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Press release from Marketwire

Fairborne Energy Ltd.- First Quarter Interim Report and News Release

Tuesday, May 04, 2010

Fairborne Energy Ltd.- First Quarter Interim Report and News Release00:05 EDT Tuesday, May 04, 2010 CALGARY, ALBERTA--(Marketwire - May 4, 2010) - Fairborne Energy Ltd. (TSX:FEL) HIGHLIGHTS ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, 2010 2009 CHANGE -------------------------------------- Financial ($thousands, except per share amounts) Petroleum and natural gas revenue 63,382 68,545 (8%) Funds generated from operations(1) 39,555 32,970 20% Per share - basic $0.39 $0.38 3% Per share - diluted $0.38 $0.38 - Cash flow from operations (including changes in working capital) 43,522 34,782 25% Per share - basic $0.42 $0.40 5% Per share - diluted $0.42 $0.40 5% Net income (loss) 3,809 (4,691) 181% Per share - basic $0.04 $(0.05) 180% Per share - diluted $0.04 $(0.05) 180% Exploration and development expenditures 65,546 52,645 25% Acquisitions, net of dispositions 1,464 - - Working capital deficit 34,611 31,641 9% Bank indebtedness 102,536 209,925 (51%) Convertible debentures 96,993 95,024 2% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Operations (Units as noted) Average production Natural gas (Mcf per day) 60,878 67,520 (10%) Crude oil (bbls per day) 3,000 3,599 (17%) Natural gas liquids (bbls per day) 686 572 20% Sulphur (tonnes per day) (2),(4) 54 93 (42%) ---------------------------------------------------------------------------- Total (BOE per day) 13,886 15,517 (11%) ---------------------------------------------------------------------------- Average sales price (3) Natural gas ($ per Mcf) 5.75 6.39 (10%) Crude oil ($ per bbl) 79.24 56.98 39% Natural gas liquids ($ per bbl) 48.71 27.24 79% Sulphur ($ per tonne) (4) - 185.15 - ---------------------------------------------------------------------------- Netback per BOE ($ per BOE) Petroleum and natural gas sales (3) 44.97 43.35 4% Sulphur block revenue 5.57 3.83 45% Royalties (4.43) (5.78) (23%) Operating expenses (8.82) (12.47) (29%) Transportation (1.03) (1.14) (10%) ---------------------------------------------------------------------------- Operating netback 36.26 27.79 30% ---------------------------------------------------------------------------- Wells drilled (gross) 16 16 - Undeveloped land (net acres) 229,270 222,936 3% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Funds generated from operations is calculated using cash flow from operations as presented in the consolidated statement of cash flows before non-cash working capital and asset retirement expenditures. 2) A BOE conversion ratio has been calculated using a conversion rate of one tonne of sulphur to one barrel. 3) Excludes the change in fair value of derivatives. 4) Excludes the sale of inventory at the West Pembina sulphur block. STRATEGIC CAPITAL SPENDING INITIATES PERFORMANCE GROWTH FOR 2010In the first quarter of 2010, Fairborne executed a focused capital program which resulted in exit production of 15,500 BOE per day, up 14% from fourth quarter average production of 13,542 BOE per day. First quarter drilling included the development of light crude oil properties at Sinclair and Brazeau and the liquid rich natural gas properties at Harlech and Westerose, as well as the continued successful development of the natural gas Wilrich play in Marlboro. The initial impact of the successful capital program was reflected in first quarter financial and operating results which included:- Exit production of 15,500 BOE per day at the end of the quarter (68 MMcf per day of natural gas, 4,200 bbls per day of light oil and NGL's);- First quarter average production of 13,886 BOE per day (61 MMcf per day of natural gas, 3,686 bbls per day of light oil and NGL's), up 3% from fourth quarter 2009 production of 13,542 BOE per day;- Capital expenditures of $67 million, including $11.2 million on land and seismic and $43.9 million on drilling and completions activities;- Drilling program of 16 (12.8 net) wells including four (3.6 net) oil wells at Sinclair; three (2.5 net) liquid rich natural gas wells at Harlech; the first (0.9 net) horizontal oil well in Brazeau, two (1.7 net) horizontal gas wells in Marlboro and two (2.0 net) horizontal wells at Westerose;- Funds generated from operations of $39.6 million ($0.39 per share), 20% higher than the first quarter of 2009 ($33.0 million);- Operating netback of $36.26 per BOE with operating costs of $8.82 per BOE;- Above-average realized natural gas prices with 42% of first quarter natural gas production hedged at an average price of $6.59 per Mcf.- 34% of natural gas production hedged for the balance of 2010 at an average price of $6.58 per Mcf.- The Company has received approval from its banking syndicate to maintain its borrowing base at the current level of $285 million.PRODUCTION AND OPERATING RESULTSFairborne's first quarter drilling program resulted in 16 (12.8 net) new wells, the majority of which were brought on production during the month of March for first quarter exit production of 15,500 BOE per day. Current production remains consistent between 15,500 and 16,000 BOE per day, with approximately 68 MMcf per day of natural gas and 4,200 bbls per day of crude oil and natural gas liquids. With the majority of additional production commencing at the end of the quarter, first quarter average production of 13,886 BOE per day was 3% higher than fourth quarter 2009 production of 13,542 BOE per day.The benefits of cost reduction initiatives which began in 2009 were sustained through the first quarter of 2010 with operating costs of $8.82 per BOE and an operating netback of $36.26 per BOE. Funds generated from operations of $39.6 million were used to partially fund the first quarter capital expenditure program of $67 million with the balance of spending funded from working capital, leaving $148 million of available credit (net of working capital) at the end of the quarter. With spring break-up, second quarter capital spending is expected to be approximately $12 million.FOCUSED ASSET DEVELOPMENTFairborne's first quarter capital program was focused on the continued advancement of emerging plays and the development of identified projects within the Company's asset base which could provide the greatest return in light of current market conditions. Based on the continuation of low natural gas prices, a portion of first quarter capital spending was allocated to crude oil and liquid rich natural gas properties to help maintain strong netbacks and stable cash flow.- Sinclair: Ongoing development of the high netback Sinclair oil property through drilling of four wells (3.6 net) and continued implementation of the successful waterflood pilot project. Additional wells and waterflood expansion are planned for the remainder of 2010.- Brazeau: In the Brazeau Belly River Unit 6, Fairborne drilled, completed, and brought on production one (0.9 net) horizontal well during the first quarter. This well has been on production for approximately 30 days and produces at a stabilized rate of 200 barrels per day of 42� API oil. The Company has identified a number of follow up locations in the Unit and Fairborne is planning to drill up to three (2.7 net) additional wells during the remainder of 2010.- Marlboro: Fairborne continued the development of the Wilrich play on its Marlboro property with two (1.7 net) successful horizontal wells drilled and completed prior to spring breakup. A third well was drilling at the end of the first quarter and will be completed in late June or early July 2010. Concurrently, a compression expansion project was completed, and with the first quarter drilling, has resulted in sales gas increasing from 20 MMcf per day (12 MMcf per day net) at the beginning of January 2010 to 31 MMcf per day (21 MMcf per day net). The Company plans to drill up to nine additional Wilrich horizontal wells in the second half of 2010. Fairborne has continued to grow its land position on the Wilrich fairway and currently controls 83.1 (59.2 net) sections.- Harlech: Fairborne continues to develop the Harlech area targeting multizone vertical wells. The zones targeted (Viking, Mannville, Glauconite and Gething) result in liquid rich natural gas and condensate production. During the first quarter, Fairborne drilled three (2.5 net) vertical wells with combined incremental production of 5.1 MMcf per day and 325 bbls per day of condensate and natural gas liquids, providing netbacks in excess of $30 per BOE. The Company plans to drill up to three additional wells in the second half of 2010.OUTLOOKWe are pleased with the results we have achieved in the first four months of 2010. Although natural gas prices continue to remain weak, we have assembled a diverse portfolio of assets that allow us the opportunity to react to market conditions and re-allocate our spending in order to maintain high operating netbacks and achieve strong cash flows. Our success over the past few months has provided a significant increase in production at the end of the first quarter. Moving forward in 2010, cash flow from operations will benefit from increased production levels as well as our risk management program with 34% of natural gas production for the balance of 2010 hedged at an average price of $6.58 per Mcf. We continue to exercise financial discipline to maintain a strong balance sheet and ensure we have the financial flexibility to take advantage of growth opportunities as they arise.Steven R. VanSicklePresident & CEOMay 3, 2010MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following Management Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") was prepared at, and is dated, May 3, 2010. This document is provided by the management of Fairborne Energy Ltd. ("Fairborne" or the "Company") to review first quarter 2010 activities and results as compared to the same period in the previous year, and should be read in conjunction with the unaudited interim consolidated financial statements including selected notes for the three months ended March 31, 2010 and the audited consolidated financial statements including notes for the years ended December 31, 2009 and 2008. The MD&A should be read in conjunction with the Company's MD&A for the year ended December 31, 2009, as disclosure which is unchanged from the December 31, 2009 MD&A has not been duplicated herein. Additional information relating to Fairborne, including Fairborne's annual information form, is available on SEDAR at www.sedar.comNature of Business: Fairborne is a growth-oriented exploration and production company. The Company maintains its head office in Calgary and is engaged in the business of exploring for, developing, acquiring and producing crude oil and natural gas in Western Canada. Fairborne follows a strategy of balancing risk and reward by focusing on opportunities by geographic area and prospect type. Within the selected areas, the Company develops a portfolio of exploration and development prospects in conjunction with an active acquisition strategy. Fairborne resulted from the reorganization of Fairborne Energy Trust (the "Trust") on December 19, 2007 (the "Reorganization").Forward Looking Statements: This document contains forward-looking statements. Management's assessment of future plans and operations, drilling plans and the timing thereof, plans for the tie in and completion of wells and the timing thereof, budgeted quarterly capital expenditures and 2010 budgeted capital expenditures and the method of funding thereof and the nature of the expenditures may constitute forward-looking statements under applicable securities laws and necessarily involve risks including, without limitation, risks associated with oil and gas exploration, development, exploitation, production, marketing and transportation, loss of markets, volatility of commodity prices, currency fluctuations, imprecision of reserve estimates, environmental risks, competition from other producers, inability to retain drilling rigs and other services, incorrect assessment of the value of acquisitions, failure to realize the anticipated benefits of acquisitions, the inability to fully realize the benefits of the acquisitions, delays resulting from or inability to obtain required regulatory approvals and ability to access sufficient capital from internal and external sources. As a consequence, the Company's actual results may differ materially from those expressed in, or implied by, the forward looking statements. Forward looking statements or information are based on a number of factors and assumptions which have been used to develop such statements and information but which may prove to be incorrect. Although Fairborne believes that the expectations reflected in such forward-looking statements or information are reasonable, undue reliance should not be placed on forward looking statements because the Company can give no assurance that such expectations will prove to be correct. In addition to other factors and assumptions which may be identified in this document and other documents filed by the Company, assumptions have been made regarding, among other things: the impact of increasing competition; the general stability of the economic and political environment in which Fairborne operates; the ability of the Company to obtain qualified staff, equipment and services in a timely and cost efficient manner; drilling results; the ability of the operator of the projects which the Company has an interest in to operate the field in a safe, efficient and effective manner; Fairborne's ability to obtain financing on acceptable terms; field production rates and decline rates; the ability to replace and expand oil and natural gas reserves through acquisition, development or exploration; the timing and costs of pipeline, storage and facility construction and expansion; the ability of the Company to secure adequate product transportation; future oil and natural gas prices; currency, exchange and interest rates; the regulatory framework regarding royalties, taxes and environmental matters in the jurisdictions in which the Company operates; and Fairborne's ability to successfully market its oil and natural gas products. Readers are cautioned that the foregoing list of factors is not exhaustive. Additional information on these and other factors that could affect the Company's operations and financial results are included in reports on file with Canadian securities regulatory authorities and may be accessed through the SEDAR website (www.sedar.com) or at the Company's website (www.fairborne-energy.com).Furthermore, the forward looking statements contained in this document are made as at the date of this document and the Company does not undertake any obligation to update publicly or to revise any of the included forward looking statements, whether as a result of new information, future events or otherwise, except as may be required by applicable securities laws.Non GAAP Terms: This document contains the terms "funds generated from operations", "funds generated from operations per share", "cash flow from operations per share", "net debt" and "netbacks" which are non-GAAP terms. The Company uses these measures to help evaluate its performance. The Company uses net debt (bank indebtedness plus negative working capital or less positive working capital) as an alternative measure of outstanding debt. The Company considers corporate netbacks a key measure as it demonstrates its profitability relative to current commodity prices. Netbacks, which have no GAAP equivalent, are calculated on a BOE basis by deducting royalties, operating costs, and transportation from petroleum and natural gas sales and sulphur block sales. The Company considers funds generated from operations a key measure as it demonstrates Fairborne's ability to generate funds necessary to repay debt and to fund future growth through capital investment. Funds generated from operations should not be considered as an alternative to, or more meaningful than, cash flow from operating activities as determined in accordance with Canadian GAAP as an indicator of Fairborne's performance. Fairborne's determination of funds generated from operations may not be comparable to that reported by other companies. The reconciliation between cash flow from operations and funds generated from operations can be found in the statement of cash flows in the consolidated financial statements with funds generated from operations calculated before non-cash working capital and asset retirement expenditures. Fairborne also presents funds generated from operations per share and cash flow from operations per share whereby per share amounts are calculated using weighted average shares outstanding consistent with the calculation of income per share.BOE Conversions: Barrel of oil equivalent ("BOE") amounts may be misleading, particularly if used in isolation. A BOE conversion ratio has been calculated using a conversion rate of one tonne of sulphur to one barrel and six thousand cubic feet of natural gas to one barrel. This conversion ratio of six thousand cubic feet of natural gas to one barrel is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. FIRST QUARTER 2010 FINANCIAL RESULTS Production ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, 2010 2009 CHANGE -------------------------------------- Natural gas (Mcf per day) 60,878 67,520 (10%) Crude oil (bbls per day) 3,000 3,599 (17%) Natural gas liquids (bbls per day) 686 572 20% Sulphur (tonnes per day) (1),(2) 54 93 (42%) ---------------------------------------------------------------------------- Total (BOE per day) 13,886 15,517 (11%) ---------------------------------------------------------------------------- Natural gas % of production 73% 73% - ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) A BOE conversion ratio has been calculated using a coversion rate of one tonne of sulphur to one barrel 2) Excludes the sale of inventory at the West Pembina sulpur block. Fairborne's first quarter drilling program resulted in an increase in production to approximately 15,500 BOE per day at the end of the quarter; however the majority of the additional production was not added until late in the first quarter. Fairborne reported average production of 13,886 BOE per day for the first quarter of 2010, a 3% increase from the preceding fourth quarter of 2009 (13,542 BOE per day), and 11% lower than the comparative first quarter of 2009 (15,517 BOE per day).Natural gas production of 60.9 MMcf per day during the first quarter of 2010 was 3% higher than the preceding fourth quarter of 2009 (59.1 MMcf per day) reflecting the Company's successful drilling program on its Harlech and Marlboro properties in the first quarter of 2010. Compared to the first quarter of 2009, natural gas production decreased 10% as a result of natural declines and property dispositions completed in the second half of 2009.Crude oil and NGL production of 3,686 bbls per day for the first quarter of 2010 was consistent with the preceding fourth quarter of 2009 (3,654 BOE per day). The 12% decrease from the comparative first quarter of 2009 (4,171 BOE per day) was primarily attributed to natural declines; however, current oil and NGL production has increased to 4,200 bbls per day. Commodity Prices & Risk Management Activities ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, 2010 2009 CHANGE -------------------------------------- Average prices (1) Natural gas ($ per Mcf) 5.75 6.39 (10%) Crude oil ($ per bbl) 79.24 56.98 39% Natural gas liquids ($ per bbl) 48.71 27.24 79% Sulphur ($ per tonne) (2) - 185.15 - ---------------------------------------------------------------------------- BOE ($ per BOE) 44.64 43.13 4% ---------------------------------------------------------------------------- Benchmark prices AECO Daily Index (Cdn$ per Mcf) 4.95 4.92 1% AECO Monthly Index (Cdn$ per Mcf) 5.36 5.63 (5%) Edmonton Par (Cdn$ per bbl) 80.31 48.23 67% Nymex Calendar Average (US$ per bbl) 78.71 43.08 83% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Excludes the change in fair value of derivatives. 2) Excludes revenue from the sale of inventory at the West Pembina sulphur block. Fairborne's risk management strategy is based on the following objectives:- protect shareholder return on investment;- reduce risk exposure in budgeted annual funds flow projections; and- help ensure transaction economics on acquisitions.Natural GasAlthough natural gas prices during the first quarter of 2010 were approximately 9% higher than average prices in the fourth quarter of 2009, spot prices were comparable to the first quarter of 2009. Fairborne's first quarter realized prices were 16% higher than the AECO Daily benchmark reference price due to 2010 corporate hedging activities and the higher heat content of Fairborne's production. However, Fairborne's realized natural gas prices were 10% lower than the average price received during the comparative first quarter in the prior year as a result of lower hedge prices in 2010. An average of 25,847 Mcf per day was sold under fixed price physical sales contracts during the first quarter of 2010 representing 42% of the Company's natural gas production. Risk management activities during the first three months of 2010 increased the Company's natural gas revenue by $3.2 million which had an effect of increasing Fairborne's realized natural gas price by $0.58 per Mcf to $5.75 per Mcf.The following table summarizes the outstanding fixed price physical sales and derivative contracts for natural gas, including contracts outstanding at March 31, 2010 as well as contracts entered into after March 31, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 2010 -------------------------------------- Q2 Q3 Q4 -------------------------------------- Swaps Volume (Mcf per day) 21,153 24,754 24,754 Average price ($ per Mcf) 6.61 6.57 6.57 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Conversion factor: 1 Mcf = 1.11 GJ Crude oilDuring the first quarter of 2010, Fairborne had an average of 1,500 bbls per day of crude oil under fixed price physical sales contracts representing 50% of crude oil production. Crude oil prices during the first quarter of 2010 showed a significant recovery when compared to the same quarter in 2009. The Company's realized crude oil price of $79.24 per bbl for the first quarter of 2010 represented an increase of 39% from the same period in 2009, reflecting the overall increase in average market prices.The following table summarizes the outstanding fixed price physical sales and derivative contracts on crude oil, including contracts outstanding at March 31, 2010 as well as contracts entered into after March 31, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 2010 -------------------------------------- Q2 Q3 Q4 -------------------------------------- Collars Volume (bbls per day) 1,500 1,500 1,500 Average floor price (CDN$ per bbl) 60.00 60.00 60.00 Average ceiling price (CDN$ per bbl) 103.72 103.72 103.72 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- At March 31, 2010, Fairborne had two crude oil collars that were accounted for as derivative contracts and the combined mark-to-market value of these contracts was recorded as a liability of $137,000 at March 31, 2010.SulphurSulphur prices significantly decreased during the fourth quarter of 2009 and continued to decrease during the first quarter of 2010. As a result, the Company did not record any revenue on its sulphur production during the first quarter of 2010. Sulphur prices have begun to recover in the second quarter and Fairborne has started receiving revenue for its sulphur production. Petroleum and Natural Gas Revenue ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, ($thousands except as noted) 2010 2009 CHANGE ---------------------------------------- Petroleum and natural gas sales: Natural gas 31,495 38,836 (19%) Crude oil 21,397 18,453 16% Natural gas liquids 3,005 1,403 114% Sulphur (114) 1,545 (107%) ---------------------------------------------------------------------------- Total 55,783 60,237 (7%) ---------------------------------------------------------------------------- Per BOE $ 44.64 $ 43.13 4% ---------------------------------------------------------------------------- Other revenue items: Sulphur block 6,959 5,353 30% Change in fair value of derivatives 222 2,643 (92%) Other income 418 312 34% ---------------------------------------------------------------------------- Total 7,599 8,308 (9%) ---------------------------------------------------------------------------- Total petroleum and natural gas revenue 63,382 68,545 (8%) ---------------------------------------------------------------------------- Per BOE $ 50.72 $ 49.08 3% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne reported petroleum and natural gas revenue of $63.4 million for the first quarter of 2010, representing a 9% increase from the immediately preceding fourth quarter of 2009 ($58.3 million) and a 8% decrease from the $68.5 million reported in the first quarter of 2009. Compared to the preceding fourth quarter of 2009, first quarter 2010 petroleum and natural gas sales reflected stronger commodity prices as well as increased production. When compared to the first quarter of 2009, first quarter 2010 petroleum and natural gas sales reflected comparable natural gas prices and higher crude oil prices but lower production.During the first quarter of 2010, Fairborne received payments of US$6.1 million pursuant to the existing contract for the sale of the Company's share of inventory at the West Pembina sulphur block. The sulphur block contract was completed during the first quarter, with no further payments owing to Fairborne. At March 31, 2010, $3.6 million was recorded as deferred revenue representing the payments received to date in excess of the volumes removed by the purchaser. The Company expects the purchaser to take delivery of the remaining sulphur volumes during the second quarter.The change in fair value of derivatives represents the change in the mark-to-market value of derivatives during 2010. The $0.2 million increase recorded in the first quarter of 2010 (2009 - $2.6 million) reflects both the changes in the unrealized value of existing contracts as well as a reduction for amounts realized on contracts that settled during the period. Fairborne's risk management program, including derivative contracts and physical sales contracts, increased the Company's realized revenue by an estimated $3.2 million in the first quarter of 2010. Royalties ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, ($thousands except as noted) 2010 2009 CHANGE -------------------------------------------- Crown 3,636 6,357 (43%) Freehold and overriding 1,898 1,716 11% ---------------------------------------------------------------------------- Total 5,534 8,073 (31%) ---------------------------------------------------------------------------- Crown (% of P&NG sales) 6.5% 10.6% (39%) Freehold and overriding (% of P&NG sales) 3.4% 2.8% 21% ---------------------------------------------------------------------------- Total (% of P&NG sales) 9.9% 13.4% (26%) ---------------------------------------------------------------------------- Per BOE $ 4.43 $ 5.78 (23%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne recorded $5.5 million of royalties for the first quarter of 2010, representing a royalty rate of 9.9%, a 26% decrease from 13.4% recorded in the first quarter of 2009. Fairborne's risk management program increases natural gas revenues resulting in higher realized prices than the prices utilized in calculating royalties which is reflected in a lower royalty rate for both years. Other factors contributing to the reduced effective royalty rate in 2010 are increased deductions for allowable operating costs and gas cost allowance which began in the second half of 2009. Operating Costs ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, ($thousands except as noted) 2010 2009 CHANGE ----------------------------------------- Operating costs Natural gas 8,173 12,472 (34%) Oil and NGLs 2,852 4,932 (42%) ---------------------------------------------------------------------------- Total 11,025 17,404 (37%) ---------------------------------------------------------------------------- Per BOE $8.82 $ 12.47 (29%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne recorded operating costs of $11.0 million ($8.82 per BOE) during the first quarter of 2010, consistent with the preceding fourth quarter of 2009 ($8.75 per BOE). Operating costs of $8.82 per BOE in 2010 have decreased 29% from $12.47 per BOE in the first quarter of 2009 as a result of cost reduction initiatives implemented later in 2009 on the Company's Wild River and Sinclair properties. Transportation Expenses ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, 2010 2009 CHANGE --------------------------------------------- Transportation ($thousands) 1,291 1,594 (19%) Per BOE $ 1.03 $ 1.14 (10%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Transportation costs of $1.3 million ($1.03 per BOE) for the first quarter of 2010 includes clean oil trucking, trucking of natural gas liquids, certain third party fuel charges and transportation and fuel costs associated with the usage of natural gas pipelines. Compared to the first quarter of 2009, transportation costs in the first quarter of 2010 are lower as a result of decreased transportation costs on the Company's Sinclair and Harlech properties. Operating Netbacks ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, ($ per BOE) 2010 2009 CHANGE ----------------------------------------- Petroleum and natural gas sales (1) 44.64 43.13 4% Sulphur block revenue 5.57 3.83 45% Other income (1) 0.33 0.22 50% Royalties (4.43) (5.78) (23%) Operating costs (8.82) (12.47) (29%) Transportation (1.03) (1.14) (10%) ---------------------------------------------------------------------------- Operating netback 36.26 27.79 30% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Excludes the change in fair value of derivatives Fairborne's operating netback of $36.26 per BOE was consistent with the fourth quarter of 2009 ($36.85 per BOE) and 30% higher when compared to the first quarter of 2009 ($27.79 per BOE). The increase in the operating netback in 2010 reflects stronger crude oil prices, increased sulphur block revenue and lower operating costs. General and Administrative ("G&A") Expenses ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, ($thousands except as noted) 2010 2009 CHANGE ----------------------------------------- G&A expenses, net of recoveries 2,338 2,151 9% Compensation costs 2,275 2,670 (15%) ---------------------------------------------------------------------------- Total G&A expenses 4,613 4,821 (4%) ---------------------------------------------------------------------------- G&A expenses, net of recoveries, per BOE $ 1.87 $ 1.54 21% Compensation costs, per BOE $ 1.82 $ 1.91 (5%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne recorded $2.3 million ($1.87 per BOE) of G&A expenses, net of recoveries, in the first quarter of 2010, a 9% increase when compared to $2.2 million ($1.54 per BOE) in the first quarter of 2009 which was reduced by an accrual adjustment for the 2008 employee bonus program.Compensation expense of $2.3 million in the first quarter of 2010 was 15% lower than the $2.7 million recorded during the first quarter of 2009. Compensation expense recorded during the first quarter of 2010 included $2.2 million related to the stock option plan and $0.1 million related to the vesting of the remaining Restricted Units and Performance Units held by senior officers and directors. Compensation expense recorded during the first quarter of 2009 included $3.0 million related to the stock option plan and $0.1 million representing the amortization of the remaining Restricted Units and Performance Units, partially offset by a $0.5 million recovery of compensation expense related to the retention award program. As at March 31, 2010, the intrinsic value of the retention award plan, being the difference between Fairborne's share price at the end of the period and the exercise price of the award, was zero. Interest ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, ($thousands except as noted) 2010 2009 CHANGE ------------------------------------------- Interest expense 2,993 3,559 (16%) Accretion of convertible debentures 483 502 (4%) ---------------------------------------------------------------------------- Total interest 3,476 4,061 (14%) Per BOE $ 2.78 $ 2.91 (4%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne recorded $3.0 million in interest expense in the first quarter of 2010, a decrease of 12% from the preceding quarter (Q4 2009 - $3.4 million) and a decrease of 16% from $3.6 million recorded in the first quarter of 2009. The decrease in interest expense from the fourth quarter of 2009 is consistent with lower debt levels maintained during the first three months of 2010. Compared to the first quarter of 2009, net debt has decreased substantially but the interest savings have been partially offset by higher borrowing margins and stamping fees initiated by the Company's lenders. Also included in interest expense is the accretion of convertible debentures. The costs associated with the debenture offering along with the amount allocated to the conversion feature are included in interest expense over the term of the debentures. Depletion, Depreciation and Accretion (DD&A) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, 2010 2009 CHANGE -------------------------------------------- Depletion, depreciation and accretion ($thousands) 31,149 37,541 (17%) Per BOE $ 24.92 $ 26.88 (7%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne recorded $31.1 million in depletion and depreciation of capital assets and accretion of asset retirement obligations during the first quarter of 2010. On a BOE basis, the 2010 first quarter DD&A rate of $24.92 per BOE was 6% lower than the average DD&A rate for the prior year ($26.45 per BOE) and 7% lower than the first quarter 2009 ($26.88 per BOE) as a result of reserve additions associated with the Company's first quarter capital expenditure program. Taxes ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, 2010 2009 CHANGE -------------------------------------------- Future tax expense (reduction) ($thousands) 2,485 (258) - Per BOE $ 1.99 $ (0.18) - ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne recorded a future tax expense of $2.5 million in the first quarter of 2010 compared to a future tax recovery of $0.3 million recorded during the first quarter of 2009, both of which reflect a provision for future tax at tax rates expected to apply when the related temporary differences reverse. The increase in tax expense is consistent with the net earnings before taxes. Net Income (Loss) and Funds Generated from Operations ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, ($thousands except as noted) 2010 2009 CHANGE ------------------------------------------ Funds generated from operations 39,555 32,970 20% Per share - basic $0.39 $0.38 3% Per share - diluted $0.38 $0.38 - Cash flow from operations (including changes in working capital) 43,522 34,782 25% Per share - basic $0.42 $0.40 5% Per share - diluted $0.42 $0.40 5% Net income (loss) 3,809 (4,691) 181% Per share - basic $0.04 $(0.05) 180% Per share - diluted $0.04 $(0.05) 180% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- The following table provides a reconciliation between cash flow from operations and funds generated from operations: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, ($thousands) 2010 2009 --------------------------- Cash flow from operations 43,522 34,782 Change in non-cash working capital (4,278) (2,311) Asset retirement expenditures 311 499 ---------------------------------------------------------------------------- Funds generated from operations 39,555 32,970 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- BOE ANALYSIS ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, 2010 2009 ($thousands) ($ per BOE) ($thousands) ($ per BOE) ------------------------------------------------- Petroleum and natural gas revenue (1) 63,382 50.72 68,545 49.08 Royalties (5,534) (4.43) (8,073) (5.78) Operating expenses (11,025) (8.82) (17,404) (12.47) Transportation (1,291) (1.03) (1,594) (1.14) Change in fair value of derivatives (222) (0.18) (2,643) (1.89) General & administrative(2) (2,338) (1.87) (2,151) (1.54) Compensation expense (3) (424) (0.34) (151) (0.11) Interest expense (4) (2,993) (2.39) (3,559) (2.55) ---------------------------------------------------------------------------- Funds generated from operations 39,555 31.66 32,970 23.60 Change in fair value of derivatives 222 0.18 2,643 1.89 Compensation expense - non-cash (1,851) (1.48) (2,519) (1.80) Accretion of convertible debentures (483) (0.39) (502) (0.36) Depletion, depreciation and accretion (31,149) (24.92) (37,541) (26.88) Future tax reduction (expense) (2,485) (1.99) 258 0.18 ---------------------------------------------------------------------------- Net income (loss) 3,809 3.06 (4,691) (3.37) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Including the change in fair value of derivatives (non-cash) and revenue from the sale of inventory at the West Pembina sulphur block. 2) Net of compensation expense (non-cash). 3) Cash component of compensation expense which resulted from the cash settlement of Restricted Units and Performance Units. 4) Net of accretion on convertible debentures (non-cash). Fairborne reported funds generated from operations of $39.6 million ($31.66 per BOE) for the first quarter of 2010, an increase of 4% from the preceding fourth quarter of 2009 ($37.9 million) and 20% higher than the first quarter of 2009 ($33.0 million). The increase in funds generated from operations reflected lower operating costs and interest expense in 2010. The net income of $3.8 million ($3.06 per BOE) for the first quarter of 2010 reflected the impact of increased cash flows and a lower depletion rate, partially offset by the future tax expense recorded during the quarter. LIQUIDITY AND CAPITAL RESOURCES Capital Expenditures ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, ($thousands) 2010 2009 --------------------------- Exploration and development Land and lease acquisitions 7,829 3,810 Geological and geophysical 3,321 84 Drilling, completions and workovers 43,882 39,370 Well equipment and facilities 10,509 9,292 Corporate assets 5 89 ---------------------------------------------------------------------------- 65,546 52,645 Property acquisitions 1,464 - ---------------------------------------------------------------------------- Total 67,010 52,645 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- During the first quarter of 2010, Fairborne's exploration and development expenditures totaled $65.5 million with capital expenditures financed through funds generated from operations as well as working capital. Land and lease acquisitions of $7.8 million during the quarter were primarily focused in the Harlech, Marlboro and Sinclair areas where $6.8 million was utilized to acquire additional acreage at provincial land sales. Property acquisitions of $1.5 million included acquiring additional working interests in the Marlboro and West Pembina areas.Fairborne spent $43.9 million on drilling and completion activities in the first quarter of 2010 with a total of 16 (12.8 net) wells drilled resulting in nine (7.7 net) natural gas wells and seven (5.1 net) oil wells. First quarter drilling activities were focused on Fairborne's Sinclair, Harlech, Brazeau, Marlboro and Westerose properties, with four (3.6 net) wells drilled in Sinclair, three (2.5 net) wells drilled on the Company's Harlech property, one (0.9 net) horizontal well drilled at Brazeau, two (1.7 net) horizontal wells drilled in Marlboro and two (2.0 net) horizontal wells at Westerose.Tangible capital expenditures during the three months ended March 31, 2010 included the tie-in of various wells in the Harlech, Sinclair and Marlboro areas as well as a significant gathering system expansion in the Marlboro area.Working Capital and Bank IndebtednessAt March 31, 2010, Fairborne had drawn $102.5 million (December 31, 2009 - $103.7 million) against its credit facilities and had a working capital deficit of $34.6 million (December 31, 2009 - $6.4 million). With continued volatility in commodity and capital markets into 2010, Fairborne intends to limit its 2010 capital expenditure program to a level which it anticipates will be able to be funded from its annual 2010 funds generated from operations. The annual capital expenditure budget was more heavily weighted to the first quarter of 2010 with drilling activities planned prior to spring break-up. As such, the Company utilized working capital in the first quarter to finance capital expenditures in excess of funds generated from operations. On an annualized basis, Fairborne anticipates capital expenditures to be financed from funds generated from operations.Fairborne's credit facilities at March 31, 2010 included a $270 million extendible revolving term credit facility and a $15 million demand operating credit facility for a total available facility of $285 million. The extendible revolving term facility is available on a revolving basis until May 28, 2010 and, if not renewed at this date, repayment of the amounts drawn will be required on May 30, 2011. The facilities continue to be subject to semi-annual reviews.Subsequent to March 31, 2010, the lending syndicate borrowing base was extended to May 27, 2011 at $285 million on substantially the same terms.Shareholders' EquityThe Company is authorized to issue an unlimited number of common shares and an unlimited number of preferred shares, issuable in series.During the first quarter of 2010 15,183 common shares were issued on the exercise of 15,582 RTU's and PTU's and 107,166 RTU's and PTU's were settled for cash. In addition, 2,204 common shares were issued on the exercise of stock options.As a result of the 2009 flow-through financing, Fairborne has a commitment to spend $20.0 million on qualifying Canadian exploration expenditures prior to December 31, 2010. As at March 31, 2010, $10.0 million of qualifying exploration expenditures have been incurred.The following table provides a summary of outstanding common shares, warrants, convertible debentures and shares under incentive plans including stock options, at the dates indicated: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- April 30 March 31 December 31 (thousands) 2010 2010 2009 -------------------------------------------- Common shares 102,482 102,479 102,462 Warrants (1) 4,406 4,406 4,406 Convertible debentures (2) $ 100,000 $ 100,000 $100,000 Incentive plans Restricted Units (3) - - 30 Performance Units (4) - - 92 Stock options 6,797 6,885 5,235 Weighted average common shares (5) Basic n/a 102,465 90,609 Diluted n/a 103,255 90,609 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Each warrant entitles the holder to acquire 0.39 of a common share at an exercise price of $8.13 per common share, exercisable until June 1, 2010. 2) The convertible debentures are convertible into common shares at a conversion price of $13.50 per share. 3) At December 31, 2009, the Restricted Units entitled the holders to acquire an aggregate of 35,125 common shares of the Company, subject to vesting in accordance with the restricted unit and performance unit incentive plan (the "Incentive Plan"). 4) At December 31, 2009, the Performance Units entitled the holders to acquire an aggregate of 84,714 common shares of the Company, subject to vesting in accordance with the Incentive Plan. 5) Weighted average common shares are for the twelve months ended December 31, 2009 and for the three months ended March 31, 2010. BUSINESS ENVIRONMENT AND RISKThe business risks the Company is exposed to are those inherent in the oil and gas industry as well as those governed by the individual nature of Fairborne's operations. Geological and engineering risks, the uncertainty of discovering commercial quantities of new reserves, commodity prices, interest rate and foreign exchange risks, competition and government regulations - all of these govern the businesses and influence the controls and management at the Company. Fairborne manages these risks by:- attracting and retaining a team of highly qualified and motivated professionals who have a vested interest in the success of the Company;- operating properties in order to maximize opportunities;- employing risk management instruments to minimize exposure to volatility of commodity prices, interest rate and foreign exchange rates;- maintaining a strong financial position; and- maintaining strict environmental, safety and health practices.CHANGE IN ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTSInternational Financial Reporting Standards ("IFRS")Effective January 1, 2011, Canadian public companies are required to adopt International Financial Reporting Standards ("IFRS"). In the time leading up to the conversion date, some existing Canadian standards will change to converge with IFRS. Fairborne's financial statements up to and including the December 31, 2010 financial statements will continue to be reported in accordance with Canadian GAAP as it exists on each reporting date. Financial statements for the quarter ended March 31, 2011, including comparative amounts, will be prepared on an IFRS basis.In order to transition to IFRS, management has formed an executive steering committee which oversees the project team. A transition plan is in place to convert the financial statements to IFRS. Training has been provided to key employees and the Company continues to assess the effect of the transition on information systems, internal controls over financial reporting and disclosure controls and procedures. Systems and controls are being updated as IFRS accounting processes are implemented. Analysis and quantification of differences between IFRS and Fairborne's current accounting policies is continuing. Some accounting policies may change on adoption of IFRS even though Fairborne's current accounting policies are acceptable under IFRS. Changes in accounting policy may materially impact the financial statements.There are several significant accounting policy changes anticipated on adoption of IFRS. Changes in IFRS prior to adoption may result in other accounting policy changes which could significantly impact the financial statements. Numerous accounting policy changes will be made under IFRS, with the most significant changes expected to include accounting for petroleum and natural gas assets and equipment ("P&NG assets"), accounting for business combinations and accounting for deferred taxes. The anticipated changes were described in more detail in our December 31, 2009 MD&A. The impact of these changes has not yet been quantified. In accordance with Fairborne's IFRS project plan and as a result of the 2009 year end reporting requirements, no further progress was completed on the Company's IFRS project in the first quarter of 2010.CONTROLS AND PROCEDURESDisclosure Controls and ProceduresFairborne's Chief Executive Officer and Chief Financial Officer have designed or caused to be designed under their supervision, disclosure controls and procedures to provide reasonable assurance that (i) material information relating to the Company is made known to Fairborne's Chief Executive Officer and Chief Financial Officer by others, particularly during the period in which the annual and interim filings are being prepared; and (ii) information required to be disclosed by the Company in its annual filings or other reports filed or submitted by it under securities legislation is recorded, processed, summarized and reported within the time period specified in securities legislation.Internal Controls over Financial ReportingFairborne's Chief Executive Officer and Chief Financial Officer have designed or caused to be designed under their supervision, internal controls over financial reporting to provide reasonable assurance regarding the reliability of the Company's financial reporting and the preparation of financial statements for external purposes in accordance with Canadian GAAP.No material changes in Fairborne's internal controls over financial reporting were identified during the three months ended March 31, 2010, that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.It should be noted that a control system, including Fairborne's disclosure and internal controls and procedures, no matter how well conceived, can provide only reasonable, but not absolute, assurance that the objectives of the control system will be met and it should not be expected that the disclosure and internal controls and procedures will prevent all errors or fraud. QUARTERLY FINANCIAL INFORMATION The following is a summary of select financial information for the quarterly periods indicated: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 2010 2009 Q1 Q4 Q3 Q2 --------------------------------------- Financial ($thousands, except per share amounts) Petroleum and natural gas revenue 63,382 58,338 55,244 58,430 Funds generated from operations 39,555 37,863 37,236 35,742 Per share - basic $0.39 $0.37 $0.43 $0.41 Per share - diluted $0.38 $0.37 $0.43 $0.41 Cash flow from operations (including changes in working capital) 43,522 38,750 40,048 27,653 Per share - basic $0.42 $0.38 $0.46 $0.32 Per share - diluted $0.42 $0.38 $0.46 $0.32 Net income (loss) 3,809 (3,124) (497) (17,333) Per share - basic $0.04 $(0.02) $(0.01) $(0.20) Per share - diluted $0.04 $(0.02) $(0.01) $(0.20) Total assets 976,138 940,443 961,920 1,001,840 Working capital deficit (surplus) 34,611 6,370 (1,539) (7,227) Bank indebtedness 102,536 103,738 204,046 232,184 Convertible debentures 96,993 96,510 96,027 95,525 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Operations Average production Natural gas (Mcf per day) 60,878 59,132 56,797 66,744 Crude oil (bbls per day) 3,000 3,037 3,292 3,552 Natural gas liquids (bbls per day) 686 617 563 632 Sulphur (tonnes per day) (1) 54 33 100 64 ---------------------------------------------------------------------------- Total (BOE per day) 13,886 13,542 13,421 15,372 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Excludes the sale of inventory at the West Pembina sulphur block. ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 2009 2008 Q1 Q4 Q3 Q2 ----------------------------------------- Financial ($thousands, except per share amounts) Petroleum and natural gas revenue 68,545 85,165 97,489 85,670 Funds generated from operations 32,970 40,309 55,307 51,458 Per share - basic $0.38 $0.46 $0.64 $0.60 Per share - diluted $0.38 $0.46 $0.63 $0.60 Cash flow from operations (including changes in working capital) 34,782 37,693 65,598 41,650 Per share - basic $0.40 $0.43 $0.76 $0.49 Per share - diluted $0.40 $0.43 $0.76 $0.48 Net income (loss) (4,691) 11,657 19,182 3,717 Per share - basic ($0.05) $0.14 $0.22 $0.04 Per share - diluted ($0.05) $0.14 $0.22 $0.04 Total assets 1,023,526 1,013,177 999,065 946,025 Working capital deficit 31,641 27,917 64,814 7,363 Bank indebtedness 209,925 196,282 161,302 180,977 Convertible debentures 95,024 94,522 94,020 93,499 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Operations Average production Natural gas (Mcf per day) 67,520 69,460 62,601 59,529 Crude oil (bbls per day) 3,599 4,086 3,312 2,506 Natural gas liquids (bbls per day) 572 657 580 610 Sulphur (tonnes per day) (1) 93 138 129 106 ---------------------------------------------------------------------------- Total (BOE per day) 15,517 16,458 14,454 13,143 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Excludes the sale of inventory at the West Pembina sulphur block. INTERIM CONSOLIDATED BALANCE SHEETS (Unaudited) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- March 31, December 31, ($thousands) 2010 2009 ------------------------------ Assets Current assets Cash and cash equivalents $ 194 $ 147 Accounts receivable 34,923 35,155 Prepaid expenses and deposits 7,667 8,079 ---------------------------------------------------------------------------- 42,784 43,381 Petroleum and natural gas properties and equipment (Note 1) 917,184 880,892 Goodwill 16,170 16,170 ---------------------------------------------------------------------------- $ 976,138 $ 940,443 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Liabilities Current liabilities Accounts payable and accrued liabilities $ 73,706 $ 44,602 Derivative liability (Note 7) 137 359 Current portion of compensation plans - 505 Deferred revenue 3,552 4,285 ---------------------------------------------------------------------------- 77,395 49,751 Bank indebtedness (Note 2) 102,536 103,738 Convertible debentures (Note 3) 96,993 96,510 Asset retirement obligation (Note 4) 11,320 11,200 Future income taxes 97,452 89,919 Shareholders' Equity Common shares (Note 5) 531,886 536,789 Warrants 2,721 2,721 Equity component of convertible debentures (Note 3) 5,581 5,581 Contributed surplus (Note 5) 27,038 24,827 Retained earnings 23,216 19,407 ---------------------------------------------------------------------------- 590,442 589,325 ---------------------------------------------------------------------------- $ 976,138 $ 940,443 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- See accompanying notes to the interim consolidated financial statements. INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (Unaudited) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- For the three months ended March 31, ($thousands except per share amounts) 2010 2009 ---------------------------- Revenue Petroleum and natural gas $ 63,382 $ 68,545 Royalties (5,534) (8,073) ---------------------------------------------------------------------------- 57,848 60,472 Expenses Operating 11,025 17,404 Transportation 1,291 1,594 General and administrative 4,613 4,821 Interest 3,476 4,061 Depletion, depreciation and accretion 31,149 37,541 ---------------------------------------------------------------------------- 51,554 65,421 ---------------------------------------------------------------------------- Income (loss) before taxes 6,294 (4,949) Future taxes (reduction) 2,485 (258) ---------------------------------------------------------------------------- Net income (loss) and comprehensive income (loss) 3,809 (4,691) Retained earnings, beginning of period 19,407 45,052 ---------------------------------------------------------------------------- Retained earnings, end of period $ 23,216 $ 40,361 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Net income (loss) per share (Note 5) Basic $ 0.04 $ (0.05) Diluted $ 0.04 $ (0.05) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- See accompanying notes to the interim consolidated financial statements. INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- For the three months ended March 31, ($thousands) 2010 2009 ---------------------------- Cash provided by (used in): Operating activities Net income (loss) $ 3,809 $ (4,691) Items not involving cash: Depletion, depreciation and accretion 31,149 37,541 Compensation expense 1,851 2,519 Future taxes (reduction) 2,485 (258) Accretion of convertible debentures 483 502 Change in fair value of derivatives (222) (2,643) Asset retirement expenditures (311) (499) ---------------------------------------------------------------------------- 39,244 32,471 Change in non-cash working capital 4,278 2,311 ---------------------------------------------------------------------------- 43,522 34,782 ---------------------------------------------------------------------------- Financing activities Bank indebtedness (1,202) 13,643 ---------------------------------------------------------------------------- Investing activities Expenditures on petroleum and natural gas properties (65,546) (52,645) Acquisition of petroleum and natural gas properties (1,464) - Change in non-cash working capital 24,737 4,218 ---------------------------------------------------------------------------- (42,273) (48,427) ---------------------------------------------------------------------------- Change in cash and cash equivalents 47 (2) Cash and cash equivalents, beginning of period 147 126 ---------------------------------------------------------------------------- Cash and cash equivalents, end of period $ 194 $ 124 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Interest paid $ 816 $ 2,437 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- See accompanying notes to the interim consolidated financial statements. Selected Notes to the Interim Consolidated Financial StatementsFor the three months ended March 31, 2010 (unaudited)(tabular amounts are stated in thousands and thousands of dollars except per share amounts)The interim consolidated financial statements of Fairborne Energy Ltd. (the "Company" or "Fairborne") have been prepared by management in accordance with accounting principles generally accepted in Canada. The interim consolidated financial statements have been prepared following the same accounting policies and methods of computation as the consolidated financial statements for the year ended December 31, 2009. The disclosure which follows is incremental to the disclosure included with the annual financial statements. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2009. 1. PETROLEUM AND NATURAL GAS PROPERTIES AND EQUIPMENT ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- March 31, December 31, 2010 2009 ---------------------------- Petroleum and natural gas properties and equipment $ 1,502,476 $ 1,435,282 Accumulated depletion and depreciation (587,130) (556,289) Corporate assets 4,312 4,307 Accumulated depreciation (2,474) (2,408) ---------------------------------------------------------------------------- $ 917,184 $ 880,892 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- As at March 31, 2010, future development costs of $201.1 million (December 31, 2009 - $193.8 million) were included in the depletion calculation and costs of acquiring unproved properties in the amount of $53.9 million (December 31, 2009 - $48.2 million) were excluded from the depletion calculation.2. BANK INDEBTEDNESSAt March 31, 2010 the Company had a $270 million extendible revolving term credit facility and a $15 million demand operating credit facility available from a syndicate of Canadian chartered banks, subject to the banks' semi-annual valuation of Fairborne's petroleum and natural gas properties. The extendible revolving term facility is available on a revolving basis until May 28, 2010 (364 day facility) at which time it may be extended, at the lenders option. If the revolving period is not extended, the undrawn portion of the facility will be cancelled and the amount outstanding will convert to a 365 day non-revolving term facility. The amounts outstanding under the non-revolving term facility are required to be repaid at the end of the term facility being May 28, 2011. Interest payable on amounts drawn under the facilities is at the prevailing bankers' acceptance rates plus stamping fees, lenders' prime rate or LIBOR rates plus applicable margins, depending on the form of borrowing by the Company. The margins and stamping fees vary from 0.75 to 4.25% depending on financial statement ratios and the form of borrowing. The credit facilities are secured by a general security agreement and a first ranking floating charge on the assets of the Company. At March 31, 2010 letters of credit totaling $0.5 million were outstanding.Subsequent to March 31, 2010, the lending syndicate borrowing base was extended to May 27, 2011 at $285 million on substantially the same terms. 3. CONVERTIBLE DEBENTURES The following table sets forth a reconciliation of the convertible debentures for the three months ended March 31, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Number of Debt Equity debentures component component -------------------------------------------- Balance, beginning of period 100,000 $ 96,510 $ 5,581 Accretion - 483 - ---------------------------------------------------------------------------- Balance, end of period 100,000 $ 96,993 $ 5,581 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 4. ASSET RETIREMENT OBLIGATION The following table sets forth a reconciliation of the asset retirement obligation for the three months ended March 31, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Balance, beginning of period $ 11,200 Liabilities incurred 189 Liabilities settled (311) Accretion expense 242 ---------------------------------------------------------------------------- Balance, end of period $ 11,320 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 5. SHAREHOLDERS' EQUITYThe Company is authorized to issue an unlimited number of common shares and an unlimited number of preferred shares, issuable in series.a) Common SharesThe following table sets forth a reconciliation of the common shares issued and outstanding for the three months ended March 31, 2010: ---------------------------------------------------------------------------- Number of shares Amount --------------------------- Balance, beginning of period 102,462 $ 536,789 Issued on vesting of Restricted Units and Performance Units 15 140 Issued on exercise of stock options 2 5 Tax effect of flow through shares issued in 2009 - (5,048) ---------------------------------------------------------------------------- Balance, end of period 102,479 $ 531,886 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- As a result of the 2009 flow-through financing, Fairborne has a commitment to spend $20.0 million on qualifying Canadian exploration expenditures. As at March 31, 2010, $10.0 million of qualifying exploration expenditures have been incurred.b) Per share amountsThe following table summarizes the weighted average common shares used in calculating net income (loss) per share: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended March 31, 2010 2009 ----------------------------- Numerator Net income (loss) - basic and diluted $ 3,809 $ (4,691) ---------------------------------------------------------------------------- Denominator Weighted average shares - basic 102,465 86,964 Options 790 - ---------------------------------------------------------------------------- Denominator for diluted net income (loss) per share 103,255 86,964 ---------------------------------------------------------------------------- Basic net income (loss) per share $ 0.04 $ (0.05) Diluted net income (loss) per share $ 0.04 $ (0.05) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Excluded from the diluted number of shares for the three months ended March 31, 2010 is the effect of convertible debentures (7.4 million shares), warrants (1.7 million shares) and 3.6 million stock options as they are out of the money. Excluded from the diluted number of shares for the three months ended March 31, 2009 is the effect of convertible debentures (7.4 million shares), warrants (1.7 million shares) and 8.6 million stock options.c) Equity and liability based compensation plansi) Incentive PlanThe following table sets forth a reconciliation of the restricted and performance incentive plan activity for the three months ended March 31, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Number of Number of Performance Restricted Units Units Total ------------------------------------------- Balance, beginning of period 30 92 122 Exercised (30) (92) (122) ---------------------------------------------------------------------------- Balance, end of period - - - ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- During the quarter ended March 31, 2010, all remaining restricted and performance units vested and were settled with either cash or common shares. As such, no liability remains at March 31, 2010.ii) Stock Option PlanThe following table sets forth a reconciliation of the stock option plan activity for the three months ended March 31, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Weighted Number average of exercise options price ---------------------------- Balance, beginning of period 5,235 $ 4.25 Granted 1,681 4.16 Exercised (6) 2.53 Forfeited (25) 6.31 ---------------------------------------------------------------------------- Balance, end of period 6,885 $ 4.22 ---------------------------------------------------------------------------- Exercisable, end of period 1,679 $ 4.37 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- The weighted average fair value of options granted during the three months ended March 31, 2010 was $1.63 per option using the Black-Scholes option pricing model with the following assumptions: risk free interest rate of two percent, expected volatility of 64 percent, average expected life of three years and dividend rate of nil. An estimated forfeiture rate of two percent has been applied to the compensation costs recognized. The following table summarizes stock options outstanding at March 31, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Options Remaining Exercise Price outstanding term (years) ------------------------------ $ 2.00 - $ 4.99 6,692 4.5 $ 5.00 - $ 7.99 55 4.1 $ 8.00 - $ 10.99 58 3.5 $ 11.00 - $ 13.99 80 3.3 ---------------------------------------------------------------------------- 6,885 4.5 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- iii) Retention Award Plan The following table sets forth a reconciliation of the retention award plan activity for the three months ended March 31, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Weighted Number average of exercise awards price ------------------------- Balance, beginning of period 1,390 $ 5.74 Forfeited (85) 5.75 ---------------------------------------------------------------------------- Balance, end of period 1,305 $ 5.74 ---------------------------------------------------------------------------- Exercisable, end of period 850 $ 5.74 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- d) Contributed Surplus The following table sets forth a reconciliation of the contributed surplus for the three months ended March 31, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Balance, beginning of period $ 24,827 Equity based compensation 2,216 Stock options exercised (5) ---------------------------------------------------------------------------- Balance, end of period $ 27,038 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 6. FINANCIAL INSTRUMENTS As at March 31, 2010, the Company's accounts receivable is aged as follows: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Current (less than 90 days) $ 30,352 Past due (more than 90 days) 4,571 ---------------------------------------------------------------------------- Total $ 34,923 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fair value of financial instruments:The carrying value of Fairborne's financial instruments, other than bank indebtedness and convertible debentures, approximate their fair value due to their short maturity. The fair value of the bank indebtedness approximates its carrying value as it bears interest at a floating rate. The fair value of the convertible debentures at March 31, 2010 was $101.9 million (December 31, 2009 - $100.3 million).7. COMMODITY CONTRACTSFairborne has a risk management program whereby the Company sells forward a portion of its future production through fixed price sales contracts with customers.a) Commodity Contracts Recorded at Fair Value:At March 31, 2010 certain contracts have been recorded on the balance sheet at their estimated fair value as a $0.1 million liability (December 31, 2009 - $0.4 million). The change in the fair value has been recorded in petroleum and natural gas sales for the three months ended March 31, 2010. Oil: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Volume Price Settlement (bbls per day) (US$ per bbl) Index ---------------------------------------------- Collars Apr 1, 2010 - Dec 31, 2010 500 55.00 - 108.00 WTI Apr 1, 2010 - Dec 31, 2010 500 70.00 - 100.15 WTI ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- b) Commodity Contracts not Recorded at Fair Value:The following oil and natural gas fixed price physical sales contracts outstanding at March 31, 2010 have been entered into for the purpose of physical delivery of a non-financial item; therefore, the physical delivery contracts are not fair valued. Settlements on these contracts are included in petroleum and natural gas revenue as they occur. Oil: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Volume Price Settlement (bbls per day) (US$ per bbl) Index ----------------------------------------------- Collars Apr 1, 2010 - Dec 31, 2010 500 55.00 - 103.00 WTI ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Natural Gas: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Volume Price Settlement (GJs per day) (CDN$ per GJ) Index ----------------------------------------------- AECO Swaps Apr 1, 2010 - Dec 31, 2010 5,000 5.86 AECO C Monthly Apr 1, 2010 - Dec 31, 2010 2,500 5.67 AECO C Monthly Apr 1, 2010 - Dec 31, 2010 1,500 5.90 AECO C Monthly Apr 1, 2010 - Dec 31, 2010 1,500 5.86 AECO C Monthly Apr 1, 2010 - Dec 31, 2010 1,500 5.88 AECO C Monthly Apr 1, 2010 - Dec 31, 2010 1,500 6.00 AECO C Monthly Apr 1, 2010 - Dec 31, 2010 4,000 6.00 AECO C Monthly Apr 1, 2010 - Dec 31, 2010 2,000 6.13 AECO C Monthly Apr 1, 2010 - Dec 31, 2010 2,000 6.15 AECO C Monthly Apr 1, 2010 - Dec 31, 2010 2,000 6.16 AECO C Monthly Jul 1, 2010 - Dec 31, 2010 4,000 5.72 AECO C Monthly ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- FOR FURTHER INFORMATION PLEASE CONTACT: Fairborne Energy Ltd. Steven R. VanSickle President and Chief Executive Officer (403) 290-7759 (403) 290-7724 (FAX) svansickle@fairborne-energy.com or Fairborne Energy Ltd. Aaron G. Grandberg Chief Financial Officer (403) 290-3217 (403) 290-7724 (FAX) agrandberg@fairborne-energy.com www.fairborne-energy.com