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Candax Annual Report - 2010

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2010 Annual Report for Candax Energy Inc (TSE:CAX)

2010 Annual Report for Candax Energy Inc (TSE:CAX)

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  • 1. 2010 ANNUAL REPORT130 ADELAIDE STREET WEST, SUITE 1010TORONTO, ONTARIO, CANADA M5H 3P5T + 416.368.9137F + 416.364.5400E INFO@CANDAX.COM
  • 2. Candax Energy Inc. (“Candax”) Corporate Information is a Canadian independent, international oil and gas exploration, development and production company. The Company’s primary objective is to increase shareholder value by building a sustainable, international upstream company focused on opportunities in Africa and the Middle East. DIRECTORS AND OFFICERS EXECUTIVE HEAD OFFICE BANKING Benoit Debray Dr. Richard J. H. Norris INDEPENDENT ENGINEERS M’hamed Ali Bouleyman 130 Adelaide Street West, Suite 1010 Bank of Montreal TUNISIA OFFICE Chairman Toronto, Ontario, Canada M5H 3P5 Main Branch – 1 First Canadian Place T + 416.368.9137 100 King Street West F + 416.364.5400 Toronto, Ontario, Canada M5X 1A3 Stephen Drinkwater President, CEO and Director E info@candax.com LEGAL COUNSEL Ryder Scott Company Christopher O. Irwin Director and Chairman, Ecumed Petroleum Ecumed Petroleum 1200, 530 - 8th Avenue SW Rue du Lac Windermere Calgary, Alberta, Canada T2P 3S8 MADAGASCAR OFFICE Thomas Rebilly Les Berges du Lac Director 1053 Tunis, Tunisia T + 216.71.962.611 McCarthy Tétrault LLP Matthieu Milandri F + 216.71.963.765 Box 48, Suite 5300 Director Toronto Dominion Bank Tower Toronto, Ontario, Canada M5K 1E6 Pascal Mirville Director Candax Madagascar Ltd T + 416.362.1812 Immeuble SANTA F + 416.868.0673 Lot III - 3è Etage Chief Financial Officer Antanimena McGrigors INVESTOR RELATIONS Charlotte M. May Antananarivo 101 5 Old Bailey TRANSFER AGENT Madagascar London EC4M 7BA Chief Operating Officer and T + 261.20.22.265.58 DX 227 London Chancery Lane BOARD SUB-COMMITTEE General Manager, Tunisian Operations F + 261.20.22.265.81 Tel: +44 (0)207 054 2500 Ecumed Petroleum MEMBERSHIP Fax: +44 (0)207 054 2501 Corporate Secretary CHF Investor Relations AUDITORS 90 Adelaide Street West, 6th Floor Equity Financial Trust Company Toronto, Ontario, Canada M5H 3V9 200 University Avenue, Suite 400 TSX: CAX T + 416.868.1079 Toronto, Ontario, Canada M5H 4H1 F + 416.868.6198 T + 416.361.0152 Audit Committee F + 416.361.0470 Mhamed Ali Bouleymen – Chairman ANNUAL & SPECIAL MEETING E: info@equityfinancialtrust.com Benoit Debray Christopher O. Irwin PricewaterhouseCoopers LLP Royal Trust Tower, TD Centre TABLE OF CONTENTS Compensation Committee 77 King Street West www.candax.com 1 Achievements from 2010 and Objectives for 2011 Benoit Debray Suite 3000, PO Box 82 2 Message to Our Shareholders Stephen Drinkwater Toronto, Ontario, Canada M5K 1G8 4 Report on Operations Thomas Rebilly Tuesday, June 28 at 10 am at the 8 Board of Directors Corporation’s head office. 9 Management’s Discussion and Analysis Governance Committee 130 Adelaide Street West, Suite 1010 23 Forward-Looking Statements Christopher O. Irwin – Chairman Toronto, Ontario, Canada M5H 3P5 24 Management’s Responsibility for Financial Reporting Benoit Debray 25 Independent Auditor’s Report Stephen Drinkwater Print date: May 24, 2011 26 Consolidated Balance Sheets Thomas Rebilly 27 Consolidated Statements of Operations and Deficit 28 Consolidated Statements of Cash Flows Disclosure Committee 29 Consolidated Statements of Comprehensive Loss Benoit Debray – Chairman 30 Notes to the Consolidated Financial Statements 41 Corporate Information Charlotte M. May Matthieu Milandri Dr. Richard J. H. NorrisNew Logo IntroductionCandax is clearly a company reborn with a clean image and a new management team. The logo incorporates theindustrys universal colours for oil and gas of green and red with the flocks of green and red colour representingboth production and share growth. A bold and custom typeface was created to communicate a sense of confidenceand stability and ultimately represent the new image of Candax.
  • 3. Achievements from 2010 Restructured balance sheet, significantly reducing the debt burden. Successfully re-connected the El Bibane 3 well and restarted production in September 2010. The Ulysse drilling rig arrived and the Ezzaouia work-over and side- track program was mostly completed. Objectives for 2011 Obtained a one-year extension to the Madagascar Block 1101 exploration permit and progressed Environmental Impact Assessments and a drilling permit. With minor exceptions, the objectives for 2011, in terms of field operationsDELIVERING are discretionary and will be completed and/or accelerated where possible, depending on the finances available to Candax.ON OUR • Work-over Robbana-1 well, with data acquisition and restart production • Reprocess existing seismic on all properties in Tunisia – Robbana, El Bibane and Ezzaouia in priorityOBJECTIVES • Acquisition of 3D on El Bibane and on Robbana – subject to proof of need from reprocessed existing data • Complete full-field numerical simulation study of El Bibane to optimize subsequent exploitation of the field • Integration of the new seismic data/interpretations • Development of an optimised field exploitation plan – for execution in 2012 • Progress planning of a full-field enhanced oil recovery plan, based on water-flooding, for Robbana • Implementation of the initial stages of this plan in the fourth quarter, with the drilling of an injector-producer pair • Complete the required works on Block 1101 Madagasacar to move into the second exploration period and potentially farm-down Candax’s Participating Interest in the block 1 • Ensure adequate financing flexibility in the short and medium term to enable these capital programs candax energy inc. annual report 2010
  • 4. At the time of last year’s annual report, Candax was facing challenges on many fronts. Today, it is very gratifying to note that, although challenges remain, very significant progress has been made and we have a clear road map for growth. To Our Shareholders DELIVERING IS A PROCESS Benoit Debray Dr. Richard J. H. Norris Chairman President, CEO and Director It is a great pleasure that we are writing this letter one year into our stewardship of Candax. At the time of last year’s annual report, Candax was facing challenges on many fronts. Today, it is very gratifying to note that, although challenges remain, very significant progress has been turn-around was made possible thanks to the efforts made and we have a clear road map for growth. of Candax’s management and board and crucially the support and belief of Candax’s new major shareholder, 2010 was a year of major changes and upheaval for Candax. namely Geofinance. At the beginning of 2010, Candax board and management were working intensively to resolve the liquidity issues which At the time of writing last year’s letter to shareholders, resulted in investment by Geofinance N.V. and a significant production was at an all time low, with El Bibane remaining change in the board and executive management. By the off-line despite a light work-over in March 2010, a long end of 2010, Candax had negotiated a reduction of its debt delayed work-over and side-track campaign was set to burden by half, and notably, negotiated a two year grace commence on the Ezzaouia field and the Robbana field period for repayments, an essential time frame that was shut-in. By the end of 2010 production albeit limited provides Candax with the ability to properly evaluate was successfully restored to El Bibane and quality upside and bring its assets back into production. Such a radical had been quantified in non-producing assets. 2candax energy inc. annual report 2010
  • 5. We aim to increase production from across the range of assets – producing, shut-in, non-producing and indeed exploration. This will not happen overnight, but we are dedicated to delivering by implementing best oil field technology and practices.In May 2010 the long awaited Ulysses rig arrived in Tunisiagoing directly to the Ezzaouia Field and work commenced onthe delayed drilling and work-over campaign. This campaignhad mixed results with the Ezzaouia 5 well side-trackencountering unexpectedly depleted levels in the Zeebag anddisappointing work-overs on the Ezzaouia 1, Ezzaouia 11 andEzzaouia 9 wells. Although further work is required to optimizeproduction from these wells, initial results are promising. Asof the writing of this letter, we are also pleased to report thatthe Ezzaouia 2 side-track has shown positive indications fromopen hole logging and is being readied for production.On the El Bibane field, the El Bibane 3 well was worked-overin August 2010 and despite finding the tubing to be broken inmore than one place, production was restored via a new tubingstring anchored above the irretrievable broken tubing andpacker. At the time of the work-over, the field had been located onshore a stepwise approach to investmentoff line for just over a year, and at start-up, it was clear can be applied, with initial wells adding data (as wellthat production levels seen before the tubing broke in August as production), with an iterative approach to optimizing2009, were unlikely to be resumed immediately. By year end, the overall development.production still required artificial lift, with no sign of the well 2011 will also be focused on significant amounts of dataresuming natural flow as the gas-cap had recompressed acquisition and field studies. Although we would want toduring the shut-in period. see the results soonest, it is important to recognize that theOn the main non-producing assets, Chaal and Madagascar process will take up most of the year and we are unlikely towere much in focus as well as former producers Al Manzah see any direct activity to increasing production on El Bibaneand Belli and our highly prospective Deep Triassic target. After until 2012. Ezzaouia is also the subject of on-going studies,having worked hard to find and close a farm-in deal on the and we anticipate that these will bear fruit both in 2011Chaal discovery, it was a major disappointment to have the via individual well optimizations and in 2012 by additionalpermit annulled when it expired in May 2010. At Madagascar, infill wells.the first major milestone was achieved in obtaining a year’s We aim to increase production from across the range ofextension to the exploration permit in June. Subsequent to assets – producing, shut-in, non-producing and indeedthis, we progressed the necessary logistical and environmental exploration. This will not happen overnight, but we areworks necessary as preparation for completing the agreed dedicated to delivering by implementing best oil fieldwork program in 2011. Candax firmly believes that the shut-in technology and practices.Belli and Al Manzah fields have potential, and we are workingactively to maximize our opportunities to drill the high-impact In closing, we want to take this opportunity to thank allDeep Triassic prospect that underlies the El Bibane and our staff at Candax, Ecumed and in Madagascar for theirEzzaouia fields. commitment in seeing Candax through the challenges of 2010. And, we also thank you, our shareholders, for yourCandax has a well balanced portfolio of assets comprising confidence and patience as we work on delivering theboth exploration and production assets, however our focus production needed to restore Candax to profit and toin 2010 was on delivering near-term production. We believe re-establish your E&P company.firmly in the upside potential of Candax’s exploration assets,but we do not take our eyes off the bottom line – productionand revenues are necessary to underpin exploration spend inan E&P company. Benoit DebrayDelivering on the strength provided by the corporate Chairmanrestructuring, Candax will be progressing multiple vectors forgrowth in 2011. Foremost is the development of Robbana. Thefield is proven to have significant volumes of oil in place, and 3to-date a very low recovery factor due to a lack of energy in thereservoir. Energy can be added by water-injection and although Dr. Richard J. H. Norrisit is too early to predict the likely recoveries, Robbana hasexcellent potential and is likely to be a key driver in Candax’s President, CEO and Directorshort, medium and long term growth. Having just one well inthe field underscores the difficulty of characterizing the fieldand the likely response to water-flooding, however being candax energy inc. annual report 2010
  • 6. Report on Operations Robbana A restructured balance sheet and a strong supportive shareholder give Candax the platform and time necessary to fully deliver the promise of the Candax assets. Robbana – with significant oil in place the development of Robbana takes front and centre position. DELIVERING ON OUR PROPERTIES Robbana takes front and centre position. The field has produced small volumes from one well over a 17 year period. Our initial analysis of the data has been subsequently confirmed by Petroleum Insights Sàrl (“Petroleum Insights”), Sucker-rod pump "Nodding Donkey" on Robbana-1 well. an independent oil and gas consulting firm with the assistance of Denver-based MHA Petroleum Consultants LLC. Based on their analysis of pressure response data from the field during its 17 years of production history as well as on volumetric calculations, Petroleum Insights has calculated a range of 18 to 25 million barrels of oil in place. Petroleum Insights has also forecast 4.3 to 5.8 million barrels of recoverable oil for 100% of the field. These figures are based on a numerical full field simulation study assuming enhanced recovery through conventional water-flooding. Subsequently, pressure data from the well has indicated that the connected volumes are at or slightly above the high end of this range. Based on Petroleum Insight’s positive evaluation, Candax is in the process of designing a water-flooding and development well program to increase recovery from the field and to enable categorization of all or part of these preliminary figures as proven and probable reserves under NI 51-101 standards. It is Early time oil-saturation map of five wells anticipated that this work will start in the second half of 2011, with the drilling (three injectors, two producers) from full field simulation model. of at least one new well on the Robbana structure. Prior to drilling, reprocessing of the existing 2D seismic data will be done, and if necessary there will be an acquisition of 3D data. The first step is to resume production, however modest, from the Robbana-1 well in the second quarter of 2011. 4candax energy inc. annual report 2010
  • 7. El Bibane EzzaouiaAfter a year of beingoff-line, El Bibane 3production wasrestarted inSeptember 2010. The El Bibane 3 well, which had gone off-line in August 2009 with a broken tubing string was worked-over in August 2010 using the Ensco 85 jack-up rig. Despite finding the tubing to be broken in more than one place, production was restored via a new tubing string anchored above the irretrievable broken tubing and packer. At this stage, the field had essentially been off line for just over a year, and at start-up, it was clear that the production levels seen before the tubing broke in August 2009 were unlikely to resume immediately. By year end, production still required artificial lift, with no sign of the well resuming natural flow. It appears that the gas-cap had recompressed during the shut-in period. It is increasingly clear that the El Bibane field has robust remaining reserves. However, it is less clear how these can be extracted with the existing infrastructure. Given the under-performance of the two redevelopment wells, studies were initiated to better understand the behaviour of the El Bibane 3 well and the El Bibane field. This full-field numerical simulation will reconcile all data, history match the production data and provide scenario planning for the extraction of the remaining reserves. In parallel the existing seismic will be reprocessed and if deemed necessary new 3D seismic will be shot over the field in 2011.The Ecumed operations team at theonshore Zarzis Central Processing Facilitywhich handles production from El Bibaneand Robbana. A multi-well work-over and side-track program was performed by Initial oil saturations in oil-rim from full- Ezzaouia’s operator Maretap in 2010, continued into 2011. The initial field simulation model of El Bibane. Ezzaouia is a mature field, with significant results of the program were mixed, with the Ezzaouia-5 side-track encountering a swept zone. On the other hand, the work-overs have remaining reserves – accessible through managed to successfully rectify various mechanical issues. The full patient and careful analysis. In collaboration potential of these work-overs has not yet been realized as the wells with our partners, studies are progressing require delicate pump optimization subsequent to the mechanical work-overs. These optimized production rates coupled with the the future of this venerable field. finalization of the Ezzaouia-2 side-track in 2011 will restore robust production levels to the Ezzaouia field. In parallel to the field operations, analysis of the Ezzaouia 3D seismic data has highlighted that improvements could be achieved by reprocessing. This work is ongoing and is expected to provide significant impetus for further infill well opportunities. 5After waiting 16 months, the Ulysse Rigarrived in the second quarter 2010 andperformed two side-tracks and three work-overs on the Ezzaouia field. candax energy inc. annual report 2010
  • 8. Belli and Al Manzah Belli and Al Manzah are non-producing fields. It is Candax’s firm belief that there is residual oil to be produced from both permits. Notwithstanding that our early focus has been on Robbana, El Bibane and Ezzaouia, the technical data on Belli and Al Manzah has been thoroughly reviewed. Belli has potential simply from re-segregation of the reservoir fluids during its 13 year shut in period. Moreover there is considerable upside potential in the possibility of the highly prolific fracture network being recharged via spontaneous imbibitions from the porous matrix. Beyond this, the tight but porous matrix provides an additional target for the future. The Boudabous formation was producing 250 bopd when shut in (due to poor economics) in 1998 – we are confident that a sidetrack on Belli 1 would provide profitable production in today’s economic climate. Candax has initiated studies with ETAP via the jointly managed operator Maretap to progress this. Likewise Al Manzah was shut-in (subsequent to an unsuccessful work over) Belli and Al Manzah but has potential for small, but economically viable production. Al Manzah has significant potential in deeper, undrilled formations that produce locally have good potential on other permits. for the redevelopment of the shut-in reservoirs, as well as exciting additional potential in unexploited levels. Al Manzah operation prior to 2007 shut-in. The Belli field site. 6candax energy inc. annual report 2010
  • 9. MadagascarCandax’s exploration portfolio includes twovery prospective exploration plays – Block 1101in Madagascar covers 14,900 sq km in East Africasmost prolific oil provinces with billion barrel potentialand in Tunisia our Deep Triassic covers over 130 sq kmwith seismic that suggests the prospect could be anequivalent to the TAGI formation, a prolific reservoir Deep Triassicin Algeria, Libya and southern Tunisia. Madagascar has reported 30 billion barrels of discovered tar sands / heavy oil and lighter oils have also been discovered onshore. In Madagascar, the first major milestone was achieved in June - obtaining a one year extension to the exploration permit. Subsequent to this, Candax progressed the necessary logistical and environmental work necessary as preparation for completing the agreed work program in 2011. The Environmental Impact Assessments (“EIAs”) and preparative logistics were slower than initially anticipated, but EIAs have been successfully completed on both areas of interest – Ambilobe and Ampasindava. It is Candax’s firm intention to remain on this block, but we are looking to reduce our working interest, in line with our core focus on near-term production assets. 2D and 3D seismic performed on the Deep Triassic identified potential of over 3 Tcf of gas. The Deep Triassic remains a significant element in the Candax portfolio. However, Candax’s Madagascar Country Manager, in 2010 attention has been focused on the near-term production gains that can be Raharivola Danielson, leading the Ambilobe achieved from existing proven assets, with a view to underpinning the future of public consultation in Antsohimbondrona, Madagascar. Candax via sustainable revenues. Notwithstanding this, geological studies have reviewed, and reached very positive conclusions, on the potential of the Deep Triassic. Candax is evaluating various options for the future drilling of these prospects, given the diverse challenges that such drilling will present and has progressed dialog with the various interested parties that would participate in drilling the Deep Triassic. 7 candax energy inc. annual report 2010
  • 10. Board of Directors Candax’s board delivers the right mix of experience, competence and culture to define and guide the current operational strategy and the growth strategy for the years ahead. Benoit Debray M’hamed Ali Bouleyman Steven Drinkwater DELIVERING Chairman Director Director Chairman, Ecumed Petroleum WITH EXPERIENCE Christopher O. Irwin Dr. Richard J. H. Norris Thomas Rebilly Director President, CEO and Director Director 8candax energy inc. annual report 2010
  • 11. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 9 MANAGEMENT‘S DISCUSSION AND ANALYSIS The following Management’s Discussion and Analysis (“MD&A”) for Candax Energy Inc. and its wholly-owned subsidiaries (“Candax” or the “Company”) should be read in conjunction with the accompanying audited consolidated financial statements and notes for the year ended December 31, 2010, as well as the MD&A and the audited consolidated financial statements for the year ended December 31, 2009. Readers should also refer to a discussion of forward-looking statements contained at the end of this MD&A. Additional information relating to Candax, including its Annual Information Form for the year ended December 31, 2010 is available on SEDAR at www.sedar.com. This information is presented as of March 31, 2011. Company Overview Candax is engaged in the exploration for and the acquisition, development and production of natural gas and crude oil. Its assets are located in Tunisia and Madagascar. Candax also owns a 50% interest in Société d’Electricité d’El Bibane (“SEEB”), a Tunisian power generation company. Foreign Exchange Fluctuations Candax operates primarily in a US dollar-based environment. The majority of the Company’s revenues and expenses are paid in US dollars, although Candax is also exposed to Canadian dollar, Euro, Pounds Sterling and Tunisian Dinar costs. However, being a Canadian company trading on the TSX, Candax has elected to report its financial results in Canadian dollars. Accordingly, all foreign currency amounts presented in Candax’s consolidated statements of operations and deficit and cash flows are converted to Canadian dollars for reporting purposes based on the average Canadian to US dollar exchange rate prevailing during the reporting period. The US to Canadian dollar closing exchange rate on December, 2010 was $.9946 (2009 – $1.0510) and averaged $1.0131 (2009 – $1.0571) during the fourth quarter of 2010 and $1.0303 (2009 – $1.1420) for the year. Capital Structure and Dilution At December 31, 2009, Candax had 169,261,606 common shares outstanding. On March 31, 2010, Candax issued 144,444,444 common shares at $0.09 per common share through a private placement and on May 27, 2010 Candax issued 75,666,666 common shares at $0.08 per common share through the exercise of warrants to bring the total number of common shares outstanding at December 31, 2010 to 389,372,716. On February 4, 2011, pursuant to the terms of the Debt Restructuring Plan, Candax issued 464,193,161 common shares of EL BIBANE the Company to Geofinance in consideration for the cancellation of US $22 million of bank debt and US $1.0 million in bank fees, which amounts were originally owing under the Company’s banking facility with the Bank of Scotland, and subsequently assigned to Geofinance pursuant to the Debt Restructuring Plan, and the conversion of a shareholder loan in the amount of EUR 2 million owing to Geofinance. The shares were issued at $0.055 per share, which price represents the five-day weighted average trading price of Candax shares on the TSX, ended Thursday, February 3, 2011. The average EURCAD and USDCAD exchange rates over the same five-day period were used to determine the number of shares to be issued. The new common shares issued represent 119% of the number of common shares of the Company issued 9 and outstanding just prior to the issuance, and as a result of this issuance, Candax now has 853,565,877 common shares outstanding as of March 31, 2011, of which Geofinance holds 684,304,271 representing 80.17%. candax energy inc. annual report 2010 At December 31, 2009, the Company did not have any warrants outstanding, however, in connection with the above-mentioned private placement the Company issued 86,666,666 warrants on March 31, 2010. On May 27, 2010, 75,666,666 warrants were exercised at an exercise price of $0.08 per share, leaving 11,000,000 warrants outstanding at December 31, 2010. The 11,000,000 warrants outstanding at December 31, 2010 expire on March 31, 2011. At December 31, 2009, the Company had 10,700,000 stock options outstanding at an average exercise price of $0.78. During the year, 7,100,000 options at an average exercise price of $0.80 expired and 3,050,000 options an average exercise price of $0.74 were forfeited, leaving 550,000 options at an average exercise price of $0.79 outstanding at December 31, 2010. During the first quarter of 2011, 200,000 options at an average exercise price of $0.97 per share expired leaving 350,000 options at an average exercise price of $0.72 per share outstanding at March 31, 2011. Business Development Activities Candax’s objective is to build a high-growth international portfolio of oil and gas assets. Review of Operations El Bibane is an oil and gas field located offshore Tunisia. Candax is the operator and holds a 73.8% working interest. The field re-development plan comprised three wells, El Bibane-3, 4 and 5. Oil production was constrained initially by capacity limitations in the export line, which, as a consequence of higher than expected water production, prevented simultaneous production from the El Bibane-3 and El Bibane-4 wells. Production has been further constrained by mechanical failures in these two wells identified in the course of a barge-based intervention program in September 2009. Remedial work programs to restore production were prepared. The first of these programs to restore production from El Bibane-3 commenced in March 2010 and was completed in April 2010. The work-over successfully retrieved the parted tubing from the well and it was determined that a packer failure and slippage of the entire down-hole production string had occurred which caused the original tubing break. After repair, the well was initially restarted under gas-lift on April 12, 2010 with evidence of liquids coming to surface, but this was curtailed by surface valve problems. Once the surface valve was reopened the gas-lift pressure remained low and no further liquids were seen on surface. Subsequent tests indicate that the replaced tubing failed, most likely at approximately the same depth as the original break. Although this result was disappointing, the reconnection work-over was considered to be a temporary fix to the existing tubing configuration, and it was recognized from the outset that further work would be required for a permanent solution, which work was planned for Phase 2 of the well interventions.
  • 12. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 10 MANAGEMENT‘S DISCUSSION AND ANALYSIS SEEB Phase 2 of the program for the El Bibane-3 well was designed during the second quarter of 2010 and the work started on July 24, 2010. The operation to remove the broken tubing from the El Bibane-3 well retrieved all but the last 200 metres of existing tubing and packer. The plan of extending the tubing into the reservoir to limit the influx of water and running logging tools to better understand the reservoir was not possible due to the inability to remove the entirety of the old tubing. The tubing was found in extremely poor condition and thus fishing operations were suspended after considerable efforts. A casing integrity tool confirmed that the casing is in acceptable condition, and thus a new completion was installed down to the top of the broken tubing. Fluid losses during fishing indicated that there was communication across the fish. The well was successfully put back on production on Friday, September 10, 2010 using gas-lift with gas supplied from the El Bibane 5 well (gas-lift is being operated as a closed loop to minimize flaring, with all high-pressure gas being re-circulated). Oil production had stabilized at approximately 100 to 150 barrels of oil per day with some 95% water-cut, production that is comparable to the overall volume of liquids that the well was producing prior to the well’s tubing failure in 2009. Prior to that tubing failure, the El Bibane-3 well was producing under natural flow and we expect that the well will revert to this behaviour. It is, however, not possible to predict exactly when this will occur. Prior to making a decision on the design of the next phase of the El Bibane program, Candax has decided to conduct a full field simulation study and has contracted a French firm, BEICIP-Franlab, to complete such. The study is currently ongoing and is expected to be completed in May 2011. The study will make recommendations as to the best alternatives to produce the remaining reserves of the El Bibane field. Candax believes that the acquisition and processing of 3D seismic will be required to increase knowledge of the El Bibane field. EZZAOUIA Candax has a 50% equity interest in Société d’Electricité d’El Bibane (“SEEB”), a Tunisian company which owns and operates a gas-fired 27 MW single cycle electricity generation plant. Gas is supplied to SEEB primarily from El Bibane. The generating capacity of the power plant was reduced by 50% from early May to December 2009 as a consequence of the failure of one of the two gas-fired turbines. The damaged turbine has been replaced though operations are presently constrained by the interruption of gas supply form the El Bibane field. Due to the interruption in gas supply from the El Bibane field, SEEB has not produced any power since early January 2010. Due to the uncertainties as to the production of the El Bibane field, it is not possible for management to predict when SEEB will resume its operations and what daily volume of gas will be delivered to SEEB. As a result of reduced generating capacity, SEEB has been unable to meet its obligations under bank financing arrangements to make repayments of principal and interest. As a consequence of the payment arrears, SEEB has received several default notices from the lenders under its bank facility. As a consequence, the loans can be called by the lenders at anytime. The Company and Caterpillar exercised joint control over the SEEB operations, however, during the fourth quarter of 2010, the banks, as lenders, started to impose tighter control over the day-to-day operations of SEEB. As a result of the actions by the banks, it was determined that the Company no longer exercised joint control over SEEB and consequently it was no longer appropriate to proportionately consolidate SEEB’s results. In accordance with Canadian GAAP, the investment in SEEB was deconsolidated and recognized at cost. As a result of the deconsolidation, a charge of $1.1 million was expensed in the consolidated statements of operations and deficit. The Company reviewed the financial position of SEEB and determined that no amounts will be recoverable from this investment. The Company has no future financial obligation to SEEB or its lenders. Ezzaouia is primarily an on-shore oil field located in Tunisia producing small quantities of associated gas. The Ezzaouia field is operated by Maretap, a company owned by the interest holders in the field which include Candax and Entreprise Tunisienne d’Activités Pétrolières (“ETAP”), the Tunisian state-owned oil company. Candax owns a 31.4% working interest. 10 On July 22, 2010, the operator hooked up a side-track on the Ezzaouia-5 well. Open-hole log data showed the reservoir intervals to have lower than expected oil saturations and the production of the well was indeed disappointing, peaking at 70 barrels per day before going down to zero (100% water cut) after a few weeks. The Ezzaouia-5 well is currently shut-in and the partners are reviewing their options to determine the bestcandax energy inc. annual report 2010 solution to resume production from that well, which may involve perforating other layers. The work-over of the Ezzaouia-1 well was completed on September 21, 2010. The well has shown disappointing production and a slickline intervention is ongoing to install a blanking sleeve in the tubing and to test the completion to identify any possible leakage. The Ulysse rig then moved to the sidetrack of the Ezzaouia-2 well. This sidetrack was temporarily suspended mid-October due to mechanical difficulties with the rig’s pump equipment. The equipment required to be able to continue with the sidetrack was received around March 20, 2011 and the work has resumed. While awaiting replacement parts, the rig was moved to the Ezzaouia-11 well location to remove the existing completion, mill the existing packer, install a new packer and a new completion. Tie-in was completed mid-November. Because of lower than expected production, it was decided to conduct a slickline operation to evaluate the formation, which is ongoing. The well will then be produced with swabbing. After the tie-in was completed on the Ezzaouia-11, the rig moved to the Ezzaouia 9 well to retrieve the coiled tubing and run a new completion. The workover was completed in January 2011. Tests are ongoing to optimize the injection pressure to improve production.
  • 13. ROBBANA FIELDCandax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 11 MANAGEMENT‘S DISCUSSION AND ANALYSIS CHAAL PERMIT Candax is conducting a reinterpretation of the 3D seismic previously acquired to enhance its understanding of the various horizons, including the Deep Triassic, present in the Ezzaouia field. We expect that this reinterpretation of seismic will identify infill drilling locations and will optimize the future work program to yield better results than the 2010 campaign. Robbana is an on-shore oil field located in Tunisia. Candax is the operator and holds an 80% working interest. As a consequence of declining well productivity, production from the field was suspended in May 2009 pending drilling and completion of a planned sidetrack of the Robbana-1 well. MHA Petroleum Consultants LLC (“MHA”) and Petroleum Insights Sàrl (“Petroleum Insights”) have completed a full-field simulation study. From their analysis of the various pressure response data from the field during its 17 years production history Petroleum Insights and MHA have MADAGASCAR identified between 18 and 25 million bbls of oil in place and 4.3 to 5.8 million bbls of recoverable volumes, assuming a waterflooding program is implemented. Candax has initiated a workover, expected to be completed in April. The objectives of the workover are: (1) to take pressure measurements to further refine estimates of oil in place; (2) to obtain bottom hole samples for PVT analysis; and (3) to reestablish production. The data collected will enable Candax to better prepare for a probable stimulation workover of this well mid-year as well as for the anticipated redevelopment of this field. Based on the positive evaluation of Petroleum Insight’s study, the design of an optimal water-flooding program is also being initiated. Chaal is an on-shore exploration permit located in central Tunisia approximately 50 kilometres west of the city of Sfax, covering an area of 1,200 square kilometres. An initial exploration well, Chaal-1, was drilled by Candax in 2006 but could not be tested due to formation damage caused by the heavy mud weights required to manage the high pressures encountered. Candax and its partners subsequently committed to drill a deviated sidetrack of the Chaal-1 well using managed pressure drilling to further evaluate the commerciality of the gas discovery and as a condition of securing an extension of the Chaal Permit to May 25, 2010. In May 2010, Candax and its partners requested an extension of the permit but the Tunisian authorities have informed Candax that they were not in a position to approve the extension. On September 24, 2010, the decision to cancel the permit was published in the official gazette of the Republic of Tunisia. The authorities are seeking penalties arising from the non-fulfillment of the committed work program. Discussions are ongoing between Candax, its partners and the Tunisian authorities to determine the amount, if any, of the applicable penalties. 11 candax energy inc. annual report 2010 Block 1101 is an on-shore exploration permit located in northwest Madagascar and covers 14,900 square kilometres. The Company is the operator with a 60% working interest. Results from the initial geological fieldwork, geochemistry and gravity/magnetics confirmed the exploration potential of Block 1101, indicating up to 9,000 metres of sedimentary section beneath the block together with numerous oil shows. In 2009, the Madagascar government approved a 12-month extension to the licence terms until July 30, 2010 and then in 2010 the licence was further extended until July 30, 2011 within which time Candax has a commitment to drill an exploration well. To accommodate this extension of the first exploration period the third exploration period will be reduced from two years to one year. Work has been continuing to identify a drilling location. Two alternative sites have been identified and discussions are continuing to determine the preferred location. The Environmental Impact Assessment is completed for one of the sites (the Ambilobe location) and is being finalized for the other location (Ampasindava). The design of the drilling program (including civil works requirement to bring equipment on site) is ongoing. Considering the size of the upcoming capex program and the risks associated with the prospects, Candax continues to explore farm-out discussions with several parties. There is no guarantee that these discussions will be successful. Non-Producing Assets The Belli and Al Manzah permits as well as the Deep Triassic are being re-examined as part of a full review of the portfolio of assets. Production from Al Manzah was characterized by a very energetic dynamic system with clear movement of fluid contacts. Having been shut-in the field will have partially re-segregated, and it is likely that modest volumes of oil are readily accessible. However, the final (failed) workover may have rendered the existing well useless. It is anticipated that, following further study, this field can resume production via new well. The reservoir is shallow, at some 800 metres. A study of the existing data on Belli coupled with a review of analogus fields and the literature by Petroleum Insights has indicated that the matrix STOIIP which is unlikely to have contributed to the production could be in the order of 50 MMbbls. It is conceivable, that in the timeframe of the shut-in (12+ years), that spontaneous recharging has occurred and that some of this oil may have migrated into the vugs/fractures. It is virtually impossible with the existing data to estimate the probability of this occurring, however Petroleum Insights suggests that there is a 10% probability of this having occurred. The Belli permit also has several promising exploration leads.
  • 14. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 12 MANAGEMENT‘S DISCUSSION AND ANALYSIS Equity Investment On March 31, 2010, the Company completed an investment agreement with Geofinance N.V., an international upstream oil and gas company (“Geofinance”). Under the terms of the agreement, Geofinance invested $13.0 million in the Company to purchase 144,444,444 units of the Company at a price of $0.09 per unit, each unit comprising one common share and 0.6 of one common share purchase warrant for a total of 86,666,666 warrants. Each whole warrant may be exercised for a period of one year from the date of the closing of the transaction at a price equal to the current market price (calculated based on the weighted average trading price of the Company’s common shares for the five trading days immediately prior to the date of exercise). On May 27, 2010, Geofinance exercised warrants to acquire 75,666,666 common shares of Candax at an exercise price of $0.08 per common share for total proceeds of $6.4 million. As a consequence, at December 31, 2010, Candax had 389,372,716 common shares outstanding. Bank Loan Restructuring On March 31, 2010 Candax concluded an Amendment and Restatement Agreement with the Bank of Scotland by which the terms of the Borrowing Base Facility Agreement were amended and restated. The agreement provided for the extension of the maturity date of the facility to June 30, 2014 and rescheduling of repayments while splitting outstanding amounts into two tranches; the Borrowing Base Amount and an Excess Tranche. Interest on the Borrowing Base Amount was calculated at US$ LIBOR plus 4% and on the Excess Tranche at US$ LIBOR plus 9.5%. Under the terms of the Amendment and Restatement Agreement, a principal payment of US $8.0 million and restructuring fees of US $1.0 million were payable on December 31, 2010. Debt Restructuring Plan On February 4, 2011, the Company completed a two-step debt restructuring plan (the “Debt Restructuring Plan”). The key elements of the Debt Restructuring Plan are as follows: • On December 24, 2010, the Bank of Scotland, as sole lender under the Company’s US$45 million bank debt (the “Bank Debt”), assigned all rights and obligations under the Bank Debt to Geofinance • On February 4, 2011, Geofinance and Candax closed the restructuring of the Bank Debt and entered into a restructuring agreement (the “Restructuring Agreement”). The main terms and conditions of the Restructuring Agreement are: • In consideration for Geofinance converting US$22 million of the US$45 million Bank Debt into equity, Candax issued 396,590,242 shares to Geofinance, at a price of $0.055 per share (representing the five-day weighted average market price at the time of the issuance); • In consideration for Geofinance waiting the right to receive certain fees on December 31, 2010 in respect of the Bank Debt, Candax issued 18,116,963 shares to Geofinance; • Geofinance also converted the then existing EUR 2 million shareholder loan into 49,485,956 shares of Candax; • Geofinance and Candax entered into a restructured and amended loan agreement for the remaining US$23 million debt (the “Amended Loan Agreement”) and into a new US$10 million shareholder loan (the “Shareholder Loan”); • The Amended Loan Agreement is split into: (1) a seven-year, US$15 million senior term loan (itself split between a US$5 million tranche A priced at 4% and a US$10 million tranche B bearing interest at 4.5%, paid in kind), which will amortize over a five-year period starting on January 31, 2013 and (2) an eight-year, US$8 million junior term loan, bearing interest at 6%, paid in kind (the Company will also pay Geofinance a cash premium at maturity in order to provide a rate of return of 10% per annum to Geofinance). This junior term loan is repayable at maturity; • The Shareholder Loan has an eight-year maturity. The interest, payable in cash, is grid-based, with rates between 3.5% and 7.5%, depending on the cumulated drawdown by Candax under the Shareholder Loan. 12 As detailed above, Geofinance received a total of 464,193,161 new shares. As at March 31, 2011, Candax had a total of 853,565,877 shares outstanding (out of which 684,304,271 are owned by Geofinance).candax energy inc. annual report 2010 In order to obtain approval for the Debt Restructuring Plan in advance of the December 31, 2010 payment owing to Bank of Scotland (as discussed above under Bank Loan Restructuring), Candax relied on the financial hardship exemption provided by the TSX rules and Multilateral Instrument 61-101. Reliance on this exemption automatically results in a TSX review for continued listing to confirm that Candax continues to meet TSX listing requirements. The TSX Continued Listing Committee will convene to review the documents provided by Candax on April 12, 2011. Board of Directors John Cullen, Adrian Jackson and Michael Wood tendered their resignations as directors of the Company on March 31, 2010 and Thomas Rebilly, Dr. Richard Norris and Stephen Drinkwater were appointed in their stead. Biographies of the new directors were disclosed in the Company’s press release of March 10, 2010. At the Candax Annual General Meeting held on June 22, 2010, Adrian Loader, the former Chairman of Candax did not stand for re-election and Benoit Debray was elected by shareholders as disclosed in the Company’s press release of June 29, 2010. Murray Grant resigned from the board on November 25, 2010. M’hamed Ali Bouleymen was appointed in his stead on January 16, 2011. Christopher Irwin remains on the board of directors of Candax.
  • 15. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 13 2009 2009 2009 2009 2009 MANAGEMENT‘S DISCUSSION AND ANALYSIS Oil (bbls/day) 1,063 1,152 582 483 818 Gas (mmcf/day) 3.5 2.9 1.2 2.3 2.5 BOEs/day 1,651 1,627 782 866 1,234 Revenue Sales, net of royalties for the three months ended December 31, 2010, were $nil (2009 – $9.1 million) and for the year ended December 31, 2010 were $0.7 million (2009 – $28.1 million). During the fourth quarter of 2010, the Company did not sell any barrels of oil (2009 – 114,211 barrels sold at an average price of US $68.48 per barrel) and on a year-to-date basis for 2010 the Company sold 9,454 barrels of oil at an average price of US Summary of Gross and Net Reserves $67.87 per barrel (2009 – 423,882 barrels sold at an average price of US $52.25 per barrel). The reduction in sales in 2010 was primarily a result Escalated Parameters, Forecast Prices and Costs of the El Bibane field being shut-in and of the natural decline in the production of the Ezzaouia field, which was not offset by the capital program BOE Oil Natural Gas implemented in 2010, as discussed above. Gross Net Gross Net Gross Net Reserves Category (Mboe) (Mboe) (Mbbl) (Mbbl) (MMcf) (MMcf) As a result of the shut-in of the El Bibane field, no gas was delivered to SEEB during the year and consequently, no electricity sales were Total Proved – All Categories 3.4 2.0 2.3 1.2 6,500 4.586 included in sales, net of royalties for the three months and year ended December 31, 2010 compared with sales of $0.5 million and $2.6 million for the same periods in 2009. Probable – All Categories 5.1 2.4 4.5 2.0 3,675 2,411 Total Proved Plus Probable 8.5 4.4 6.8 3.2 10,175 6,997 Production The following table summarizes the quarterly net production (after royalty production) for 2010 and 2009: Q1 Q2 Q3 Q4 Total BBLS 2010 2010 2010 2010 2010 265 154 160 244 206 – – – – – 265 154 160 244 206 Production for the three months and year ended December 31, 2010 was lower than the same periods in 2009 due to reduced production from the El Bibane and Ezzaouia fields as discussed earlier. Reserves 13 candax energy inc. annual report 2010 The following table outlines Ryder Scott’s forecasted future prices for each of oil and natural gas. These forecasts form the basis for Ryder Scott’s evaluation of the Company’s reserves at December 31, 2010 as outlined above. Crude Oil and Natural Gas Price Natural Gas Liquids US$/Mcf $US/Bbl 2011 0.42 83.49 2012 0.54 83.49 2013 0.55 83.49 2014 0.56 85.46 2015 0.57 87.25 Average thereafter 0.60 95.85 Where amounts are expressed on a barrel of oil equivalent (boe) basis, natural gas volumes have been converted to barrels of oil equivalent at 6,000 cubic feet to one barrel of oil equivalent (6 mcf = 1 boe). This conversion ratio is the convention used in the oil and natural gas industry and is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. The use of boe may be misleading, particularly if used in isolation. Operating Costs Operating costs for the year and three months ended December 31, 2010, were $8.9 million and $1.0 million respectively, compared to $9.8 million and $3.6 million for the same periods in 2009. Operating costs were lower for the year ended December 31, 2010 compared to 2009 due to reduced workover activity and the reversal of the year end accrual for the overlifting.
  • 16. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 14 MANAGEMENT‘S DISCUSSION AND ANALYSIS Depletion, Depreciation and Amortization Expense For the year and three months ended December 31, 2010, depletion, depreciation and amortization was $2.6 million and $0.6 million, respectively, (2009 – $45.6 million and $24.5 million, respectively). Depletion is calculated using the purchase price of the acquired assets, capital expenditures and proved reserves as at year-end. The significant decrease in 2010 over 2009 was due to reduced sales during 2010. Asset Impairment Asset impairment for the year and three months ended December 31, 2010, was $nil and $nil respectively, (2009 – $20.6 million and $19.2 million, respectively). There was no impairment charge for 2010 as in 2009 writedowns were taken for Chaal in the amount of $10.2 million, Madagascar $3.5 million and an additional impairment charge of $4.6 million was taken after giving further consideration to potential impairment to the carrying value of its petroleum and natural gas properties by reference to a number of external factors including the market capitalization of the Company and the proposed transaction with Geofinance NV. Bad debt expense Bad debt expense for the year and three months ended December 31, 2010, was $1.1 million and $1.1 million respectively, (2009 – $nil and $nil, respectively). During 2010 the Company wrote off receivables from SEEB. General and Administrative Costs For the year and three months ended December 31, 2010, general and administrative costs were $10.2 million and $0.8 million, respectively, (2009 - $6.0 million and $1.7 million, respectively). The increase in costs over 2009 was primarily as a result of a provision made for government claims, severance payments made to the previous management and the bank loan restructuring fee (which has subsequently been waived by Geofinance – see Note 23, Subsequent Event) in the Consolidated Financial Statements for the year ended December 31, 2010. Loss on deconsolidation of joint venture interest For the year and three months ended December 31, 2010, the loss on deconsolidation of joint venture interest was $1.1 million and $1.1 million, respectively, (2009 – $nil and $nil, respectively). The Company and Caterpillar exercised joint control over the SEEB operations, however, during the fourth quarter of 2010, the banks, as lenders, started to impose control over the day-to-day operations of SEEB. As a result of the actions by the banks, it was determined that the Company no longer exercised joint control over SEEB and consequently it was no longer appropriate to proportionately consolidate SEEB’s results. In accordance with Canadian GAAP, the investment in SEEB was deconsolidated and recognized at cost. The Company reviewed the financial position of SEEB and determined that no amounts will be recoverable from this investment. The Company has no future financial obligation to SEEB or its lenders. Interest Expense Interest expense for the year and three months ended December 31, 2010 was $3.8 million and $1.1 million, respectively, (2009 – $4.5 million and $1.4 million, respectively). Interest expense for 2010 was lower than the same periods in 2009 primarily as a result of the restructuring of the SEEB debt in June 2009 as well as a stronger Canadian dollar; the term loan is denominated in US dollars and the loans in SEEB are denominated in US dollars and Euros. Foreign Exchange The unrealized foreign exchange gain for the year and three months ended December 31, 2010 was $0.6 million and $nil respectively (2009 – losses of $2.6 million and $1.3 million, respectively). The unrealized foreign exchange gain for 2010 compared to losses in 2009 was due to a stronger Canadian dollar and the revaluation of the Euro-denominated loan in SEEB. Related Party Transactions During the year, the Company had gas sales to SEEB of $ nil (2009 – $0.4 million) and at December 31, 2010 the Company had a receivable from 14 SEEB in the amount of $0.9 million (2009 – $0.8 million). The receivable amount has been fully provided for.candax energy inc. annual report 2010 At December 31, 2010, the Company had a related party term loan of US $44.5 million payable to its major shareholder, Geofinance. As described in the debt restructuring plan above, in February 2011, Geofinance cancelled US $22 million of the related party term loan and rescheduled the January 31, 2011 principal repayment to January 31, 2013, in exchange for common shares. The Company had a loan from its major shareholder, Geofinance, in the amount of EUR 2.0 million at December 31, 2010. As described in the debt restructuring plan above, in February 2011, Geofinance converted the shareholder loan into common shares. During the year, the Company’s major shareholder charged one of the Company’s subsidiaries $0.4 million for services provided by its employees in accordance with the services agreement.
  • 17. Sales, net of royalties Loss Loss per share – basic and diluted Total assets Long-term financial liabilitiesCandax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 15 2009 Sales, net of royalties 8,288 8,548 2,181 9,123 28,140 Loss (13,943) (3,129) (3,681) (40,443) (61,196) Loss per share – basic and diluted (0.08) (0.02) (0.02) (0.24) (0.36) MANAGEMENT‘S DISCUSSION AND ANALYSIS Total assets 193,256 159,745 136,576 95,518 95,518 Long-term financial liabilities 48,201 32,755 28,619 39,315 39,315 2008 Selected Quarterly Financial Data Sales, net of royalties 2,097 14,909 13,864 3,896 34,766 (in thousands of Canadian dollars except per share amounts) Net income (loss) (2,298) 2,820 1,573 (15,244) (13,149) Net income (loss) per share – basic and diluted (0.01) 0.02 0.01 (0.09) (0.08) Q1 Q2 Q3 Q4 Year Total assets 185,802 183,811 183,812 194,254 194,254 2010 Long-term financial liabilities 38,129 39,400 40,928 52,206 52,206 – – 696 – 696 (3,614) (3,759) (13,900) (5,423) (26,696) (0.02) (0.01) (0.04) (0.02) (0.08) 89,063 98,202 80,875 68,200 68,200 38,906 34,310 33,727 28,317 28,317 15 There were no sales during the first, second and fourth quarters of 2010 and only minimal sales during the third quarter of 2010 due to lower production at El Bibane and Ezzaouia and the lifting process in Tunisia (where production from the El Bibane, Ezzaouia and Robbana fields are candax energy inc. annual report 2010 aggregated in 200,000 bbls tanks before being sold). Sales for the third quarter of 2009 were lower than each of the other three quarters of 2009 primarily due to lower production at El Bibane. Sales for the first quarter of 2009 were higher than the fourth quarter of 2008 due to the timing of the liftings. Sales for the second quarter of 2008 were significantly higher than the first quarter of 2008 due to the start-up of production at the El Bibane field. The loss for the fourth quarter of 2010 was lower than the loss for the third quarter of 2010 as during the third quarter of 2010 significant costs were incurred for the workover of the El Bibane field. The loss for the fourth quarter of 2009 was significantly higher than the current quarters in 2010 and the previous three quarters of 2009, primarily as a result of the recognition of asset impairments and related writedowns of $19.2 million. The assets were lower in the fourth quarter of 2010 compared to the first three quarters of 2010 due primarily to the deconsolidation of the SEEB joint venture assets as described earlier. The long-term liabilities for the fourth quarter of 2010 were lower than the previous three quarters of 2010 due to the increase in the amount recorded in the current portion. The assets for the first three quarters of 2010 were lower than the first three quarters of 2009 due to the asset writedown. The long-term financial liabilities were lower in the fourth quarter of 2009 due to the stronger Canadian dollar against the US dollar which resulted in a lower liability for the US dollar-based term loan. The long-term financial liabilities for the second quarter of 2009 were lower than the first quarter of 2009 and the fourth quarter of 2008 due to principal repayments made and the increase in the amount recorded in the current portion. The increase in the long-term liabilities in the fourth quarter of 2008 over the first three quarters of 2008 was due to a drawdown in the credit facility. Liquidity, Capital Resources and Capital Expenditures Candax has historically relied on debt and equity financing to raise capital and expects to be able to continue to do so. Candax is also dependent upon sustained cash flow from its operations. A material fall in the oil price or prolonged curtailment of production risks could compromise the ability of Candax to meet its obligations as they fall due. As at December 31, 2010, Candax had a cash balance of $2.8 million (December 31, 2009 – $9.8 million) and accounts receivable of $0.3 million (December 31, 2009 – $4.1 million) compared to accounts payable and accrued liabilities of $9.0 million (December 31, 2009 – $17.9 million). The working capital deficit before financing at December 31, 2010 was $22.1 million. As noted above, on March 31, 2010 Candax completed an investment agreement with Geofinance by which Geofinance contributed new equity of $13.0 million (net proceeds of $11.5 million) which funds were used to finance work programs and for general working capital purposes in 2010. In addition, on May 27, 2010, Geofinance invested a further $6.4 million on the exercise of warrants.
  • 18. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 16 MANAGEMENT‘S DISCUSSION AND ANALYSIS In conjunction with the investment by Geofinance, on March 31, 2010, the Company concluded an Amendment and Restatement Agreement with the Bank of Scotland by which the terms of the Borrowing Base Facility Agreement were amended and restated. The Agreement provided for the extension of the final maturity date of the facility from December 31, 2012 to June 30, 2014 and rescheduling of principal repayments, while splitting outstanding amounts into two tranches; the borrowing base amount and an excess tranche. The new repayment schedule required the Company to make a principal repayment of US$8.0 million and a restructuring fee of US $1.0 million on December 31, 2010. On May 19, 2010, the Company executed a EUR 2.0 million loan agreement with Geofinance. The shareholder loan was utilized for working capital requirements of Candax and utilization was subject to Geofinance’s approval. The loan bore interest at a rate of 3.5% per annum and matured July 15, 2014. It was subordinated to the term loan provided by Bank of Scotland and repayments were governed by a subordination agreement entered into by Candax, Geofinance and Bank of Scotland. This loan was cancelled on February 4, 2011 and converted to common shares of Candax as part of the Debt Restructuring Plan discussed above. As noted above in the “Debt Restructuring Plan” section, Candax completed a two-step restructuring in February 2011. As the Amended Loan Agreement has no principal amortization before January 31, 2013 and the interest payable under the Amended Loan Agreement are modest and largely paid in kind and further that Geofinance has made a US$ 10 million shareholder loan available to Company, and finally that Candax has minimal required capital investment obligations over the next 12 months, Candax expects to be able to continue as a going concern. The Company is in discussions with several providers of capital. While there is no certainty these discussions will be successful, Candax would use these funds to accelerate its redevelopment programs, notably through the implementation of a water-flooding program on the Robbana field. Candax’s work programs for 2011 include minimal already committed expenses. Depending on the outcome of the full-field simulation study being conducted by Beicip, Candax and its partners may acquire and interpret 3D seismic on El Bibane in Q3 and Q4 2011, at a cost of approximately US $3.1 million (the final price may vary depending on the defined seismic area). On the Ezzaouia field, the sidetrack of the Ezzaouia-2 well will be completed in Q2 2011. Maretap, the operator of the Ezzaouia field, will also improve and maintain its processing facilities. The total capex, net to the Company, on the Ezzaouia field, is expected to be approximately US $2.7 million. Candax is planning to hold a technical committee meeting in April 2011 to initiate the reopening of the Belli field, which may occur at the end of Q3 or in Q4 2011. Capital Management and Sensitivities Candax manages its capital to ensure that the Company and its subsidiaries will be able to continue as a going concern while attempting to maximize the return to shareholders through the optimization of debt and equity financing. The Board of Directors does not establish quantitative return on capital criteria for management, but rather relies on the expertise of the Company’s management to sustain future development of the Company. The capital structure consists of debt, cash and cash equivalents and shareholders’ equity excluding accumulated other comprehensive income (loss). Candax monitors its capital through its net cash position calculated as cash less term loan debt. The Company maintains this structure by managing working capital, capital spending programs and debt repayment terms. The Company raises capital, as necessary and the optimal balance between debt and equity may change over time. Management reviews its capital management approach on an ongoing basis and believes that this approach, given the relative size of the Company, is reasonable. There were no changes in the Company’s approach to capital management during the period ended December 31, 2010 compared to the year ended December 31, 2009. Sensitivity Analysis Based on balances at December 31, 2010, the following shows the approximate impact on the Company’s earnings of a change in selected key variables. The impact is measured changing one variable at a time and may not necessarily be indicative of sensitivities on future results: • Cash and cash equivalents include deposits which are at variable interest rates. Term debt under the related party term loan was also 16 at variable interest rates. Sensitivity to a plus or minus 1% change in rates would affect the loss by $0.5 million for the year ended December 31, 2010. • The Company does not hold significant balances or debt in currencies other than the US dollar to give rise to exposure to significantcandax energy inc. annual report 2010 foreign exchange risk. • The Company is exposed to changes in oil prices. Sensitivity to a plus or minus $1.00 change in the price of crude oil would affect the loss by $nil for the year ended December 31, 2010. Commitments and Contingencies Under the provisions of the hydrocarbons law of Tunisia, 20% of the Company’s oil production must be sold to ETAP. Candax receives 90% of the export sales price achieved by ETAP on sale of such production. Candax has provided a standby letter of credit in the amount of US $0.5 million in favour of Madagascar Ministry of Industry and Mines in accordance with the terms of the production sharing agreement entered into in November 2006. The letter of credit will be released when the Company has satisfied the commitments as outlined in the agreement.
  • 19. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 17 MANAGEMENT‘S DISCUSSION AND ANALYSIS The Company’s joint venture partners in the Chaal permit have submitted reports arising from their audit of the expenditures associated with the initial Chaal exploration well. Amongst other matters, the reports assert claims for credit which, if sustained would result in the Company incurring additional liability of US $0.4 million. The Company has received the reports and responded to the partners at the end of April 2010 but have still not received a response from either partner. It is not anticipated that any additional material liability will be incurred and, accordingly no amounts have been accrued for in this regard. Critical Accounting Estimates In preparing financial statements management has to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Based on historical experience, current conditions and expert advice, management makes assumptions that are believed to be reasonable under the circumstances. These estimates and assumptions form the basis for judgments about the carrying value of the assets and liabilities and reported amounts for revenues and expenses. Different assumptions would result in different estimates and actual results may differ materially from results based on these estimates. These estimates and assumptions are also affected by management’s application of accounting policies. Critical accounting policies and estimates are those that affect the consolidated financial statements materially and involve a significant level of judgment by management. Going Concern The Company’s consolidated financial statements have been prepared on the basis that the Company will continue as a going concern and, as such, has sufficient assets and working capital to satisfy its financial obligations as they come due. In making this determination, management has made estimates of future revenues, and costs, and made assumptions on reserve status and the likelihood and timing for accessing reserves. This process involves making various assumptions and judgments about each of the factors affecting the determination of cash flows, production rates and fair values. Changes in any of these assumptions or judgments could result in significant difference from those used by management. Reserves The Company’s management makes estimates that relate to the future development costs associated with proved undeveloped reserves, reserve volumes, future production and revenues, and future costs associated with asset retirement obligations. The Company has its oil and gas reserves, future development costs and future cash flows from those reserves evaluated and reported on by Ryder Scott Company Petroleum Consultants, independent petroleum reserve engineering consultants. The estimation of these amounts is a subjective process, based on engineering data, forecasted prices and production levels and the timing of expenditures. All of these estimates are subject to numerous uncertainties and various interpretations, and consequently will change over time to reflect updated information as it is received. 17 Petroleum and Natural Gas Properties candax energy inc. annual report 2010 Candax follows the full cost method of accounting, whereby all costs incurred in exploring for and developing oil and gas reserves are capitalized. Such expenditures include geological and geophysical expenses, carrying charges for unproved properties, costs of drilling both productive and non-productive wells, gathering and production facilities and general and administrative costs directly related to exploration and development activities. Capitalized costs are accumulated on a country-by-country basis and are amortized and depleted using the unit-of-production method based upon estimated proved reserves. For those properties that are still in the development stage, related costs are capitalized until either commercial production commences or it is determined that the invested amounts will never be recovered. Natural gas reserves are converted to equivalent barrels of oil on the basis of their relative energy content (6 mcf equals 1 barrel). Costs directly associated with the acquisition and evaluation of unproved properties are initially excluded from the computation of depletion. These unproved properties are assessed periodically to ascertain whether impairment has occurred. When proved reserves are assigned, the cost of the property is added to all other capitalized costs subject to amortization and depletion. Candax calculates a ceiling test whereby the net capitalized costs of properties cannot exceed discounted cash flows from proved and probable reserves. Cash flows are calculated based on third-party quoted forward prices and adjusted for the Company’s contracted prices and quality differentials. If there is impairment, the magnitude of it would be calculated by comparing the carrying amount of property, plant and equipment to the estimated net present value of future cash flows from proved plus risked probable reserves. A risk-free interest rate is used to arrive at the net present value of the future cash flows. Any excess carrying value above the net present value of future cash flows would be recorded as a permanent impairment and charged as additional depletion expense in the consolidated statements of operations and deficit. Sales of oil and gas properties are accounted for as adjustments to capitalized costs, with no gain or loss recognized unless such adjustments would alter the rate of depletion and amortization by more than 20%. Business Risks A comprehensive assessment of Candax’s business risks is set out in the 2010 Annual Information Form. There are a number of inherent risks associated with oil and gas operations and development. Many of these risks are beyond the control of the Company. The following outlines some of the principal risks and their potential impact on the Company:
  • 20. EXPLORATION, DEVELOPMENT AND PRODUCTION RISKS Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 18 MANAGEMENT‘S DISCUSSION AND ANALYSIS PETROLEUM AND NATURAL GAS RESERVES A portion of the current working capital of Candax will be expended on petroleum and natural gas exploration, exploitation and development activities, which are high-risk ventures with uncertain prospects for success. Oil and gas exploration involves a high degree of risk and there is no assurance that expenditures made on future exploration activities by the Company will result in new discoveries of oil, condensate or natural gas that are commercially viable or economically producible. Holders of securities of the Company must rely on the ability, expertise, judgment, discretion, integrity and good faith of management of the Company. It is difficult to project the costs of implementing any exploratory or developmental drilling program due to the inherent uncertainties of drilling in unknown formations, the costs associated with encountering various drilling conditions such as over-pressured zones and tools lost in the hole and changes in drilling plans and locations as a result of prior exploratory wells or additional seismic data and interpretations thereof. Few properties that are explored are ultimately developed into new reserves. In certain instances, the Company may be precluded from pursuing an exploration program or decide not to continue with an exploration program and such an occurrence may have a negative effect on the value of the securities of the Company. Future oil exploration may involve unprofitable efforts, not only from dry wells, but from wells that are productive but do not produce sufficient net revenues to return a profit after drilling, operating and other costs. Completion of a well does not assure a profit on the investment or FLUCTUATION OF COMMODITY PRICES recovery of drilling, completion and operating costs. In addition, drilling hazards or environmental damage could greatly increase the cost of operations, and various field operating conditions may adversely affect the production from successful wells. These conditions include: delays in obtaining governmental approvals or consents, shut-ins of connected wells resulting from extreme weather conditions, insufficient storage or transportation capacity or other geological and mechanical conditions. While diligent well supervision and effective maintenance operations can contribute to maximizing production rates over time, production delays and declines from normal field operating conditions cannot be eliminated and can be expected to adversely affect revenue and cash flow levels to varying degrees. All evaluations of future net revenues are before consideration of indirect costs such as administrative overhead, other miscellaneous expenses and income taxes. The future net revenues may not be representative of the fair market value of the reserves. There is no assurance that the forecast price and cost assumptions contained in the year end 2010 Ryder Scott Report will be attained and variances may be material. There are numerous uncertainties inherent in estimating quantities of proved and probable reserves, including many factors beyond the control of the Company. The reserves data and net present value of future cash flows set forth represent estimates only. In general, estimates of economically recoverable petroleum and natural gas reserves and the future net revenues therefrom are based upon a number of variable factors and assumptions, such as historical production from the properties, commodity prices, the assumed effects of regulation by governmental agencies and future operating costs, each of which may vary considerably from actual results. Estimates of the economically recoverable petroleum and natural gas reserves attributable to any particular group of properties, classification of such reserves based on risk of recovery and estimates of future net revenues expected therefrom, prepared by different engineers or by the same engineers at different times, may vary substantially. Oil and natural gas are commodities whose prices are determined based on world demand, supply and other factors all of which are beyond the control of the Company. Crude oil price is influenced by many factors, including the world economy, OPEC’s ability to adjust supply to demand and political events. Where natural gas prices are not legislated to be linked to the price of oil, they are characterized more by regional supply and demand considerations, as in North America, Europe, and the Middle East, where pipeline infrastructure between producing and consuming nations plays a key role in price setting. More recently, LNG cargoes are setting the marginal cost for trans-ocean supply from gas rich producing nations when pipeline delivery is impossible. Based on concerns for future oil supply and huge undeveloped gas reserves, natural gas demand growth is transforming economics for both export and domestic markets around the world. 18 World prices for oil and natural gas have fluctuated widely in recent years. Future price fluctuations in world prices may continue and may have a significant impact upon the projected revenue of the Company, the projected return from its existing and future reserves and the generalcandax energy inc. annual report 2010 financial viability of the Company. The oil and natural gas prices realized by the Company are affected by factors such as supply and demand, oil quality and transportation adjustments. The Company expects to market its oil and natural gas production in a manner consistent with past practices. In the case of natural gas, the Company has fixed rate sales contracts. The Company’s current natural gas production is subject to the provisions of the Petroleum Law, which provides for sales into the Tunisian domestic market at rates less than those which would be realized in the international market. While the Company sells the majority of its Tunisian oil to arms-length purchasers priced on a sale by sale basis at prevailing market conditions, a portion of the oil produced by the Company is required to be sold domestically in Tunisia at rates less than those which would be realized in the international market. There is no assurance that the price paid for the oil produced by the Company will remain at current levels. A decrease in the price obtained for its oil may have a material adverse effect on the financial condition of the Company and its future operations.
  • 21. ASSET IMPAIRMENT RISK FOREIGN CURRENCY EXCHANGE RATESCandax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 19 MANAGEMENT‘S DISCUSSION AND ANALYSIS COMPETITION As discussed above, future additional declines in commodity prices and uncertainty in the capital markets could lead to additional impairments of the carrying value of the oil and gas assets held by the Company and thus may require a future significant charge to earnings. Similarly, the Company may be required to record an asset impairment charge if the ongoing full-field simulation study on El Bibane proved to be disappointing. ENVIRONMENTAL REGULATION The Company’s reporting currency is the Canadian dollar and the functional currency for the operating subsidiaries is the US dollar as all major business dealings are transacted in US dollars. The Company sells its oil production pursuant to marketing agreements that are denominated in US dollars or indexed to the US dollar. Many of the operational and other expenses incurred by the Company are paid in US dollars or in local currency of the country where operations are performed. The Company funds the majority of its transactions using US dollar currency from its US dollar bank account held with a European bank. The related party term loan is also US dollar denominated. Management believes the foreign exchange risk derived from currency conversions is negligible and therefore does not hedge its foreign exchange risk. The reported assets and liabilities of the Company (including reserve information) are recorded in Canadian dollars. As a result, fluctuations in the US dollar against the Canadian dollar and each of these currencies against local currencies in jurisdictions where properties of the Company are located could result in unanticipated and material fluctuations in the reported accounting financial results of the Company. A number of other oil and gas companies operate and are allowed to bid for exploration and production licenses and other services in countries POLITICAL RISKS in Africa and the Middle East which are the focus of the business and operations of the Company, thereby providing competition to the Company. Larger companies may have access to greater resources than the Company, may be more successful in the recruitment and retention of qualified employees and may conduct their own refining and petroleum marketing operations, which may give such companies a competitive advantage over the Company. Some of these companies have been conducting operations in Tunisia for considerably longer periods of time than has the Company and thus these companies may be more familiar with the political and business landscape in Tunisia than the Company. In addition, actual or potential competitors may be strengthened through the acquisition of additional assets and interests. The current and future operations of the Company that are conducted in Tunisia and Madagascar are subject to environmental regulations enforced by the respective Governments. Should the Company initiate operations in other countries, such operations 19 will be subject to environmental legislation in such jurisdictions. Current environmental legislation generally provides for restrictions and prohibitions on spills, releases or emissions of various substances produced in association with oil, condensate and natural gas candax energy inc. annual report 2010 operations. In addition, certain types of operations may require the submission and approval of environmental impact assessments. The existing operations of the Company are subject to such environmental policies and legislation. Environmental legislation and policy is periodically amended. Such amendments may result in stricter standards and enforcement and in more stringent fines and penalties for non-compliance. Environmental assessments of existing and proposed projects carry a heightened degree of responsibility for companies and their directors, officers and employees. The costs of compliance associated with changes in environmental regulations could require significant expenditures, and breaches of such regulations may result in the imposition of material fines and penalties. In an extreme case, such regulations may result in temporary or permanent suspension of production operations. There can be no assurance that these environmental costs or effects will not have a material adverse effect on the future financial condition or results of the operations of the Company. In January 2011, the citizens of Tunisia initiated mass demonstrations against President Ben Ali and his government. These demonstrations led to President Ben Ali leaving the country and to the resignation of the government then in place. New President, Prime Minister and government have been appointed for the transition period, as per the constitution, with elections to be organized in July 2011. The new authorities have been recognized by the international community. Certain people in the administration have left or changed positions, notably the head of the Direction Générale de l’Energie (Head of Energy Department within the secretary of energy), who has been appointed head of ETAP, the national oil company. The recent demonstrations in Tunisia have encouraged citizens of other countries to rise up against their respective governments and neighbouring Libya is currently in a state of unrest and as of the date of this MD&A certain NATO allies are undertaking airborne military action to protect the citizens of Libya. Future unrest in any of the neighbouring countries could affect Tunisia. In Madagascar, there has been instability in the administration, with several cabinet changes recently. In addition to the political risks, the Company is also subject to the laws of the various levels of government in the countries, Tunisia and Madagascar, in which it conducts business. Such legislation may be changed from time to time in response to economic or political conditions, and the implementation of new legislation or modification of existing legislation affecting the oil and gas industry could change the Company’s revenues and/or costs and have a material adverse impact on the business, results of operations, financial condition and liquidity.
  • 22. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 20 MANAGEMENT‘S DISCUSSION AND ANALYSIS In Tunisia and Madagascar, like in most countries, the government authorities have latitude in granting oil and gas permits, licences, and extensions thereof. The Company will be seeking extensions to its licences in the coming years and there is no guarantee that the government authorities will grant them. A refusal to receive an extension would negatively impact the cash flows and asset value of the Company. Recent Accounting Pronouncements The Company will cease to prepare its consolidated financial statements in accordance with Canadian GAAP as set out in Part V of the CICA Handbook – Accounting (“Canadian GAAP”) for the periods beginning on January 1, 2011 when it will start to apply International Financial Reporting Standards as published by the International Accounting Standards Board. Consequently, future accounting changes to Canadian GAAP are not discussed in this MD&A as they will never be applied by the Company. Convergence with International Financial Reporting Standards (“IFRS”) The Accounting Standards Board (“AcSB”) requires all Canadian publicly accountable entities to adopt IFRS for years beginning on or after January 1, 2011. Candax’s first annual filing will be for the year ended December 31, 2011 and its first filing under IFRS will be for the quarter ending March 31, 2011 and will include IFRS comparative figures for the period ended March 31, 2010. Accordingly, Candax’s adoption date for IFRS is January 1, 2011, but its effective transition date (“Transition Date”) is January 1, 2010 in order to accommodate IFRS comparative figures in Candax’s 2011 financial statements. IFRS uses a conceptual framework similar to Canadian GAAP (“CGAAP”) however, there are significant differences in recognition, measurement and disclosure. Given the nature of Candax’s business and the make-up of its current balance sheet, IFRS could have an impact on its reported financial statements. Candax’s implementation of IFRS will require the Company to make and disclose certain policy choices and increase the amount of disclosure necessary to fulfill its IFRS reporting obligations. Adoption of IFRS is not expected to change the actual cash flows the Company generates or change its business activities. To the extent possible, Initial analysis of key areas for which changes to accounting policies may be required. Completed Candax will make these choices with a view to providing meaningful information to stakeholders that is also comparable between industry peers. The Company has commenced the development of an IFRS implementation plan to prepare for this transition, and is currently in the process Detailed analysis of all relevant IFRS requirements and identification of areas Completed of analyzing the key areas where changes to current accounting policies may be required. While an analysis will be required for all current requiring accounting policy changes or those with accounting policy alternatives. accounting policies, the initial key areas of assessment will include: Assessment of first-time adoption (IFRS 1) requirements and alternatives. Completed • Evaluation of full-cost oil and gas accounting; Final determination of changes to accounting policies and choices • Accounting for exploration and evaluation expenditures; Completed to be made with respect to first-time adoption alternatives. • Property, plant and equipment (measurement and valuation); • Provisions, including asset retirement obligations; Resolution of the accounting policy change implications on information • Stock-based compensation; Completed technology, internal controls and contractual arrangements. • Foreign currency translation; • Accounting for joint ventures; Management and employee education and training. Completed • Accounting for income taxes; and • First-time adoption of International Financial Reporting Standards (IFRS 1) Quantification of the Financial Statement impact of changes in accounting policies. In process As the analysis of each of the key areas progresses, other elements of the Company’s IFRS implementation plan will also be addressed, including: the implication of changes to accounting policies and processes; financial statement note disclosures; internal controls; contractual arrangements; and employee training. The table below summarizes the expected timing of activities related to the Company’s transition to IFRS. 20candax energy inc. annual report 2010
  • 23. PROPERTY, PLANT & EQUIPMENTCandax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 21 MANAGEMENT‘S DISCUSSION AND ANALYSIS The following provides a summary of the Company’s evaluation to date of potential changes to accounting policies in key areas based on the current standards and guidance within IFRS. This is not intended to be a complete list of areas where the adoption of IFRS will require a change in accounting policies, but is intended to highlight the areas the Company has identified as having the most potential for a significant change. The International Accounting Standards Board has a number of ongoing projects, the outcome of which may have an effect on the changes required to the Company’s accounting policies on adoption of IFRS. At the present time, however, the Company is not aware of any significant expected EXPLORATION AND EVALUATION COSTS changes prior to its adoption of IFRS that would affect the summary provided below: Oil and gas properties Under Canadian GAAP, the Company follows the CICA’s guideline on full cost accounting in which all costs directly associated with the acquisition of, the exploration for, and the development of petroleum and natural gas reserves are capitalized on a country-by-country cost centre basis. Costs accumulated within each country cost centre are depleted using the unit-of-production method based on proved reserves. Full cost accounting is not permitted under IFRS. Under IFRS the Company will follow a modified successful efforts method of accounting, whereby all costs incurred in exploring for and developing oil and gas reserves are capitalized on a field-by-field basis. Oil and gas properties include acquisition costs and development costs related to producing wells, properties under development, and properties held for future development. IFRS 1 provides an exemption that allows oil and gas companies not to have to recalculate the valuation of each CGU based on the retroactive restatement of its asset balances using the IFRS method acceptable under IFRS – “successful efforts” or modified successful efforts. The Company has elected to use this exemption. Other plant & equipment IFRS requires that the Company identify the different components of its fixed assets and record amortization based on the useful lives of IMPAIRMENT OF NON-FINANCIAL ASSETS each component. The Company has reviewed and analyzed the depreciation of its existing property, plant & equipment on this basis, and has concluded that there were some differences between IFRS and current depreciation policies. As such, an adjustment will be required on the opening Statement of Financial Position as at January 1, 2010. Subsequent additions to property, plant & equipment from the transition date will be subject to componentization and amortized over their respective useful lives. Under Canadian GAAP, pre-exploration costs related to properties held for future development are capitalized as incurred, including property carrying costs, drilling and other development costs. IFRS 6 segregates capital expenditures into different phases: 21 (i) Pre-exploration costs are costs incurred by the Company before it obtains the legal right to explore an area. Under Canadian GAAP candax energy inc. annual report 2010 and full cost accounting, these costs are capitalized, whereas IFRS requires that these costs be expensed as incurred. (ii) Exploration and evaluation costs are costs incurred after the pre-exploration phase but before technical feasibility and commercial viability has been determined. Under Canadian GAAP and full cost accounting, these costs are capitalized. IFRS provides the Company with the BUSINESS COMBINATIONS option of expensing these costs as incurred, or deferring these costs until technical feasibility and commercial viability has been determined, at which point they are transferred to the development and production phase and allocated to specific projects. (iii) Post-exploration development and production costs are costs incurred after technical feasibility and commercial viability have been determined. Accounting for post-exploration costs are subject to the guidance provided in IAS 16: Property, Plant and Equipment. On implementation of IFRS, there are no exploration and evaluation costs previously incurred to re-classify on the consolidated balance sheets. Under Canadian GAAP and full cost accounting, impairment tests for property, plant and equipment were performed based on the expected recoverability of costs in each geographic area through the full cost ceiling test. For purposes of impairment testing, IFRS requires that property, plant and equipment be segregated into cash generating units (“CGUs”) which are defined as the smallest identifiable group of assets that generates sufficient cash inflows that are largely independent of the cash inflows from other assets or group of assets. Impairment calculations will be performed at the CGU level using either proved or probable reserves. Canadian GAAP does not permit the reversal of impairment losses. Under IFRS, if the conditions giving rise to impairment losses have reversed, impairment losses previously recorded would also be reversed. The Company’s accounting policies related to impairment of non-financial assets will be changed to reflect these differences. However, the Company does not expect that this change will have an immediate impact on the carrying value of its assets. The Company will perform impairment assessments in accordance with IFRS at the transition date. IFRS 1 provides an exemption that allows companies transitioning to IFRS not to restate business combinations completed prior to the date of transition. The Company has elected to use this exemption and will not be restating the accounting for any acquisitions prior to January 1, 2010.
  • 24. ASSET RETIREMENT OBLIGATIONS Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 22 SHARE-BASED PAYMENTS MANAGEMENT‘S DISCUSSION AND ANALYSIS INCOME TAXES The Company has elected to use an IFRS 1 exemption to take a simplified approach to calculate and recognize the asset related to the asset FOREIGN CURRENCY retirement obligation on the opening IFRS Statement of Financial Position. The provision for asset retirement obligation is calculated as at the transition date in accordance with IAS 37: Provisions, Contingent Liabilities and Contingent Assets (“IAS 37”). To determine the amount of the corresponding asset, the calculated provision under IAS 37 is discounted back to the date when the provision first arose, at which date the corresponding asset is recognized. This asset is depreciated to its carrying amount as at the transition date. IFRS will require the Company to re-measure its provision for asset retirement obligations on a quarterly basis using a pre-tax risk free rate adjusted for the risks specific to the obligation or will adjust the cash flows to reflect the risk, which will result in some variability in both the carrying value of the liability and corresponding asset, and associated expenses in profit or loss. CUMULATIVE TRANSLATION DIFFERENCES The above asset retirement obligations policy choices may result in a net increase or decrease in shareholders’ equity as at January 1, 2010. In certain circumstances, IFRS requires a different measurement of stock-based compensation related to stock options than current Canadian GAAP. The Company will change its accounting policies related to share-based payments to include a forfeiture rate for stock options granted in the calculation of the expense. The Company does not expect any significant impact on the consolidated financial statements at the transition date. In certain circumstances, IFRS contains different requirements related to recognition and measurement of future income taxes. The Company is still evaluating the impact of these changes on the consolidated financial statements. IFRS requires that the functional currency of the Company be determined separately, and the factors considered to determine functional currency are somewhat different than current Canadian GAAP. The Company does not expect any changes to its accounting policies related to foreign currency that would result in a significant change to line items within its financial statements at the transition date. IFRS 1 permits cumulative translation gains and losses to be reset to zero at the transition date. The Company elected this exemption which reduced the cumulative translation amount to zero at the transition date with a subsequent increase in the deficit. Internal Control over Financial Reporting Internal controls over financial reporting are procedures designed to provide reasonable assurance that transactions are properly authorized, assets are safeguarded against unauthorized or improper use, and transactions are properly recorded and reported. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance with respect to the reliability of financial reporting and financial statement preparation. Evaluation of Disclosure Controls and Procedures and Internal Control over Financial Reporting The Canadian Securities Administrators have issued National Instrument 52-109 – Certification of Disclosure in Issuers’ Annual and Interim Filings which requires public companies in Canada to submit annual and interim certificates relating to the design and effectiveness of the 22 disclosure controls and procedures that are in use at the company. Disclosure controls and procedures are designed to provide reasonable assurance that all relevant information is gathered and reported on a timely basis to senior management, including the Company’s Chief Executive Officer and Chief Financial Officer, to enable this information to be reviewed and discussed so that appropriate decisions can becandax energy inc. annual report 2010 made regarding the timely public disclosure of the information. As of December 31, 2010, management has evaluated the effectiveness of the design and the operating effectiveness of the disclosure controls and procedures as defined by National Instrument 52-109. This evaluation was performed under the supervision of and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the design and operation of the disclosure controls and procedures were effective as of December 31, 2010.
  • 25. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 23 MANAGEMENT‘S DISCUSSION AND ANALYSIS Internal Control over Financial Reporting National Instrument 52-109 also requires public companies in Canada to submit an annual certificate relating to the design and operating effectiveness of internal control over financial reporting (“ICFR”). ICFR is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with Canadian generally accepted accounting principles. Management is responsible for establishing and maintaining ICFR and management, including the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the design and tested the effectiveness of the ICFR at December 31, 2010. Based on this evaluation, management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has concluded that the design and operating effectiveness of ICFR was effective as of December 31, 2010. The Company has continued to use the COSO framework to design its ICFR. Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements on a timely basis as such systems can only be designed to provide reasonable as opposed to absolute assurance. Also projections of any evaluation of the effectiveness of ICFR to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Changes in Internal Control over Financial Reporting National Instrument 52-109 also requires public companies in Canada to disclose in their MD&A any change in ICFR during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting. There were no changes in ICFR during the quarter ended December 31, 2010 that materially affected or are reasonably likely to materially affect the Corporation’s internal control over financial reporting. Forward-Looking Statements This Management’s Discussion and Analysis includes “forward-looking statements”, within the meaning of applicable securities legislation, which are based on the opinions and estimates of Management and are subject to a variety of risks and uncertainties and other factors that could cause actual events or results to differ materially from those projected in the forward looking statements. Forward-looking statements are often, but not always, identified by the use of words such as “seek”, “anticipate”, “budget”, “plan”, “continue”, “estimate”, “expect”, “forecast”, “may”, “will”, “project”, “predict”, “potential”, “targeting”, “intend”, “could”, “might”, “should”, “believe” and similar words suggesting future outcomes or statements regarding an outlook. Such risks and uncertainties include, but are not limited to, risks associated with the oil and gas industry (including operational risks in exploration development and production; delays or changes in plans with respect to exploration or development projects or capital expenditures; the uncertainty of reserve estimates; the uncertainty of estimates and projections in relation to production, costs and expenses; the uncertainty surrounding the ability of Candax. to obtain all permits, consents or authorizations required for 23 its operations and activities; and health safety and environmental risks), the risk of commodity price and foreign exchange rate fluctuations, the ability of Candax to fund the capital and operating expenses necessary to achieve the business objectives of Candax, the uncertainty associated candax energy inc. annual report 2010 with commercial negotiations and negotiating with foreign governments and risks associated with international business activities, as well as those risks described in public disclosure documents filed by Candax. Due to the risks, uncertainties and assumptions inherent in forward- looking statements, prospective investors in securities of Candax should not place undue reliance on these forward-looking statements. Statements in relation to “reserves” are deemed to be forward-looking statements, as they involve the implied assessment, based on certain estimates and assumptions, that the reserves described can be profitably produced in the future. Readers are cautioned that the foregoing lists of risks, uncertainties and other factors are not exhaustive. The forward-looking statements contained in this MD&A are made as of the date hereof and the Company undertakes no obligation to update publicly or revise any forward- looking statements contained in this MD&A or in any other documents filed with Canadian securities regulatory authorities, whether as a result of new information, future events or otherwise, except in accordance with applicable securities laws. The forward-looking statements contained in this MD&A are expressly qualified by this cautionary statement.
  • 26. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 24 MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING The consolidated financial statements are the responsibility of, and have been prepared by, the management of Candax Energy Inc (the “Company”). To fulfill this responsibility, the Company maintains appropriate systems of internal control, policies and procedures. These systems of internal control, policies and procedures help ensure that the Company’s reporting practices and accounting and administrative procedures provide reasonable assurance that the financial information is relevant, reliable, and accurate, and that assets are safeguarded and transactions are executed in accordance with proper authorization. These consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles. Where appropriate, these consolidated financial statements reflect estimates based on judgments of the management. PricewaterhouseCoopers LLP, the independent auditors, have examined the consolidated financial statements of the Company. The independent auditors’ responsibility is to express a professional opinion on the fairness of the consolidated financial statements. The auditors’ report outlines the auditors’ opinion and the scope of their examination and their report follows. The consolidated financial statements have also been reviewed by the Directors of Candax Energy Inc. and by its Audit Committee. The Audit Committee is comprised of independent directors, and meets periodically during the year with the independent auditors and the management. The independent auditors have full and unrestricted access to the Audit Committee. Dr. Richard Norris Matthieu Milandri President and Chief Executive Officer Chief Financial Officer March 31, 2011 24candax energy inc. annual report 2010
  • 27. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:25 AM Page 25 INDEPENDENT AUDITOR’S REPORT To the Shareholders of Candax Energy Inc. We have audited the accompanying consolidated financial statements of Candax Energy Inc. and its subsidiaries, which comprise the consolidated balance sheets as at December 31, 2010 and 2009 and the consolidated statements of operations and deficit, cash flows and comprehensive loss for the years then ended, and the related notes including a summary of significant accounting policies. Management’s responsibility for the consolidated financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with Canadian generally accepted accounting principles, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s responsibility Our responsibility to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion 25 In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Candax Energy Inc. and its subsidiaries as at December 31, 2010 and 2009 and its results of operations and cash flows for the years then ended in accordance with candax energy inc. annual report 2010 Canadian generally accepted accounting principles. PricewaterhouseCoopers, LLP Chartered Accountants, Licensed Public Accountants Toronto, Ontario March 31, 2011
  • 28. 2009 Cash and cash equivalents $ 9,782 Accounts receivable 4,089 Inventory 137 Deposits, prepaids and other 505 14,513 Deferred financing fees 163 Petroleum and natural gas properties 69,699 Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 26 Property, plant and equipment (Note 6) 11,143 $ 95,518 CONSOLIDATED BALANCE SHEETS Accounts payable and accrued liabilities $ 17,886 As at December 31 (in thousands of Canadian dollars) Current portion of related party term loan (Note 9) 8,408 Current portion of long-term debt (Note 8) 210 Limited recourse long-term debt (Note 10) 9,109 35,613 2010 Related party term loan (Note 9) 37,738 Assets Long-term debt (Note 8) 1,577 Current Shareholder loan (Note 11) – $ 2,770 Asset retirement obligation (Note 12) 1,945 308 Future income tax liability (Note 13) 3,257 3,570 80,130 388 7,036 Capital stock (Note 14) 111,791 – Contributed surplus (Note 14) 3,513 61,165 115,304 – Accumulated other comprehensive loss (Note 18) (13,527 $ 68,201 Deficit Liabilities (99,916) Current 15,388 $ 9,011 $ 95,518 19,892 199 Commitments (Note 20) – 29,102 24,368 1,293 2,656 2,997 4,075 64,491 Shareholders’ Equity 129,877 3,434 133,311 (16,516) (113,085) (86,389) (129,601) 3,710 $ 68,201 26 The accompanying notes are an integral part of these consolidated financial statements.candax energy inc. annual report 2010 Approved on behalf of the Board of Directors M’hamed Ali Bouleymen Benoit Debray Director Director
  • 29. 2009 Sales, net of royalties $ 28,140 Interest and other income 2,536 30,676 Operating costs (Note15) 9,841 Depletion, depreciation and amortization 45,558 Asset impairment 20,629 Bad debt expense –Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 27 General and administrative 6,045 Loss on deconsolidation of joint venture interest (Note 7) – Interest 4,548 Foreign exchange (gain) loss 2,558 CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT Stock-based compensation (Note 14) 277 For the year ended December 31 (in thousands of Canadian dollars except for per share amounts) Accretion on asset retirement obligation (Note 12) 137 89,593 (58,917) Current income tax expense (recovery) 3,409 2010 Future income tax expense (recovery) (1,130) Revenues 2,279 $ 696 $ (61,196) 449 Deficit, beginning of year (25,193) 1,145 $ (86,389) Expenses $ (0.36) 8,897 169,261,606 2,638 – 1,057 10,178 1,111 3,845 (554) (79) 173 27,266 Loss for the year before current and future income taxes (26,121) (85) 660 575 Loss for the year $ (26,696) (86,389) Deficit, end of year $ (113,085) 27 Loss per share – basic and diluted $ (0.08) Weighted average number of shares outstanding – basic and diluted 323,885,350 candax energy inc. annual report 2010 The accompanying notes are an integral part of these consolidated financial statements.
  • 30. 2009 Loss $ (61,196) Items not affecting cash Stock-based compensation 277 Depletion, depreciation and amortization 45,558 Asset impairment 20,629 Bad debt expenses – Loss on deconsolidation of joint venture interest – Future income tax expense (recovery) (1,130) Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 28 Accretion on asset retirement obligation 137 4,275 Net change in non-cash working capital 7,456 11,731 CONSOLIDATED STATEMENTS OF CASH FLOWS For the year ended December 31 (in thousands of Canadian dollars) Additions to petroleum and natural gas properties (5,651) Change in non-cash working capital from deconsolidation of joint venture interest Additions to property plant and equipment (1,688) (7,339) 2010 Operating Activities Proceeds from shareholder loan (Note 11) – $ (26,696) Issuance of common shares, net of share issue costs (Note 14) – Repayment of long-term debt – (79) Deferred share issuance costs (163) 2,638 Costs of share issuance – – (163) 1,057 Foreign currency translation (3,378) 1,111 851 660 Cash and cash equivalents, beginning of year 8,931 173 $ 9,782 (21,136) (6,034) Cash $ 9,782 (27,170) Interest paid during the year $ 3,006 Investing Activities Income taxes paid during the year $ 1,097 (3,317) 1,083 – (2,234) Financing Activities 2,656 18,086 (201) – – 20,541 1,851 Net increase (decrease) in cash and cash equivalents (7,012) 9,782 Cash and cash equivalents, end of year $ 2,770 Cash and cash equivalents are comprised of: $ 2,770 $ 1,868 $ 817 The accompanying notes are an integral part of these consolidated financial statements. 28candax energy inc. annual report 2010
  • 31. 2009 Loss for the period $ (61,196) Other comprehensive loss: Unrealized foreign exchange loss on translation of self-sustaining foreign operations (24,648) Income taxes – Other comprehensive loss: (24,648) Comprehensive loss $ (85,844)Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 29 CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS For the year ended December 31 (in thousands of Canadian dollars) 2010 $ (26,696) (2,989) – (2,989) $ (29,685) The accompanying notes are an integral part of these consolidated financial statements. 29 candax energy inc. annual report 2010
  • 32. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 30 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS For the years ended December 31, 2010 and 2009 (in thousands of Canadian dollars unless otherwise stated) 1. DESCRIPTION OF BUSINESS AND NATURE OF OPERATIONS Candax Energy Inc., (the “Company” or “Candax”), is incorporated under the laws of the province of Ontario. Candax is a Toronto-based oil and natural gas company engaged in the exploration for, and the acquisition, development and production of, natural gas and crude oil. At present, all of the operating assets of the Company are located in Tunisia and Madagascar. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of presentation The consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles (“GAAP”) and are presented in Canadian dollars unless otherwise stated. These consolidated financial statements have been prepared on the basis that the Company is a going concern which contemplates the realization of its assets and the settlement of its liabilities in the normal course of operations. The ability of the Company to continue operations is dependent upon maintaining sufficient oil production and to continue further exploration and development of its properties. The significant accounting policies are summarized below: Consolidation The consolidated financial statements include the accounts of Candax together with its wholly owned subsidiaries, Ecumed Petroleum Grombalia, Ltd., Ecumed Petroleum Tunisia, Ltd., Ecumed Petroleum Zarzis, Ltd. and Falcan Chaal Petroleum, Ltd. (known collectively as the “Tunisian properties”), Candax Energy Limited (“CEL”), Candax Energy Services Limited (“CESL”) and the proportionate share of its 50% investment in Société d’Electricité d’El Bibane (“SEEB”) when such accounting is appropriate. All significant intercompany balances and transactions have been eliminated. Investment in Equity Securities Investment in equity securities is classified as an available-for-sale financial asset and recognized at cost as there is no quoted market price in an active market. Measurement uncertainty Management has made estimates and assumptions regarding certain assets, liabilities, contingent liabilities, revenues and expenses in the preparation of the consolidated financial statements. Such estimates primarily relate to unsettled transactions and events as of the date of the consolidated financial statements. Accordingly, actual results may differ from estimated amounts. Depletion and amortization, and amounts used for ceiling test calculations are based on estimates of oil and natural gas reserves and commodity prices, production expenses and capital costs required to develop and produce those reserves. The Company’s reserve estimates are evaluated annually by Ryder-Scott Company Petroleum Consultants, independent petroleum reserve engineering consultants. By their nature, estimates of reserves and the related future cash flows are subject to measurement uncertainty, and the impact of differences between actual and estimated amounts on the consolidated financial statements of future periods could be material. The calculation of the asset retirement obligation includes estimates of the future costs to settle the asset retirement obligation, the timing of the cash flows to settle the obligation, and the future inflation rates. The impact of differences between actual and estimated costs, timing and inflation on the consolidated financial statements of future periods could be material. Cash and cash equivalents 30 Cash and cash equivalents comprise cash and short-term market investments with maturities of three months or less at the date of acquisition. Petroleum and natural gas properties and related depletion and amortizationcandax energy inc. annual report 2010 Candax follows the full cost method of accounting, whereby all costs incurred in exploring for and developing oil and gas reserves are capitalized. Such expenditures include geological and geophysical expenses, carrying charges for unproved properties, costs of drilling both productive and non-productive wells, gathering and production facilities and general and administrative costs directly related to exploration and development activities. Capitalized costs are accumulated on a country-by-country basis and are amortized and depleted using the unit-of-production method based upon estimated proved reserves. For those properties that are still in the development stage, related costs are capitalized until either commercial production commences or it is determined that the invested amounts will never be recovered. Natural gas reserves are converted to equivalent barrels of oil on the basis of their relative energy content (6 mcf equals 1 barrel). Costs directly associated with the acquisition and evaluation of unproved properties are initially excluded from the computation of depletion. These unproved properties are assessed periodically to ascertain whether impairment has occurred. When proved reserves are assigned, the cost of the property is added to all other capitalized costs subject to amortization and depletion.
  • 33. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 31 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars unless otherwise stated) The Company calculates a ceiling test whereby the net capitalized costs of properties cannot exceed discounted cash flows from proved and probable reserves. Cash flows are calculated based on third-party quoted forward prices and adjusted for the Company’s contracted prices and quality differentials. If there is an impairment, the magnitude would be calculated by comparing the carrying amount of property, plant and equipment to the estimated net present value of future cash flows from proved plus risked probable reserves. A risk-free interest rate is used to arrive at the net present value of the future cash flows. Any excess carrying value above the net present value of future cash flows would be recorded as a permanent impairment and charged as additional depletion expense in the consolidated statements of operations and deficit. Sales of oil and gas properties are accounted for as adjustments to capitalized costs, with no gain or loss recognized unless such adjustments would alter the rate of depletion and amortization by more than 20%. Foreign currency translation The Tunisian subsidiaries are considered self-sustaining operations and exist in a business environment where the US dollar is their functional currency. The financial statements of self-sustaining operations are translated into Canadian dollars from their functional currency using the current rate method. Under this method, assets and liabilities are translated into Canadian dollars using the exchange rate in effect at the consolidated balance sheet date. Revenues and expenses are translated into Canadian dollars at the average exchange rate for the period. All resulting exchange gains and losses are recorded in shareholders’ equity in the accumulated other comprehensive loss account. CEL and CESL are considered integrated foreign operations and as such, their financial statements are translated using the temporal method. Under this method, monetary assets and liabilities denominated in foreign currency are translated into Canadian dollars at the exchange rate in effect at the consolidated balance sheet date and non-monetary assets and liabilities are translated into Canadian dollars at the exchange rate in effect on the transaction date. Revenues and expenses denominated in foreign currencies are translated into Canadian dollars at the average exchange rate for the period. All resulting exchange gains and losses are recorded in the consolidated statements of operations and deficit. Inventory valuation The crude oil inventory and the material and supplies inventory are valued at the lower of cost and net realizable value. Asset retirement obligation The Company recognizes the fair value of an asset retirement obligation (“ARO”) in the period in which it is incurred when a reasonable estimate of fair value can be made. The fair value of the estimated ARO is recorded as a long-term liability, with a corresponding increase in the carrying amount of the related asset. The capitalized amount is amortized to expense through depletion over the life of the asset. The liability amount 31 is increased each reporting period due to the passage of time and the amount of this accretion is charged to earnings in the period. Revisions, if any, to the estimated timing of cash flows or to the original estimated undiscounted cost, if any, also result in an increase or decrease to the candax energy inc. annual report 2010 ARO and the related asset. Actual costs incurred upon settlement of the ARO are charged against the ARO to the extent of the liability recorded. Any difference between the actual costs incurred upon settlement of the ARO and the recorded liability is recognized as a gain or loss in the Company’s earnings in the period in which the settlement occurs. Stock-based compensation plan The Company has an incentive stock option plan which is described in Note 14. The Company accounts for its stock-based compensation plan using the fair value method. The fair value of stock options is determined on their grant date and recorded as compensation expense over the period that the stock options vest, with a corresponding increase in contributed surplus. When stock options are exercised, the proceeds, together with the amount recorded in contributed surplus, are recorded in capital stock. The calculation of this expense is described in Note 14. Financial Instruments Financial instruments have been classified into one of the following five categories: held for-trading assets or liabilities, held-to-maturity investments, loans and receivables, available-for-sale financial assets or other financial liabilities. Held-for-trading financial instruments are measured at fair value and all gains and losses are included in consolidated statements of operations and deficit in the period in which they arise. Available-for-sale financial instruments are measured at fair value with revaluation gains and losses included in accumulated other comprehensive income until the instruments are derecognized or impaired. Loans and receivables, investments held-to-maturity and other financial liabilities are measured at amortized cost. The Company made the following classifications: Cash and cash equivalents Held for trading Accounts receivable Loans and receivables Investment in equity securities Available-for-sale Accounts payable Other financial liabilities Related party term loan Other financial liabilities Long-term debt Other financial liabilities Transaction costs are expensed for all financial instruments.
  • 34. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 32 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars unless otherwise stated) Revenue Recognition Oil production from the El Bibane, Ezzaouia and Robbana fields is blended and accumulated in a storage tank owned by the Ezzaouia JV and periodically lifted in marketable cargo sizes. The Tunisian state-owned company Entreprise Tunisienne d’Activités Pétrolières (“ETAP”), with respect to its 55% participating interest in Ezzaouia field production and on behalf of the Government with respect to the royalty and domestic market delivery obligations, and the other partners in those fields acting in consortium have an agreement to lift in turn to optimize tanker lifting volumes. As a result of this practice, a short-term volumetric imbalance may arise through an “under/over” lift position. Overlift and underlift are in effect a sale of oil at the point of lifting by the underlifter to the overlifter. As the criteria for revenue recognition is considered to have been met, no deferred revenue is recorded. The Company treats an overlift as a purchase of oil at market price with an associated liability also recorded; conversely, an underlift is treated as a sale of oil at market price with an associated asset also recorded. Income taxes The Company follows the liability method of accounting for income taxes. Under this method future tax liabilities and assets are recognized for the estimated tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Future tax liabilities and assets are measured using enacted tax rates. The effect on future tax liabilities and assets of a change in tax rates is recognized in the period that the change occurs. Net income (loss) per common share Net income (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. For the purposes of the weighted average number of common shares calculation, common shares are determined to be outstanding from the date they are issued. Diluted income (loss) per common share is calculated using the treasury stock method, which assumes that all outstanding stock option grants are exercised, if dilutive, and the assumed proceeds are used to purchase the Company’s common shares at the average market price during the year. 2009 Crude Oil $ – 3. RECENT ACCOUNTING PRONOUNCEMENTS Materials and supplies – 137 The Company will cease to prepare its consolidated financial statements in accordance with Canadian GAAP as set out in Part V of the CICA $ 137 Handbook – Accounting (“Canadian GAAP”) for the periods beginning on January 1, 2011 when it will start to apply International Financial Reporting Standards as published by the International Accounting Standards Board. Consequently, future accounting changes to Canadian GAAP are not discussed in these consolidated financial statements as they will never be applied by the Company. 4. EQUITY INVESTMENT On March 31, 2010, the Company completed an investment agreement with Geofinance N.V., an international upstream oil and gas company (“Geofinance”). Under the terms of the agreement, Geofinance invested $13.0 million in the Company to purchase 144,444,444 units of the Company at a price of $0.09 per unit, each unit comprising one common share and 0.6 of one common share purchase warrant for a total of 86,666,666 warrants. Each whole warrant may be exercised for a period of one year from the date of the closing of the transaction at a price equal to the current market price (calculated based on the weighted average trading price of the Company’s common shares for the five trading days immediately prior to the date of exercise). If all of the warrants are exercised, Geofinance will own 231,111,110 common shares in aggregate. On May 27, 2010, Geofinance exercised warrants to acquire 75,666,666 common shares of the Company at an exercise price of $0.08 per common share for total proceeds of $6.4 million. 5. INVENTORY 32 2010 $ 3,570candax energy inc. annual report 2010 $ 3,570 During 2010, crude oil net inventory changes (opening less closing values) of $2.2 million (2009 – $0.9 million) were expensed which includes a write-down to net realizable value of $2.2 million (2009 – $nil). During 2010, materials and supplies inventory in the amount of $nil (2009 – $0.5 million) was written off due to obsolescence.
  • 35. 2010 Petroleum and natural gas properties Property, plant and equipment 2009 Petroleum and natural gas properties $ 160,561 $ (90,862) $ 69,699 Property, plant and equipment 19,241 (8,098) 11,143 $ 179,802 $ (98,960) $ 80,842Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 33 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars unless otherwise stated) 6 CAPITAL ASSETS Accumulated Carrying Cost Amortization Value $ 158,083 $ (96,918) $ 61,165 – – – $ 158,083 $ (96,918) $ 61,165 As discussed in Note 7, the assets and liabilities of the Company’s joint venture interest in SEEB were deconsolidated and all the property, plant and equipment belonged to SEEB. As a result, there is no balance in property, plant and equipment for 2010. 2011 2012 Exploration and Appraisal 2013 During 2009, the Company evaluated the carrying values of its interests in the Chaal Permit in Tunisia and in Block 1101 in Madagascar due 2014 to the imminence of the expiry of the licence terms and the uncertainties concerning the nature and timing of drilling operations. Accordingly, the Company concluded that it was appropriate to record impairment charges of $10.2 million and $3.5 million respectively in relation to those 2015 interests. During 2010, any costs incurred on either of these two properties were expensed in the consolidated statements of operations and Average thereafter deficit. Neither of these properties was included in the depletion calculation. Producing Assets In addition to the annual ceiling test described in Note 2 and undertaken as at December 31, 2009, the Company gave further consideration to potential impairment to the carrying value of its petroleum and natural gas properties by reference to a number of external factors including the market capitalization of the Company and the proposed transaction with Geofinance NV. Having regard to such factors, the Company recorded an additional impairment charge of $4.6 million. No impairment charge was recorded on the Company’s producing assets for 2010. 33 As at December 31, 2010: candax energy inc. annual report 2010 • there are no amounts of capitalized head office general and administrative costs included in the cost of properties (2009 – $nil) • the prices used in the ceiling test evaluation of the Company’s crude oil and natural gas reserves were: Crude Oil and Natural Gas Price Natural Gas Liquids US$/Mcf $US/Bbl 0.42 83.49 0.54 83.49 0.55 83.49 0.56 85.46 0.57 87.25 0.60 95.85 7. DECONSOLIDATION OF JOINT VENTURE INTEREST The Company and Caterpillar Power Ventures International Ltd. (“Caterpillar”) each have a 50% interest in SEEB, a Tunisian power generation company. Late in the fourth quarter in 2010, the Company and Caterpillar exercised joint control over the operations, however, during the fourth quarter of 2010, the banks, as lenders, started to impose control over the day-to-day operations of SEEB. As the loans to the banks were in default, the banks had the right to foreclose on the securities granted to them under the loan agreement, including, but not limited to, the shares owned by the Company and Caterpillar. As a result of the actions by the banks, management determined that the Company no longer exercised joint control over SEEB and consequently it was no longer appropriate to proportionately consolidate SEEB’s results. In accordance with Canadian GAAP, the investment in SEEB was deconsolidated and recognized at cost. As a result of the deconsolidation, a charge of $1.1 million was expensed in the consolidated statements of operations and deficit. The Company reviewed the financial position of SEEB and determined that no amounts will be recoverable from this investment. The Company has no future financial obligation to SEEB or its lenders.
  • 36. December 31, 2009 Related party term loan – borrowing base amount LIBOR +4% $ 46,146 Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 34 Related party term loan – excess tranche amount LIBOR +9.5% – Less: current portion (8,408) $ 37,738 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars unless otherwise stated) 8. LONG-TERM DEBT In June 2009, the Company and Caterpillar agreed that Caterpillar’s US $5.0 million loan to SEEB should be converted from debt to equity and that new shares issued by SEEB should be allotted equally between the Company and Caterpillar. Upon the debt to equity conversion, the Company became unconditionally liable to Caterpillar for US $2.5 million which at December 31, 2010 amounted to US $1.5 million (December 31, 2009 – US $1.7 million), of which US $0.2 million is current. The Company’s payment obligations were unchanged. 9. RELATED PARTY TERM LOAN Rate ($000s) December 31, 2010 December 31, $ 17,130 2009 27,130 Limited recourse SEEB debt (19,892) Project financing (US$ based) LIBOR +2.25% +2% $ 24,368 default margin* $ 3,210 Project financing (Euro based) ADB** +2.25% +2% default margin* 5,899 On March 31, 2010, the Company concluded an Amendment and Restatement Agreement with the Bank of Scotland by which the terms of 9,109 the Borrowing Base Facility Agreement were amended and restated. The Agreement provided for the extension of the final maturity date of Amounts due within one year the facility from December 31, 2012 to June 30, 2014 and the rescheduling of repayments while splitting outstanding amounts into two tranches; Project financing (US$ based) (3,210) the borrowing base amount and an excess tranche. Bank restructuring fees of US $1.0 million were payable on December 31, 2010. Project financing (Euro based) (5,899) On December 24, 2010, the Bank of Scotland assigned all rights and obligations under the US $45 million term loan to Geofinance, the major (9,109) shareholder of the Company, under the same terms and conditions. Geofinance waived the principal repayment of US $8.0 million and the bank $ – restructuring fees of US $1.0 million, otherwise payable on December 31, 2010, until January 31, 2011. As per Note 23, Subsequent Event, in February 2011, Geofinance cancelled US $22 million of bank debt and US $1.0 million in bank restructuring fees and rescheduled the January 31, 2011 principal repayment to January 31, 2013, in exchange for common shares. For the year ended December 31, 2010, interest expense in the amount of $3.1 million (2009 – $3.2 million) has been recorded in the consolidated statements of operations and deficit. 10. LIMITED RECOURSE LONG-TERM DEBT Rate December 31, 2010 $ – – – – – 34 – $ –candax energy inc. annual report 2010 * The 2% default margin commenced August 2009 as principal payments were deferred and the loans were technically in default. ** African Development Bank Base Rate.
  • 37. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 35 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars unless otherwise stated) Limited Recourse Long-Term Debt represents the Company’s share of the indebtedness of SEEB. The indebtedness comprises limited-recourse 2009 bank financing, denominated in separate tranches of US dollars and Euros. Security for the bank financing is limited to the project assets, Balance at January 1 $ 1,449 the Company’s shareholding in SEEB and a fully collateralized non-performance guarantee from the Company of US $0.8 million. Accretion expense 137 As SEEB was in payment arrears, it received formal notice from the lending banks that it was in default and as such the loans could be called Foreign exchange (210) by the lenders at anytime and therefore the entire amount of the limited-recourse loans was considered current during 2009. Revision in estimate 569 Balance at December 31 $ 1,945 As described in Note 7, during the fourth quarter of 2010, it was determined that the Company no longer exercised joint control over SEEB and as a result the Company’s share of the limited recourse long-term debt was deconsolidated. For the year ended December 31, 2010, interest expense in the amount of $0.6 million (2009 – $0.6 million) has been recorded in the consolidated statements of operations and deficit. 11. SHAREHOLDER LOAN On May 19, 2010, the Company executed a EUR 2.0 million loan agreement with Geofinance. The shareholder loan is available for working capital requirements of the Company and utilization is subject to Geofinance’s approval. The loan bears interest at a rate of 3.5% per annum and matures July 15, 2014. The shareholder loan is subordinated to the term loan and repayments are governed by a subordination agreement entered into by the Company and Geofinance. During 2010, the entire amount of the EUR 2.0 million loan was drawn down and as at December 31, 2010 $2.7 million was outstanding. As per Note 23, Subsequent Event, in February 2011, Geofinance converted the shareholder loan into 2009 common shares. Loss before income taxes $ (58,917) 12. ASSET RETIREMENT OBLIGATION Canadian corporate tax rate 33.00% 2010 Calculated income tax provisions (19,443) $ 1,945 Effect on taxes from foreign tax rate differential (10,016) 173 Expenses incurred with no recognized tax benefit 31,738 (111) $ 2,279 990 $ 2,997 35 candax energy inc. annual report 2010 The total undiscounted amount of estimated cash flows required to settle the obligation is $9.5 million at December 31, 2010, which has been discounted using a credit-adjusted risk-free rate of 9%. Most of these obligations are not expected to be paid until 2023 and beyond. 13. INCOME TAXES The future tax liability of $4.1 million at December 31, 2010 (2009 – $3.3 million), relates to the difference in the unclaimed tax deductible costs of capital assets in Tunisia and the related carrying value. The carrying value is based on the fair value of net assets acquired in the acquisition. When the assets are amortized there will be an associated tax benefit for accounting purposes. The liability is based on consolidated accounting values and any cash liability for income tax purposes is not triggered unless the underlying assets are sold. The approximate value of tax pools available in Tunisia is $116.8 million (2009 – $123.4 million). 2010 $ (26,121) 31.00% (8,097) (4,963) 13,635 $ 575
  • 38. 2009 Capital assets $ 3,257 Non-capital loss carryforwards (2,912) Valuation allowance 2,912 Net future tax liability $ 3,257 Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 36 2014 2015 2026 2027 2028 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 2029 (in thousands of Canadian dollars unless otherwise stated) 2030 Future income taxes have been provided for on the following temporary differences: 2010 $ 4,075 (3,802) 3,802 $ 4,075 At December 31, 2010, the Company had non-capital tax losses available to offset future income for tax purposes in Canada. The losses expire in the years as noted: Issuance of shares through private placement 144,444,444 13,000 $ 404 Share issuance costs – (1,303) 2,562 Issuance of shares through the excercise of warrants 75,666,666 6,389 1,107 3,957 1,981 2,378 2,819 $ 15,208 The Company has not recognized a future tax asset for Canadian non-capital losses carried forward. In addition, the Company has not recognized a future tax asset of $20.9 million relating to the Tunisian properties. These assets have not been recognized since it is not, more likely than not, that such assets will be utilized in the foreseeable future. Stock-based compensation 276 14. CAPITAL STOCK Stock-based compensation 71 Common shares Forfeiture of stock options (150) Candax is authorized to issue an unlimited number of common shares without par value. The Company’s issued and outstanding common shares consist of the following: Balance at December 31, 2008 and 2009 169,261,606 $ 111,791 Balance at December 31, 2010 389,372,716 $ 129,877 As described in Note 4, on March 31, 2010, the Company issued 144,444,444 common shares at $0.09 per common share for gross proceeds of $13.0 million and net proceeds of $11.7 million after deducting share issuance costs of $1.3 million. On May 27, 2010, Geofinance exercised warrants to acquire 75,666,666 common shares of the Company at an exercise price of $0.08 per common share for total proceeds of $6.4 million. The common shares issued upon exercise of the warrants were subject to a hold period which expired on August 1, 2010. 36 Contributed Surpluscandax energy inc. annual report 2010 Balance at December 31, 2008 $ 3,237 Balance at December 31, 2009 $ 3,513 Balance at December 31, 2010 $ 3,434
  • 39. 2009Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 37 Weighted Average Exercise Number Price of Options $ 0.79 13,550,000 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars unless otherwise stated) Granted 0.20 50,000 Exercised – – Expired – – Forfeited 0.80 (2,900,000) Stock Options $ 0.78 10,700,000 In April 2005, the Board of Directors established a share incentive plan to provide additional incentive to its directors, officers, employees and consultants for their efforts on behalf of the Company in the conduct of its affairs. The maximum number of common shares reserved for issuance under the share option plan comprising part of the share incentive plan may not exceed 10% of the number of common shares Weighted Average outstanding. Under the terms of the plan, all options vest immediately, unless otherwise specified. All options granted under the plan expire Remaining Life on Outstanding no later than the tenth anniversary of the grant date. Price Options Options in Options Range Outstanding Months Exercisable A summary of the status of the plans as of December 31, 2010 and 2009 and changes during the years ended on those dates are presented as follows: $0.20–$1.13 550,000 17 533,333 2010 Weighted Average Exercise Number Price of Options Outstanding – December 31, 2009 $ 0.78 10,700,000 2009 Transactions during the period: Expected volatility 75% – – Risk-free interest rate 1.50% – – Term 5 years 0.80 (7,100,000) Dividend yield nil 0.74 (3,050,000) Outstanding – December 31, 2010 $ 0.79 550,000 EI Bibane workover costs 2,193 Production operating costs and other 7,648 37 9,841 candax energy inc. annual report 2010 Using the fair value method, the compensation expense is amortized over the three-year vesting period of the options. For the year ended December 31, 2010, the Company recorded a stock-based compensation recovery of $0.1 million (2009 – $0.3 million expense) relating to share options. The portion of the fair value charge to be recognized in future periods is $ nil. The fair value was estimated on the date of the grant using the Black-Scholes fair value option-pricing model and the following assumptions: 2010 N/A N/A N/A N/A 15. OPERATING COSTS $ 6,678 2,219 8,897
  • 40. December 31, Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 38 2009 Total debt $ 57,042 Less: Cash and cash equivalents 9,782 Net debt 47,260 Shareholders’ equity 28,915 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS $ 76,175 (in thousands of Canadian dollars unless otherwise stated) 16. CAPITAL MANAGEMENT The Company manages its capital to ensure that the Company and its subsidiaries will be able to continue as a going concern while attempting to maximize the return to shareholders through the optimization of debt and equity financing. The Board of Directors does not establish quantitative return on capital criteria for management, but rather relies on the expertise of the Company’s management to sustain future development of the Company. The capital structure consists of debt, (Notes 8, 9 and 11), cash and cash equivalents and shareholders’ equity excluding accumulated other comprehensive income (loss). Candax monitors its capital through its net cash position calculated as cash less term loan debt. The Company maintains this structure by managing working capital, capital spending programs and debt repayment terms. The Company raises capital, as necessary and the optimal balance between debt and equity may change over time. The Company is not subject to externally imposed capital requirements. December 31, 2010 $ 48,407 2,770 45,637 20,226 Total Capital $ 65,863 Management reviews its capital management approach on an ongoing basis and believes that this approach, given the relative size of the Company, is reasonable. There were no changes in the Company’s approach to capital management during the year ended December 31, 2010 compared to the year ended December 31, 2009. 17. FINANCIAL INSTRUMENTS Fair Value Estimation Financial instruments are classified as held for trading, loans and receivables, available-for-sales or other financial liabilities. Financial instruments carried at fair value on the consolidated balance sheets are classified within a fair value hierarchy that prioritizes the inputs to fair value measurements. The three levels of the fair value hierarchy are: • Level 1 – Quoted prices in active markets for identical assets or liabilities; • Level 2 – Inputs other than quoted prices that are observable for the asset or liability either directly or indirectly; and • Level 3 – Inputs that are not based on observable market data. The Company’s cash and cash equivalents are classified as Level 2. The fair values of cash and cash equivalents, trade and other receivables and accounts payable and accrued liabilities approximate their carrying values because of the short-term nature of these instruments. The fair value of the Company’s debt obligations approximate their carrying value because substantially all of the total obligation is subject to variable interest rates. The Company’s risk exposures and the impact on the Company’s financial instruments are summarized below: 38 Credit risk Credit risk is the risk of loss associated with a counterparty’s inability to fulfil its payment obligations. The Company’s credit risk is primarilycandax energy inc. annual report 2010 attributable to accounts receivable. The Company has no significant concentration of credit risk arising from operations. Cash consists of funds that have been invested with reputable financial institutions and management believes the risk of loss to be remote. Accounts receivable consists of amounts due from partners and value added tax due from governments. Management believes that the credit risk with respect to accounts receivable is low.
  • 41. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 39 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars unless otherwise stated) Liquidity risk The Company’s approach to managing liquidity risk is to ensure that it will have sufficient funds to meet liabilities as they come due. As at December 31, 2010, the Company had a cash balance of $2.8 million (December 31, 2009 – $9.8 million) and accounts receivable of $0.3 million (December 31, 2009 – $4.1 million) to settle current liabilities, excluding the current portion of limited recourse long-term debt, of $29.1 million (December 31, 2009 – $26.5 million). At December 31, 2010 the Company had a working capital deficit of $22.1 million (December 31, 2009 – $21.1 million). The maturities of the Company’s accounts payable and accrued liabilities are within 1 year. As per Note 23, Subsequent Event, Geofinance cancelled US $22 million of bank debt, US $1.0 million in bank fees and the EUR $2.0 million shareholder loan in February 2011 in exchange for common shares. Interest rate risk The Company has cash balances and interest-bearing debt. The Company’s current policy is to invest excess cash in highly rated short-term deposits issued by a large European banking institution. The Company periodically monitors the investments it makes and is satisfied with the credit ratings of its banks. Changes in interest rates will result in a change in the amount of interest charged on the Company’s term loan. Given the current levels of interest rates and the economic conditions throughout the world, Management believes that the risk of material changes to interest rate in the short to medium term is remote and therefore does not hedge its interest rate risk. Foreign currency risk The Company’s reporting currency is the Canadian dollar and the functional currency for the operating subsidiaries is the US dollar as all major business dealings are transacted in US dollars. The Company funds the majority of its transactions using US dollar currency from its US dollar bank account held with a European bank. The related party term loan debt is also US dollar denominated. Management does not hedge its foreign exchange risk. Price risk The Company is exposed to price risk with respect to oil. The price of oil has been subject to substantial volatility in recent years. Future price declines could cause continued reported accounting losses and future exploration to be uneconomical. Sensitivity analysis Based on management’s knowledge and experience of the financial markets, the Company believes the following movements are “reasonably possible” over a one year period: 39 • Cash and cash equivalents include deposits which are at variable interest rates. The related party term loan is also at variable interest candax energy inc. annual report 2010 rates. Sensitivity to a plus or minus 1% change in rates would affect the loss by $0.5 million for the year ended December 31, 2010. • The Company does not hold significant balances or debt in currencies other than the US dollar to give rise to exposure to significant foreign exchange risk. • The Company is exposed to changes in oil prices. Sensitivity to a plus or minus $1.00 change in the price of crude oil would affect the loss by $nil for the year ended December 31, 2010. 18. ACCUMULATED OTHER COMPREHENSIVE LOSS The balance in accumulated other comprehensive loss represents the cumulative amount of unrealized foreign exchange losses on translation of self-sustaining foreign operations. 19. RELATED PARTY TRANSACTIONS As described in Note 2, the Company has a 50% interest in SEEB. During the year the Company had gas sales to SEEB of $ nil (2009 – $0.4 million) and at December 31, 2010 the Company had a receivable from SEEB in the amount of $0.9 million (2009 – $0.8 million). The receivable amount has been fully provided for. As described in Note 9, the Company had a related party term loan of US $44.5 million payable to its major shareholder, Geofinance. As per Note 23, Subsequent Event, in February 2011, Geofinance cancelled US $22 million of the related party term loan and rescheduled the January 31, 2011 principal repayment to January 31, 2013, in exchange for common shares. As described in Note 11, the Company had a loan from its major shareholder, Geofinance in the amount of EUR 2.0 million at December 31, 2010. As per Note 23, Subsequent Event, in February 2011, Geofinance converted the shareholder loan into common shares. During the year, the Company’s major shareholder charged one of the Company’s subsidiaries $0.4 million for services provided by its employees in accordance with the services agreement.
  • 42. Candax_AR10_pg9_40_v1.8.qxd:Layout 1 6/3/11 9:26 AM Page 40 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 2009 2009 2009 (in thousands of Canadian dollars unless otherwise stated) Sales (net of royalties) $ 25,514 $ 2,626 $ 28,140 Depletion, depreciation 20. COMMITMENTS AND CONTINGENCIES and amortization 44,917 641 45,558 (a) Under the provisions of the hydrocarbon law of Tunisia, 20% of the Company’s oil production must be sold to ETAP. The Company receives Interest expense 3,917 631 4,548 90% of the export sales price achieved by ETAP on sale of such production. Loss (60,924) (272) (61,196) (b) As at December 31, 2010, the Company had provided a standby letter of credit in the amount of US $0.5 million in favour of Madagascar 69,699 11,143 80,842 Ministry of Industry and Mines in accordance with the terms of the production sharing agreement entered into in November 2006. The letter of credit will be released when the Company has satisfied the commitments as outlined in the agreement. 82,994 12,524 95,518 (c) The Company’s joint venture partners in the Chaal permit have submitted reports arising from their audit of the expenditures associated with the initial Chaal exploration well. Amongst other matters, the reports assert claims for credit which, if sustained would result in the Company incurring additional liability of US $0.4 million. The Company has received the reports and responded to the partners at the end of April 2010 but has still not received a response from either partner. It is not anticipated that any additional material liability will 2009 be incurred and, accordingly no amounts have been accrued for in this regard. $ 1,085 4,328 21. SEGMENTED INFORMATION 414 – Electricity Generation 365 Oil and Gas Operations Operations Total 945 2010 2010 2010 319 For the year ended $ 7,456 December 31 $ 656 $ 40 $ 696 2,175 463 2,638 3,090 755 3,845 (25,577) (1,119) (26,696) Capital assets as at December 31 61,165 – 61,165 Total assets as at December 31 68,201 – 68,201 22. CHANGES IN NON-CASH WORKING CAPITAL 2010 Accounts receivable $ 3,781 Inventory (3,433) Deposits and prepaids 117 Deferred financing fees 163 Long-term receivable – Restricted investment – Accounts payable and accrued liabilities (6,662) $ 6,034 40 23. SUBSEQUENT EVENT On February 4, 2011, pursuant to the terms of the Debt Restructuring Plan, Candax issued 464,193,161 common shares of the Companycandax energy inc. annual report 2010 to Geofinance in consideration for the cancellation of US $22 million of bank debt and US $1.0 million in bank fees, which amounts were originally owing under the Company’s banking facility with the Bank of Scotland, and subsequently assigned to Geofinance pursuant to the Debt Restructuring Plan, and the conversion of a shareholder loan in the amount of EUR 2.0 million owing to Geofinance. The shares were issued at $0.055 per share, which price represents the five-day weighted average trading price of the Company’s shares on the TSX February 3, 2011. The average EURCAD and USDCAD exchange rates over the same five-day period were used to determine the number of shares to be issued. The new common shares issued represent 119% of the number of common shares of the Company issued and outstanding just prior to the issuance, and as a result of this issuance, Candax now has 853,565,877 common shares outstanding of which Geofinance holds 684,304,271 representing 80.17%. As part of the Debt Restructuring Plan, the first principal repayment on the term loan is due January 31, 2013. In addition, Geofinance and the Company entered into a Shareholder Loan Agreement which provides for borrowings up to US $10 million at interest rates varying from 3.5% to 7.5% per annum.
  • 43. Candax Energy Inc. (“Candax”) Corporate Information is a Canadian independent, international oil and gas exploration, development and production company. The Company’s primary objective is to increase shareholder value by building a sustainable, international upstream company focused on opportunities in Africa and the Middle East. DIRECTORS AND OFFICERS EXECUTIVE HEAD OFFICE BANKING Benoit Debray Dr. Richard J. H. Norris INDEPENDENT ENGINEERS M’hamed Ali Bouleyman 130 Adelaide Street West, Suite 1010 Bank of Montreal TUNISIA OFFICE Chairman Toronto, Ontario, Canada M5H 3P5 Main Branch – 1 First Canadian Place T + 416.368.9137 100 King Street West F + 416.364.5400 Toronto, Ontario, Canada M5X 1A3 Stephen Drinkwater President, CEO and Director E info@candax.com LEGAL COUNSEL Ryder Scott Company Christopher O. Irwin Director and Chairman, Ecumed Petroleum Ecumed Petroleum 1200, 530 - 8th Avenue SW Rue du Lac Windermere Calgary, Alberta, Canada T2P 3S8 MADAGASCAR OFFICE Thomas Rebilly Les Berges du Lac Director 1053 Tunis, Tunisia T + 216.71.962.611 McCarthy Tétrault LLP Matthieu Milandri F + 216.71.963.765 Box 48, Suite 5300 Director Toronto Dominion Bank Tower Toronto, Ontario, Canada M5K 1E6 Pascal Mirville Director Candax Madagascar Ltd T + 416.362.1812 Immeuble SANTA F + 416.868.0673 Lot III - 3è Etage Chief Financial Officer Antanimena McGrigors INVESTOR RELATIONS Charlotte M. May Antananarivo 101 5 Old Bailey TRANSFER AGENT Madagascar London EC4M 7BA Chief Operating Officer and T + 261.20.22.265.58 DX 227 London Chancery Lane BOARD SUB-COMMITTEE General Manager, Tunisian Operations F + 261.20.22.265.81 Tel: +44 (0)207 054 2500 Ecumed Petroleum MEMBERSHIP Fax: +44 (0)207 054 2501 Corporate Secretary CHF Investor Relations AUDITORS 90 Adelaide Street West, 6th Floor Equity Financial Trust Company Toronto, Ontario, Canada M5H 3V9 200 University Avenue, Suite 400 TSX: CAX T + 416.868.1079 Toronto, Ontario, Canada M5H 4H1 F + 416.868.6198 T + 416.361.0152 Audit Committee F + 416.361.0470 Mhamed Ali Bouleymen – Chairman ANNUAL & SPECIAL MEETING E: info@equityfinancialtrust.com Benoit Debray Christopher O. Irwin PricewaterhouseCoopers LLP Royal Trust Tower, TD Centre TABLE OF CONTENTS Compensation Committee 77 King Street West www.candax.com 1 Achievements from 2010 and Objectives for 2011 Benoit Debray Suite 3000, PO Box 82 2 Message to Our Shareholders Stephen Drinkwater Toronto, Ontario, Canada M5K 1G8 4 Report on Operations Thomas Rebilly Tuesday, June 28 at 10 am at the 8 Board of Directors Corporation’s head office. 9 Management’s Discussion and Analysis Governance Committee 130 Adelaide Street West, Suite 1010 23 Forward-Looking Statements Christopher O. Irwin – Chairman Toronto, Ontario, Canada M5H 3P5 24 Management’s Responsibility for Financial Reporting Benoit Debray 25 Independent Auditor’s Report Stephen Drinkwater Print date: May 24, 2011 26 Consolidated Balance Sheets Thomas Rebilly 27 Consolidated Statements of Operations and Deficit 28 Consolidated Statements of Cash Flows Disclosure Committee 29 Consolidated Statements of Comprehensive Loss Benoit Debray – Chairman 30 Notes to the Consolidated Financial Statements 41 Corporate Information Charlotte M. May Matthieu Milandri Dr. Richard J. H. NorrisNew Logo IntroductionCandax is clearly a company reborn with a clean image and a new management team. The logo incorporates theindustrys universal colours for oil and gas of green and red with the flocks of green and red colour representingboth production and share growth. A bold and custom typeface was created to communicate a sense of confidenceand stability and ultimately represent the new image of Candax.
  • 44. 2010 ANNUAL REPORT130 ADELAIDE STREET WEST, SUITE 1010TORONTO, ONTARIO, CANADA M5H 3P5T + 416.368.9137F + 416.364.5400E INFO@CANDAX.COM

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