 per share. The conversion pricewill be reset to $1.30 per share if the stock price is at or below $1.30 pershare for 10 out of any 20 consecutive trading days at any time in the 12 monthsfollowing the closing date. The notes will be automatically converted intocommon stock at the conversion price if the stock price exceeds two times theconversion price for at least 20 consecutive trading days. As part of theclosing of the notes, debt issuance costs of approximately $2.7 million wereincurred, of which approximately $1.5 million was paid in cash and $1.2 millionof additional convertible notes and stock options were issued for the remainder. During June 2007, note holders holding $100,000 of convertible notes elected toconvert their notes into 59,880 shares of common stock. During December 2007, the Company elected to pay the fourth quarter interestpayments in kind and issued $1,672,500 in additional convertible notes inaccordance with terms of the note purchase agreement. 6. Income Taxes The Company has incurred losses since inception and, therefore, has not beenrequired to pay federal income taxes. As of December 31, 2007, the Company hasgenerated net operating loss ("NOL") carryforwards of approximately $54.4million that may be available to reduce future income taxes. Thesecarryforwards begin to expire in 2012 with a limited annual utilization. Several factors may further limit the Company's ability to utilize thesecarryforwards, including a lack of future taxable income, a change of Companyownership (as defined by federal income tax regulations) or the expiration ofthe utilization period allowed by federal income tax regulations. During 2007 and 2006, the valuation allowance increased $6,695,139 and$3,272,035, respectively, primarily due to the Company's losses. The effectivetax rate for 2007 and 2006 differs from the statutory tax rate due primarily tothe valuation allowance. The components of the Company's deferred taxliabilities and assets at December 31, 2007 and 2006, are as follows: 2007 2006 Deferred tax liabilities Geological & geophysical $(2,097,343) $ (938,023) Other (244,852) - Deferred tax assets Net operating losses - U.S. 18,488,940 12,890,000 Net operating losses - foreign 17,891,823 16,282,696 Depreciation and amortization 330,127 328,891 Accrued salaries 19,367 46,159 Other 5,973 3,654 Stock compensation 914,481 - 35,308,516 28,613,377 Valuation allowance (35,308,516) (28,613,377) Net deferred tax assets $ - $ - The valuation allowance is primarily attributed to U.S. federal deferred taxassets. Management believes enough uncertainty exists regarding the realizationof these items and has recorded a full valuation allowance. Profits derived from oil and gas operating activities are subject to a profitstax on taxable income as defined by Georgian law. However, under the terms ofthe Block 12 PSA, Georgian Oil is responsible for paying the Company's profittax liabilities with respect to income derived from these activities. Althoughthe Company has incurred operating losses in Georgia, no adjustment with respectto deferred tax assets or a potentially related valuation allowance has beenmade, as any future benefit related to these operating losses would serve toreduce Georgian Oil's liability. On January 1, 2007, the Company adopted the provisions of FIN 48. The Companyhas determined that no uncertain tax positions exist where the Company would berequired to make additional tax payments. As a result, the Company has notrecorded any additional liabilities for any unrecognized tax benefits as ofDecember 31, 2007. The Company and its subsidiaries file income tax returns inthe US federal jurisdiction. Tax years 2004 to present remain open for thesetaxing authorities. The Company's accounting policy is to recognize penaltiesand interest related to unrecognized tax benefits as income tax expense. TheCompany does not have an accrued liability for the payment of penalties andinterest at December 31, 2007. 7. Commitments and Contingencies Operating Leases The Company has noncancelable operating leases for office facilities andlodging. Approximate future minimum annual rental commitments under theseoperating leases are as follows: Years Ending December 31, 2008 $ 566,428 2009 508,117 2010 247,860 2011 52,730 2012 - $ 1,375,135 Rental expense for the years ended December 31, 2007 and 2006 was approximately$452,000 and $429,000, respectively. SOCAR Arbitration In June 1998, Frontera Resources Azerbaijan Corporation, an indirect whollyowned subsidiary of the Company, entered into a production sharing agreementwith the State Oil Company of the Azerbaijan Republic (SOCAR), hereafterreferred to as the "Azerbaijan PSA". The Azerbaijan PSA covered the Kursangiand Karabagli onshore oilfields in an area of Azerbaijan known as the "K&KBlock". The Company and an operating partner undertook an exploration anddevelopment program on the K&K Block. The Company's relationship with SOCARdeteriorated as a result of several disputes under the Azerbaijan PSA and theCompany was unsuccessful at reaching a settlement with SOCAR. Frontera initiated binding arbitration against SOCAR in October 2003 related toclaims resulting from SOCAR's halting of oil exports from the K&K Block duringthe fourth quarter of 2000. The arbitration was held in Stockholm under therules of the United Nations Commission on International Trade Law. In January2006, the arbitral panel found that the halting of exports of crude oil from theK&K Block was in violation of the Azerbaijan PSA and awarded Fronteraapproximately $1.2 million plus interest from 2000 until payment is made.Thearbitral panel rejected all other claims and counterclaims between the parties. SOCAR has refused to pay the award and filed an action in the Svea Court ofAppeals in Stockholm to annul the award. The Company moved to dismiss onprocedural grounds, and the court ruled in the Company's favor on a majority ofthe counts. The proceedings are continuing before the appeals court and finaldisposition is expected in 2008. As a result of SOCAR's refusal to pay theaward, the Company commenced an action in the United States District Court forthe Southern District of New York in February 2006, seeking to enforce theaward. In March 2007, the District Court granted SOCAR's motion to dismiss, andthe Company appealed that decision in July 2007 to the United States Court ofAppeals for the Second Circuit. The hearing on the appeal is expected to occur in the second quarter of 2008. GAC Arbitration In June 2007, Frontera Resources Georgia Corporation, an indirect wholly ownedsubsidiary of the Company ("FRGC"), was served a notice of arbitration and claimby GAC Energy Company and an affiliated company (collectively, "GAC"). GAC andFrontera were parties to a Farmout Agreement dated June 2002 covering Block 12(the "Farmout Agreement"), pursuant to which GAC would earn a 25% workinginterest in Block 12 and a 12.5% interest in Frontera Eastern Georgia Limited,an indirect consolidated subsidiary of the Company ("FEGL"), upon thefulfillment of certain financial and work program commitments. In September2004, as required under the terms of the Farmout Agreement, GAC reassigned itsinterest in Block 12 to Frontera as a result of GAC's default on its financialand work program commitments. The notice of arbitration and claim alleges thatGAC did not default on its obligations under the Farmout Agreement and should beawarded a 25% working interest in Block 12, a 12.5% ownership interest in FEGLand a proportionate share of the revenue from oil sales from July 2002 to August2003. In August 2007, Frontera filed its statement of defense and counterclaimsagainst GAC, and in October 2007, Frontera initiated arbitration against certainthird parties involved with GAC alleging that they fraudulently induced Fronterato enter into the Farmout Agreement with GAC. The evidentiary hearing in theGAC arbitration has been scheduled for July 2008. Frontera considers the GACclaim to be without merit and intends to vigorously defend itself against thisclaim. ARAR Arbitration In January 2008, FEGL, served a notice of arbitration and claim on ARAR, Inc.("ARAR"), for breach of contract under a drilling services contract dated May2007, specifically for, among other things, failure to commence work by the timespecified in the contract, failure of the drilling rig to meet requiredspecifications and failure to reconcile advance payments made by FEGL with workactually performed. FEGL terminated the contract after ARAR failed to mobilizethe rig to the required location and failed to commence work as otherwiserequired under the contract. FEGL seeks damages in excess of US $2 million inthe arbitration. ARAR denies FEGL's claims and has filed counterclaims againstFEGL, seeking payments in excess of $3 million for, among other things, standbycharges for the period of time the rig was undergoing inspection and repairs tobring it into contract specification, early termination fees and demobilizationfees. Frontera considers the ARAR counterclaims to be without merit and intendsto vigorously defend itself. The arbitration panel has not yet been confirmed,and therefore no timeline for the arbitration has been established. Vendor Invoices In August 2003 and July 2004, the Company settled vendor invoices ofapproximately $2.3 million. The terms of these settlement agreements providedthat Frontera would not be responsible to repay the liability unless the Companygenerated Profit Oil revenues, as defined in the Block 12 PSA, by August 2007and July 2008, respectively. Because Profit Oil is determined based on therecovery of cumulative costs incurred for the development of Block 12, theCompany did not consider it probable that any additional amounts under thesettlement agreements would be paid and, accordingly, the remaining liabilitiesof approximately $2.3 million were written-off for the year ended December 31,2006. 8. Stockholders' Equity Preferred Stock The Company has the authority to issue up to 10,000,000 shares, par value$.00001, of serial preferred stock. No preferred stock is outstanding atDecember 31, 2007 and 2006. The Board of Directors may designate and authorizethe issuance of such shares with such voting power and in such classes andseries, and with such designation, preferences and relative participation,optional, or other special rights, qualifications, limitations, or restrictionsas deemed appropriate by the Company's Board of Directors. Common Stock As of December 31, 2007 the Company is authorized to issue 200,000,000 shares ofcommon stock, par value $.00004 per share. As of December 31, 2007 and 2006,the Company had 70,463,408 and 70,383,528 shares of common stock issued andoutstanding, respectively. At December 31, 2007 and 2006, additional shares inthe amount of 15,061,000 and 11,310,000, respectively, of common stock werereserved for the exercise of existing options and warrants. Treasury Stock As of December 31, 2007 and 2006, the Company had 5,739,855 shares of treasurystock, all held as common stock. 1998 Employee Stock Incentive Plan In 1998, the Company's stockholders approved the 1998 Employee Stock IncentivePlan (the "Plan"), pursuant to which options may be granted to purchase up to15% of the Company's common stock authorized to be issued by the Company,reduced by the total number of shares of stock subject to stock options andstock awards that have been granted under the Plan and the Frontera ResourcesCorporation 2000 Nonqualified Stock Option and Stock Award Plan at any giventime. The Board of Directors has appointed Frontera's chief executive officeras administrator (the "Administrator") of the Plan. In this capacity, theAdministrator determines which employees will receive options, the number ofshares covered by any option agreement, and the exercise price and other termsof each such option. The Board of Directors is responsible for administeringthe Plan as it relates to options granted to the chief executive officer. Under the terms of the Plan, any issued options expire ten years after the dateof grant, with the exception of options granted to 10% stockholders which expirefive years after the date of grant, or upon earlier termination of employment. Options granted vest over periods ranging from immediate vesting to vesting inequal increments over three years from the date of grant. 2000 Nonqualified Stock Option and Stock Award Plan In 2000, the Company's Board of Directors approved the 2000 Nonqualified StockOption and Stock Award Plan (the "Stock Award Plan"), pursuant to which optionsmay be granted to purchase up to 15% of the Company's common stock authorized tobe issued by the Company, reduced by the total number of shares of stock subjectto stock options and stock awards that have been granted under the Stock AwardPlan and the Frontera Resources Corporation 1998 Employee Stock Incentive Plan. The Board of Directors has appointed Frontera's chief executive officer asadministrator of the Stock Award Plan. In this capacity, the Administratordetermines which employees will receive options, the number of shares covered byany option agreement, and the exercise price and other terms of each suchoption. The Board of Directors is responsible for administering the Stock AwardPlan as it relates to options granted to the chief executive officer. Under the terms of the Stock Award Plan, any issued options expire ten yearsafter the date of grant or upon earlier of termination of employment oraffiliation relationship between the grantee and the Company. Options grantedvest over periods ranging from immediate vesting to vesting in equal incrementsover three years from the date of grant. A summary of the Company's stock option activity and related information is asfollows: Options Weighted-Average Exercise Price Options outstanding at December 31, 2006 9,363,763 $ 1.87 Granted 4,203,000 2.87 Exercised (20,000) 0.92 Surrendered (435,000) 2.50 Options outstanding at December 31, 2007 13,111,763 $ 2.16 Options exercisable at December 31, 2007 9,421,097 $ 1.89 At December 31, 2007, the total intrinsic value and weighted average life forstock options outstanding was $0 and 7.01 years, respectively. At December 31,2007, the total intrinsic value and weighted average life for stock optionsexercisable was $0 and 6.17 years, respectively. The following table summarizes information about stock options outstanding atDecember 31, 2007: Weighted- Number Average Weighted- Number Weighted- Range of Outstanding Remaining Average Exercisable Average at at Exercise December 31, Contractual Exercise December Exercise 31, Prices 2007 Life Price 2007 Price (Years) $0.92-1.00 4,426,750 5.22 $ 1.00 4,426,750 $1.00 2.00-2.87 8,580,013 8.01 2.71 4,889,347 2.60 5.28-8.85 105,000 0.36 6.30 105,000 6.30 13,111,763 7.01 $ 2.16 9,421,097 $ 1.89 Stock option information related to the nonvested options for the year endedDecember 31, 2007, was as follows: Number of Weighted-Average Shares Grant Date Fair Underlying Value Options Nonvested options outstanding at December 31, 2006 2,659,330 $ 1.86 Granted 4,203,000 1.17 Vested (2,871,664) 1.44 Canceled (300,000) 1.70 Nonvested options outstanding at December 31, 2007 3,690,666 $ 1.41 The Company granted 4,203,000 options to employees during 2007 with exerciseprices of $2.87 which was at or above the market value of the Company's commonstock at the time of grant. The weighted average fair value of the optionsgranted in 2007 was $1.17. The fair value of the option grants were calculatedusing a Black-Scholes option pricing model, with the following weighted averageassumptions: risk free interest rate of 4.5%; no dividend yield; volatilityfactor of 97%; and an expected option life of 9.64 years. 9. Related Party In conjunction with the Company's private placement of approximately $67.0million of convertible unsecured notes in May 2007, a director of the Companywas paid a fee pursuant to a 2001 consulting and advisory agreement withFrontera. The fee was approximately $0.8 million and was comprised ofapproximately $0.3 million in cash and $0.5 million of additional convertibleunsecured notes. Also, as part of the fee, the director received 600,000 stockoptions with a strike price of $2.87 vesting immediately. Due to regulatoryrequirements, these options were not issued until October 2007. Management's Discussion and Analysis of Financial Condition and Results of Operations TABLE OF CONTENTS Introduction................................................................. 1 Overview of Our Company....................................................... 1 Results of Operations......................................................... 1 Liquidity and Capital Resources............................................... 3 Risk Factors.................................................................. 5 Cautionary Statement Concerning Forward-Looking Statements.................... 7 Management's Discussion and Analysis of Financial Condition and Results of Operations Introduction The following discussion and analysis should be read in conjunction with theaccompanying financial statements and related notes thereto. The followingdiscussion contains forward-looking statements that reflect our future plans,estimates, beliefs and expected performance. The forward-looking statements aredependent upon events, risks and uncertainties that may be outside our control. Our actual results could differ materially from those discussed in theseforward-looking statements. Factors that could cause or contribute to suchdifferences include, but are not limited to, market prices for natural gas andoil, economic and competitive conditions, regulatory changes, estimates ofproved reserves, potential failure to achieve production from developmentprojects, capital expenditures and other uncertainties, as well as those factorsdiscussed below, particularly in "Risk Factors" and "Cautionary StatementConcerning Forward-Looking Statements," all of which are difficult to predict.In light of these risks, uncertainties and assumptions, the forward-lookingevents discussed may not occur. Overview of Our Company Frontera Resources Corporation, a Delaware corporation, and its subsidiaries(collectively "Frontera" or the "Company") are engaged in the development of oiland gas projects in emerging marketplaces. Frontera was founded in 1996 and isheadquartered in Houston, Texas. The Company emphasizes development of reservesin known hydrocarbon-bearing basins, and is attracted to projects that havesignificant exploration upside. Since 2002, the Company has focusedsubstantially all of its efforts on the exploration and development of oilfieldswithin the Republic of Georgia ("Georgia"), a member of the Former SovietUnion. Prior to 2002, the Company's other significant operating focus was onthe exploration and development of an oilfield within the Azerbaijan Republic("Azerbaijan"), which was sold during 2002 and all operating activities inAzerbaijan ceased at that time. In accordance with full cost accounting rules, we are subject to a limitation oncapitalized costs. The capitalized cost of natural gas and oil properties, netof accumulated depreciation, depletion and amortization, may not exceed theestimated future net cash flows from proved oil and gas reserves discounted at10%, plus the lower of cost or fair market value of unproved properties asadjusted for related tax effects, which is known as the ceiling limitation. Ifcapitalized costs exceed the ceiling limitation, the excess must be charged toexpense. We did not have any adjustment to earnings due to the ceilinglimitation for the periods presented herein. Results of Operations Twelve Months Ended December 31, 2007 Compared to Twelve Months Ended December31, 2006 Revenue. Total revenue increased to $1.9 million for the twelve months endedDecember 31, 2007 from $0.8 million in the same period in 2006. This increasewas primarily due to a Q1 2007 sale of the Company's 2006 Q3 and Q4 production. Operating Costs and Expenses. Total operating costs and expenses increased to$19.5 million for the twelve months ended December 31, 2007 compared to$14.3 million for the same period in 2006. Field operating and project costs includes the costs associated with ourexploration and production activities, including, but not limited to, drilling,field operating expense and processing costs. Field operating and project costs increased $2.4 million primarily due to thecost of oil sold in Q1 2007 which was attributable to Q3 and Q4 2006 production,and an ex-pat staffing increase and associated costs carried out in support of aramp up in the Company's exploration and development activities in 2007 ascompared 2006. DD&A decreased $0.3 million primarily due to lower depletion expense associatedwith lower production volumes in 2007, and our oil processing facility becomingfully depreciated during 2007. General and administrative expenses increased $3.0 million to $14.9 million forthe twelve months ended December 31, 2007 from $11.9 million for the comparableperiod in 2006. The increase was principally attributable to an increase instaff as the Company completed staffing the organization in anticipation of aramp up in exploration and production activity in 2007 as compared with the sameperiod in 2006. Salaries, wages and associated employee expenses accounted for$1.0 million of the increase. Legal and investor relations expenses increased$0.8 million as the Company pursued a US OTC listing and various legal matterswere addressed. Travel increased $0.4 million as the Company's internationalexploration and production activities increased in 2007 as compared to 2006. ITand communications increased $0.3 million due to costs associated with IT andcommunications infrastructure improvements and larger staff sizes. Audit and taxexpenditures increased $0.1 million due to implementation of quarterly reportingand associated reviews by the Company's auditors during 2007 as compared to2006. Rent, utilities and other office services accounted for the remaining $0.4million increase all of which increased with the size of the organization in2007 as compared to 2006. Other Income (Expense). Total other expense increased to $2.1 million in thetwelve month period ended December 31, 2007 from other income of $3.8 million inthe twelve month period ended December 31, 2006. The $5.9 million increase isprimarily attributable to an increase in interest expense of $4.3 million, and a$2.3 million decrease in forgiveness of debt income which was partially offsetby a $0.8 million increase in interest income. Interest income increased to $2.5 million for the twelve months ended December31, 2007 from $1.7 million for the same period in 2006. This increase was dueto interest income from excess cash in investment accounts which was higher in2007 due to the Company's Q2 2007 $67.0 million convertible debt offering. Interest expense increased to $4.6 million for the twelve months ended December31, 2007 from $0.3 million for the same period in 2006. This increase wasattributable to increased average debt balances attributable to the Company's$67.0 million convertible debt offering during Q2 2007. Results of Operations Three Months Ended December 31, 2007 Compared to Three Months Ended December 31,2006 Revenue. There were no revenues for the three months ended December 31, 2007and 2006. The Q4 2007 production is expected to be sold in Q1 2008 and the 2006production for the same period was sold in Q1 2007. Operating Costs and Expenses. Total operating costs and expenses increased to$5.2 million for the three months ended December 31, 2007 compared to$4.3 million for the same period in 2006. Field operating and project costs includes the costs associated with ourexploration and production activities, including, but not limited to, drilling,field operating expense and processing costs. Field operating and project costs increased $0.3 million to $0.8 million duringthe three months ended December 31, 2007 as compared to $0.5 million for thethree months ended December 31, 2006 primarily due to the cost of an ex-patstaffing increase and associated costs carried out in support of a ramp up inthe Company's exploration and development activities in 2007 as compared 2006. DD&A decreased $0.1 million during the three months ended December 31, 2007 ascompared to the three months ended December 31, 2006 primarily due to lowerdepletion expense associated with lower production volumes in the 2007 period,and our oil processing facility becoming fully depreciated during 2007. General and administrative expenses increased $0.6 million to $4.2 million forthe three months ended December 31, 2007 from $3.6 million for the comparableperiod in 2006. The increase was attributable to an increase in compensationexpense of $0.3 million of which $0.1 million related to a non-cash charge forstock option compensation expense under the provisions of SFAS 123R. Theremaining $0.2 million increase in compensation expense was attributable to theamount of bonuses in 2007 versus the same period in 2006. Travel expensesincreased $0.1 million as the Company's exploration and production activitiesincreased in 2007 as compared to 2006. The remaining $0.1 million increase wasassociated with IT infrastructure improvements and other office services whichincreased with the size of the organization in 2007 as compared to 2006. Other Income (Expense). Total other expense increased to $1.1 million in thethree month period ended December 31, 2007 from other income of $2.7 million inthe three month period ended December 31, 2006. The $3.8 million increase isprimarily attributable to an increase in interest expense of $1.8 million, and adecrease in forgiveness of debt income of $2.3MM partially offset by a $0.3million increase in interest income. Interest income increased to $0.7 million for the three months ended December31, 2007 from $0.4 million for the same period in 2006. This increase was dueto interest income from excess cash in investment accounts which was higher in2007 due to the Company's Q2 2007 $67.0 million convertible debt offering. Interest expense increased to $1.8 million for the three months ended December31, 2007 from $0.1 million for the same period in 2006. This increase wasattributable to increased average debt balances in the 2007 period attributableto the Company's $67.0 million convertible debt offering during Q2 2007. Liquidity and Capital Resources Summary Our operating cash flow is influenced mainly by the prices that we receive forour oil production; the quantity of oil we produce; and the success of ourdevelopment and exploration activities. Currently we do not generate sufficientoperating cash flows to cover our general corporate activities or our plannedcapital expenditure programs. During the second quarter of 2007, we sold in a private placement approximately$67 million principal amount of our 10% convertible notes due 2012 to fund our2007 planned capital expenditure program and general corporate activitiesthrough the end of this year and into early 2008. As of December 31, 2007, ourcash and cash equivalents were $4.9 million, our short-term investments were$25.6 million and we had approximately $15.1 million of restricted cash. Up to$5.0 million of the restricted cash will be released if the Company's stockprice exceeds $1.67 for twenty consecutive trading days, an additional $5.0million of the restricted cash will be released if the Company's stock priceexceeds $3.34 for 20 consecutive trading days. At December 31, 2007, theCompany's stock was trading at $1.37. During Q1 2008 we met the first thresholdabove and $5.0 million of the restricted cash was released to the Company. Theremaining $5.0 million of restricted cash serves as collateral for a $5.0million line of credit that is used from time to time to support letters ofcredit that provide financial assurance that the Company will fulfill itsobligations with respect to service contracts with certain vendors. See notes2, 4, and 5 of the attached consolidated financial statements for furtherdiscussion of the convertible notes, the line of credit and the restrictedcash. At December 31, 2007 the Company had $68.6 million of convertible longterm debt outstanding. During the fourth quarter of 2007, as per the terms ofthe note agreement, the Company elected to pay it's Q4 interest payment in kindby issuing additional convertible notes in the amount of $1.7 million. TheCompany had no other outstanding debt at December 31, 2007. During the third quarter of 2007, the Company retired a $3.5 million vendor notepayable upon its maturity from available cash on hand. Capital Expenditures We make and expect to continue to make substantial capital expenditures in theexploration, development, and production of natural gas and oil reserves. Webelieve that our cash flows from operations, current cash and investments onhand will be sufficient to meet our non-discretionary capital expenditure budgetfor the next twelve months. Our total capital expenditures for 2007 were approximately $28.9 million,representing a 32% increase over 2006. Our 2007 capital expenditures were focused on growing and developing ourreserves and production on our existing Block 12 acreage. Substantially all ofour 2007 capital expenditures were for exploration and production activities inour Tarabani and Basin Edge Units. The 2008 capital expenditure program is estimated to be $27.3 million. It isenvisaged that these capital expenditures, $11.6 million of which arenon-discretionary, would be used to drill and complete the Lloyd #1 well, whichwas in-progress at year end on the Basin Edge Unit, drill a new well in theTarabani Unit, frac two wells in the Tarabani Unit, and drill ten ultra-shallowwells in the Mirzaani Field Area Shallow Production Unit. There could be significant additional capital expenditures associated withdrilling in 2008, depending on the final results of the 2007 program and theavailability of financing on acceptable terms. Cash Flow Activity Operating Activities. Cash flows used in operating activities increased $1.5million to $11.7 million for the twelve months ended December 31, 2007 from$10.2 million for the twelve months ended December 31, 2006. The increase wasprimarily attributable to a higher net loss of $19.7 million for the twelvemonths ended December 31, 2007 as compared to $9.7 million for the comparableperiod in 2006. The higher net loss was primarily attributable to increasedgeneral and administrative costs and field operating costs due to a ramp up inactivity during 2007 as compared to 2006. The net loss was also higher due to a$4.4 million increase in interest expense and a $2.3 million decrease inforgiveness of debt income for the twelve months ended December 31, 2007 ascompared to the twelve months ended December 31, 2006. Investing Activities. Cash flows used in investing activities increased to$44.8 million in the twelve month period ended December 31, 2007 from$2.9 million in the 2006 period. The increase was primarily attributable to anet $10.9 million purchase of short term investments and auction rate securitiesin 2007 compared with a net $15.6 million redemption in short term investmentsfor the 2006 period. The increase was also due to a $7.0 million increase incapital expenditures for the twelve months ended 2007 as compared to 2006 as theCompany's two rig drilling campaign ramped up in the latter part of 2007 whichwas partially offset by substantially less seismic and geophysical expenses in2007 as the 3D program was completed during the first nine months of 2006. Also,$5.0 million of cash was restricted due to the Company collateralizing a $5.0million line of credit with $5.0 million of cash and cash equivalents in 2007 tocollateralize various vendor letters of credit. Financing Activities. Since March 2005, we have used equity issuances,borrowings and, to a lesser extent, our cash flows from oil sales to fund ourexploration and production costs and general corporate overhead. Proceeds fromborrowings increased to $66.5 million for the twelve months ended December 31,2007, and we repaid approximately $3.5 million leaving net borrowings during theperiod of approximately $63.0 million. Of this amount, approximately $10.1million is restricted as to use by the terms of the convertible debt agreementsdiscussed at note 2 and 5 in the attached consolidated financial statements. Weused the net proceeds to fund our capital expenditure programs and for generalcorporate purposes and short-term investments. Our financing activitiesprovided $51.5 million in cash for the twelve month period ended December 31,2007 compared to $3.5 million in the comparable period in 2006. Contractual Obligations and Commitments The following table outlines our contractual obligations and commitments bypayment due dates as of December 31, 2007 (in millions): Payments Due by Period Less 2-3 4-5 After than 5 Total 1 Year Years Years Years Contractual Obligations and Commitments Long-term debt-principal $68.6 $- $ - $68.6 $ -Long-term debt-interest 29.8 6.8 13.7 9.3 Lease agreements 1.4 0.6 0.5 0.2 0.1Total contractual obligations and commitments $99.8 $ 7.4 $ 14.2 $78.1 $0.1 Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operationsare based upon our condensed consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of our financial statements requires us to makeassumptions and prepare estimates that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities and revenuesand expenses. We base our estimates on historical experience and various otherassumptions that we believe are reasonable; however, actual results may differ. See notes 1 and 2 ("Nature of Operations" and "Summary of Significant AccountingPolicies") to our consolidated financial statements for a discussion of oursignificant accounting policies. Risk Factors Risks Related to the Natural Gas and Oil Industry and Our Business Natural gas and oil prices are volatile, and a decline in natural gas and oilprices can significantly affect our financial results and impede our growth. Our revenue, profitability and cash flow depend upon the prices and demand fornatural gas and oil. The markets for these commodities are very volatile. Evenrelatively modest drops in prices can significantly affect our financial resultsand impede our growth. Changes in natural gas and oil prices have a significantimpact on the value of our reserves and on our cash flow. Prices for natural gasand oil may fluctuate widely in response to relatively minor changes in thesupply of and demand for natural gas and oil and a variety of additional factorsthat are beyond our control, such as: •the domestic and foreign supply of natural gas and oil; •the price of foreign imports; •worldwide economic conditions; •political and economic conditions in oil producing countries; •the ability of members of the Organization of Petroleum Exporting Countries toagree to and maintain oil price and production controls; •the level of consumer product demand; •weather conditions; •technological advances affecting energy consumption; •availability of pipeline infrastructure, treating, transportation and refiningcapacity; •domestic and foreign governmental regulations and taxes; •the price and availability of alternative fuels; •the inability to obtain financing on satisfactory terms. Lower oil and natural gas prices may not only decrease our revenues on a pershare basis, but also may reduce the amount of oil and natural gas that we canproduce economically. This may result in our having to make substantial downwardadjustments to our estimated proved reserves. Our estimated reserves are based on many assumptions that may turn out to beinaccurate. Any significant inaccuracies in these reserve estimates orunderlying assumptions will materially affect the quantities and present valueof our reserves. The present value of future net cash flows from our proved reserves will notnecessarily be the same as the current market value of our estimated natural gasand oil reserves. Unless we replace our natural gas and oil reserves, our reserves and productionwill decline, which would adversely affect our business, financial condition andresults of operations. Our potential drilling location inventories are scheduled over several years,making them susceptible to uncertainties that could materially alter theoccurrence or timing of their drilling. We will not know conclusively prior to drilling whether natural gas or oil willbe present in sufficient quantities to be economically viable. Our use of 2-D and 3-D seismic data is subject to interpretation and may notaccurately identify the presence of natural gas and oil, which could adverselyaffect the results of our drilling operations. Market conditions or operational impediments may hinder our access to naturalgas and oil markets or delay our production. Our development and exploration operations require substantial capital and wemay be unable to obtain needed capital or financing on satisfactory terms. We have a substantial amount of indebtedness, which may adversely affect ourcash flow and our ability to operate our business. Competition in the natural gas and oil industry is intense, which may adverselyaffect our ability to succeed. Our operations expose us to potentially substantial costs and liabilities withrespect to environmental, health and safety matters. The inability of one or more of our customers to meet their obligations mayadversely affect our financial results. Our development and exploration operations require substantial capital and wemay be unable to obtain needed capital or financing on satisfactory terms, whichcould lead to a loss of properties and a decline in our natural gas and oilreserves. Foreign Operations Frontera's future revenues depend on operating results from its operations inthe Republic of Georgia. The success of Frontera's operations is subject tovarious contingencies beyond management control. These contingencies includegeneral and regional economic conditions, prices for crude oil, competition andchanges in regulation. Frontera is subject to various additional political andeconomic uncertainties in Georgia which could include restrictions on transferof funds, import and export duties, quotas and embargoes, domestic andinternational customs and tariffs, and changing taxation policies, foreignexchange restrictions, political conditions and regulations. Cautionary Statement Concerning Forward-Looking Statements Various statements contained in this management's discussion and analysis ( MD&A), including those that express a belief, expectation, or intention, as well asthose that are not statements of historical fact, are forward-lookingstatements. The forward-looking statements may include projections and estimatesconcerning the timing and success of specific projects and our futureproduction, revenues, income and capital spending. Our forward-lookingstatements are generally accompanied by words such as "estimate," "project,""predict," "believe," "expect," "anticipate," "potential," "could," "may,""foresee," "plan," "goal" or other words that convey the uncertainty of futureevents or outcomes. The forward-looking statements in this MD&A speak only as ofthe date of this MD&A; we disclaim any obligation to update these statementsunless required by securities law, and we caution you not to rely on themunduly. We have based these forward-looking statements on our currentexpectations and assumptions about future events. While our management considersthese expectations and assumptions to be reasonable, they are inherently subjectto significant business, economic, competitive, regulatory and other risks,contingencies and uncertainties relating to, among other matters, the risksdiscussed under the heading "Risk Factors" and the following: •the volatility of natural gas and oil prices; •discovery, estimation, development and replacement of natural gas and oilreserves; •cash flow and liquidity; •financial position; •business strategy; •amount, nature and timing of capital expenditures, including future developmentcosts; •availability and terms of capital; •timing and amount of future production of natural gas and oil; •availability of drilling and production equipment; •availability of oil field labor; •operating costs and other expenses; •prospect development and property acquisitions; •availability of pipeline infrastructure to transport natural gas production; •marketing of natural gas and oil; •competition in the natural gas and oil industry; •governmental regulation and taxation of the natural gas and oil industry; and •developments in oil-producing and natural gas-producing countries. END This information is provided by RNS The company news service from the London Stock Exchange