Frontera Resources Regulatory News (FRR)

15 Nov 2007 07:03

Frontera Resources Corporation15 November 2007 FRONTERA RESOURCES CORPORATION Houston, Texas, U.S.A. - 15 November 2007 THIRD QUARTER RESULTS AND OPERATIONS REVIEW Frontera Resources Corporation (London Stock Exchange, AIM Market - Symbol: FRR;Over-the-Counter Market, U.S.A. - Symbol: FRTA), an independent oil and gasexploration and production company, today announced results for the quarterlyperiod ended 30 September 2007 and provided a review and update of itsoperations in Block 12, Georgia. Highlights For Quarter Ended 30 September 2007 Corporate • Strong cash position with over $62 million in cash and marketablesecurities to carry out Block 12 work programs into 2008. • Net loss of $5.9 million, or $0.08 per share, on a fully-dilutedbasis. • Operating expenses of $5.0 million, an increase of $1.7 million fromprevious year. Operations Review Taribani Field Unit Zone 9 development drilling commenced in the third quarter of 2007 as follows: • Re-entry and re-completion of the Dino #2 well were finished inSeptember; the well is now awaiting arrival of equipment for a frac-paccompletion in December. • A second well, T-#45, commenced and is currently drilling ahead. Itis expected to reach total depth of approximately 2,400 meters in December, atwhich time it will also receive a frac-pac completion. • Access road and drillsite location for a third well, Taribani South #1, was commenced in anticipation of drilling operations that are scheduled tocommence in December. Basin Edge Play Unit • Drilling commenced at the "C" Prospect. The Lloyd #1 well iscurrently drilling ahead and is expected to reach total depth of approximately2,700 meters in early December. Mirzaani Field Area Production Unit • Production operations continued at Mirzaani Field Area Production Unitat approximately 80 barrels per day. Mirzaani Field Area Exploration Unit • A farmout effort continues to seek a partner for drilling the MirzaaniDeep Prospect. Steve C. Nicandros, President and Chief Executive Officer, commented: "In the third quarter we continued to advance work across our portfolio ofbusiness units. Most significantly, we successfully commenced and progresseddrilling operations in two of our four primary business units. This haspositioned us for results from these operations in December and early 2008.Simultaneously, we have continued to maintain profitable production operations.As a result, our financial results reflect the expected investment to supportthis effort and, looking ahead, with our strong cash position we are wellpositioned to follow through and achieve the objectives we have targeted." OPERATIONS REVIEW Taribani Field Unit The Taribani Field is a large, undeveloped oil field covering an area ofapproximately 80 square kilometers with productive horizons situated in Mioceneand Pliocene age reservoirs. These reservoirs are located at depths between2,200 meters and 3,500 meters. The independent consulting firm Netherland,Sewell & Associates has assigned 118 million barrels of P3 reserves from Zones9, 14, 15 and 19 within the field. Additionally, Netherland, Sewell & Associateshas assigned as much as 36 million barrels of unrisked resource potentialassociated with five deeper horizons in the field. Frontera currently plans a thirty-six month, 20-well drilling program for Zone9, which represents approximately 17 percent of identified Taribani Fieldreserves. As part of this program, location construction and drillingoperations commenced during the third quarter for the initial three wells. Thefirst of these wells - the Dino #2 - was recompleted during September. Thedrilling rig was mobilized to the second well location, T-#45, in September andcommenced drilling on 10 October. This well is currently drilling ahead and isexpected to reach an estimated total depth of 2,400 meters in December. At thattime, specialized equipment will be mobilized to apply frac-pac completions tothis well and the Dino #2 well. The third scheduled Zone 9 well for this year -the Taribani South #1 - is expected to commence drilling in December. Eightadditional wells are planned for 2008. Basin Edge Play Unit Frontera's Basin Edge Play Unit is located along the northern border of Block 12and represents what the company believes is one of the newest and potentiallymost prolific exploration plays in the Upper Kura Basin. Netherland, Sewell andAssociates estimate total unrisked resource potential to be in excess of onebillion barrels of recoverable oil within the unit's two major prospects ("B"and "C"). Of this total, prior to the acquisition of new seismic datasuggesting an even larger structure, the "C" Prospect was estimated to containas much as 500 million barrels of recoverable oil. Frontera's primary reservoirtargets are located in the Cretaceous age carbonate rocks, with secondaryreservoir targets in the Miocene and Pliocene age clastic rocks as well asJurassic carbonates. During the third quarter, six kilometers of new access road and drillsiteconstruction were completed for the Lloyd #1 well, a drilling rig was mobilizedand drilling operations commenced on 17 September. The Lloyd #1 is currentlydrilling ahead and is expected to reach total depth in the primary objective inearly December, after which well results will be evaluated. At the Basin Edge "B" Prospect, Frontera completed new geologic field work thatwas integrated into the current interpretation and mapping of the prospect. Mirzaani Field Area Production Unit The Mirzaani Field Area Production Unit is comprised of three underdeveloped andundeveloped, shallow Pliocene-age fields with targeted normal pressurereservoirs situated between 400 meters and 1,500 meters deep. One of thesefields, the Mirzaani Field, currently produces at nominal production levelssufficient to yield annual revenues of approximately $2 million per year atcurrent oil prices. During the third quarter of 2007, production at the Mirzaani Field continued atapproximately 80 barrels per day. No oil sales were made of existing producedinventory in an effort to aggregate necessary volumes for efficient sale. Thenext expected sale of current inventory is planned during the fourth quarter of2007. In addition, design was completed and locations were chosen for two newwells that target existing, undeveloped field reservoir objectives at theMirzaani Field situated at approximately 1,200 meters in depth. These wells aredesigned to extend development of untapped portions of this field to increaseproduction and book additional reserves. Rig procurement has taken longer thanexpected and, as a result, these wells are scheduled to be drilled within thenext several months. Finally, new work progressed in the development of a planto target ultra-shallow oil reserves situated from 20 meters to 500 meters indepth throughout the three fields within the unit. Mirzaani Field Area Exploration Unit The Mirzaani Field Area Exploration Unit is an area of new prospectivitysituated beneath the existing shallow, Pliocene-age fields. In order toaccelerate testing of the Mirzaani Deep Prospect in parallel with ongoingoperations in other business units, an effort commenced during the secondquarter of 2007 to seek a farmout partner with which to undertake new drillingoperations at this important prospect within the next several months. Thiseffort continued through the third quarter. Block 12 Area-Wide Field/Prospect Inventory Development Unit During the third quarter of 2007 technical work progressed within Frontera'sBlock 12 Area-Wide Field/Prospect Inventory Development Unit. This unit isfocused on evolving and prioritizing the company's extensive inventory ofprospects within Block 12, including 19 identified prospects and leads and fiveundeveloped fields. FINANCIAL REVIEW - THIRD QUARTER 2007 For the three months ending 30 September 2007, Frontera incurred a net loss of$5.9 million, or $0.08 per share on a fully-diluted basis. This loss comparesto a net loss of $3.0 million, or $0.05 per share for the corresponding threemonths of 2006. The increase in the net loss reported is due primarily tohigher operating expenses and lower other income. There were no crude oil sales during the third quarter in 2007 or thecorresponding quarter in 2006. The next sale is expected to occur during thefourth quarter of 2007. Operating expenses were $5.0 million during the three months ending 30September, an increase of $1.7 million from $3.3 million in 2006. General andadministrative expenses increased by $1.4 million in 2007. The increases areprimarily attributable to supporting a ramp up of exploration and developmentactivities in 2007 as compared to the same period in 2006. Frontera incurred other expenses of $0.9 million during the third quarter of2007 as compared to other income of $0.3 million in 2006. The decrease in otherincome was largely attributable to additional interest expense of $1.8 millionas a result of completing a $67.0 million convertible note offering in May ofthis year. For the nine months ending 30 September, Frontera incurred a net loss of $13.4million, or $0.19 per share on a fully-diluted basis. This compares to a netloss of $8.1 million, or $0.13 per share for the first nine months of 2006. Theincrease in the net loss reported is due primarily to higher operating expensesand lower other income. Revenues from crude oil sales during the first nine months of 2007 were $1.9million, an increase of $1.1 million from $0.8 million during the same periodlast year. The increase in revenues was related to timing of crude oil sales,as crude oil produced in the last half of 2006 was not sold until January of2007. Operating expenses were $14.3 million during the first nine months of 2007, anincrease of $4.4 million from $9.9 million in 2006. In 2007, Frontera incurred a$2.0 million non-cash charge related to the expensing of stock options inaccordance with provisions of SFAS 123R, as compared to $2.2 million in theprior year. Field operating and project costs increased by $2.1 million thisyear owing to additional costs associated with the ramp-up of our work programsin Georgia and the production costs associated with the oil sold this year. Frontera incurred other expenses of $0.9 million during the first nine months of2007 as compared to other income of $1.1 million in 2006. The decrease in otherincome was largely attributable to additional interest expense of $2.6 millionas a result of completing a $67.0 million convertible note offering in May ofthis year. Enquiries: Frontera Resources Corporation Liz Williamson Vice President, Investor Relations and Corporate Communications (713) 585-3216 lwilliamson@fronteraresources.com Brunswick Group LLP Patrick Handley / Mark Antelme +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. 2. The reserve information herein was determined by the independentconsulting firm of Netherland, Sewell & Associates in accordance with thepetroleum resource definitions adopted by the Society of Petroleum Engineers(SPE), World Petroleum Council (WPC) and the American Association of PetroleumGeologists (AAPG) in 2000. 3. This release contains certain forward-looking statements, including,without limitation, expectations, beliefs, plans and objectives regarding thepotential transactions, potential drilling schedule and ventures discussed inthis release, as well as reserves, future drilling, development and production.Among the important factors that could cause actual results to differ materiallyfrom those indicated by such forward-looking statements are future explorationand development results, availability and performance of needed equipment andpersonnel, seismic data, fluctuations in oil and gas prices, weather conditions,general economic conditions and the political situation in Georgia andneighbouring countries. There is no assurance that Frontera's expectations willbe realized, and actual results may differ materially from those expressed inthe forward-looking statements. Frontera Resources Corporation and Subsidiaries Condensed Consolidated Financial Statements Three and Nine Months Ended September 30, 2007 and 2006 Page(s) Condensed Consolidated Financial Statements (Unaudited) Balance Sheets............................................................ 1 Statements of Operations.................................................... 2 Statement of Stockholders' Equity........................................... 3 Statements of Cash Flows.................................................... 4 Notes to Financial Statements............................................... 5-10 Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 11-18 September 30, December 31, 2007 2006 AssetsCurrent assets Cash and cash equivalents $ 7,174,954 $ 9,927,181 Restricted cash 15,126,728 - Short-term investments 40,075,006 14,823,000 Accounts receivable 117,467 139,107 Inventory 7,546,137 3,124,858 Prepaid expenses and other current assets 3,587,939 267,720 Total current assets 73,628,231 28,281,866 Property and equipment, net 939,566 1,081,213Oil and gas properties, full cost method Properties being depleted 23,750,981 23,750,981 Properties not subject to depletion 38,520,726 27,631,505 Less: Accumulated depletion (21,368,707) (21,107,707) Net oil and gas properties 40,903,000 30,274,779Other assets 1,885,203 - Total assets $ 117,356,000 $ 59,637,858Liabilities and Stockholders' EquityCurrent liabilities Accounts payable $ 146,212 $ 566,396 Accrued liabilities 6,670,099 518,004 Current maturities of notes payable-vendor - 3,450,941 Current maturities of notes payable-related party - 51,097 Total current liabilities 6,816,311 4,586,438Convertible notes payable 66,900,000 -Other long-term liabilities 39,675 41,669 Total liabilities 73,755,986 4,628,107Commitments and contingenciesStockholders' equity Common stock 2,821 2,818 Additional paid-in capital 151,601,316 149,499,177 Common stock warrants 1,266 1,266 Treasury stock, at cost (567,832) (567,832) Accumulated deficit (107,437,557) (94,050,228) Accumulated other comprehensive income - 124,550 Total stockholders' equity 43,600,014 55,009,751 Total liabilities and stockholders' equity $ 117,356,000 $ 59,637,858 Three Months Ended Nine Months Ended September 30, September 30, 2007 2006 2007 2006 Revenue - crude oil sales $ $ $ 1,878,540 $ 758,630 - -Operating expensesField operating and project costs 594,824 271,831 3,031,388 918,749General and administrative 4,272,978 2,848,286 10,713,027 8,335,030Depreciation, depletion and amortization 133,677 214,552 534,598 679,245 Total operating expenses 5,001,479 3,334,669 14,279,013 9,933,024 Loss from operations (5,001,479) (3,334,669) (12,400,473) (9,174,394)Other income (expense)Forgiveness of debt - - - 11,732Interest income 972,090 364,882 1,791,537 1,291,263Interest expense (1,830,117) (76,821) (2,814,541) (221,600)Other, net 3,837 16,406 36,148 26,930 Total other income (854,190) 304,467 (986,856) 1,108,325 (expense) Net loss $(5,855,669) $(3,030,202) $(13,387,329) $(8,066,069)Loss per shareBasic and diluted $ $ $ $ (0.08) (0.05) (0.19) (0.13)Number of shares used incalculating loss per shareBasic and diluted 70,459,278 66,810,763 70,409,783 61,502,366 Accumulated Additional Common Other Total Common Paid-in Stock Treasury Accumulated Comprehensive Stockholders' Stock Capital Warrants Stock Deficit Income Equity Balances at December 31, $2,818 $149,499,177 $1,266 $(567,832) $(94,050,228) $124,550 $55,009,7512006 Conversion of 2 99,998 - - - - 100,000convertible debt Exercise of common stock 1 18,399 - - - - 18,400options Compensation - 1,983,742 - - - - 1,983,742expense-common stock options Unrealized gain on - - - - - 53,420 53,420marketable securities Reclassification adjustment for gains on marketable securities - - - - - (177,970) (177,970)included in net income Net loss - - - - (13,387,329) - (13,387,329)Total comprehensive loss - - - - - - (13,511,879)for the year Balances at September $2,821 $151,601,316 $1,266 $(567,832)$(107,437,557) $- $43,600,01430, 2007 Nine Months Ended September 30, 2007 2006 Cash flows from operating activitiesNet loss $ (13,387,329) $ (8,066,069)Adjustments to reconcile net loss to net cash used in operating activities Depreciation, depletion and amortization 534,598 679,245 Gain on sale - (85,000) Interest income-restricted cash (126,728) - Debt issuance cost amortization 152,725 - Amortization of warrants - 72,504 Stock based compensation 1,983,742 2,174,287 Forgiveness of debt - (11,732)Changes in operating assets and liabilities: Accounts receivable 21,640 (32,755) Inventory (4,421,279) (857,597) Prepaid expenses and other current assets (3,320,219) 239,999 Accounts payable (420,184) (519,432) Accrued liabilities 6,152,095 (832,458) Other long-term liabilities (1,994) 41,033 Net cash used in operating activities (12,832,933) (7,197,975)Cash flows from investing activitiesInvestment in oil and gas properties (10,889,219) (21,698,405)Investment in property and equipment (131,953) (71,502)Restricted cash (5,000,000) -Restricted short-term investments - (1,225,000)Net redemption (purchase) of other short-term investments (10,451,556) 22,036,511Purchase of auction rate securities (33,150,000) -Redemption of auction rate securities 18,225,000 -Proceeds from disposal of property, plant and equipment - 85,000 Net cash used in investing activities (41,397,728) (873,396)Cash flows from financing activitiesRepayments of borrowings (3,502,038) -Proceeds from convertible debt 66,500,000 -Restricted cash (10,000,000) -Exercise of common stock warrants - 3,072,879Debt issuance costs (1,537,928) -Exercise of common stock options 18,400 525,000 Net cash provided by financing activities 51,478,434 3,597,879 Net decrease in cash and cash equivalents (2,752,227) (4,473,492)Cash and cash equivalentsBeginning of year 9,927,181 19,586,747End of period $ 7,174,954 $ 15,113,255Supplemental disclosure of noncash investing and financing activitiesNotes payable used to exercise common stock warrants $ - $ 212,174Noncash debt issuance costs 500,000 -Conversion of debt to common stock 100,000 - 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 Soviet Union. 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. Basis of Presentation and Summary of Significant AccountingPolicies The condensed consolidated balance sheet of the Company at December 31, 2006 wasderived from the Company's audited consolidated financial statements as of thatdate. The condensed consolidated balance sheet at September 30, 2007, thecondensed consolidated statements of operations for the three and nine monthperiods ended September 30, 2007 and 2006, the condensed consolidated statementof changes in stockholders' equity for the nine month period ended September 30,2007, and the condensed consolidated statements of cash flows for the nine monthperiods ended September 30, 2007 and 2006 were prepared by the Company. In the opinion of Company management, all adjustments, consisting of normalrecurring adjustments, necessary to state fairly the consolidated financialposition, results of operations and cash flows were recorded. The results ofoperations for the nine month period ended September 30, 2007 are notnecessarily indicative of the operating results for a full year or of futureoperations. Certain information and footnote disclosures normally included in financialstatements presented in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted. Theaccompanying condensed consolidated financial statements should be read inconjunction with the financial statements and notes thereto contained in theCompany's consolidated financial statements for the year ended December 31,2006. Certain amounts in the unaudited condensed consolidated financial statementshave been reclassified in the prior period to conform with current periodpresentation. Reclassifications have no impact on the Company's financialposition, results of operations, or cash flows. For a description of the Company's accounting policies, refer to Note 2 of the2006 consolidated financial statements. Restricted Cash At September 30, 2007 the Company had approximately $15,127,000 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 $10,127,000 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. See Note 5 for further discussion of the convertible notes terms. AtDecember 31, 2006, the Company had no cash equivalents restricted as to use oravailability. 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 September 30, 2007, short-term investments consist of investments in M-STARSwith an estimated fair value of $40,075,006 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. 3. Detail of Certain Balance Sheet Accounts 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: September 30, December 31, 2007 2006 Materials and supplies $ 6,722,603 $ 1,405,610Crude oil 823,534 1,719,248 $ 7,546,137 $ 3,124,858 Accrued liabilities consist of the following: September 30, December 31, 2007 2006 Accrued payables $ 4,876,568 $ 331,103Accrued interest 1,672,500 58,097Accrued benefits 121,031 128,804 $ 6,670,099 $ 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 its 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 early January 2007. Notes payable-related party outstanding as ofSeptember 30, 2007 and December 31, 2006 was $0 and $51,097, respectively. During the first nine months of 2006, warrant holders exercised warrants topurchase 8,907,884 common shares for approximately $72,879. Notes 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. The note bears interest at 5% per annum.Notes payable-vendor outstanding as of September 30, 2007 and December 31, 2006was $0 and $3,450,941, respectively. During the first nine months of 2006, warrants were exercised to purchase3,000,000 common shares for $3,000,000 related to a prior senior note. 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 shares 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 shares 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 $1.9 million wereincurred, of which approximately $1.4 million was paid in cash and $0.5 millionof additional convertible notes were issued for the remainder. During June 2007, note holders holding $100,000 of convertible notes elected toconvert their notes into 59,880 common shares. For the nine months ended September 30, interest payments were $1,004,866 in2007 and $258,393 in 2006. 6. Income Taxes The Company has incurred losses since inception and, therefore, has not beenrequired to pay federal income taxes. In accordance with applicable generallyaccepted accounting principles, the Company estimates for each interim reportingperiod the effective tax rate expected for the full fiscal year and uses thatestimated rate in providing income taxes on a current year to date basis. TheCompany has established a valuation allowance that is primarily attributable toU.S. federal deferred tax assets. Management believes enough uncertainty existsregarding the realization of the deferred items and has recorded a fullvaluation allowance. On January 1, 2007, the Company adopted the provisions of FASB InterpretationNo. 48 ("FIN48"), Accounting for Uncertainty in Income Taxes. The Company hasdetermined 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 ofSeptember 30, 2007. The Company and its subsidiaries file income tax returns inthe US federal jurisdiction. Tax years 2002 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 September 30, 2007. For the nine months ended September 30, 2007 and 2006, no income tax paymentswere made. 7. Commitments and Contingencies 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&K Block". 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 fromthe K&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 refused to pay the award and filed an action in the Svea Court of Appealsin Stockholm seeking to annul the award. The Company moved to dismiss onprocedural grounds, and the Svea Court of Appeals recently ruled in theCompany's favor on a majority of the counts. Final disposition is expected in2008. As a result of SOCAR's refusal to pay the award, the Company commenced anaction in the United States District Court for the Southern District of New Yorkin February 2006, seeking to enforce the award. In March 2007, the DistrictCourt granted SOCAR's motion to dismiss, and the Company appealed that decisionin July 2007 to the United States Court of Appeals for the Second Circuit. Thehearing on the appeal is expected to occur in the first 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 FRGC upon the fulfillment ofcertain financial and work program commitments. In September 2004, as requiredunder the terms of the Farmout Agreement, GAC reassigned its interest in Block12 to Frontera as a result of GAC's default on its financial and work programcommitments. The notice of arbitration and claim alleges that GAC did notdefault on its obligations under the Farmout Agreement and should be awarded a25% working interest in Block 12, a 12.5% ownership interest in FRGC and aproportionate share of the revenue from oil sales from July 2002 to August 2003. 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. Frontera considers the GAC claimto be without merit and intends to vigorously defend itself against this claim. 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 was outstanding atSeptember 30, 2007 and December 31, 2006. The Board of Directors may designateand authorize the issuance of such shares with such voting power and in suchclasses and series, and with such designation, preferences and relativeparticipation, optional, or other special rights, qualifications, limitations,or restrictions as deemed appropriate by the Company's Board of Directors. Common Stock As of September 30, 2007 and December 31, 2006 the Company was authorized toissue 200,000,000 shares of common stock, par value $.00004 per share. As ofSeptember 30, 2007 and December 31, 2006, the Company had 70,463,408 and70,383,528, respectively, of common shares issued and outstanding. At September 30, 2007 and December 31, 2006, there were an additional 13,508,000 and11,310,000 shares, respectively, of common stock reserved for the exercise ofexisting options and warrants. Treasury Stock At September 30, 2007 and December 31, 2006, the Company had 5,739,855 shares oftreasury stock, all held as common shares. For the nine months ended September 30, the Company recognized stock-basedcompensation expense related to common stock options of approximately $2.0million in 2007 and $2.2 million in 2006. Stock-based compensation expense isreflected in general and administrative expense in the consolidated statementsof operations. 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 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. The financial information with respect to the three and nine month periods endedSeptember 30, 2007 and 2006 that is discussed below is unaudited. In theopinion of management, this information contains all adjustments, consistingonly of normal recurring accruals, necessary for the fair presentation of theresults for such periods. The results of operations for the interim periods arenot necessarily indicative of the results of operations for the full fiscalyear. 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 Soviet Union.Prior to 2002, the Company's other significant operating focus was on theexploration 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 Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30,2006 Revenue. Total revenue increased to $1.9 million for the nine months endedSeptember 30, 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$14.3 million for the nine months ended September 30, 2007 compared to $9.9million 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 $2.1 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 ofa ramp up in the company's exploration and development activities in 2007 ascompared 2006. DD&A decreased $0.2 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 $2.4 million to $10.7 million forthe nine months ended September 30, 2007 from $8.3 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 and wages accounted for $1.2 million of the increase.Legal and investor relations expenses increased $0.5 million and travel was up$0.3 million as the company's exploration and production activities increased in2007 as compared to 2006. The remaining $0.4 million increase was associatedwith IT infrastructure improvements and other office services which increasedwith the size of the organization in 2007 as compared to 2006. Other Income (Expense). Total other expense increased to $1.0 million in thenine month period ended September 30, 2007 from other income of $1.1 million inthe nine month period ended September 30, 2006. The $2.1 million increase isprimarily attributable to an increase in interest expense of $2.6 millionpartially offset by a $0.5 million increase in interest income. Interest income increased to $1.8 million for the nine months ended September30, 2007 from $1.3 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 $2.8 million for the nine months ended September30, 2007 from $0.2 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 of 2007. Results of Operations Three Months Ended September 30, 2007 Compared to Three Months Ended September30, 2006 Revenue. There were no revenues for the three months ended September 30, 2007and 2006. The Q3 2007 production is expected to be sold in Q4 2007 and the 2006production for the same period was sold in early 2007. Operating Costs and Expenses. Total operating costs and expenses increased to$5.0 million for the three months ended September 30, 2007 compared to $3.3million 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 $0.6 million duringthe three months ended September 30, 2007 as compared to $0.3 million for thethree months ended September 30, 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 September 30, 2007 ascompared to the three months ended September 30, 2006 primarily due to lowerdepletion expense associated with lower production volumes in 2007, and our oilprocessing facility becoming fully depreciated during 2007. General and administrative expenses increased $1.5 million to $4.3 million forthe nine months ended September 30, 2007 from $2.8 million for the comparableperiod in 2006. The increase was attributable to an increase in compensationexpense of $0.6 million of which $0.2 million related to a non-cash charge forstock option compensation expense under the provisions of SFAS 123R. Theremaining $0.4 million increase in compensation expense was attributable to thetiming and amount of bonuses in 2007 versus 2006. Legal and investor relationsexpenses increased $0.2 million and travel was up $0.2 million as the company'sexploration and production activities increased in 2007 as compared to 2006.The remaining $0.5 million increase was associated with IT infrastructureimprovements and other office services which increased with the size of theorganization in 2007 as compared to 2006. Other Income (Expense). Total other expense increased to $0.9 million in thethree month period ended September 30, 2007 from other income of $0.3 million inthe three month period ended September 30, 2006. The $1.2 million increase isprimarily attributable to an increase in interest expense of $1.8 millionpartially offset by a $0.6 million increase in interest income. Interest income increased to $1.0 million for the three months ended September30, 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 September30, 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 of 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 September 30, 2007, ourcash and cash equivalents were $7.2 million, our short term investments were$40.1 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 September 30, 2007, theCompany's stock was trading at $1.45. The remaining $5.0 million serves ascollateral for a $5.0 million line of credit that is used from time to time tosupport letters of credit that provide financial assurance that the Company willfulfill its obligations with respect to service contracts with certain vendors.See notes 4 and 5 of the attached financial statements for further discussion ofthe convertible notes, the line of credit and the restricted cash. At September30, 2007 the company had $66.9 million of convertible long term debtoutstanding. The company had no other outstanding debt at September 30, 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 capital expenditure budget for the nexttwelve months. We estimate that our total capital expenditures for 2007 will be approximately$37.9 million, of which $11.0 million had been spent as of September 30, 2007.Our planned 2007 capital expenditures represent a 74% increase over 2006. Our 2007 capital expenditures are focused on growing and developing our reservesand production on our existing Block 12 acreage. Of our total $37.9 millioncapital expenditure budget, approximately $37.0 million is budgeted forexploration and production activities. We plan to drill three wells in theTarabani unit, and one well in Basin Edge Unit and one shallow well in theMirzaani Field Area Shallow Production Unit. The 2008 capital expenditure program is estimated to be $20 million. It isenvisaged that these capital expenditures, all of which are discretionary, wouldbe used to drill a new well on the Basin Edge Unit, a new well in the TarabaniUnit, and one shallow well in the Mirzaani Field Area Shallow Production Unit. There could be significant additional capital expenditures associated withdrilling in 2008, depending on the results of the 2007 program and theavailability of financing on acceptable terms. Cash Flow Activity Operating Activities. Cash flows used in operating activities increased $5.6million to $12.8 million for the nine months ended September 30, 2007 from $7.2million for the nine months ended September 30, 2006. The increase wasprimarily attributable to a higher net loss of $13.4 million for the nine monthsended September 30, 2007 as compared to $8.0 million for the comparable periodin 2006. The higher net loss was primarily attributable to increased generaland administrative costs and field operating costs due to a ramp up in activityduring 2007 as compared to 2006. Investing Activities. Cash flows used in investing activities increased to$41.4 million in the nine month period ended September 30, 2007 from $0.9million in the 2006 period. The increase was primarily attributable to a net$25.4 million purchase of short term investments and auction rate securities in2007 compared with a $22.0 million redemption in short term investments for the2006 period. This was partially offset by an $10.8 million decrease in capitalexpenditures for the nine months ended 2007 as compared to 2006 as the Company'sdrilling campaign was launched later than originally expected in 2007 and therewere substantially less seismic and geophysical expenses in 2007 as the 3Dprogram was completed during the first nine months of 2006. 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 nine months ended September 30,2007, 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 4 in the attached condensed consolidated financial statements.We used the net proceeds to fund our capital expenditure programs and forgeneral corporate purposes and short term investments. Our financing activitiesprovided $51.4 million in cash for the nine month period ended September 30,2007 compared to $3.6 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 September 30, 2007 (in millions): Payments Due by Period Less than 2-3 4-5 After 5 Total 1 Year Years Years Years Contractual Obligations and Commitments Long-term debt-principal $ 66.9 $ - $ - $ 66.9 $ -Long-term debt-interest 30.8 6.7 13.4 10.7 -Lease agreements 0.9 0.3 0.4 0.2 -Total contractual obligations and commitments $ 98.6 $ 7.0 $ 13.8 $ 77.8 $ - 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 to agree 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 refining capacity; • 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 oil reserves; • cash flow and liquidity; • financial position; • business strategy; • amount, nature and timing of capital expenditures, including future development costs; • 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. 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