SkyWest Energy Corp. Condensed Interim Consolidated Financial Statements. For the period ended June 30, 2011 (unaudited)

Transcription

1 Condensed Interim Consolidated Financial Statements For the period ended June 30, 2011

2 Condensed Consolidated Balance Sheets Assets June 30, December 31, January 1, Notes Current assets Cash and cash equivalents 4 $ 460,077 $ 9,932,306 $ 873,113 Accounts receivable 4,559,674 7,428,037 2,529 Income tax receivable 339, ,874 Deposits and prepaid expenses 314, ,489 17,187 Investments 5 385, ,760 Commodity contracts 17d 204,824 Total current assets 6,264,585 18,544, ,829 Exploration and evaluation assets 6 10,029,019 9,977, ,815 Property, plant and equipment 7 98,171,021 82,248,055 3,331 Total assets $ 114,464,625 $ 110,770,304 $ 1,272,975 Liabilities Current liabilities Bank debt 8 14,668,848 2,797,222 Accounts payable and accrued liabilities 6,957,261 17,011,308 17,458 Payable to vendor for land 187,500 Flow through share premium 179,533 Total current liabilities 21,626,109 19,988, ,958 Decommissioning liabilities 9 5,924,451 5,953,898 Deferred tax liabilities 11,199,000 10,051,946 Total liabilities 38,749,560 35,993, ,958 Shareholders' Equity Share capital 10 79,099,325 78,992,957 1,103,248 Contributed surplus 3,485,018 2,615,064 Deficit (6,869,278) (6,831,624) (35,231) Total shareholders' equity 75,715,065 74,776,397 1,068,017 Total liabilities and shareholders' equity $ 114,464,625 $ 110,770,304 $ 1,272,975 Commitments 16 Subsequent Events 19 See accompanying notes to the condensed interim consolidated financial statements. Approved on behalf of the Board: (signed) Dennis Feuchuk Director (signed) Don Garner Director 2

3 Condensed Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) Three months ended Six months ended Notes June 30, 2011 June 30, 2010 June 30, 2011 June 30, 2010 Revenue Oil and natural gas revenue $ 7,115,635 $ 140,482 $ 14,098,571 $ 149,756 Royalties (586,012) (16,280) (1,304,245) (18,288) 6,529, ,202 12,794, ,468 Unrealized gain (loss) on investment (16,782) Realized gain on settlement of commodity contracts 35,750 35,750 Unrealized gain (loss) on commodity contracts 204, ,824 6,770, ,202 13,018, ,468 Expenses Exploration and evaluation 174,699 Production and operating expenses 1,765,572 61,602 3,536,777 72,878 Transportation expenses 332, ,564 Depletion and depreciation 2,048,000 59,839 4,375,653 63,951 Loss on disposition of properties 7 326, ,828 General and administrative 1,032, ,291 1,973, ,803 Stock based compensation 432,253 2,668, ,954 2,668,583 5,937,029 3,310,315 11,885,460 3,393, ,168 (3,186,113) 1,132,658 (3,261,747) Finance income ,558 14,794 13,558 Finance expense 12 (148,022) (4,975) (217,584) (4,975) Net finance income (expenses) (147,867) 8,583 (202,790) 8,583 Income (loss) before income taxes 685,301 (3,177,530) 929,868 (3,253,164) Income tax expense Deferred income tax expense (recovery) 583,493 (154,735) 967,522 (154,735) Income (loss) and comprehensive income (loss) for the period $ 101,808 $ (3,022,795) $ (37,654) $ (3,098,429) Earnings (loss) per share 13 Basic $ 0.00 $ (0.14) $ (0.00) $ (0.20) Diluted $ 0.00 $ (0.14) $ (0.00) $ (0.20) See accompanying notes to the condensed interim consolidated financial statements. 3

4 Condensed Consolidated Statements of Changes in Shareholders' Equity Notes Common Shares Share Capital Contributed Surplus Deficit Total equity Balance at January 1, ,541,665 $ 1,103,248 $ $ (35,231) $ 1,068,017 Issued for oil and natural gas interests 10b 1,921, , ,500 Issued for cash 10b 75,416,678 22,625,006 22,625,006 Issued on corporate acquisitions 10b 17,673,910 5,302,173 5,302,173 Share issue costs net of tax effect of $393,160 10b (1,179,481) (1,179,481) Stock based compensation related to warrants 11c 2,506,083 2,506,083 Net income (loss) for the period (3,098,429) (3,098,429) Balance at June 30, ,553,407 $ 28,350,446 $ 2,506,083 $ (3,133,660) $ 27,722,869 Balance at January 1, ,971,715 $ 78,992,957 $ 2,615,064 $ (6,831,624) $ 74,776,397 Stock based compensation related to stock options 11c 869, ,954 Shares issued on warrant exercise 10b 531, , ,368 Net income (loss) for the period (37,654) (37,654) Balance at June 30, ,503,548 $ 79,099,325 $ 3,485,018 $ (6,869,278) $ 75,715,065 See accompanying notes to the condensed interim consolidated financial statements. 4

5 Condensed Consolidated Statements of Cash Flows Three months ended Six months ended Notes June 30, 2011 June 30, 2010 June 30, 2011 June 30, 2010 Cash flows from (used in) operating activities Loss for the period $ 101,808 $ (3,022,795) $ (37,654) $ (3,098,429) Adjustments for: Amortization of other liabilities (28,000) (56,000) Depletion and depreciation 2,048,000 59,839 4,375,653 63,951 Stock based compensation 432,253 2,668, ,954 2,668,583 Unrealized (gain) loss on investment 16,782 Unrealized (gain) loss on commodity contract (204,824) (204,824) Loss on disposition of property, plant and equipment 326, ,828 Accretion of decommissioning liabilities 51, , Exploration and evaluation expenditures 174,699 Deferred income tax expense (recovery) 583,493 (154,735) 967,522 (154,735) Changes in non cash working capital 14 1,659,738 (843,304) 723,220 (263,962) Net cash from (used in) operating activities 4,970,875 (1,291,603) 7,259,799 (783,783) Cash flows used in investing activities Additions to exploration and evaluation assets (337,503) (496,022) (638,815) Corporate acquisitions, net of cash (6,671,276) (6,671,276) Property, plant and equipment expenditures (3,317,754) (547,091) (20,763,426) (549,734) Proceeds on disposition of property, plant and equipment 175, ,000 Proceeds on disposition of exploration and evaluation assets 100, ,000 Changes in non cash working capital 14 (5,610,375) (7,725,574) Net cash used in investing activities (8,990,632) (7,218,367) (28,710,022) (7,859,825) Cash flows from financing activities Proceeds from bank debt, net 2,721,057 (235,421) 11,871,626 (235,421) Proceeds from issuance of share capital 16,000 20,889, ,368 20,889,865 Changes in non cash working capital , ,751 Net cash from financing activities 2,737,057 20,762,195 11,977,994 20,762,195 Change in cash and cash equivalents (1,282,700) 12,252,225 (9,472,229) 12,118,587 Cash and cash equivalents, beginning of period 1,742, ,475 9,932, ,113 Cash and cash equivalents, end of period $ 460,077 $ 12,991,700 $ 460,077 $ 12,991,700 See accompanying notes to the condensed interim consolidated financial statements. 5

6 1. General business description SkyWest Energy Corp. ( SkyWest or the Corporation ) is engaged in the acquisition of, exploration for, development of and production of oil and natural gas. SkyWest Energy Corp. is a publicly traded company on the TSX Venture Exchange under the symbol SKW.V, incorporated and domiciled in Canada. The Corporation s operations are in Alberta and Saskatchewan. The address of business of the Corporation is Suite #480, th Avenue SW, Calgary, Alberta, Canada, T2P 3A8. These condensed interim consolidated financial statements were approved and authorized for issuance by the Board of Directors on August 25 th, Basis of preparation (a) Statement of compliance In conjunction with the Corporation s annual audited consolidated financial statements to be issued under International Financial Reporting Standards ( IFRS ) for the year ended December 31, 2011, these condensed interim consolidated financial statements present SkyWest s financial results of operations and financial position as at and for the three and six months ended June 30, 2011, including 2010 comparative periods. These financial statements have been prepared in accordance with IFRS 1 First Time Adoption of International Financial Reporting Standards and with International Accounting Standard ( IAS ) 34, Interim Financial Reporting. These condensed interim consolidated financial statements do not include all the necessary annual disclosures in accordance with IFRS. Prior to January 1, 2011, the Corporation prepared its interim and annual consolidated financial statements in accordance with Canadian generally accepted accounting principles ( Canadian GAAP ). The preparation of these condensed interim consolidated financial statements resulted in selected changes to SkyWest s accounting policies as compared to those disclosed in the Corporation s annual audited consolidated financial statements for the year ended December 31, 2010 issued under Canadian GAAP. A summary of significant changes to SkyWest s accounting policies is disclosed in note 20 along with reconciliations presenting the impact of the transition to IFRS for the comparative periods for the three and six months ended June 30, 2010, and a reconciliation of shareholders equity at June 30, A summary of SkyWest s significant accounting policies under IFRS is presented in note 3. These policies have been retrospectively and consistently applied, except where specific exemptions permitted an alternative treatment upon transition to IFRS in accordance with IFRS 1 as disclosed in note 20. The condensed interim consolidated financial statements should be read in conjunction with SkyWest s Canadian GAAP annual audited consolidated financial statements for the year ended December 31, 2010 and unaudited condensed interim consolidated financial statements for the three month period ended March 31, 2011 prepared under IFRS. (b) Basis of measurement The consolidated financial statements have been prepared on the historical cost basis, except for investments and commodity contracts which are measured at fair value. The methods used to measure fair values are discussed further in note 17. 6

7 (c) Functional and presentation currency These consolidated financial statements are presented in Canadian dollars, which is the Corporation s functional currency. (d) Use of estimates and judgments The preparation of consolidated financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. Estimates and judgments are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Accounting estimates will, by definition, seldom equal the actual results. Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future years affected. The following discussion sets forth management s most critical estimates and assumptions in determining the value of assets, liabilities and equity: Depletion and depreciation and valuation of property, plant and equipment The amounts recorded for depletion and depreciation of property, plant and equipment and the valuation of property, plant and equipment are based on estimates. These estimates include proved and probable reserves, production rates, future oil and natural gas prices, future development costs, remaining lives and periods of future benefits of the related assets and other relevant assumptions. Petroleum and natural gas properties, exploration and evaluation assets and other corporate assets are aggregated into cash generating units ( CGUs ) based on their ability to generate largely independent cash flows and are used for impairment testing. The determination of the Corporation s CGUs is subject to management s judgement. The Corporation s reserve estimates are evaluated annually pursuant to the parameters and guidelines stipulated under National Instrument Standards of Disclosure for Oil and Gas Activities. Valuation of exploration and evaluation assets The value of exploration and evaluation assets are dependent upon the discovery of economically recoverable reserves which, in turn, is dependent on future oil and natural gas prices, future capital expenditures and environmental and regulatory restrictions. The decision to transfer exploration and evaluation assets to property, plant and equipment is based on management s determination of an area s technical feasibility and commercial viability based on proved and/or probable reserves. Decommissioning liabilities The value of decommissioning liabilities depends on estimates of current risk free interest rates, future restoration and reclamation expenditures and the timing of those expenditures. 7

8 Valuation of accounts receivable The valuation of accounts receivable is based on management's best estimate of the provision for doubtful accounts. Income taxes The amounts recorded for deferred income taxes are based on estimates as to the timing of the reversal of temporary differences and tax rates currently substantively enacted. They are also based on estimates of the probability of the Corporation utilizing certain tax pools and assets which, in turn, is dependent on estimates of proved and probable reserves, production rates, future petroleum and natural gas prices and changes in legislation, tax rates and interpretations by taxation authorities. The availability of tax pools and other deductions are subject to audit and interpretation by taxation authorities. Stock based compensation The amounts recorded relating to the fair value of stock options and warrants issued are based on estimates of the future volatility of the Corporation s share value, estimated market value of the Corporation's shares at grant date, forfeiture rates, expected lives of the options and warrants, expected dividends and other relevant assumptions. Commodity contracts The amounts recorded for the fair value of commodity contracts are based on estimates of future commodity prices and foreign exchange rates. Business combinations The values assigned to the common shares issued in the corporate acquisitions completed in 2010 and the allocation of the purchase price to the net assets in the acquisitions are based on numerous estimates that affect the valuation of certain assets and liabilities acquired including discount rates, estimates of proved and probable reserves, estimates of fair values of exploration and evaluation assets, future oil and natural gas prices and other factors. 3. Significant accounting policies The interim consolidated financial statements have been prepared following the same accounting policies and methods of computation as disclosed in the interim consolidated financial statements as at and for the three month period ended March 31, The significant accounting policies are described in note 3 of the March 31, 2011 interim consolidated financial statements. Recent accounting pronouncements: 8

9 Future Accounting Changes The following pronouncements from the IASB will become effective for financial reporting periods beginning on, or after, January 1, 2013 and have not yet been adopted by the Corporation. All of these new or revised standards permit early adoption with transitional arrangements, depending upon the date of initial application: IFRS 9 Financial Instruments addresses the classification and measurement of financial assets. IFRS 10 Consolidated Financial Statements builds on existing principles and standards and identifies the concept of control as the determining factor in whether an entity should be included within the consolidated financial statements of the parent company. IFRS 11 Joint Arrangements establishes the principles for financial reporting by entities when they have an interest in arrangements that are jointly controlled. IFRS 12 Disclosure of Interest in Other Entities provides the disclosure requirements for interests held in other entities, including joint arrangements, associates, special purpose entities and other off balance sheet entities. IFRS 13 Fair Value Measurement defines fair value, requires disclosure about fair value measurements and provides a framework for measuring fair value when it is required or permitted within the IFRS standards. IAS 19 Employee Benefits revised the existing standard to eliminate options to defer the recognition of gains and losses in defined benefit plans, requires remeasurements of a defined benefit plan s assets and liabilities to be presented in other comprehensive income and increases disclosure. IAS 27 Separate Financial Statements revised the existing standard which addresses the presentation of parent company financial statements that are not consolidated financial statements. IAS 28 Investments in Associates and Joint Ventures revised the existing standard and prescribes the accounting for investments and sets out the requirements for the application of the equity method when accounting for investments in associates and joint ventures. The IASB also issued Presentation of Items of Other Comprehensive Income, an amendment to IAS 1 Financial Statement Presentation. The amendment addresses the presentation of other comprehensive income and requires the grouping of items within other comprehensive income that might eventually be reclassified to the profit and los section of the income statement. The change becomes effective for financial years after July 1, 2012 with earlier adoption permitted. The Corporation has not completed its evaluation of the effect of adopting these standards on its consolidated financial statements. 9

10 4. Cash and cash equivalents Cash and cash equivalents is comprised of: June 30, 2011 December 31, 2010 January 1, 2010 Bank balances in non interest bearing $ 460,077 $ 1,800,332 $ 873,113 Bank balances in interest bearing accounts 8,131,974 $ 460,077 $ 9,932,306 $ 873, Investments June 30, 2011 December 31, 2010 Number of Shares Balance Balance Investment in Base Oil & Gas Ltd. 1,678,165 $ 385,978 $ 402,760 Base Oil & Gas Ltd. ( BOG ) is a publicly traded junior oil and natural gas company that trades on the TSX Venture Exchange. SkyWest and BOG are related as they share a common director. These shares were sold subsequent to quarter end. See details in note Exploration and evaluation assets Cost Balance January 1, 2010 $ 376,815 Additions 4,285,171 Acquisition of exploration and evaluation assets 8,753,462 Transfers to property, plant and equipment (note 7) (2,564,271) Lease expiries expensed (873,394) Balance, December 31, ,977,783 Additions 496,022 Transfers to property, plant and equipment (note 7) (170,087) Lease expiries expensed (174,699) Dispositions (100,000) Balance, June 30, 2011 $ 10,029,019 Exploration and evaluation assets consist of the Corporation s exploration projects that are pending the determination of proved and/or probable reserves. Additions represent the Corporation s share of costs incurred on exploration and evaluation assets during the period. 10

11 7. Property, plant and equipment Oil and natural gas interests Corporate assets Total Cost Balance, January 1, 2010 $ $ 5,938 $ 5,938 Additions 27,903,217 30,942 27,934,159 Corporate acquisitions (note 20) 54,997,139 54,997,139 Dispositions (129,755) (129,755) Transfers from exploration and evaluation assets 2,564,271 2,564,271 Change in decommissioning liabilities 225, ,679 Balance, December 31, 2010 $ 85,560,551 $ 36,880 $ 85,597,431 Additions 20,753,280 10,146 20,763,426 Dispositions (724,141) (724,141) Transfers from exploration and evaluation assets (note 6) 170, ,087 Change in decommissioning liabilities 89,247 89,247 Balance, June 30, 2011 $ 105,849,024 $ 47,026 $ 105,896,050 Oil and natural gas interests Corporate assets Accumulated depletion and depreciation and impairment losses Balance, January 1, 2010 $ $ (2,607) $ (2,607) Depletion and depreciation for the period (1,821,000) (5,462) (1,826,462) Impairment for the period (1,520,307) (1,520,307) Balance, December 31, 2010 $ (3,341,307) $ (8,069) $ (3,349,376) Depletion and depreciation for the period $ (4,360,000) $ (15,653) $ (4,375,653) Balance, June 30, 2011 $ (7,701,307) $ (23,722) $ (7,725,029) Total Oil and natural gas interests Corporate assets Total Net book value At January 1, 2010 $ $ 3,331 $ 3,331 At December 31, 2010 $ 82,219,244 $ 28,811 $ 82,248,055 At June 30, 2011 $ 98,147,717 $ 23,304 $ 98,171,021 (a) The calculation of Q depletion and depreciation expense included an estimated $97,199,100 (Q $9,115,100) in the depletable base for future development costs associated with proved and probable undeveloped reserves. 11

12 (b) During 2010, SkyWest recognized a $1,520,307 impairment relating to non core assets of the Corporation. An impairment charge was taken at December 31, 2010 and was recorded as additional depletion and depreciation expense in the fourth quarter of The impairment was based on the difference between the period end book value of the assets and the recoverable amount. The recoverable amount was determined using fair value less costs to sell based on discounted cash flows of proved plus probable reserves using forecast prices and a discount rate of 10%. No impairment was recorded for the six month period ended June 30, (c) During the six month period ended June 30, 2011, SkyWest completed the sale of a combination of non core properties in Alberta for net proceeds of $275,000 which included disposition of exploration and evaluation assets for $100,000. A $326,828 loss was recognized on this transaction. 8. Bank debt The Corporation has available a $21,000,000 revolving operating demand loan ( Facility A ). Facility A bears interest at the bank s prime rate plus 0.5% per annum and shall only be used for general corporate purposes. The Corporation also has available a $9,000,000 non revolving acquisition/development demand loan ( Facility B ). Facility B bears interest at the bank s prime rate plus 0.75% per annum and shall only be used for acquisitions of producing oil and natural gas reserves and/or development of existing proved non producing/undeveloped oil and natural gas reserves. Under Facility B, repayment of principal and interest will commence the month following the drawdown. Facility B also includes a drawdown fee of between 0.375% and 0.50%. Facility A and Facility B are secured by a general assignment of book debts and a $50,000,000 debenture with a first floating charge over all assets of the Corporation with an undertaking to provide fixed charges on the Corporation s petroleum and natural gas properties at the request of the bank. At June 30, 2011, the Corporation had drawn $14,668,848 on Facility A. The interest rate at June 30, 2011 was prime plus 0.5% per annum for an effective interest rate of 3.5%. The Corporation is subject to certain reporting and financial covenants that require: 1. the Corporation to maintain a working capital ratio of at least 1:1 (for the purposes of the covenant, bank debt and the fair value of any commodity contracts are excluded and the unused portion of the credit facility may be added to current assets); and 2. the Corporation to not hedge greater than 50% of its petroleum and natural gas production. As at June 30, 2011, the Corporation was in compliance with all reporting requirements, the working capital ratio was 1.78:1.00 and was within hedge guidelines. 9. Decommissioning liabilities The Corporation s decommissioning liabilities result from its ownership interest in oil and natural gas assets, including well sites and gathering systems. The total decommissioning liability is estimated based on the Corporation s net ownership interest in all wells and facilities, estimated costs to reclaim and abandon these wells and facilities and the estimated timing of the costs to be incurred in future years. The total estimated, undiscounted risked cash flows required to settle the liabilities, before considering salvage, is approximately $10,340,000 at June 30, 2011 (December 31, 2010 $11,043,000), which has been discounted using a risk free 12

13 rate between 1% and 4% at June 30, 2011 (December 31, 2010 between 1% and 4%). These obligations are to be settled based on the economic lives of the underlying assets, which currently extend up to 36 years into the future and will be funded from general corporate resources at the time of abandonment. The majority of the costs will be incurred between 2019 and The following table summarizes changes in the decommissioning liabilities for the six months ended June 30, 2011 and the year ended December 31, 2010: June 30, 2011 December 31, 2010 Decommissioning liabilities, beginning of period $ 5,953,898 $ Liabilities incurred 89, ,994 Liabilities acquired in property acquisition (note 20) 698,932 Liabilities assumed on acquisition of EMM (note 20) 1,595,558 Liabilities assumed on acquisition of Stratosphere (note 20) 42,700 Liabilities assumed on acquisition of Base (note 20) 3,346,000 Liabilities settled on disposition (222,313) (32,888) Accretion 103,619 42,602 Decommissioning liabilities, end of period $ 5,924,451 $5,953, Share capital (a) Authorized Unlimited number of common shares with voting rights. Unlimited number of preferred shares, issuable in series. (b) Issued The following table summarizes the changes in common shares outstanding: Number of Common Shares Stated Amount Outstanding, January 1, ,541,665 $ 1,103,248 Common shares issued for oil and natural gas interests 1,921, ,500 Common shares issued on corporate acquisitions (note 20) 36,983,718 17,274,254 Common shares issued for cash, net of share issue costs of $4,553,850 and related tax effect of $1,145,179 including $162,500 of compensation expense related to units issued 136,955,178 51,216,355 Flow through common shares issued 18,520,000 8,889,600 Common shares issued on exercise of warrants 50,000 10,000 Outstanding, January 1, ,971,715 78,992,957 Common shares issued on exercise of warrants 531, ,368 Outstanding, June 30, ,503,548 $ 79,099,325 13

14 11. Stock based compensation (a) Stock option plan Under the Corporation's stock option plan, the Corporation may grant options to its directors, officers, employees and consultants. The aggregate number of common shares to be issued upon the exercise of all options granted under the plan shall not exceed 10% of the issued and outstanding common shares at the time of the option grant. The maximum number of common shares optioned to any one optionee during a twelve month period shall not exceed 5% (2% for consultants) of the outstanding common shares of the Corporation at the time of grant. Options granted under the plan have a five year term and have vesting periods as determined by the Corporation's directors at the date of grant. The exercise price of each option equals the market price of the Corporation s share of the date of grant. The following options have been awarded under the stock option plan: Number Weighted Average Exercise Price Outstanding, January 1, 2010 $ Granted 8,140,681 $0.68 Forfeited Outstanding, December 31, ,140,681 $0.68 Granted 245,000 $0.65 Cancelled (125,000) $0.68 Outstanding at June 30, ,260,681 $0.68 Exercisable at June 30, 2011 The options vest 1/3 each on each of the twelve month, eighteen month and twenty four month anniversaries from the grant dates. The following table summarizes the expiry terms and exercise prices of the Corporation's outstanding stock options as at June 30, 2011: Outstanding Options Exercise Price Weighted Average Remaining Contractual life (years) Number of Stock Options Exercisable 8,015,861 $ ,000 $ ,000 $ ,260,681 $

15 (b) Warrants Series I Number Weighted Average Exercise Price Outstanding, January 1, ,770,828 $ 0.20 Granted Exercised (50,000) $ 0.20 Outstanding, December 31, ,720,828 $ 0.20 Granted Exercised (531,833) $ 0.20 Outstanding at June 30, ,188,995 $ 0.20 Exercisable at June 30, ,188,995 $ 0.20 All of the Series I warrants have a term of two years and are exercisable into one common share. All warrants have vested and were exercisable as at June 30, Series II, III and IV Number Weighted Average Exercise Price Outstanding, January 1, 2010 Granted, April 29, ,250,000 $ 0.35 Granted, June 22, ,000,000 $ 0.35 Granted, August 17, ,000 $ 0.48 Outstanding at Dec 31, 2010 and June 30, ,500,000 $ 0.35 Exercisable at June 30, ,333,333 $ 0.35 All of the Series II, III and IV warrants have a term of five years, are exercisable into one common share and 1/3 become exercisable if the 20 day weighted average trading price of SkyWest common shares is equal to or greater than $0.55 at any time before the expiry date; a further 1/3 will be exercisable if the 20 day weighted average trading price of SkyWest common shares is equal to or greater than $0.75 at any time before the expiry date; and the final 1/3 will be exercisable if the 20 day weighted average trading price of SkyWest common shares is equal to or greater than $0.95 at any time before the expiry date. These warrants have a weighted average life remaining to expiry of 3.8 years. During the three month period ended December 31, 2010, the 20 day weighted average trading price of SkyWest common shares was equal to or greater than $0.55. Therefore, 1/3 of the warrants became exercisable. During the three month period ended March 31, 2011, the 20 day weighted average trading price of SkyWest common shares was equal to or greater than $0.75. Therefore, an additional 1/3 of the warrants became exercisable. During the three month period ended June 30, 2011, the 20 day weighted average trading price of SkyWest common shares was not equal to or greater than $0.95. Therefore, no additional warrants became exercisable. 15

16 (c) Stock based compensation expense Compensation costs of $869,954 for the six months ended June 30, 2011 (2010 $ 2,668,583) have been expensed and have resulted in a corresponding increase in contributed surplus. The fair value of stock options granted during the six months ended June 30, 2011 were estimated on the date of grant using the Black Scholes option pricing model with the following assumptions: June 30, 2011 Risk free interest rate 2.60% Expected volatility 52% Expected life 5 years Expected dividend yield N/A Estimated forfeiture rate 0% Fair value per option/warrant $ 0.29 A forfeiture rate of 0% was used when recording stock based compensation as it is expected that all officers, directors, employees and consultants will continue with Corporation over the vesting period. This estimate is adjusted each period to the actual forfeiture rate. 12. Finance income and expense Three months ended June 30, Six months ended June 30, Finance income Interest income on cash and cash equivalents $ 155 $ 13,558 $ 14,794 $ 13,558 Finance expenses Accretion of decommissioning liabilities 51, , Interest expense on bank debt 96,443 4, ,965 4, ,022 4, ,584 4,975 Net finance income (expense) $ (147,867) $ 8,583 $ (202,790) $ 8,583 16

17 13. Earnings per share The following table summarizes the common shares used in calculating basic and diluted earnings per share: Weighted Average Common Shares Outstanding Three months ended June 30, Six months ended June 30, Basic 202,499,152 21,139, ,376,398 15,322,895 Diluted 209,466,419 21,139, ,376,398 15,322,895 For the three month period ended June 30, 2011, 18,688,995 warrants were included in the calculation of diluted earnings per share as they were in the money during the period. All options were excluded as they were out of the money during the period. For the six month period ended June 30, 2011 and for the three and six month period ended June 30, 2010, all warrants and options have been excluded from the calculation of diluted earnings (loss) per share as they would be anti dilutive. 14. Supplemental cash flows information Changes in non cash working capital is comprised of: Three months ended June 30, Six months ended June 30, Source/(use) of cash: Accounts receivable $ 764,327 $ 202,750 $ 2,868,363 $ (198,305) Income tax receivable 125,558 Prepaid expenses and deposits (79,232) (18,394) 1,773 (55,394) Accounts payable and accrued liabilities (4,635,732) 919,909 (9,998,048) 97,488 Changes in non cash working capital (3,950,637) (735,553) (7,002,354) (156,211) Related to operating activities 1,659,738 (843,304) 723,220 (263,962) Related to investing activities (5,610,375) (7,725,574) Related to financing activities 107, ,751 Changes in non cash working capital (3,950,637) (735,553) (7,002,354) (156,211) Interest Paid 96,443 4, ,965 4, Related party transactions For the three and six month period ended June 30, 2011, the Corporation had the following related party transaction: (a) The Corporation is involved in several joint ventures with BOG, a corporation with which the Corporation 17

18 shares a common director. At June 30, 2011, accounts receivable included $246,940 (December 31, 2010 $1,953,400) related to amounts owing to the Corporation for its share of capital expenditures. Subsequent to quarter end the entire balance owed by BOG was collected. These amounts are billed and recorded at rates consistent with those charged to third parties. 16. Commitments The Corporation has a rental commitment, exclusive of operating costs, related to leased office premises, as follows: Total Operating lease office building $ 228,083 $ 290,119 $ 518,202 At December 31, 2010, the Corporation was committed to spend approximately $1,615,800 of qualifying expenditures related to flow through shares issued in During the period ended June 30, the Corporation fulfilled its remaining obligation of $1,615,800. No further amounts are remaining to be spent. 17. Financial risk management The Corporation s risk management policies are established to identify and analyze the risks faced by the Corporation, to set appropriate risk limits and controls and to monitor risks and adherence to market conditions and the Corporations activities. There have been no changes to these policies during the period ended June 30, (a) Risk management overview The Corporation s activities expose it to a variety of financial risks that arise as a result of its exploration, development, production and financing activities including credit risk, liquidity risk and market risk. This note presents information about the Corporation s exposure to each of the above risks, the Corporation s objectives, policies and processes for measuring and managing risk, and the Corporation s management of capital. Further quantitative disclosures are included throughout these condensed interim consolidated financial statements. The Corporation employs risk management strategies and polices to ensure that any exposure to risk are in compliance with the Corporation s business objectives and risk tolerance levels. While the Board of Directors has the overall responsibility for the Corporation s risk management framework, the Corporation s management has the responsibility to administer and monitor these risks. (b) Credit risk Credit risk is the risk of financial loss to the Corporation if a customer or counterparty to a financial instrument fails to meet its contractual obligations. Substantially all of the Corporation s accounts receivable are due from purchasers of the Corporation s oil and natural gas production, joint venture partners and government agencies and are subject to normal industry credit risk. Significant changes in industry conditions and risks that negatively impact partners' ability to generate cash flow will increase the risk of not collecting receivables. SkyWest transacts with a number of oil and natural gas marketing companies who typically remit amounts to the Corporation by the 25th day of the month following production. At June 30, 2011, 37% of total accounts receivable was owing from one 18

19 marketing company, therefore, the Corporation was subject to concentration risk. Management of the Corporation believes the risk is mitigated by the size and reputation of the companies to which they extend credit. Joint venture receivables are typically collected within one to three months of the joint venture bill being issued to the partner. The Corporation attempts to mitigate the risk from joint venture receivables by obtaining partner approval of significant capital expenditures prior to expenditure and, in certain circumstances, may elect to cash call a joint venture partner in advance of the work. However, the receivables are from participants in the oil and natural gas sector and collection of the outstanding balances is dependent on industry factors such as commodity price fluctuations, escalation costs and the risk of unsuccessful drilling. The Corporation does not typically obtain collateral from oil and natural gas marketers or joint venture partners, however, the Corporation does have the ability to withhold production from joint venture partners in the event of non payment. Management believes all receivables will be collected. As at June 30, 2011 and December 31, 2010, the Corporation's accounts receivable were comprised of the following and represents the Corporation s maximum credit exposure: June 30, 2011 December 31, 2010 Oil and natural gas marketing companies $ 2,079,209 $1,129,781 Joint venture partners and other 2,509,946 5,232,690 Drilling royalty credits 109,000 Government agencies 102,221 1,201,937 4,691,376 7,673,408 Less: allowance for doubtful accounts (131,702) (245,371) Total accounts receivable $ 4,559,674 $ 7,428,037 The Corporation s accounts receivable are aged as follows: As at: June 30, 2011 December 31, 2010 Current (less than 90 days) $ 3,801,131 $7,151,804 Past due (more than 90 days) 758, ,233 $ 4,559,674 $ 7,428,037 The Corporation has provided an allowance for doubtful accounts as at June 30, 2011 of $131,702 (December 31, 2010 $245,371) which relates primarily to working capital assumed on corporate acquisitions. The amount decreased during the period as amounts previously allowed for were collected. The Corporation manages the credit exposure related to cash and cash equivalents of $460,077 by selecting financial institutions with high credit ratings and monitors all short term deposits to ensure an adequate rate of return. Given these credit ratings, management does not expect any counterparty to fail to meet its obligations. 19

20 The Corporation is exposed to credit risk associated with possible non performance by counter parties related to the commodity contracts of $204,824 (note 17(d)). (c) Liquidity risk Liquidity risk is the risk that the Corporation will not be able to meet its financial obligations as they are due. The Corporation s approach to managing liquidity is to ensure it will have sufficient liquidity to meet its liabilities when due. The Corporation prepares annual capital expenditure budgets which are regularly monitored and updated as considered necessary. The Corporation also utilizes authorization for expenditures on both operated and non operated projects to further manage capital expenditures. The Corporation's ongoing liquidity is impacted by various external events and conditions, including commodity price fluctuations and the global economic downturn. The Corporation expects to repay its financial liabilities in the normal course of operations and to fund future operational and capital requirements through operating cash flow, as well as future equity and debt financings. The Corporation also has a credit facility to facilitate the management of liquidity risk. See note 8 for credit facility disclosure. The Corporation's credit facility is subject to review on September 1, The Corporation is required to meet certain financial commitments as described in notes 16 and 17(d). The Corporation s financial liabilities on the balance sheet consist of accounts payable and accrued liabilities and bank debt. As at June 30, 2011, the Corporation had $6,331,152 available under credit Facility A for general corporate use and $9,000,000 available under Facility B for acquisition of proved oil and natural gas interests as described in note 8 and a negative working capital position of $692,676 (excluding bank debt). The Corporation believes it has sufficient funds to meet its foreseeable obligations. The following table details SkyWest s financial liabilities as at June 30, 2011: < 1 year Accounts payable and accrued liabilities $ 6,957,261 Bank debt 14,668,848 21,626,109 (d) Market risk Market risk is the risk that changes in market prices, such as commodity prices, interest rates and foreign exchange rates, will affect the Corporation s net earnings, or the value of financial instruments, and are largely outside the control of the Corporation. The objective of the Corporation is to manage and mitigate market risk exposures within acceptable limits, while maximizing returns. Market risks are as follows: 20

21 Foreign currency risk Prices for oil are determined in global markets and generally denominated in United States dollars. Natural gas prices obtained by the Corporation will be influenced by both U.S. and Canadian demand and the corresponding North American supply, and by imports of liquefied natural gas. An increase in the value of the Canadian dollar relative to the U.S. dollar will decrease the revenues received from the sale of oil and gas commodities. The impact of such exchange rate fluctuations cannot be accurately quantified. As at June 30, 2011, the Corporation had no forward exchange rate contracts in place nor any working capital items denominated in foreign currencies. Interest rate risk Interest rate risk is the risk that future cash flows will fluctuate as a result of changes in market interest rates. The Corporation is exposed to interest rate risk to the extent that changes in market interest rates impact its borrowings under the floating rate credit facility. The Corporation had no interest rate swaps or financial contracts in place as at or during the periods ended June 30, 2011 or December 31, For the three months ended June 30, 2011, a 100 basis points change to the effective interest rate would have an impact of approximately $27,000 (three months ended June 30, 2010 $ 3,600) on net income. For the six months ended June 30,2011 a 100 basis points change to the effective interest rate would have an impact of approximately $54,000 (six months ended June 30, 2010 $7,200) on net income. Commodity price risk The nature of the Corporation s operations results in exposure to fluctuations in commodity prices. Commodity prices for oil and natural gas are impacted by global economic events that dictate the levels of supply and demand. SkyWest's management continuously monitors commodity prices and may consider instruments to manage exposure to these risks when it deems appropriate. The Corporation s production is generally sold using spot contracts, with prices fixed at the time of transfer of custody or on the basis of a monthly average market price. The Corporation, however, may give consideration in certain circumstances to the appropriateness of entering into long term, cash settled contracts to fix the price on certain notional volumes of production. As at June 30, 2011 the Corporation had the following commodity contract outstanding with a fair value of $204,824: Type Notional Oil Volume Price Index Term Collar 3,100 bbl/month USD $105/bbl floor/ WTI NYMEX May 1,2011 to USD $116.50/bbl ceiling Dec. 31, 2011 For the three months ended June 30, 2011, a $1/bbl change in oil price would have an impact of approximately $15,000 on net income. (e) Capital management The Corporation s capital management policy is to maintain a strong capital base that optimizes the Corporation s ability to grow, maintain investor and creditor confidence and to provide a platform to create value for its shareholders. The Corporation maintains a flexible capital structure to maximize its 21

22 ability to pursue oil and natural gas exploration opportunities and the requirement to sustain future development of the business. The Corporation monitors the level of risk associated for each capital project to balance the proportion of debt and equity in its capital structure. The Corporation monitors capital based on its current working capital, available bank line of credit, projected cash flow from operating activities and anticipated capital expenditures. The Corporation's officers are responsible for managing the Corporation's capital and do so through quarterly meetings and regular reviews of financial information, including budgets and forecasts. The Corporation's directors are responsible for overseeing this process. The Corporation considers its capital structure to include shareholders equity and bank debt. In order to maintain or adjust the capital structure, the Corporation may issue shares, seek debt financing and adjust its capital spending to manage its current and projected capital structure. The Corporation's ability to raise additional debt or equity financing is impacted by external conditions, including future commodity prices, particularly natural gas, and the global economic downturn. The Corporation continually monitors business conditions including: changes in economic conditions; the risk of its drilling programs; forecasted commodity prices; and potential corporate or asset acquisitions. The Corporation monitors capital based on two financial ratios: net debt to annualized funds flow and working capital ratio. The net debt to annualized funds flow represents the time period it would take to pay off the debt if no further capital expenditures were incurred and if funds flow from operating activities remained constant. This ratio is calculated as net debt, defined as outstanding bank debt plus or minus net working capital (excluding fair value of commodity contracts), divided by funds flow from operating activities before changes in non cash working capital for the most recent quarter and then annualized. The Corporation's strategy is to monitor the ratio and the ratio can, and will, fluctuate based on the timing of property transactions, commodity prices and on the mix of exploratory and development drilling. The following table summarizes the Corporation's net debt to annualized funds flow calculation: June 30, 2011 December 31, 2010 Net debt: Current assets $ 6,264,585 $ 18,544,466 Accounts payable and accrued liabilities (6,957,261) (17,011,308) Bank debt (14,668,848) (2,797,222) Net debt $ (15,361,524) $ (1,264,064) 22

23 Three months ended June 30, 2011 December 31, 2010 Funds from operations: Net income $ 101,808 $ (2,508,105) Adjustments for: Depletion and depreciation 2,048,000 2,776,699 Stock based compensation 432,253 38,648 Other 145,583 (474,131) Exploration and evaluation expenditures 349,298 Deferred income tax expense 583,493 (3,498) 3,311,137 $ 178,911 Annualized 13,244,548 $ 715,644 Net debt to annualized funds flow As at June 30, 2011, the Corporation's ratio of net debt to funds flow was 1.16 to 1 (at December 31, to 1). The Corporation's share capital is not subject to external restrictions but the amount of the bank facility is determined by the lenders and based on the lenders' borrowing base models which are based on independent valuation of the Corporation's oil and gas reserves. The credit facility is also subject to certain financial and other covenants as described in note 8. In regards to the working capital ratio, the Corporation is required to maintain under their credit facility a ratio of greater than 1:1 defined as the ratio of current assets including undrawn available credit divided by current liabilities less the current portion of bank debt. The fair value of commodity contracts is excluded from this calculation. At June 30, 2011 the working capital ratio was 1.78 to 1.0 (December 31, to 1.0) 18. Fair value of financial instruments The fair values of cash and cash equivalents, accounts receivable, and accounts payable and accrued liabilities and bank debt approximate their carrying value due to the short term maturity of those instruments. The fair value of investments is described in note 5 and the fair value of commodity contracts is described in note 17. Cash and cash equivalents and investments are measured at fair value based on a Level 1 designation. Commodity contracts are measured at fair value based on a Level 2 designation. 19. Subsequent Events Subsequent to June 30, 2011, the Corporation entered into the following transactions: (a) Sale of BOG Shares Subsequent to June 30, 2011, the 1,678,165 BOG shares were sold for net proceeds of $468,

24 20. Transition to IFRS As disclosed in note 2, these interim condensed consolidated financial statements represent the Corporation s presentation of the financial results of operations and financial position under IFRS for the period ended June 30, 2011 in conjunction with the Corporation s annual audited consolidated financial statements to be issued under IFRS as at, and for the year ended, December 31, These interim condensed consolidated financial statements have been prepared in accordance with IFRS 1, First time Adoption of International Financial Reporting Standards and with IAS 34, Interim Financial Reporting, as issued by the IASB. Prior to January 1, 2011, the Corporation prepared its interim and annual consolidated financial statements in accordance with Canadian GAAP. IFRS 1 requires the presentation of comparative information as at the January 1, 2010 transition date and subsequent comparative periods, as well as the consistent and retrospective application of IFRS accounting policies. To assist with the transition, the provisions of IFRS 1 allow for certain mandatory and optional exemptions for first time adopters to alleviate the retrospective application of all IFRSs. The following reconciliations present the adjustments made to the Corporation s previous Canadian GAAP financial results of operations and financial position to comply with IFRS 1. 24