NXT Energy Solutions Inc. - Quarter Report: 2001 September (Form 10-Q)

We have prepared these consolidated financial statements for our three-month and nine-month interim periods ending and as at September 30, 2001 and 2000 in accordance with accounting principles generally accepted in the United States for interim financial reporting. While these financial statements for these interim periods reflect all normal recurring adjustments which, in the opinion of our management, are necessary for fair presentation of the results of the interim period, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. For additional information, refer to our consolidated financial statements included in our annual report on form 10-K for our fiscal year ended December 31, 2000.

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Certain items in our prior year's consolidated financial statements have been reclassified to conform to our current year's consolidated financial statement presentation.

The preparation of these consolidated financial statements in conformity with generally accepted accounting principles in the United States requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of these consolidated financial statements and the reported amount of revenues and expenses during the reporting periods. Actual results may differ from those estimates.

For purposes of preparing the consolidated balance sheets and statements of cash flows contained in these consolidated financial statements, we consider all investments with original maturities of ninety days or less to constitute "cash and cash equivalents".

We amortize debt issuance costs on a straight-line basis over the life of the related debt.

Our financial instruments consist of cash, accounts receivable, notes receivable, trade payables, accrued liabilities and long-term debt. The book value of these financial instruments, other than long-term debt, approximates their fair values due to their short-term to maturity and similarity to current market rates. The carrying value of our long-term debt is considered to approximate its fair value because the interest rate is comparable to current rates available to the company. It is the opinion of our management that we are not exposed to significant interest, currency or credit risks arising from these financial instruments.

We follow the full cost method of accounting for oil and natural gas properties and equipment whereby we capitalize all costs relating to our acquisition of, exploration for and development of oil and natural gas reserves. These capitalized costs include:

We only capitalize overhead that is directly identified with acquisition, exploration or development activities. All costs related to production, general corporate overhead and similar activities are expensed as incurred.

Under the full cost method of accounting, capitalized costs are accumulated into cost centers on a country-by-country basis. These costs, plus a provision for future development costs (including estimated dismantlement, restoration and abandonment costs) of proved undeveloped reserves, are then depleted and depreciated using the unit-of-production method, based on estimated proved oil and gas reserves as determined by independent engineers where significant. For purposes of the depletion and depreciation calculation, proved oil and gas reserves are converted to a common unit of measure on the basis of their approximate relative energy content. No depletion or depreciation expense was recorded as NXT is a development stage enterprise. As a development stage enterprise, any net revenues received prior to achieving commercial production will be accounted for as an adjustment to capitalized costs.

In applying the full cost method of accounting, capital costs in each cost center less accumulated depletion and depreciation and related deferred income taxes are restricted from exceeding an amount equal to the sum of the present value of their related estimated future net revenues discounted at 10% less estimated future expenditures, and the lower of cost or estimated fair value of unproved properties included in the costs being amortized, net of related tax effects. Should this comparison indicate an excess carrying value, a write-down would be recorded.

The carrying values of unproved properties, which are excluded from the depletion calculation, are assessed on a quarterly basis to ascertain whether any impairment in value has occurred. This assessment typically includes a determination of the anticipated future net cash flows based upon reserve potential and independent appraisal where warranted. Impairment is recorded if this assessment indicates the future potential net cash flows are less than the capitalized costs.

All recoveries of costs through the sale or other disposition of oil and gas properties and equipment are accounted for as adjustments to capitalized costs, with no gain or loss recorded, unless the sale or disposition involves a significant change in the relationship between costs and the value of proved reserves or the underlying value of unproved property, in which case the gain or loss is computed and recognized.

We conduct oil and natural gas exploration, drilling, development and production activities through our joint venture partners. These consolidated financial statements reflect only our proportionate interest in these activities.

We carry our other capitalized property and equipment at cost, and depreciate or amortize them over their estimated service lives using the declining balance method as follows:

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When we retire or otherwise dispose of our other capitalized property and equipment, we remove their cost and related accumulated depreciation or amortization from our accounts, and record any resulting gain or loss in the results of operations for the period. Our management periodically reviews the carrying value of our property and equipment to ensure that any permanent impairment in value is recognized and reflected in our results of operations.

We expense all research and development expenditures we incur to develop, improve and test our SFD survey system and related components, including allocable salaries.

We expense all survey support expenditures we incur, after netting costs which are reimbursable by our joint venture partners. Survey support expenditures consist primarily of the cost, including allocable salaries, to:

We expense all survey operations and data analysis costs we incur, after netting costs which are reimbursable by our joint venture partners. Survey operations and data analysis expenditures consist primarily of:

Our only operations outside of the United States are in Canada. Foreign currency translation adjustments resulting from the translation of the financial statements of our Canadian subsidiaries, whose functional currency is Canadian dollars, into US dollar equivalents for purposes of consolidating our financial statements, are included in other comprehensive loss. For purposes of consolidation, we use the following methodology to convert Canadian dollar denominated accounts and transactions into US dollars:

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We record the cumulative gain or loss arising from the conversion of the noted Canadian dollar denominated accounts and transactions into US dollars as a foreign currency translation adjustment as a component of accumulated other comprehensive income or loss for that period.

Our basic loss per share is computed in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128"), by dividing the net loss for the period by the weighted average number of common shares outstanding for the period. Our diluted loss per share is computed, also in accordance with SFAS 128, by including the potential dilution that could occur if holders of our dilutive securities were to exercise or convert these securities into common shares.

In calculating our basic and diluted loss per share, we take into consideration deemed distributions analogous to the declaration of a dividend attributable to the beneficial conversion features affording a discount or benefit to the holders of our securities. See note 10.

In accounting for the grant of our employee and director stock options, we have elected to follow Accounting Principles Board No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations. Under APB 25, companies are not required to record any compensation expense relating to the grant of options to employees or directors where the awards are granted upon fixed terms with an exercise price equal to fair value and the only condition of exercise is continued employment. See note 12.

On January 1, 2001, NXT adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging" ("SFAS No. 133"), as modified by SFAS No. 138, "Accounting for Certain Derivative Instruments and Hedging Activities" ("SFAS No. 138"). SFAS No. 133 requires a company to recognize all derivative instruments on the balance sheet as either an asset or a liability measured at fair value. Changes in fair value of derivative instruments are recognized in earnings unless specific hedge criteria are met. Changes in fair value of derivative instruments that are designated as hedges are recognized in earnings in the same period as the hedged item. SFAS No. 133 requires that a company formally document, designate and assess the effectiveness of instruments that receive the hedge accounting. NXT has no derivative instruments and the adoption of SFAS No. 133 on January 1, 2001 has not had a material impact to our consolidated financial condition and results of operations.

In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations" ("SFAS No. 141"), and SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting, and broadens the criteria for recording intangible assets separate from goodwill. Recorded 

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goodwill and intangibles will be evaluated against these new criteria and may result in certain intangibles being included with goodwill or, in the alternative, amounts initially recorded as goodwill may be separately identified and recognized apart from goodwill. SFAS No. 142 requires the use of a non-amortization approach to account for purchased goodwill and certain intangibles. Under a non-amortization approach, goodwill and certain intangibles will not be amortized into results of operations, but instead will be reviewed for impairment and written down and charged to results of operations only in the periods in which the recorded value of goodwill and certain intangibles is in excess of its fair value. The provisions of each statement will be adopted by NXT on January 1, 2002. The effect of adopting these standards will not be material to these consolidated financial statements.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and provides a single accounting model for long-lived assets to be disposed of.  NXT is required to adopt the provisions of SFAS No. 144 on January 1, 2002.  While NXT is currently evaluating the impact that the adoption of SFAS No. 144 will have on our consolidated financial condition and results of operations, we do not expect any impact to be material to these consolidated financial statements.

We acquired what is now our wholly-owned subsidiary, NXT Energy USA (then known as Pinnacle Oil Inc.), on January 20, 1996, in a transaction accounted for as a "reverse acquisition". This acquisition was effected through the issuance of 10,090,675 common shares of NXT (then known as Auric Mining Corporation), constituting approximately 92% of its outstanding shares at that date, in exchange for all of the outstanding shares of NXT Energy USA. As a result of the application of the noted accounting principles governing reverse acquisitions, NXT Energy USA (and not NXT) was treated as the "acquiring" or "continuing" entity for financial accounting purposes.

We have accounted for the NXT Energy USA acquisition as an issuance of stock by NXT Energy USA in exchange for the tangible net assets of NXT, valued at fair value, which approximate historical costs. As a result, our consolidated statements of loss and shareholders' equity (deficit) included in these consolidated financial statements are deemed to be a continuation of NXT Energy USA's financial statements, and therefore reflect:

We closed a private placement of common shares on September 18, 2001. See note 9. In connection with that private placement: