Frontera Resources Regulatory News (FRR)

13 Apr 2006 07:01

Frontera Resources Corporation13 April 2006 FRONTERA RESOURCES ANNOUNCES RESULTS FOR THE PERIOD ENDED DECEMBER 31, 2005 AND PROVIDES AN OPERATIONS UPDATE Houston, Texas U.S.A. (April 13, 2006): Frontera Resources Corporation (LondonStock Exchange, AIM Market - Symbol: FRR), an independent oil & gas explorationand production company operating in the country of Georgia, today announces itsannual results for the period ended December 31, 2005 and provides an update onits operations to date. HIGHLIGHTS Corporate • Raised approximately $88.7 million through an initial placing and admission to trading on AIM in March 2005. • Reported a net loss of $4.4 million for the year ending December 31, 2005, in line with expectations • Work program through 2007 expected to be completed within the company's budgeted cash needs • In April 2005 the company announced the appointment of Luis E. Giusti to the board as an independent non-executive director Georgia Operations Taribani Field Unit: • Drilling program commenced to evaluate multiple horizons in the Taribani Field. • At the Dino#2 well, a vertical pilot hole was drilled to a planned depth of 2,700 metres and, following completion of coring and logging operations, horizontal drilling commenced in zone 15. • Acquired 60 kilometers of 2D seismic data in 2005 to further delineate the updip southwest portion of the Taribani Field. Interpretation of this new seismic data is currently underway. • Netherland, Sewell and Associates identified 36 million barrels of additional resource potential reserves in the Taribani Field. Basin Edge Play Unit: • Interpretation of 165 kilometers of 2D seismic data acquired in 2005 confirms the "C" prospect to be an independent four-way structural closure of approximately 55 square kilometers in size. • Commenced an 80 square kilometer 3D seismic survey over the "C" prospect in anticipation of drilling in 2007. • Interpretation underway of 170 kilometers of 2D seismic data acquired in 2005 over Prospect "'B". Mirzaani Field Area Exploration Unit: • Interpretation underway of 105 kilometers of 2D seismic data acquired in 2005 to delineate mapped prospects beneath the Mirzaani Field. Mirzaani Field Area Production Unit • Continued profitable production from the Mirzaani Field Area Production Unit. • Netherland, Sewell and Associates complete first reserve booking associated with the Mirzaani Field, one of three fields contained within the Unit. Block 12 Area-wide Field/Prospect Inventory Development Unit • Continued evaluation/prioritization of inventory of existing fields and prospects within Block 12. Steve C. Nicandros, Chairman and Chief Executive Officer, commented: "This is an exciting time for Frontera. With the proceeds from our offering onAIM last year, we have been able to continue to pursue our well-established,multiple paths for value creation from within our broad portfolio of explorationand development opportunities. To this end, we were able to successfully complete a series of major seismicacquisition programs totalling 500 kilometers of new 2D data over the TaribaniField Unit, the Basin Edge Play Unit and the Mirzaani Field Area ExplorationUnit. Our ongoing interpretation of this new data is revealing an enhancedunderstanding of the large prospectivity we have identified within each of theseoperational units. Of significance is our recently announced commencement of an80 square kilometer 3D seismic survey over the sizable Basin Edge Play Unit's "C" prospect. In 2006, we began drilling operations at the Taribani Field Unit and we continueto be encouraged by the progress of these operations. We are currently in theprocess of completing the Dino #2 well that was commenced in February. As partof a larger drilling program, this well is providing us with criticalinformation in determining the commerciality of the Taribani Field. We at Frontera remain committed to work hard to realize the value we believethat our assets hold. I look forward to reporting on our continued progress inthe weeks and months ahead." ENQUIRIES Citigate Dewe Rogerson (+44 20 7638 9571) - Martin Jackson For additional information, please visit Frontera's website at:www.fronteraresources.com CHAIRMAN AND CHIEF EXECUTIVE OFFICER'S STATEMENT During 2005, Frontera continued to advance its specific work programs throughoutfive primary areas of focus in Block 12: The Taribani Field Unit; The Basin EdgePlay Unit; The Mirzaani Field Area Exploration Unit; The Mirzaani Field AreaProduction Unit and The Block 12 Area-wide Inventory Development Unit. Our workin these areas continues according to plan and is aimed at accessing commercialproduction from the 118 million barrels of P3 reserves and 1.4 billion barrelsof unrisked resource potential that has been identified from within a subset ofthese areas. We are pursuing these work programs with a strong balance sheet as a result ofour offering and listing on the AIM market in 2005. As a result of thisoffering, we were able to significantly reduce our outstanding debt and positionthe company for undertaking our planned work programs from a strong financialfoundation. An update of progress in each of our focus areas within Block 12 follows below,together with a more detailed overview of our 2005 annual results: Taribani Field Unit: Drilling Operations: Horizontal drilling operations are currently underway atthe Dino #2 well. The well was designed to evaluate multiple horizons within thefield, with a primary objective of a final horizontal completion into horizon 15at a total depth of approximately 2,700 meters. Since commencement of operations on February 17th, drilling of the verticalpilot hole successfully encountered the Pliocene age zones 9, 14 and 15 asexpected, with hydrocarbon shows from each while drilling. Extensive coring andlogging operations were completed throughout key portions of the vertical pilothole. Zone 9 was encountered from 2,300 meters to 2,311 meters. In addition, apreviously unmapped oil bearing reservoir interval was encountered above zone 9from 2,275 meters to 2,285 meters. Zones 14 and 15 were encountered between2,560 meters and 2,700 meters. All of the data collected from the coring andlogging runs are currently undergoing detailed analysis in order to enhance ourunderstanding of reservoir properties and associated fracture systems inanticipation of additional drilling operations from other locations within thefield. After coring and logging operations were completed in the vertical pilot hole,the decision was made to drill the well horizontally into zone 15 where thehorizontal portion of the well is currently being drilled into a 15 meterinterval of zone 15. While drilling the horizontal section, high pressure oiland gas bearing intervals have been encountered with oil and gas flowing to thesurface. This has resulted in slower than expected drilling progress. As aresult, it is anticipated that drilling will be completed and an extendedtesting program undertaken within the next two to three weeks. Seismic Operations: Acquisition of 60 kilometers of 2D seismic over thesouthwestern portion of the Taribani Field was successfully completed. Thesouthwest area of the field is situated approximately 900 feet updip from thearea of the field where our current drilling operations are currently underway.This new seismic data has been processed and is currently being interpreted andintegrated into our existing mapping of the field in anticipation of futuredrilling operations. Reserves Booking: Netherland, Sewell and Associates (NS) completed analysis onthree additional horizons in the field in 2005. After originally identifying118 million barrels of P3 reserves from horizons 9, 14, 15 and 19, continuedanalysis resulted in the identification of as much as 36 million barrels ofadditional resource potential associated with horizons 20, 21, 23, 24 and 25.As the field continues to grow in potential size, results from our seismicprogram over the southwest portion of the field will provide an understanding ofhow much additional potential exists in the field. Basin Edge Play Unit Frontera has commenced operations to acquire a new 80 square kilometer 3Dseismic survey over its Basin Edge Play Unit's "C" prospect. Processing andinterpretation of approximately 165 kilometers of 2D seismic data that wasrecently acquired over the "C" prospect has revealed an independent four-waystructural closure of approximately 55 square kilometres in size. As a result,we have chosen to prioritize and focus on this large prospect within the broaderBasin Edge Play Unit that is located in the northeastern portion of Block 12.Acquisition of the new 3D survey is expected to be complete in June and will befollowed by a processing and interpretation effort that will be integrated intoexisting mapping prior to the end of this year. Drilling operations are plannedfor 2007. The objective of the new 3D seismic program is to determine the exact lateraland vertical limits of this large structure, evaluate the extensions of faultblocks and fracture systems contained within it, and identify reservoirs on thebasis of seismic attributes. Global Geophysical Services, Inc. of Houston, Texaswill acquire the survey over this prospect for Frontera. Frontera also recently completed the acquisition of approximately 170 kilometersof 2D seismic data acquired over a second prospect within the Basin Edge PlayUnit, known as the "B" prospect. Interpretation of this data is currentlyunderway. Frontera's objectives within the Basin Edge Play Unit remain focused oncommercially accessing the unrisked resource potential of 1.4 billion barrelsthat have been attributed to the "B" and "C" prospects by the independentconsulting firm of Netherland, Sewell and Associates. Mirzaani Field Area Exploration Unit In 2005, approximately 105 kilometers of 2D seismic were acquired over mappedprospects within the Mirzaani Field Area Exploration Unit. With processing ofthis data now complete, interpretation is currently underway to remap andenhance our existing prospect mapping in order to select specific drillinglocations. Mirzaani Field Area Production Unit Operations within the Mirzaani Field Area Production Unit profitably yielded anaverage daily production rate of approximately 90 barrels per day of oil during2005. While this volume is not significant in terms of our long term strategy,the day to day operations also provide us a platform to develop the productionexpertise which will be required as we unlock the larger reserves in Block 12. Netherland, Sewell and Associates completed an initial reserve booking on theMirzaani Field, one of three fields within this operating unit. Provedproducing, probable and possible reserves total approximately 442,000 barrelsand yield an NPV of approximately $5 million - $7 million at discount rates of8% and 12%, respectively. Block 12 Area-Wide Field/Prospect Inventory Development Unit During 2005, our team advanced work on our extensive inventory of prospects andleads throughout Block 12 with regional geologic and geophysical studies,including new extensive field work. New maps were completed that integrate surface geology, fractures, oil seeps,dip information, rivers and major streams together with our existing database.This work will highlight future areas of focus within Block 12 for new drillingoperations outside of our four main areas of focus detailed above. Today, ourinventory consists of more than 20 identified prospects, including severalundeveloped fields. Corporate News Financial Review. We significantly improved our balance sheet by raising $88.7million as part of our IPO in March, 2005. After retiring $17.1 million of debtfrom a portion of the offering proceeds, we had $53 million in cash andmarketable securities with $3.5 million in long-term debt at December 31, 2005. We experienced a net loss of $4.4 million for 2005, or $0.10 per share on afully-diluted basis. Revenues from oil sales were $1.8 million. Operatingexpenses were $10.4 million, which included $3.1 million of non-recurringgeneral and administrative expenses related to the offering and the SOCARarbitration. These costs were anticipated in our plan for use of proceeds fromthe IPO. We also reported other income of $4.2 million, including a $3.0 milliongain on income from retiring a portion of the long-term debt at a discount. Looking forward, we are experiencing higher capital costs for services andmaterials in Georgia, but we are taking steps to ensure we have sufficientcapital to complete the objectives of our work program through 2007. That workprogram includes the current drilling program in the Taribani Field Unit thisyear, and a 3D seismic acquisition and drilling program at the Basin Edge PlayUnit. SOCAR Arbitration. In January 2006, we announced that our wholly ownedsubsidiary, Frontera Resources Azerbaijan Corporation, was awarded $1.2 millionplus interest from 2000 until payment is made in connection with its bindingarbitration case with SOCAR, the State Oil Company of the Azerbaijan Republic.The arbitration was held in Sweden and is binding on the parties under the rulesof UNCITRAL, the United Nations Commission on International Trade Law. As you will recall, Frontera initiated the arbitration against SOCAR in October2003 related to claims resulting from SOCAR's halting of exports from theonshore Kursangi & Karabagli oilfields in the Azerbaijan Republic during thefourth quarter of 2000. The arbitral panel found that the halting of exports of crude oil from theKursangi & Karabagli oil fields in the Azerbaijan Republic was in violation ofthe Agreement on Rehabilitation, Exploration, Development and Production Sharingbetween SOCAR, Frontera, Delta/Hess and SOCAR Oil Affiliate (the "PSA"). Thearbitration panel rejected all other claims and counterclaims between theparties and the arbitration therefore resolves all claims between Frontera andSOCAR with respect to the PSA. In February 2006, Frontera Azerbaijan filed an action in the United StatesDistrict Court, Southern District of New York seeking to enforce the tribunal'saward in the United States. Contemporaneously, SOCAR filed a challenge to theaward with the Swedish Court of Appeals. Frontera Azerbaijan does not believethere is any basis for a challenge by SOCAR and will continue to pursueenforcement of the Swedish tribunal's award. ***** As we pursue an active work program in Georgia in 2006, all of us at Fronteraremain very committed to continue to work very hard on behalf of all of ourshareholders to realize the value we believe that our assets hold. I lookforward to reporting our continued progress in the months ahead. Steve C. NicandrosChairman and Chief Executive OfficerFrontera Resources Corporation About Frontera Frontera Resources Corporation is an independent Houston, Texas, U.S.A.- basedinternational oil and gas exploration and production company whose strategy isto identify and operate opportunities in emerging markets around the world. Frontera was admitted to the Alternative Investment Market, operated by theLondon Stock Exchange, on March 14, 2005. Frontera has operated in Georgia since 1997 where it holds a 100 per centworking 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 . This release contains certain forward-looking statements, including, withoutlimitation, expectations, beliefs, plans and objectives regarding the potentialtransactions, potential drilling schedule and ventures discussed in thisrelease, as well as reserves and future production. Among the important factorsthat could cause actual results to differ materially from those indicated bysuch forward-looking statements are future exploration and development results,availability and performance of needed equipment and personnel, the finalresults of the processing of seismic data, fluctuations in oil and gas prices,weather conditions, general economic conditions and the political situation inGeorgia and neighboring countries. There is no assurance that Frontera'sexpectations will be realized, and actual results may differ materially fromthose expressed in the forward-looking statements. The common shares of Frontera have not been registered under the U.S. SecuritiesAct of 1933. Transfer of these securities is prohibited, except in accordancewith the provisions of Regulation S, pursuant to registration under the U.S.Securities Act, or pursuant to an available exemption from registration.Hedging transactions involving these securities may not be conducted unless incompliance with the U.S. Securities Act. This document does not constitute an offer to sell or the solicitation of anoffer to buy the Company's securities in any jurisdiction in which such offer isunlawful. Enquiries Citigate Dewe Rogerson (+44 20 7638 9571) Martin Jackson FRONTERA RESOURCES CORPORATIONCONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2005 AND 2004 FRONTERA RESOURCES CORPORATIONCONSOLIDATED BALANCE SHEETS December 31, 2005 2004 ASSETS CURRENT ASSETS Cash and cash equivalents $ 19,586,747 $ 1,503,621 Restricted cash equivalent 250,000 - Restricted short-term investments 2,950,000 - Marketable securities 30,600,000 - Trade receivables, net - 507,868 Accounts receivable - other 146,300 637,816 Inventory 1,970,128 1,700,359 Prepaid expenses and other 568,804 138,057 TOTAL CURRENT ASSETS 56,071,979 4,487,721 PROPERTY AND EQUIPMENT, net 580,419 213,011 OIL AND GAS PROPERTIES, full cost method Properties being depleted 24,652,783 24,213,991 Properties not subject to depletion 5,929,994 144,376 30,582,777 24,358,367 Less: accumulated depletion (20,685,118) (20,328,697) NET OIL AND GAS PROPERTIES 9,897,659 4,029,670 TOTAL ASSETS $ 6,550,057 $ 8,730,402 December 31, 2005 2004LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES Accounts payable $ 601,227 $ 576,338 Accrued liabilities 1,758,043 2,086,269 Accrued interest 114,266 1,586,530 Line of credit - 850,670 Current portion of notes payable, related party 403,604 12,784,011 TOTAL CURRENT LIABILITIES OTHER THAN SHARES 2,877,140 17,883,818 REDEEMABLE PREFERRED SHARES Series A1, stated at redemption value - 4,804,856 Series A2, stated at redemption value - 2,011,959 Series B, stated at redemption value - 3,805,767 TOTAL REDEEMABLE PREFERRED SHARES - 10,622,582 TOTAL CURRENT LIABILITIES 2,877,140 28,506,400 NOTES PAYABLE Related party, less current portion - 6,403,604 Vendor 3,450,941 3,450,941 TOTAL NOTES PAYABLE 3,450,941 9,854,545 OTHER LONG-TERM LIABILITIES 2,327,366 2,419,044 TOTAL LIABILITIES 8,655,447 40,779,989 COMMITMENTS AND CONTINGENCIES - - STOCKHOLDERS' EQUITY (DEFICIT) Convertible preferred stock - Series E - 29 Common stock 2,178 242 Additional paid-in capital 142,480,721 48,382,082 Common stock warrants 31,151 36,927 Treasury stock, at cost (567,832) (567,832) Accumulated deficit (84,315,968) (79,901,035) Accumulated other comprehensive income 264,360 - TOTAL STOCKHOLDERS' EQUITY (DEFICIT) 57,894,610 (32,049,587) TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 66,550,057 $ 8,730,402 FRONTERA RESOURCES CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, 2005 2004REVENUE Crude oil sales $ 1,809,427 $ 1,040,656 TOTAL REVENUE 1,809,427 1,040,656 OPERATING EXPENSES Field operating and project costs 1,466,364 189,148 General and administrative 8,354,984 4,035,327 Depreciation, depletion and amortization 610,320 525,902 TOTAL OPERATING EXPENSES 10,431,668 4,750,377 LOSS FROM OPERATIONS (8,622,241) (3,709,721) OTHER INCOME (EXPENSE) Forgiveness of debt 4,158,861 114,920 Interest income 1,445,624 - Interest expense (1,384,583) (2,019,378) Other, net (12,594) 9,265 TOTAL OTHER INCOME (EXPENSE) 4,207,308 (1,895,193) NET LOSS $ (4,414,933) $ (5,604,914) Net Loss per common share Basic (0.10) (0.94) Diluted (0.10) (0.94) Weighted Average Common Shares Outstanding: Basic 45,206,970 5,994,276 Diluted 45,206,970 5,994,276 FRONTERA RESOURCES CORPORATIONCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) - PART 1 OF TABLEYEARS ENDED DECEMBER 31, 2005 AND 2004 Convertible Convertible Preferred Preferred Additional Preferred Stock Stock Common Paid-in Stock Series D Series E Stock Capital Warrants Balance, January 1, 2004 $ - $ 29 $ 240 $43,183,632 $5,268,936 Exercise of common stock - - 2 1,198 - warrants Repurchase of preferred stock Series E warrants - - - 5,189,902 (5,268,936) Issuance of common stock options for services - - - 7,350 - Purchase of treasury - - - - - stock Net loss - - - - - Balance, December 31, 2004 - 29 242 48,382,082 - Exercise of common stock warrants - - 94 81,588 - Issuance of common stock, net of offering costs - - 1,229 80,168,951 - Compensation expense from repricing of stock - - - 12,632 - options Conversion of bridge loan to common stock, including beneficial conversion - - 43 3,124,957 - Conversion of Series A1, A2 & B redeemable preferred stock to common stock - - 172 10,710,880 - Conversion of Series D & E preferred stock to common stock - (29) 398 (369) - Unrealized gain on marketable securities - - - - - Net loss - - - - - Comprehensive loss - - - - - Balance, December 31, 2005 $ - $ - $2,178 $142,480,721 $ - FRONTERA RESOURCES CORPORATIONCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) - PART 2 OF TABLEYEARS ENDED DECEMBER 31, 2005 AND 2004 Accumulated Common Other Total Stock Treasury Accumulated Comprehensive Stockholders' Warrants Stock Deficit Income (Deficit) Equity Balance, January 1, 2004 $ 36,927 $(495,366) $(74,296,121) - $(26,301,723) Exercise of common stock - - - - 1,200 warrants Repurchase of preferred stock Series E warrants - - - - (79,034)Issuance of common stock options for services - - - - 7,350Purchase of treasury - (72,466) - - (72,466)stock Net loss - - (5,604,914) - (5,604,914) Balance, December 31, 36,927 (567,832) (79,901,035) - (32,049,587)2004 Exercise of common stock warrants (5,776) - - - 75,906Issuance of common stock, net of offering costs - - - - 80,170,180Compensation expense from repricing of stock - - - - 12,632 options Conversion of bridge loan to common stock, including beneficial conversion - - - - 3,125,000Conversion of Series A1, A2 & B redeemable preferred stock to common stock - - - - 10,711,052Conversion of Series D & E preferred stock to common stock - - - - -Unrealized gain on marketable securities - - - 264,360 264,360Net loss - - (4,414,933) - (4,414,933) Comprehensive loss - - - - (4,150,573) Balance, December 31, $ 31,151 $(567,832) $(84,315,968) $ 264,360 $ 57,894,610 2005 FRONTERA RESOURCES CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, 2005 2004 CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (4,414,933) $ (5,604,914)Adjustments to reconcile net loss to net cash used in operating activities: Depreciation, depletion and amortization 610,320 525,902 Interest on redeemable preferred shares 88,470 462,410 Beneficial conversion of bridge loan 625,000 - Net amortization of debt discounts - (74,832) Common stock options issued for compensation 12,632 7,350 Forgiveness of debt income (4,158,861) (114,920)Changes in operating assets and liabilities: Receivables 999,384 (450,211) Inventory (269,769) 43,774 Prepaid expenses and other (430,746) 123,035 Accounts payable 1,320,640 (1,014,335) Accrued liabilities (328,226) (985,600) Accrued interest (1,134,754) 1,094,582 NET CASH USED IN OPERATING ACTIVITIES (7,080,843) (5,987,759) CASH FLOWS FROM INVESTING ACTIVITIES Investment in oil and gas properties (6,224,410) - Investment in property and equipment (621,307) - Investment in certificates of deposit (3,200,000) - Investment in marketable securities (30,335,640) - NET CASH USED IN INVESTING ACTIVITIES (40,381,357) - CASH FLOWS FROM FINANCING ACTIVITIES (Payment on) proceeds from line of credit (850,670) 850,670 (Payment on) proceeds from related party notes (13,758,412) 6,630,711 Payment on long-term liabilities (91,678) - Exercise of common stock warrants 75,906 1,200 Proceeds from issuance of common stock 80,170,180 - Purchase of treasury stock - (151,500) NET CASH PROVIDED BY FINANCING ACTIVITIES 65,545,326 7,331,081 NET INCREASE IN CASH AND CASH EQUIVALENTS 18,083,126 1,343,322 CASH AND CASH EQUIVALENTS, beginning of year 1,503,621 160,299 CASH AND CASH EQUIVALENTS, end of year $ 19,586,747 $ 1,503,621 SUPPLEMENTAL CASH FLOW INFORMATION Cash paid for interest $ 1,805,867 $ 555,374 NOTE A - 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 exploitation projectsthat have significant exploration upside. Beginning in 2002, the Company hasfocused substantially all of its efforts on the exploration and development ofoilfields within the Republic of Georgia ("Georgia"), a member of the FormerSoviet Union. Prior to 2002, the Company's other significant operating focuswas on the exploration and development of an oilfield within the AzerbaijanRepublic ("Azerbaijan"), which was sold during 2002 and all operating activitiesin Azerbaijan ceased at that time. 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. NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation: The consolidated financial statements include theaccounts of Frontera Resources Corporation ("FRC") and its wholly and majorityowned subsidiaries. The wholly owned subsidiaries are Frontera InternationalCorporation ("FIC"); Frontera Resources Caucasus Corporation ("FRCC"); FronteraResources Georgia Corporation ("FRGC"); Frontera Resources AzerbaijanCorporation ("FRAC"); Frontera Resources Overseas Corporation ("FROC"); FronteraAzerbaijan Ventures Corporation ("FAVC") and Frontera Resources Georgia, Limited("FRGL"). Also included are the accounts of Frontera Eastern Georgia, Limited("FEGL"), a 50%-owned subsidiary, as control is deemed to reside with theCompany. All significant intercompany transactions and accounts have beeneliminated in consolidation. Cash and Cash Equivalents: Cash and cash equivalents include all cash balances,money market accounts and certificates of deposit, all of which have maturitiesof three months or less. Restricted Cash Equivalent and Short-Term Investments: At December 31, 2005,the Company has $250,000 and $2,950,000 of restricted cash equivalent andrestricted short term investments. The restricted cash equivalent andrestricted short-term investments serves as collateral for an irrevocablestandby letter of credit that provides financial assurance that the Company willfulfill its obligations with respect to service contracts with certain vendors.The cash is held in custody by the issuing bank, is restricted as to withdrawalor use, and is currently invested in certificates of deposit. Income from theseinvestments is paid to the Company. Marketable Securities: The Company determines the appropriate classification ofits investments in debt and equity securities at the time of purchase andreevaluates such determinations at each balance sheet date. Debt securities areclassified as held-to-maturity when the Company has the positive intent andability to hold the securities to maturity. Debt securities for which theCompany does not have the intent or ability to hold to maturity are classifiedas available-for-sale. Held-to-maturity securities are recorded as eithershort-term or long-term on the balance sheet based on contractual maturity dateand are stated at amortized cost. Marketable securities that are bought andheld principally for the purpose of selling them in the near term are classifiedas trading securities and are reported at fair value, with unrealized gains andlosses recognized in earnings. Debt and marketable equity securities notclassified as held-to-maturity or as trading, are classified asavailable-for-sale, and are carried at fair market value, with the unrealizedgains and losses, net of tax, included in the determination of comprehensiveincome and reported in shareholders' equity. The fair value of substantially all securities is determined by quoted marketprices. The estimated fair value of securities for which there are no quotedmarket prices is based on similar types of securities that are traded in themarket. At December 31, 2005, available-for-sale securities consist of investments incorporate bonds with an estimated fair value of $30,600,000 and net unrealizedholding gains in the amount of $264,360, which have been included in accumulatedother comprehensive income. Inventory: Inventory consists primarily of materials to be used in theCompany's foreign oilfield operations and crude oil held in stock tanks.Inventory is valued using the first-in, first-out method and is stated at thelower of cost or market. Inventory consists of the following: December 31, 2005 2004 Materials and supplies $ 1,679,538 $ 1,604,488Crude oil 290,590 95,871 $ 1,970,128 $ 1,700,359 Property and Equipment: Property and equipment are stated at cost.Expenditures for major renewals and betterments, which extend the originalestimated economic useful lives of applicable assets, are capitalized.Expenditures for normal repairs and maintenance are charged to expense asincurred. The costs and related accumulated depreciation of assets sold orretired are removed from the accounts, and any gain or loss thereon is reflectedin operations. Depreciation of property and equipment is computed using thestraight-line method over the estimated useful lives of the assets, ranging fromthree to seven years. Oil and Gas Properties: The Company follows the full cost method of accountingfor oil and gas properties. Accordingly, all costs associated with acquisition,exploration, and development of oil and gas reserves, including directly relatedoverhead costs, 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. Noimpairment writedown was necessary for the years ended December 31, 2005 and2004. Sales of proved and unproved properties are accounted for as adjustments ofcapitalized costs with no gain or loss recognized, unless such adjustments wouldsignificantly alter the relationship between capitalized costs and provedreserves of oil and gas, in which case the gain or loss is recognized in income.Abandonments of properties are accounted for as adjustments of capitalized costswith no loss recognized. Income Taxes: The Company follows the provisions of SFAS No. 109, "Accountingfor Income Taxes", which requires the recognition of deferred tax liabilitiesand assets for the expected future tax consequences of events that have beenincluded in the financial statements or tax returns. Under this method,deferred tax liabilities and assets are determined based on the differencebetween the financial statements and the tax basis of assets and liabilitiesusing enacted rates in effect for the years in which the differences areexpected to reverse. Valuation allowances are established, when appropriate, toreduce deferred tax assets to the amount expected to be realized. Revenue Recognition: Revenues and their related costs are recognized upondelivery of commercial quantities of crude oil produced from proven reserves, inaccordance with the accrual method of accounting. Foreign Currency Transactions: The financial statements of the foreignsubsidiaries are prepared in United States dollars, and the majority oftransactions are denominated in United States dollars. Gains and losses onforeign currency transactions are the result of changes in the exchange ratebetween the time a foreign currency-denominated invoice is recorded and when itis ultimately paid and are included in operations. Foreign currency transactiongains and losses were not material for the years ended December 31, 2005 and2004. Foreign Operations: Frontera's future revenues depend on operating results fromits operations in the Republic of Georgia. The success of Frontera's operationsis subject to various contingencies beyond management control. Thesecontingencies include general and regional economic conditions, prices for crudeoil, competition and changes in regulation. Frontera is subject to variousadditional political and economic uncertainties in Georgia which could includerestrictions on transfer of funds, import and export duties, quotas andembargoes, domestic and international customs and tariffs, and changing taxationpolicies, foreign exchange restrictions, political conditions and regulations. Concentrations of Credit and Other Risks: Financial instruments whichpotentially subject the Company to concentrations of credit risk consistprincipally of cash and accounts receivables. The Company maintains its cash inbank deposits with various major financial institutions. These accounts, attimes, exceed federally insured limits. Deposits in the United States areguaranteed by the Federal Deposit Insurance Corporation up to $100,000. TheCompany monitors the financial condition of the financial institutions and hasnot experienced any losses on such accounts. Receivables that potentially subject the Company to credit risk consistprincipally of amounts due from unrelated parties in Georgia. The Companyestablishes an allowance for doubtful accounts based on factors surrounding thecredit risk of the specific debtor, historical trends and other relatedinformation. Collateral is generally not required to secure receivables. Fair Value of Financial Instruments: Frontera's financial instruments consistof cash, accounts receivable, accounts payable, and a variety of debtinstruments, including a line of credit, and senior and subordinated notespayables (collectively, the "Debt Instruments"). The fair value of cash,accounts receivable and accounts payable are estimated to approximate thecarrying value due to the liquid nature of these instruments. The fair value ofthe Debt Instruments was determined based upon discount rates which approximatevariable interest rates for borrowings of a similar nature. The fair values ofthe Debt Instruments on December 31, 2005 and 2004 were approximately $2.7million, and $22.5 million, respectively. Earnings per share: Basic earnings per share amounts are calculated based onthe weighted average number of shares of Common Stock outstanding during eachperiod. Diluted earnings per share is based on the weighted average number ofshares of Common Stock outstanding for the periods, including the dilutiveeffect of stock options, warrants, convertible notes, and convertible PreferredStock. Dilutive options and warrants that are issued during a period or thatexpire or are canceled during a period are reflected in the computations for thetime they were outstanding during the periods being reported. Options andwarrants where the exercise price exceeds the average stock price for the periodare considered antidilutive, and therefore are not included in the calculationof dilutive shares. Basic and diluted loss per share for the years endedDecember 31, 2005 and 2004 are the same since the effect of all common stockequivalents is antidilutive to the Company's net loss per share under SFAS No.128. Major Customers: For the years ended December 31, 2005 and 2004, 100% of theCompany's crude oil sales were to one unrelated customer. Use of Estimates: The preparation of financial statements in conformity withaccounting principles generally accepted in the United States requires theCompany to make estimates and assumptions that affect the reported amounts ofassets and liabilities and disclosure of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from thoseestimates. Stock-Based Compensation: In accordance with the provisions of Statement ofFinancial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-BasedCompensation", the Company has elected to follow the Accounting PrinciplesBoard's Opinion No. 25, "Accounting for Stock Issued to Employees", ("APB 25")and related interpretations in accounting for its employee stock-basedcompensation plans. Under APB 25, if the exercise price of the Company'semployee stock options equals or exceeds the fair value of the underlying stockon the date of grant, no compensation expense is recognized. If the Company applied the fair value provisions of SFAS No. 123, net loss wouldhave been as follows: Year Ended December 31, 2005 2004 Net loss attributable to common stockholders, as reported $ (4,414,933) $ (5,604,914)Deduct: total stock based compensation expense determined under fair value based method for all awards, net of related income tax (3,133,879) (5,250) Net loss attributable to common stockholders, pro forma $ (7,548,812) $ (5,610,164) Basic loss per share: As reported (0.10) (0.94) Pro forma (0.17) (0.94) Diluted loss per share: As reported (0.10) (0.94) Pro forma (0.17) (0.94) The fair value for these options was estimated at the date of grant using theBlack Scholes pricing model with the following weighted-average assumptions: December 31, 2005 2004 Risk-free interest rate 4.28% 2.38%Dividend yield - -Weighted-average expected life of options (years) 10 10Volatility 100% 100% Recently Issued Accounting Pronouncements: In December 2004, the FASB issuedSFAS No. 123R, SHARE-BASED PAYMENT (SFAS 123R). SFAS 123R revises SFAS No. 123,ACCOUNTING FOR STOCK-BASED COMPENSATION, and focuses on accounting forshare-based payments for services by employer to employee. The statementrequires companies to expense the fair value of employee stock options and otherequity-based compensation at the grant date. The statement does not require acertain type of valuation model and either a binomial lattice or Black-Scholesmodel may be used. The provisions of SFAS 123R are effective for financialstatements for annual periods beginning after June 15, 2005. We are currentlyevaluating the method of adoption and the impact on our operating results, whichwe believe will be material. Our future cash flows will not be impacted by theadoption of this standard. NOTE C - INITIAL PUBLIC OFFERING In March 2005 the Company successfully completed its initial public offering(IPO) of common stock. The Company raised approximately $80,000,000 in netproceeds through the sale of 30,685,215 shares at a U.S. dollar equivalent priceof $2.89. In conjunction with the IPO the Company was admitted for trading onthe AIM market of the London Stock Exchange. A portion of the proceeds from theoffering was used to retire $17,135,000 of long-term and short-term debt, ofwhich approximately $2,500,000 was forgiven. Also, immediately prior to the IPOall of the Company's Series A1, A2, B, D and E preferred shares were convertedto common stock as follows: Number of Number of Preferred Shares Common shares prior to IPO Upon conversion Series A1 Redeemable Preferred Stock 322,400 1,935,913Series A2 Redeemable Preferred Stock 135,000 810,633Series B Redeemable Preferred Stock 254,000 1,533,313Series D Convertible Preferred Stock 23,600 2,240,000Series E Convertible Preferred Stock (1) 2,889,333 13,406,505 3,624,333 19,926,364 Also in March 2005, the Company converted $2,500,000 of related party debt intocommon stock at a pre-agreed discount to the IPO price. The Company issued1,081,858 shares of common stock and recorded a beneficial conversion feature tointerest expense and additional paid in capital in the amount of $ 625,000 inconnection with the conversion. (1) As of December 31, 2004, out of total Series E convertible preferred stockof 2,889,333 outstanding, the Company had repurchased 1,229,234 as treasurystock. NOTE D - MANDATORY REDEEMABLE PREFERRED STOCK Series A1 and Series A2 Redeemable Preferred Stock: In March 2005, all of theCompany's redeemable preferred stock was converted to common stock during theCompany's initial public offering as discussed in Note C above. As of December31, 2004, the Company had 322,400 designated, issued and outstanding shares ofSeries A1 Redeemable Preferred Stock ("Series A1") and 135,000 designated,issued and outstanding shares of Series A2 Redeemable Preferred Stock ("SeriesA2"), respectively. Series A1 and Series A2 had a par value of $0.00001 pershare, had no voting or conversion rights and were not entitled to dividends.The holders of Series A1 and Series A2 were afforded preference in liquidationand in redemption over the Company's common stock, Series B Redeemable PreferredStock, Series D Convertible Preferred Stock and Series E Convertible PreferredStock. During the years ended December 31, 2005 and 2004, the Company accreteddividends of $56,882 and $297,310 respectively, relating to the Series A1 andSeries A2 shares. The Company adopted the provisions of SFAS No. 150, "Accounting for CertainFinancial Instruments with Characteristics of Both Liabilities and Equity",effective in 2004. SFAS No. 150 requires that financial instruments that aremandatorily redeemable on a certain date or upon an event certain to occur beclassified as liabilities. As Series A1 and Series A2 were redeemable on March15, 2002, these instruments were classified as current liabilities on theaccompanying consolidated balance sheet at December 31, 2004. Series B Redeemable Preferred Stock: In March 2005, all of the Company'sredeemable preferred stock was converted to common stock during the Company'sinitial public offering as discussed in Note C above. As of December 31, 2004,the Company had 254,000 designated, issued and outstanding shares of Series BRedeemable Preferred Stock ("Series B"). Series B had a par value of $0.00001per share and were identical to Series A1 and Series A2 except no shares ofSeries B may be redeemed until all shares of Series A1 and Series A2 have beenredeemed and Series B is subordinated in liquidation to Series A1 RedeemablePreferred Stock, Series A2 Redeemable Preferred Stock, Series D ConvertiblePreferred Stock and Series E Convertible Preferred Stock. In accordance withSFAS No. 150, these shares have been classified as a current liability on theaccompanying consolidated balance sheet at December 31, 2004. During the years ended December 31, 2005 and 2004, the Company accreteddividends of $31,588 and $165,100, respectively, relating to Series B shares. NOTE E - STOCKHOLDERS' EQUITY The Company has the authority to issue up to 10,000,000 shares, par value$.00001, of serial preferred stock. The Board of Directors may designate andauthorize the issuance of such shares with such voting power and in such classesand series, 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. Series D Convertible Preferred Stock: In March 2005, all of the Company'sSeries D convertible preferred stock was converted to common stock during theCompany's initial public offering as discussed in Note C above. As of December31, 2004, the Company had 23,600, designated, issued and outstanding shares ofSeries D Convertible Preferred Stock ("Series D"). Series D had a par value of$0.00001 per share and was a voting convertible equity security that was notredeemable. Each share of Series D Preferred Stock was convertible, at theoption of the holder thereof, at any time after the date of issuance of suchshare into the number of shares of Common Stock at the conversion price then ineffect upon the earlier to occur of (i) the closing of an underwritten publicoffering pursuant to an effective registration statement under the SecuritiesAct of 1933, as amended (the "Securities Act"), covering the offer and sale ofCommon Stock with an offering price per share of at least two times theconversion price (as adjusted to reflect certain recapitalizations) and withgross offering proceeds (prior to underwriting discounts and commissions andoffering expenses) to the Company of at least $25 million, or (ii) the datespecified by vote or written consent of the holders of at least a majority ofthe then outstanding Series D Preferred Stock, voting as a class, for suchconversion. The price at which Common Stock was deliverable upon conversion of the Series DPreferred Stock initially was $237.295 per share of Common Stock, whichconversion price was subject to adjustment as provided in the AmendedCertificate of Designations. Except as otherwise required by law, the holder of each share of Series DPreferred Stock had the right to one vote for each full share of Common Stockinto which such Series D Preferred Stock could then be converted. With respectto such vote, such holder had full voting rights and powers equal to the votingrights and powers of the holders of Common Stock and is entitled to vote,together with holders of Common Stock and the holders of any other class orseries of stock that also has the right to vote with the holders of the CommonStock, with respect to any question upon which holders of the Common Stock havethe right to vote. The holders of Series D also had certain special votingrights that require their consent prior to certain major corporate actions, asdefined. In December 2004, the Company signed an agreement with the Series D holdersthat, contingent upon the closing of the public offering, all Series D shareswould be immediately converted into common shares of the Company at a rate of94.9153 shares of common stock for each share of Series D Preferred Stock. Series E Convertible Preferred Stock: In March 2005, all of the Company'sSeries E convertible preferred stock was converted to common stock during theCompany's initial public offering as discussed in Note C above. As of December31, 2004, the Company had 4,000,000 designated shares and 1,660,099 outstandingshares of Series E Convertible Preferred Stock ("Series E"), respectively.Series E had a par value of $0.00001 per share and was a voting convertibleequity security with a preference in liquidation over Series B and common stockbut was subordinate in liquidation to Series A1 and Series A2. Each share ofSeries E Preferred Stock was convertible, at the option of the holder thereof,at any time after the date of issuance of such share into the number of sharesof Common Stock equal to $11.60 divided by the conversion price then in effect.Each share of Series E Preferred Stock automatically converted into shares ofCommon Stock at the conversion price then in effect upon the earlier to occur of(i) the closing of an underwritten public offering pursuant to an effectiveregistration statement under the Securities Act covering the offer and sale ofthe Company's Common Stock with an offering price per share of at least $18.99(as adjusted to reflect certain recapitalizations) and with gross offeringproceeds (prior to underwriting discounts and commissions and offering expenses)to the Company of at least $25 million, or (ii) the date specified by vote orwritten consent of the holders of at least a majority of the then outstandingSeries E Preferred Stock, voting as a class, for such conversion. The price at which Common Stock was deliverable upon conversion of the Series EPreferred Stock initially was $8.878214 per share of Common Stock of theCompany, which conversion price is subject to adjustment as provided in theAmended Certificate of Designations. As of December 31, 2004, the conversionprice for the Series E Preferred Stock was $8.836545. The holders of the Series E had a right to have the Company redeem their sharesof Series E under certain limited circumstances after December 31, 2003, none ofwhich occurred. The redemption price is $11.60 per share, less the per-shareamount of any dividends previously declared and paid to holders of Series EPreferred Stock, plus the per-share amount of any declared but unpaid dividends,plus interest on $11.60 per share at a simple rate of 6.5 percent per annum,calculated from the later of the date of issuance or September 30, 1999, to andincluding the applicable redemption date. Other than rights of redemption and the number of shares convertible into theCompany's common stock, the conversion, voting, and dividend rights of theSeries E were substantially identical to Series D. Similar to Series D, theholders of Series E had certain special voting rights that required theirconsent prior to certain major corporate actions, as defined. In December 2004, the Company signed an agreement with the Series E holdersthat, contingent upon the successful closing of the public offering, all SeriesE shares would be immediately converted into common shares of the Company at arate of 4.64 shares of common stock for each share of Series E Preferred Stock. Preferred Series E Stock Warrant: In 1999, the Company sold a warrant topurchase 96,035 shares of Series E or an equivalent number of common shares asdetermined by the conversion price at the earliest of the exercise date or thelast conversion date of the warrant holder's Series E shares. The Company soldthe warrant at a purchase price of $1,017,965. In 2000, the Company soldanother warrant to purchase 401,035 shares of Series E of the Company or anequivalent number of common shares for total proceeds of $4,250,971. Bothwarrants had no expiration date. During 2004, both warrants were repurchased bythe Company in a transaction that also included the repurchase of certain SeriesE shares, for a total purchase price of $150,000. The portion of the purchaseprice allocated to the warrants was $79,034. The balance of the originalproceeds after the $79,034 repurchase was recorded to additional paid-incapital. As of December 31, 2004, the status of the preferred shares designated andoutstanding is summarized as follows: Shares Shares Designated Outstanding Series A1 Redeemable Preferred Stock 322,400 322,400Series A2 Redeemable Preferred Stock 135,000 135,000Series B Redeemable Preferred Stock 254,000 254,000Series D Redeemable Preferred Stock 23,600 23,600Series E Redeemable Preferred Stock 4,000,000 1,660,099 4,735,000 2,395,099Undesignated 5,265,000 Total shares authorized 10,000,000 Common Stock: As of December 31, 2005, the Company is authorized to issue200,000,000 shares of common stock, par value $.00004 per share. As of December31, 2005 and 2004, the Company had 54,389,787 and 6,027,872 of common sharesoutstanding, respectively. At December 31, 2005 and 2004, there are anadditional 26.5 million and 25.8 million shares of common stock reserved for theexercise of existing options and warrants, respectively. Treasury Stock: The Company has repurchased both common stock and preferredSeries E stock as treasury stock. As of December 31, 2005 and 2004, the Companyhad 5,739,855 and 1,265,433 shares of treasury stock, respectively. Of theseamounts, 5,739,855 and 36,209 shares of treasury stock are comprised of commonstock in 2005 and 2004, respectively. 1998 Employee Stock Incentive Plan: In 1998, the Company's stockholdersapproved the 1998 Employee Stock Incentive Plan (the "Plan"), pursuant to whichoptions may be granted to purchase up to 15% of the Company's common sharesauthorized to be issued by the Company, reduced by the total number of shares ofstock subject to stock options and stock awards that have been granted under thePlan and the Frontera Resources Corporation 2000 Nonqualified Stock Option andStock Award Plan at any given time. The Board of Directors has appointedFrontera's chief executive officer as administer (the "Administrator") of thePlan. In this capacity, the Administrator determines which employees willreceive options, the number of shares covered by any option agreement, and theexercise price and other terms of each such option. The Board of Directors isresponsible for administering the Plan as it relates to options granted to thechief 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'sBoard of Directors approved the 2000 Nonqualified Stock Option and Stock AwardPlan (the "Stock Award Plan"), pursuant to which options may be granted toemployees, directors, consultants, and advisors of the Company or any of itsaffiliates, to purchase up to 15% of the Company's common shares 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 asadminister 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 Plan as itrelates 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 informationfollows: Weighted- Average Options Exercise Price Options outstanding at January 1, 2004 5,997,513 1.28 Granted 60,000 1.00 Exercised - - Surrendered (62,000) 1.84 Options outstanding at December 31, 2004 5,995,513 1.26 Granted 3,112,500 2.67 Exercised - - Surrendered (45,000) 1.00 Options outstanding at December 31, 2005 9,063,013 1.74 The following table summarizes information about stock options outstanding atDecember 31, 2005: Options Outstanding Options Exercisable Weighted- Number Average Weighted- Number Weighted- Range of Outstanding at Remaining Average Exercisable at Average Exercise December 31, Contractual Exercise December 31, Exercise Prices 2005 Life (Years) Price 2005 Price $0.92 - 1.00 4,993,000 7.24 0.99 4,968,000 0.99 $2.00 - 2.87 3,965,013 8.19 2.57 1,002,513 2.00 $5.28 - 8.85 105,000 2.36 6.30 105,000 6.30 9,063,013 1.74 6,075,513 1.23 During 2003, the Company repriced certain outstanding options downward to bemore in line with the value of the Company. According to FIN 44, Accounting forCertain Transactions Involving Stock Compensation - An Interpretation of APBOpinion No. 25, if a fixed stock option or award is canceled or modified suchthat a new measurement of compensation cost or variable accounting is required,compensation cost shall be adjusted for increases or decreases in the intrinsicvalue of the modified award in subsequent periods until that award is exercised,is forfeited, or expires unexercised. However, compensation cost shall not beadjusted below the intrinsic value (if any) of the modified stock option oraward at the original measurement date unless the award is forfeited because theemployee fails to fulfill an obligation. As of December 31, 2005 and 2004,there are 644,084 remaining options subject to variable accounting. NOTE F - PROPERTY AND EQUIPMENT Property and equipment consists of the following: Estimated December 31, Useful Lives 2005 2004 Field equipment 7 years $ 2,086,084 $ 1,708,557Automobiles 5 years 302,553 192,701Telecommunications equipment 7 years 367,337 367,337Office furniture, fixtures and computer-related equipment 7 years 1,541,810 1,423,224Leasehold improvements 3 years 29,526 25,196 4,327,310 3,717,015Less: accumulated depreciation 3,746,891 3,504,004 $ 580,419 $ 213,011 NOTE G - GAC ENERGY FARMOUT AGREEMENT In August 2002, Frontera entered into a Farmout Agreement with GAC Energy ("GAC"), a Houston-based exploration and production company. Under the terms of theFarmout Agreement, Frontera agreed to farmout an interest in the Block 12 PSA toGAC in consideration of a cash payment and work commitments. In 2002, GAC paidFrontera $1,750,000. Although the Company follows the full cost method ofaccounting for its oil and gas properties, a gain of approximately $786,000 wasrecognized on this sale because the reduction to the full cost pool for thetotal proceeds received would have resulted in a significantly alteredrelationship between capitalized costs and proved reserves. In August 2003, GAC exercised an option under the Farmout Agreement that createdan additional obligation to Frontera that resulted in a gain of approximately$1,458,000, which was deferred because the obligation was entirely financed withan account receivable from GAC. As discussed below, GAC began experiencingfinancial difficulty and never paid the receivable. Accordingly, the deferredgain was reversed in 2004 and never recorded to the Company's statement ofoperations. Shortly after August 2003, GAC began experiencing financial difficulty. As aresult, Frontera began making cash calls on behalf of GAC, and recording this asan account receivable from GAC. In February 2004, the Company notified GAC thatthey were in default of the terms of the Farmout Agreement. At that time, GACinformed the Company that they were putting a financing arrangement in place;however they were unsuccessful in these efforts. As a result, in July 2004, theCompany once again notified GAC of the default and set out to remedy GAC'sdefault in accordance with the provisions of the Farmout Agreement. Inaccordance with prescribed remedies under the Farmout Agreement, GAC's interestin the Block 12 PSA was officially reassigned to Frontera on September 29, 2004.Upon GAC's default, in addition to the interest in the Block 12 PSA, theCompany acquired all operating assets, primarily consisting of materials andsupplies and also assumed all liabilities, primarily consisting of unpaidoperating invoices. Combined with the reassignment of assets and the assumptionof liabilities, the Company also applied a receivable from GAC which resulted ina total reassignment cost of approximately $2.4 million. NOTE H - NOTES PAYABLE AND LINE OF CREDIT Notes payable and line of credit consist of the following: December 31, 2005 2004 Line of Credit: 16% due May 24, 2005 (1) $ $ 850,670 - Total Line of Credit $ $ 850,670 - Notes Payable - Related Party: 15% Senior, due April 1, 2005 (2) $ $ 4,000,000 - 12% Senior, due May 14, 2006 (3) - 6,000,000 12% Convertible, due March 15, 2005 (4) - 2,500,000 2001 Stockholders Notes (5) - 360,000 2001 Rights Offering (6) 403,604 403,604 2004 Stockholder Notes (7) - 1,358,211 Dynamic Trading, Inc. (8) - 250,000 SEM Consulting LLC (#1) (9) - 80,800 SEM Consulting LLC (#2) (10) - 210,000 CSTN, Ltd. (11) - 100,000 Glenmont Enterprises S.A. (12) - 100,000 DDJ Assigned Note (13) - 3,825,000 Total Notes Payable - Related Party 403,604 19,187,615 Less: Current Portion 403,604 12,784,011 Long-Term Note Payable - Related Party $ $ 6,403,604 - Notes Payable - Vendor: Saipem S.p.A. (14) $ 3,450,941 $ 3,450,941 Total Notes Payable - Vendor 3,450,941 3,450,941 Less: Current Portion - - Long-Term Notes Payable - Vendor $ 3,450,941 $ 3,450,941 Maturities of notes payable and line of credit as of December 31, 2005 are asfollows: Year Ending December 31, 2006 $ 403,604 2007 3,450,941 $ 3,854,545 (1) Line of Credit In November 2004, the Company raised $850,670 under an unsecured line of creditfor up to $1,000,000 from Bank Republic, a financial institution in the Republicof Georgia. The line of credit bore interest at a rate of 16% per annum and wasdue on May 24, 2005. This note was retired in March 2005 with proceeds from theCompany's IPO. (2) 15% Senior Notes Payable - Related Party During August 2001, the Company raised $400,002, less commitment fees totaling$20,001, from the issuance of three promissory notes to a syndicate made up ofthree funds managed by DDJ Capital Management, LLC ("DDJ"), a shareholder with aposition on the Board of Directors at Frontera. Each promissory note containedthe same provisions and terms. Each note was for $133,334, was due in March2002 and carried an initial interest rate of 15% which increased by 1% per annumat the beginning of each month starting on October 1, 2001. At the same timethese three $133,334 notes payable were issued, the Company raised $3,500,000,less commitment fees totaling $113,000, from the issuance of a promissory noteto DDJ. This note payable was due in March 2002 and carried an initial interestrate of 15%, which increased by 1% per annum at the beginning of each monthstarting on October 1, 2001. On September 1, 2002, the three $133,334 notes payable and the $3,500,000 notepayable were renegotiated to increase the aggregate principal amount due to$4,000,000, an increase of $99,998, to remove the upward adjusting interestrate, to amend certain covenants and to issue new promissory notes and warrantsto purchase 1,950,000 shares of common stock of the Company at a price of $2.00per share and expiring on September 1, 2007. Under the terms of therenegotiated note payable agreement, each note holder received a note payable of$1,333,333 bearing interest at 15% per annum, due on September 1, 2004, and650,000 warrants to purchase shares of common stock. The notes payableagreements were subject to various operational and non-financial covenants, theviolation of which results in an event of default. Should there be an event ofdefault, the outstanding note balances are subject to an additional 3% interestper annum and the notes payable can be accelerated to be due immediately.Effective December 31, 2004, the notes payable were amended to waive any and allevents of default, including cross-defaults, and the maturity date was extendedto April 1, 2005. These notes were retired in March 2005 with proceeds from theCompany's IPO. At the time the $4,000,000 debt was issued, $929,626 in accrued interest was dueon the 15% Senior Notes. In accordance with the restructuring agreement, ofthis amount, $99,998 was converted into debt and applied to the new principalbalance, $500,000 was paid to the holders of the 15% Senior Notes, $75,000 wasapplied to the purchase of the 1,950,000 warrants to purchase shares of commonstock and $254,628 was forgiven. The Company accounted for the restructuring ofthese notes as a troubled debt restructuring in accordance with SFAS No. 15 "Accounting for Debtors and Creditors for Troubled Debt Restructurings", andaccordingly no gain was recognized on the restructuring. Rather, the face valueof $4,000,000 was increased by the amount of accrued interest, offset by thecash paid and warrants transferred, which had a fair value of $1,268 based onthe Black-Scholes model. (3) 12% Senior Notes Payable - Related Party In May 2003, the Company entered into a senior note purchase agreement with asyndicate that included two funds managed by DDJ; two directors of the Company;CSTN Ltd., a trust whose primary beneficiary is a director of the Company;Glenmont Enterprises, S.A., an entity controlled by a director of the Company;and Baker Hughes Finance, Incorporated, a shareholder with a position on theCompany's board of directors. Under the terms of the agreement, the syndicatecommitted to loan the Company up to $6,000,000 at a 12% annual interest ratethrough two different lending tranches. The 12% senior notes are due May 14,2006. Under the terms of the note payable agreement, the Company pays intereston the unpaid principal amount outstanding in cash quarterly in arrears fromtheir date of issuance until the senior notes are paid in full. The notepurchase agreement included warrants to purchase up to 3,000,000 common sharesof the Company, at a price of $1.00 per share, allocated among the syndicatemembers in the same pro rata percentage as their loan commitment. The warrantsexpire on May 14, 2006. No portion of the proceeds raised through the notepayable agreement was allocated to the warrants as the fair value of thewarrants on the date of issuance was immaterial. The note payable agreement is subject to various operational and non-financialcovenants, the violation of which results in an event of default. Should therebe an event of default, the outstanding note balance is subject to an additional3% interest per annum and the notes payable can be accelerated to be dueimmediately. The notes were in default, however effective December 31, 2004,the Company obtained a waiver that cured any and all events of default,including cross-defaults through December 31, 2004. These notes were retired inMarch 2005 with proceeds from the Company's IPO. (4) 12% Convertible Note Payable - Related Party In December 2004, the Company raised $2.5 million through the issuance of fourconvertible notes payable to a syndicate made up of three funds which arecontrolled by DDJ and a company controlled by a Frontera director. Eachconvertible note payable has the same terms and conversion features including aninterest rate of 12% per annum and a due date of March 15, 2005. Under theterms of the convertible note payable agreement, the Company pays interest onthe unpaid principal amount outstanding monthly from the date of issuance untilthe note is converted or matures. At any time prior to one business day priorto the maturity date, upon the successful closing of the public offering, theholders of the convertible notes may convert all or a portion of the notes intocommon shares of the Company at a conversion price which is equal to 80% of theprice established by the underwriter in connection with the potential publicoffering. These notes were converted into 1,081,858 shares in March 2005, and abeneficial conversion feature of $625,000 was recorded as interest expense onthat date. This conversion is discussed in further detail in Note C. (5) 2001 Stockholder Notes During March 2001, the Company raised $360,000 from the issuance of debt in theform of three notes payable of $120,000 each to certain stockholders at a rateof 6% per annum. Under the original terms, the notes were due on or beforeApril 14, 2001. Effective December 31, 2004, the note was amended to waive anyand all events of default, including cross-defaults, and the maturity date wasextended to April 15, 2005. The notes were retired in March 2005 from proceedsof the Company's IPO. (6) 2001 Stockholder Rights Offering and 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 entitle theholders to purchase an aggregate of 15,637,329 shares of common stock of theCompany at an exercise price of $0.032 per share. The notes are due on December31, 2006, and the warrants expire on December 31, 2006. Holders of common stockare entitled to purchase one Right for every 20.8333 shares of common stock heldon December 19, 2001. Holders of Series D preferred shares and Series Epreferred shares were entitled to purchase one Right for every 20.8333 shares ofcommon stock that their preferred shares could be converted into on December 19,2001. Each Right entitled the holder to purchase for $1 subscription price $1in principal amount of Notes and Warrants to purchase 31.25 shares of commonstock. In accordance with APB No. 14 "Accounting for Convertible Debt and DebtIssued with Stock Purchase Warrants", the Company allocated the proceeds to thenotes and the warrants based on relative fair values. Accordingly, $338,347 wasallocated to the notes, $37,478 was allocated to the warrants, and the remainingproceeds of $124,566 was recorded to paid-in capital. During 2003, a warrant holder exercised warrants to purchase 758,946 commonshares for $24,286, resulting in a $24,286 decrease in notes payable and acorresponding aggregate increase in common stock and additional paid in capital.During 2004, a warrant holder exercised warrants to purchase 37,500 commonshares for $1,200, resulting in a $1,200 decrease in notes payable and acorresponding aggregate increase in common stock and additional paid-in capital.During 2005 warrant holders exercised warrants to purchase 2,372,124 commonshares for $75,906 in cash. (7) 2004 Stockholder Notes - Related Party During the year ended December 31, 2004, the Company raised an aggregate amountof $1,358,211 from directors, officers and stockholders of the Company inamounts ranging from $10,000 up to $600,003 through the issuance of negotiablepromissory notes. The terms and conditions of the notes payable were identical,each issued at a rate of 1% per month due on various dates throughout 2004.Effective December 31, 2004 the notes were amended to waive any and all eventsof default, including cross-defaults, and the maturity date was extended toApril 15, 2005. These notes were retired in March and May 2005 from proceeds ofthe Company's IPO. (8) Negotiable Promissory Note Payable to Dynamic Trading, Inc. - Related Party During March 2001, the Company raised $250,000 from the issuance of debt in theform of a negotiable promissory note payable to Dynamic Trading, Inc. ("DynamicTrading"), a company controlled by a director of Frontera, at a rate of 6% perannum. At the time it was issued, the note was due on April 27, 2001. EffectiveDecember 31, 2004, the note was amended to waive any and all events of default,including cross-defaults, and the maturity date was extended to April 15, 2005.This note was retired in March 2005 from the proceeds of the Company's IPO. (9) Negotiable Promissory Note Payable to SEM Consulting, LLC #1 - Related Party During April 2001, in exchange for consulting services provided, the Companyissued to SEM Consulting, LLC ("SEM"), a company controlled by a director ofFrontera, a $175,000 negotiable promissory note payable at a rate of 6% perannum. During 2002, the Company made a payment to SEM of $108,200, of which$94,200 was applied to outstanding debt and $14,000 was applied to accruedinterest. Effective December 31, 2004, the note was amended to waive any andall events of default, including cross-defaults, and the maturity date wasextended to April 15, 2005. This note was retired in March 2005 with proceedsfrom the Company's IPO. (10) Negotiable Promissory Note Payable to SEM Consulting, LLC #2 - RelatedParty During December 2002, in exchange for consulting services provided, the Companyissued SEM a $210,000 negotiable promissory note payable at a rate of 6% perannum. At the time it was issued, the note was due on December 31, 2003.Effective December 31, 2004, the note was amended to waive any events ofdefault, including counter-defaults, and the due date was changed to April 15,2005. This note was retired in March 2005 with proceeds from the Company's IPO. (11) Negotiable Promissory Note Payable to CSTN, Ltd. - Related Party During August 2001, the Company raised $100,000, less a $5,000 commitment fee,from the issuance of a $100,000 negotiable promissory note payable to CSTN, Ltd.("CSTN") at a rate of 15% per annum. At the time it was issued, the note wasdue on March 8, 2002. Effective December 31, 2004, the note was amended towaive any and all events of default, including cross-defaults, and the maturitydate was extended to April 15, 2005. This note was retired in March 2005 withproceeds from the Company's IPO. (12) Negotiable Promissory Note Payable to Glenmont Enterprises S.A. - RelatedParty During August 2001, the Company raised $100,000, less a $5,000 commitment fee,from the issuance of a $100,000 negotiable promissory note payable to GlenmontEnterprises S.A. at a rate of 15% per annum. At the time it was issued, thenote was due on March 8, 2002. Effective December 31, 2004, the note wasamended to waive any and all events of default, including cross-defaults, andthe maturity date was extended to April 15, 2005. This note was retired in March2005 with proceeds from the Company's IPO. (13) DDJ Assigned Note Payable - Related Party In August 2002, the Company settled a disputed account payable which wasincurred in 2001 to Schlumberger Overseas S.A. ("Schlumberger") by issuing anote payable for $4,000,000. Under the terms of the Schlumberger note payableand settlement agreement, the Company agreed to pay Schlumberger $175,000 at thetime of the settlement and the remaining $3,825,000 on or before August 22,2005. The note bears interest at 5% per annum. The Schlumberger note was purchased by two funds controlled by DDJ(collectively, the "Assignees") on October 29, 2003. The Assignees assumed alllegal rights to the note as to which Schlumberger was entitled. On December 31,2004, the Assignees and the Company agreed to an option whereby the Companywould be allowed to purchase the Schlumberger note payable from the Assigneesfor $1.3 million, plus interest accrued at a rate of 12% per annum beginning onDecember 31, 2004. Further, the Company agreed to a mandatory repurchase of theSchlumberger note payable within ten business days of a successful public stockoffering. During March 2005 the Company exercised it's option to repurchase thenote using proceeds from the Company's IPO and the difference was recorded asforgiveness of debt income. (14) Saipem S.p.A. Note Payable 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 is due in full. The note bears interest at 5% per annum. (15) M-I Drilling Fluids Co. Note Payable During April 2001, the Company converted a $691,623 account payable to M-IDrilling Fluids Co. ("M-I") into a note payable for the same amount. Under theterms of the M-I note payable agreement, the Company agreed to pay M-I $691,623on or before April 1, 2002. The note bore interest at 9% per annum, payablemonthly beginning on May 1, 2001. Due to the financial condition of the Companyduring that period, the Company was unable to make all required principal andinterest payments, and the note was renegotiated in August 2003. At that time,the Company agreed to pay M-I $175,000 to settle the outstanding note payableand accrued interest. This settlement resulted in forgiveness of $516,623 indebt and $124,492 in accrued interest. In exchange for agreeing to settle thenote payable, the Company agreed to pay M-I up to 20% of its share of ProfitOil, as defined in the Production Sharing Contract and Refinery Study betweenthe Company and the State Company Georgian Oil, in excess of operating coststhrough the earlier of August 2007 or until M-I has recovered $641,115 from theCompany in additional cash payments. Because Profit Oil is determined based oncumulative operating expenses, the Company does not expect to pay M-I anyadditional amounts under this settlement; however, the $641,115 will continue tobe accrued in other long-term liabilities until August 2007 when the contingentaspect of the settlement expires. NOTE I - INCOME TAXES The Company files a consolidated U.S. federal income tax return. No benefit forU.S. income taxes has been recorded in these consolidated financial statementsbecause of Frontera's inability to recognize deferred tax assets underprovisions of SFAS 109. A reconciliation of the differences between incometaxes computed at the U.S. federal statutory rate of 34% and Frontera's reportedprovision for income taxes is as follows: Year ended December 31, 2005 2004 Income tax benefit (expense) at statutory rate $ 1,621,029 $ 1,886,619Utilization (benefit) of losses not recognized (1,621,029) (1,886,619) Income tax expense (benefit) at effective tax rate $ - $ - At December 31, 2005, the Company has a net operating loss carryforward ofapproximately $72.5 million for tax purposes that will expire at various datesthrough 2025. Significant components of the Company's deferred tax liabilities and assets asof December 31, 2005 and 2004 are as follows: Year Ended December 31, 2005 2004Deferred tax liabilities: Depreciation and amortization $ 328,891 $ - Accrued salaries - - Other - - Deferred tax assets: Net operating losses - U.S. 9,280,174 7,941,210 Net operating losses - Foreign 15,722,756 15,772,756 Depreciation and amortization - 61,335 Other 9,520 9,095 25,341,341 23,784,396Valuation allowance (25,341,341) (23,784,396) 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. NOTE J - DEFINED CONTRIBUTION SAVINGS PLAN The Company sponsors a defined contribution 401(k) savings plan which covers alleligible employees. Company matching contributions to the defined contributionplan are discretionary. During the years ended December 31, 2005 and 2004, theCompany made contributions of $3,561 and $3,313 to the defined contributionplan, respectively. NOTE K - COMMITMENTS AND CONTINGENCIES Operating Leases: The Company has non-cancelable operating leases for officefacilities and lodging. Approximate future minimum annual rental commitmentsunder these operating leases are as follows: Year Ending December 31, 2006 $ 403,287 2007 215,811 2008 218,989 2009 223,274 2010 256,830 $ 1,318,191 Rental expense for the years ended December 31, 2005 and 2004 was approximately$234,000 and $161,000, respectively. BJ Services Company Middle East Limited Litigation: In September 2004, BJServices Company Middle East Limited ("BJ Services") filed a claim in TbilisiDistrict Court in Tbilisi, Georgia against FEGL due to non-payment for servicesrendered. BJ Services performed certain oil field services for FEGL between Mayand June 2003; however, the Company has argued that the services were defectiveand that certain other charges were not properly levied. The BJ Services claimwith interest and penalties is $299,375, net of a $160,000 prepayment made bythe Company in advance of the services being undertaken. This matter wassettled in May 2005 by payment of $61,146 plus court fees of approximately$1,400. SOCAR Arbitration: In June 1998 Frontera Resources Azerbaijan Corporation, anindirect wholly owned subsidiary of the Company, entered into a productionsharing agreement with SOCAR, the State Oil Company of Azerbaijan Republic,hereafter referred to as the "Azerbaijan PSA". The Azerbaijan PSA coveredonshore oilfields in an area of Azerbaijan known as the K&K Block. The Companyand an operating partner undertook an exploration and development program on theK&K Block. The Company's relationship with SOCAR deteriorated as a result ofseveral disputes under the Azerbaijan PSA and the Company was unsuccessful atreaching a settlement with SOCAR. In October 2003, FRAC initiated arbitration proceedings against SOCAR to recoupfunds for oil deliveries made between 1999 and 2002. The Azerbaijan PSAprovided that arbitration shall be governed by the United National Commission onInternational Trade Law rules on arbitration and a hearing has been scheduledfor March 2005 in Stockholm, Sweden. In January 2006, FRAC, was awarded approximately $1,250,000 plus interest at arate equal to LIBOR plus 4% from January 1, 2001 until full payment is made inconnection with its binding arbitration case with SOCAR. The award alsoincluded a requirement for the Company to pay for certain costs of arbitrationof approximately $254,000 and to pay SOCAR approximately $290,000 for part ofSOCAR's costs of arbitration. The arbitration panel rejected all other claimsand counterclaims between the parties and the arbitration therefore resolves allclaims between Frontera and SOCAR with respect to the Azerbaijan PSA. InFebruary 2006, SOCAR filed a challenge to the arbitral award in the Svea Courtof appeal in Sweden. As part of its challenge, SOCAR requests that the Companybe required to pay all costs of the arbitrators and SOCAR's full costs for thearbitration. The Company intends to vigorously defend the challenge by SOCAR.No gain or loss from this ruling has been recorded in the Company's consolidatedfinancial statements pending ultimate resolution on this matter. Vendor Invoices: In August 2003 and July 2004, the Company settled vendorinvoices of $79,036 and $1,607,214, respectively. The terms of both settlementagreements provided that Frontera would not be responsible to repay theliability unless the Company generated Profit Oil revenues, as defined in theBlock 12 PSA by August 2007 and July 2008, respectively. Because Profit Oil isdetermined based on the recovery of cumulative costs incurred for thedevelopment of Block 12, the Company does not expect to pay these vendors anyadditional amounts under the settlements; however, the costs will continue to beaccrued until the Profit Oil contingency expires. NOTE L - NON-CASH INVESTING AND FINANCING ACTIVITIES The following non-cash transactions took place during the year ended December31, 2005: During 2005, a 12% Convertible $ 2,500,000 Note Payable to a related party wasconverted to common stock at a 20% discount. In conjunction with thistransaction the Company recorded a beneficial conversion feature to interestexpense and additional paid in capital of $625,000 and the related note payablewas retired. This transaction is discussed in further detail in Note C. During 2005 a Note Payable to a related party for $3,825,000 and related accruedinterest of $370,164 was settled for $1,332,055 resulting in forgiveness of debtincome of $ 2,863,109. During 2005, Related Party Notes Payable of $75,906 were utilized by noteholders to fund the exercise of common stock warrants with a total exerciseprice of $75,906. During 2005, an entity of the Georgian government acknowledged responsibility ofpreviously accrued social taxes, resulting in forgiveness of debt income of$1,131,134. During 2005, a number of old payables were deemed to be forgiven, resulting inforgiveness of debt income of $164,606. The following non-cash transactions took place during the year ended December31, 2004: The Company converted a vendor account payable of $3,450,941 into a note payablewhich matures in 2007. During 2004, the Company transferred a vendor account payable of $1,607,214 tolong-term liabilities upon the negotiation of a settlement agreement which willnot be recognized as income from forgiveness of debt until 2008. During 2004, the Company reacquired oil & gas properties of $2,532,598 byagreeing to forgive a $1,962,268 payable with the operator and by assuming thepayables and accrued liabilities of the operator. Included in this transactionwas the assumption of $3,802,712 in current liabilities and the acquisition ofcurrent assets of $1,270,114. At the time this transaction closed, the Companyreversed the existing $1,458,168 deferred gain associated with the 2003 sale ofan interest in the property which was never recognized. Independent Auditors' Report Board of DirectorsFrontera Resources Corporation We have audited the accompanying consolidated balance sheets of FronteraResources Corporation and Subsidiaries (the "Company") as of December 31, 2005and 2004, and the related consolidated statements of operations, stockholders'equity (deficit), and cash flows for the years then ended. These consolidatedfinancial statements are the responsibility of the Company's management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits. We conducted our audits in accordance with auditing standards generally acceptedin the United States of America. Those standards require that we plan andperform the audits to obtain reasonable assurance about whether the consolidatedfinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe consolidated financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, as wellas evaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofFrontera Resources Corporation and Subsidiaries at December 31, 2005 and 2004,and the consolidated results of their operations and their cash flows for theyears then ended, in conformity with accounting principles generally accepted inthe United States of America. Houston, TexasJanuary 28, 2006 This information is provided by RNS The company news service from the London Stock Exchange