NXT Energy Solutions Inc. - Quarter Report: 2002 March (Form 10-Q)

In preparing the above tables, we have eliminated all inter-segment revenues, expenses and assets.

On May 1, 2002, we completed the sale of our Piaggio Avanti P180 aircraft to a third party for gross proceeds of $2,580,000, and net proceeds of $1,054,464 after settlement of principal and interest due on the related asset based collateralized loan. We recorded a loss from the sale of this aircraft in the amount of $184,316 as part of our operating loss for the period ended March 31, 2002. See note 7. We also expensed the remaining unamortized debt issuance costs of $22,805 originally incurred for the financing of this aircraft. See note 7.

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We are a technology-based reconnaissance exploration company which utilizes our SFD technology to identify and high-grade oil and natural gas prospects. We conduct our reconnaissance exploration activities, as well as land acquisition, drilling, completion and production activities to exploit prospects identified using our SFD technology, through our two wholly-owned operating subsidiaries, NXT Energy USA which focuses on United States-based exploration, and NXT Energy Canada which focuses on Canadian-based exploration. NXT concentrates on research and development efforts to improve the efficacy of our SFD survey system, and oversees the operations of and provides management, financial and administrative services to our subsidiaries.

During our three-month interim period ended March 31, 2002, we realized revenues from Canadian natural gas and natural gas liquids production of $10,718 on production of 4,506 mcfe for a netback of $1.93 per mcfe. This production represents our interest in three Canadian wells, which commenced production late in the quarter. Oil and natural gas revenues from United States operations will commence in the second quarter of 2002.

We incurred an operating loss of $749,763 for our three-month interim period ended March 31, 2002, as compared to $630,658 for the corresponding interim period in fiscal 2001, representing a $119,105 or 18.9% overall increase. The increase in our operating loss for our three-month interim period March 31, 2002 over the corresponding interim period in fiscal 2001 was primarily attributable to the following changes in expenses:

• a $184,316 write-down of aircraft and flight equipment;

• a $26,680, or 8.5%, increase in administrative expense from $314,150 to $340,830;

• a $15,219 charge to reflect depletion and impairment in our oil and natural gas properties;

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• a $7,678, or 15%, increase in survey support expense from $51,082 to $58,760; and

• an oil and natural gas operating expense of $2,022;

partially offset by

• a $43,203, or 56.4%, decrease in amortization and depreciation from $76,579 to $33,376;

• a $24,966, or 65.8%, decrease in survey operations and data analysis expense from $37,957 to $12,991; and

• a $17,148, or 13.2%, decrease in research and development expense from $130,115 to $112,967.

The continuing increase in our operating losses for our three-month period ended March 31, 2002 over the prior corresponding fiscal period generally reflect severance costs incurred to reduce staff levels. As noted below in that section of this quarterly report captioned "Liquidity And Capital Resources-Plan Of Operation And Prospective Capital Requirements", we are currently reducing the level of our general and administrative and exploration expenses pending the completion of our Antelope Tail drilling activities.

The $17,148 or 13.2% decrease in research and development expense for our three-month interim period ended March 31, 2002 over the corresponding interim period in fiscal 2001 was principally attributable to a decrease in research and development staff as we decrease operating costs until we complete our Antelope Tail drilling.

The $15,219 depletion and impairment of oil and natural gas properties for our three-month interim period ended March 31, 2002 relates to depletion expense recorded based on our first quarter production and a ceiling test write-down of Canadian cost center oil and natural gas properties. Depletion rates for our Canadian and United States operations for fiscal 2002 are estimated at $5.53 per boe and $5.90 per boe, respectively.

The $43,203 or 56.4% decrease in amortization and depreciation for our three-month interim period ended March 31, 2002 over the corresponding interim period in fiscal 2001 was primarily attributable aircraft and flight equipment held for sale in the first quarter of 2002 not being depreciated.

Survey support expense generally relates to costs-including allocable salaries-to:

• equip, maintain and hangar our survey aircraft;

• conduct field evaluations designed by our joint venture partners to evaluate our SFD technology (after netting any costs which our joint venture partners are required to reimburse us for); and

• develop, organize, staff and train our survey and interpretation operational functions.

Excluded from survey support expense are costs capitalized as property and equipment (including costs relating to our survey aircraft) and costs capitalized as exploration costs related to oil and gas prospects identified through our commercial SFD survey activities.

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The $7,678 or 15% increase in survey support expense for our three-month interim period ended March 31, 2002 over the corresponding interim period in fiscal 2001 was primarily attributable to higher costs to maintain our survey aircraft for the period.

Survey and data analysis expenditures consist primarily of any costs we incur conducting commercial SFD survey activities. These costs can generally be broken down into the following two components:

• aircraft operating costs, travel expenses and allocable salaries of our personnel while on survey assignment (after netting any costs our joint venture partners are required to reimburse us for); and

• allocable salaries incurred by our personnel interpreting SFD data.

Excluded from survey and data analysis expense are costs capitalized as property and equipment (including costs relating to our survey aircraft) and costs capitalized as exploration costs related to oil and gas prospects identified through our commercial SFD survey activities.

Our survey and data analysis expense for our three-month interim period ended March 31, 2002 was $12,991 as compared to $37,957 over the corresponding interim period in fiscal 2001, before and after taking joint venture partner reimbursements into consideration. Our joint venture partner reimbursement for our three-month interim periods ended March 31, 2002 and 2001 were $0.

The decrease in survey and data analysis expense for our three-month interim period ended March 31, 2002 over the corresponding interim period in fiscal 2001 was primarily attributable to a reduction in SFD survey and interpretation activities in the period due to our efforts to reduce operating costs pending the completion of Antelope Tail drilling.

The $26,680 or 8.5% increase in our administrative expense for our three-month interim period ended March 31, 2002 over the corresponding interim period in fiscal 2001 was primarily attributable to the severance costs incurred to reduce general and administrative staff levels.

We recorded a $1,511 foreign currency translation gain for our three-month interim period ended March 31, 2002 as a comprehensive loss item on our statements of loss and shareholders' equity (deficit), as compared to a $132,500 currency translation loss for our three-month 

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interim period ended March 31, 2001. Comprehensive gains or losses arise in consolidating our accounting records for financial reporting purposes as a result of the fluctuation in United States-Canadian currency exchange rates during that period.

We have not entered into any transactions during our three-month interim period ended March 31, 2002 with any parties that are not clearly independent on terms that might not be available from other clearly independent third parties related parties.

• a private placement in May 1996 of 975,000 shares of our common stock for total gross proceeds of $975,000,

• loans to our company in the amount of $1,000,000 in January 1997, and the subsequent conversion of the outstanding balance of principal and accrued interest of these loans in the amount of $1,120,000 into 411,764 shares of our common stock in February 1998;

• a private placement in April 1998 of 800,000 shares of our convertible series "A" preferred stock and 200,000 common stock purchase warrants for total gross proceeds of $6,000,000;

• a private placement in May 1999 of 400,000 shares of our common stock for total gross proceeds of $6,000,000;

• the exercise on March 31, 2000 of warrants to purchase 200,000 shares of our common stock at an exercise price of $7.50 per share, resulting in gross proceeds of $1,500,000;

• the exercise of employee stock options during fiscal 2000 and fiscal 1999 resulting in aggregate gross proceeds of $953,854; and

• a private placement closed in September 2001 of 3,803,684 common shares for total gross proceeds of $4,374,237.

We also borrowed $1,600,000 for working capital purposes on November 6, 2000 pursuant to an asset-based loan collateralized by our Piaggio P180 Avanti aircraft. The principal and interest on this loan, which accrues at the rate of 9.65% per annum, are repayable in 156 equal installments of $18,037 each, commencing January 1, 2001 with the last payment due on December 1, 2013. The loan contains no restrictive or financial ratio covenants, although it does allow the lender to accelerate the loan in the event of our insolvency or bankruptcy or any adverse change in our consolidated financial condition, or in the event the estimated retail value of the secured collateral falls anytime to less than 50% of the outstanding balance of the loan. We sold the Piaggio aircraft on May 1, 2002, and retired this loan.

Our cash position as of March 31, 2002 was $2,018,897, as compared to $2,994,608 as of December 31, 2001. Our cash position as of March 31, 2001 was $3,219,806, as compared to $4,279,279 as of December 31, 2000. We maintain the bulk of our cash in a United States government and government-backed securities money-market account.

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The $975,711 decrease in our cash position for our three-month period ended March 31, 2002 was attributable to $344,731 in cash used in operating activities, $638,083 in cash used in investing activities, $5,592 in cash generated through financing activities and a $1,511 comprehensive gain due to the effect of exchange rate changes. The $1,059,473 decrease in our cash position for our three-month period ended March 31, 2001 was attributable to $15,160 in cash used through financing activities, $417,778 in cash used in operating activities, $494,035 in cash used in investing activities, and a $132,500 comprehensive loss due to the effect of exchange rate changes.

Our operating activities required cash in the amount of $344,731 for our three-month period ended March 31, 2002, as compared to cash requirements of $417,778 for our three-month period ended March 31, 2001. The $344,731 of cash used in operating activities for our three-month period ended March 31, 2002 reflected our net loss of $793,216 for that period, as decreased for non-cash deductions and a net increase in non-cash working capital balances. The $417,778 of cash used in operating activities for our three-month period ended March 31, 2001 reflected our net loss of $624,957 for that period, as decreased for non-cash deductions and a net increase in non-cash working capital balances.

We generated $5,592 in cash from financing activities for our three-month period ended March 31, 2002, as compared to using $15,160 in cash from financing activities for our three-month period ended March 31, 2001. The $5,592 in cash generated through financing activities for our three-month period ended March 31, 2002 was due to principal repayments of loan proceeds from an asset-based loan collateralized by our Piaggio P180 Avanti aircraft offset by the realization of previously deferred insurance costs. The $15,160 of cash used through financing activities for our three-month period ended March 31, 2001 was due to principal repayments of loan proceeds from an asset-based loan collateralized by our Piaggio P180 Avanti aircraft.

We used cash in the amount of $638,083 for investing activities for our three-month period ended March 31, 2002, as compared to $494,035 in cash used for investing activities for our three-month period ended March 31, 2001. The principal use of cash for our three-month period ended March 31, 2002 was to drill two wells, complete three wells, tie-in two wells and purchase seismic data ($624,644), while the principal use of cash for our three-month period ended March 31, 2001 was to acquire drilling rights and seismic data in exploratory blocks pursuant to working interest elections ($511,501).

Due to the nature and early stage of development of our SFD technology and also due to the practices of the oil and natural gas industry and their experience and attitudes toward new and unproven technologies, the only practical way for NXT to prove-out the efficacy of our SFD technology, achieve industry acceptance and to generate revenues and profits is to participate in drilling projects either through our joint venture partners or on our own account. We believe that we would need to participate in a minimum of 30 prospects in order to account for a variety of different geological conditions and statistically prove-out the efficacy of our SFD technology. Since costs to acquire or conduct ancillary seismic, to acquire drilling rights, and to drill, case and complete wells and to tie them into sales or gathering systems are very expensive and can easily exceed $1 million per well (indeed, total drilling and completion costs alone on our Wyoming prospects range from $1.25 million to up to $4 million), the overall cost to prove-out our SFD technology over at least 30 prospects will require significant capital resources, particularly if NXT as opposed to our joint venture or other drilling partners is required to bear a significant portion or all of these costs.

We have approximately $2,198,000 in cash on hand as of the date of this quarterly report to fund our pending drilling program and to contribute toward our administration, operational and research and development requirements. Of this amount, approximately $975,000 has been set aside to fund our share of drilling and completion costs for our pending Antelope Tail project in Wyoming, leaving $1,223,000 toward operational, research and development, and prospective exploration requirements. Given the continuing delays in the spud date for our Antelope Tail exploration well, we have taken steps to 

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significantly cut-back our expenses relating to administration, exploration and research and development staffing, activities and operations from approximately $250,000 per month to approximately $110,000 going forward as of the date of this quarterly report. We have also raised funds through the sale of our Piaggio P180 Avanti survey aircraft, and have agreed to sell our interest in our producing Beiseker, Alberta, prospect for CDN $390,500.

Based upon current rates and commodity prices, we anticipate monthly revenue going forward of approximately $35,000 to our interest with respect to our Ice Caves prospect in the Williston basin of North Dakota. Production at this well commenced in late April 2002. After taking into consideration projected proceeds from Ice Caves, prospective proceeds from the sale of our Beiseker prospects, and our anticipated cost to participate in drilling the Antelope Tail well, we believe we could maintain our current level of operations for approximately twelve to 18 months. We would ramp-up operations, including acquiring or leasing another survey aircraft, if the Antelope Tail project is successfully drilled or we otherwise raise sufficient revenues or additional working capital through public or private sales of our securities in order to support increased operations.

We can give no assurance that any or all projects in our pending drilling, completion and tie-in programs will be commercial, or if commercial will generate sufficient revenues to cover our operating or other exploration costs. Should this be the case, we would be forced, unless we can raise sufficient additional working capital, to suspend our operations, and possibly even liquidate our assets and wind-up and dissolve our company. Our inability to raise sufficient additional working capital in the longer-term would likely force us to suspend our operations, and possibly even liquidate our assets and wind-up and dissolve our company.

We may, in consolidating our accounting records for financial reporting purposes in any period rates, record a comprehensive gain or loss item on our statements of loss and shareholders' equity (deficit) during that period as a result of the fluctuation in United States-Canadian currency exchange rates. Our exposure to significant foreign currency gains or losses on our accounting records will increase to the extent we invest a greater portion of our United States-dollar denominated cash reserves into our Canadian operations and properties through intercompany advancements. We cannot give you any assurance that our future operating results will not be adversely affected by currency exchange rate fluctuations. See that section of this quarterly report captioned "Quantitative And Qualitative Disclosure About Market Risk" for a description of other aspects of our company that may be potentially affected by foreign exchange fluctuations.

We do not believe that our operating results were adversely affected during the first three months of fiscal 2002 or fiscal 2001 by inflation or changing prices.

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. Our consolidated financial condition and results of operations are sensitive to, and may be adversely affected by, a number of subjective or complex judgments relating to methods, assumptions or estimates required under the full cost method of accounting concerning the effect of matters that are inherently uncertain. For example:

• Capitalized costs under the full cost method of accounting are generally depleted and depreciated on a country-by-country cost center basis using the unit-of-production method, based on estimated proved oil and gas reserves as determined by independent engineers, where significant. In addition, capital costs in each cost center are also restricted from exceeding the sum of the present value of the estimated discounted future net revenues of those properties, plus the cost or estimated fair value of unproved properties (the "ceiling test"). Should this comparison indicate an excess carrying value, a write-down would be recorded. In making these accounting determinations, we rely in part upon a reserve report prepared by independent engineers specifically engaged for this purpose. To economically evaluate our proved oil and natural gas reserves, these 

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independent engineers must necessarily make a number of assumptions, estimates and judgments that they believe to be reasonable based upon their expertise and professional and SEC guidelines. Were the independent engineers to use differing assumptions, estimates and judgments, then our consolidated financial condition and results of operations would be affected. For example, we would have lower net profits (or higher net losses) in the event the revised assumptions, estimates and judgments resulted in higher reserve estimates, since our depletion and depreciation rate would then be lower. Similarly, we would have lower net profits (or higher net losses) in the event the revised assumptions, estimates and judgments resulted in lower reserve estimates in the event this were to cause write-downs under the ceiling test.

For a more complete description of the full cost method of accounting for oil and natural gas properties and equipment, see that section in explanatory note 2 to our consolidated financial statements included with this quarterly report captioned "Oil And Natural Gas Properties".

For a summary of the effect of recent accounting pronouncements on our company, see that section in explanatory note 2 to our consolidated financial statements included with this quarterly report captioned "Recent Accounting Pronouncements".

Our primary market risks are related to market changes in oil and natural gas prices. Since our prospective revenues will be tied to the price at which either NXT or our joint venture partners sell oil and natural gas on the world market, any fluctuations in these prices will directly and proportionately impact our income base. Similarly, our ability to acquire drilling rights is also directly affected by fluctuations in oil and natural gas prices, since competition for and the cost to acquire drilling rights is generally a function of oil and natural gas prices. Specifically, increases in oil and natural gas prices are generally accompanied by increases in industry competition and costs to acquire drilling rights, while decreases in oil and natural gas prices are generally accompanied by a similar decline in competition and costs to acquire drilling rights. The effect of changes in oil and natural gas prices will also affect our joint venture partner's decision-making relative to the scope and budget for exploration, land acquisition, drilling, completion and tie-in activities, which will then impact NXT.

An additional significant market risk relates to foreign currency fluctuations between United States and Canadian dollars. Since our royalty or working interest revenues generated by our Canadian-based joint venture partners will be denominated in Canadian currency, our consolidated financial condition and results of operations could be adversely affected by United States-Canadian currency fluctuations. We have not previously engaged in activities to mitigate the effects of foreign currency fluctuations due to the absence of Canadian revenues to date, and we anticipate that the exchange rate between the United States and Canadian dollar will remain fairly stable. If earnings from our Canadian operations increase, our exposure to fluctuations in the 

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United States-Canadian exchange rate will increase, and we may utilize forward exchange rate contracts or engage in other efforts to mitigate these foreign currency risks. We cannot give you any assurance that the use of exchange rate contracts or other mitigating efforts would effectively limit any adverse effects of foreign currency fluctuations on our consolidated financial condition and results of operations.

It is our policy to maintain the bulk of our available cash in U.S. dollar-denominated money-market accounts. Our interest income from these short-term investments could be adversely affected by any material changes in interest rates within the United States.

Our future results of operations or financial condition may be affected by the uncertainties and other risk factors enumerated below as well as those presented elsewhere in this quarterly report and in other reports we periodically file with the SEC, including our annual report on form 10-K for the fiscal year ended December 31, 2001, and should be considered in context with the various disclosures concerning our company presented elsewhere herein and therein.

Future oil and gas 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 exploration, drilling, operating and other costs. Completion of wells by us or our partners does not assure a profit on the investment or recovery of exploration, drilling, completion and operating costs. Drilling hazards or environmental damage could greatly increase the cost of operations, and various field operating conditions may adversely affect production. Adverse 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.

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Although we commenced receiving production revenues in the first quarter of fiscal 2002, the amount of those revenues going forward will not cover our operating costs. Until the first quarter of fiscal 2002, we were a development stage company. Our failure to increase oil and natural gas revenues and ultimately derive operating profits from our pending drilling program would:

• complete pending and proposed drilling and development programs and fund our current operational requirements; and

• raise additional working capital;

Decisions relating to the drilling, completion and tie-in of wells for our pending drilling program as well as additional prospects and their tie-in into gathering systems will ultimately be made by our joint venture partners. We can therefore give no assurance as to when or whether any of these wells will be tied-into gathering systems or the underlying fields developed other than assurances or estimates given to us by our joint venture partners. We have, as a result of our lack of revenues, incurred a cumulative net loss (after taking comprehensive gains and losses into consideration) in the amount of $15,380,430 from our inception in October 1995 through March 31, 2002, and we anticipate that we will continue to incur substantial operating losses for the foreseeable future unless and until we are able to bring satisfactory additional producing wells and fields on-line. We cannot give you any assurance that we will generate revenues or profits in the near future or at all.

We hope to leverage our pending drilling program to raise additional capital to fund additional drilling programs and operational requirements. If our pending drilling program is not successful or its development is delayed, we will need to raise a significant amount of additional capital to fund our further drilling and operational requirements. We cannot give you any assurance that we will be able to secure the additional capital we require to fully or partially fund those needs which will not be objectionable to our company or our shareholders, including substantial dilution. Given pending reductions in our staffing and exploration activities, our inability to raise sufficient additional working capital in the longer-term would likely force us to suspend our operations, and possibly even liquidate our assets and wind-up and dissolve our company.

Our future success is dependent upon our ability, through utilization of our SFD technology, to successfully identify commercially viable hydrocarbon accumulations for development by our joint venture partners or for our own account. Based on our business plan, we will be dependent on:

Our SFD technology is still being tested and at this time must be regarded as a speculative and unproven technology. We believe that we would need to participate in a minimum of 30 prospects in order to account for a variety of different geological conditions and statistically prove the efficacy of our SFD technology (to date we have participated in only seven prospects, although nineteen wells have been drilled on those prospects). Since costs to acquire ancillary seismic data, to acquire drilling rights, to drill, case and complete wells, and to tie them into sales or gathering systems are very expensive and can easily exceed $1 million per well (indeed, total drilling and completion costs alone on our Wyoming prospects range from $1.25 million to up to $4 million), the overall cost to prove our SFD technology over at least 30 prospects will require significant capital resources, particularly if NXT (as opposed to our joint venture or other drilling partners) is required to bear a significant portion or all of these costs.

Although we believe that our SFD technology has demonstrated a prospective ability as a geologic structural identification tool, we nevertheless cannot give you any assurance that our SFD technology will be able to consistently identify oil and natural gas prospects, or that these prospects will be commercially exploitable. We also cannot give you any assurance that we will be able to consistently discover commercial quantities of oil and natural gas, or that our joint venture partners will successfully acquire and drill properties at low finding costs.

The exploration process is exceedingly expensive and complicated. We will be reliant, at least in the near-term, upon our joint venture partners for opportunities to participate in exploration prospects through overriding royalties or equity participation on a working interest basis from producing SFD prospects. Currently, we do not concurrently anticipate renewed exploration activities with CamWest under our joint venture with that company as we focus on developing our inventory of prospects under that joint venture. We also do not currently have an active Canadian joint venture partner, although we are in active discussions with several prospective partners. We intend, however, to suspend formal joint venture activities pending current drilling results at our Antelope Tail prospect in order to preserve cash flow. Our inability to enter into new joint ventures would have a material adverse effect on the realization of return from our interest in projects and on our overall financial condition and results of operations.

We exclusively focus on exploration and the review and identification of viable prospects through our SFD technology, and rely upon our joint venture partners to provide and complete all other project operations and responsibilities, including land acquisition, seismic, drilling, marketing and project administration. As a result, we have only a limited ability to exercise control over the selection of prospects for development, drilling or production operations, or the associated costs of such operations, and the timeliness of our partners in pursuing or carrying-out those activities. The success of each project will be dependent upon a number of factors which are outside our control, or controlled by our joint venture partners or other third-parties acting as project operator, in accordance with the applicable agreements between our company and the joint venture partners or other parties. These factors include:

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Our reliance on our joint venture partners, and our limited ability to directly control project operations, costs and distributions, could have a material adverse effect on the realization of return from our interest in projects and on our overall financial condition and results of operations.

Pursuant to our business plan, our revenues and cash flow will, at least in the near-term, be principally dependent upon the success of drilling and production from prospects in which we participate through agreements with our joint venture partners in the form of an overriding royalty or a working interest or other participation right. The success of these prospects will be determined by the location, development and production of commercial quantities of hydrocarbons. Exploratory drilling is subject to numerous risks, including the risk that no commercially productive oil and natural gas reservoirs will be encountered. The cost to our joint venture partners to drill, complete and operate wells is often uncertain, and drilling operations may be curtailed, delayed or cancelled as a result of a variety of factors including unexpected formation and drilling conditions, pressure or other irregularities in formations, equipment failures or accidents, as well as weather conditions, compliance with governmental regulations and shortages or delays in the delivery of equipment. Our joint venture partners' inability to successfully acquire prospects and drill wells on these prospects which produce commercial quantities of oil and natural gas would have a material adverse effect on our business, consolidated financial condition and results of operations.

Our future operating results may fluctuate significantly depending upon a number of factors including industry conditions, prices of oil and natural gas, rate of drilling success, rates of production from completed wells and the timing of capital expenditures. This variability could have a material adverse effect on our business, consolidated financial condition and results of operations. In addition, any failure or delay in the realization of expected cash flows from initial operating activities could limit our future ability to continue exploration and to participate in economically attractive projects.

Oil and natural gas are commodities whose prices are determined based on world demand, supply and other factors, all of which are beyond our control. It is impossible to predict future oil and natural gas price movements with any certainty, as they have historically been subject to wide fluctuations in response to a variety of market conditions, including:

Any extended or substantial decline in oil and natural gas prices would have a material adverse effect on:

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We do not currently intend to engage in hedging activities (although we reserve the right to do so in the future), and may be more adversely affected by fluctuations in oil and natural gas prices than other industry participants that do engage in such activities. A sustained material decline in prices from historical average prices could add additional limitation factors to our borrowing base, reducing credit available to our company. Our business, consolidated financial condition and results of operations would be materially and adversely affected by adverse changes in prevailing oil and natural gas prices.

Should we pursue exploration and development activities without partners, we will have to establish markets for any oil and natural gas we produce and we will also have to market our oil and natural gas to prospective buyers. The marketability and price of oil and natural gas which may be acquired or discovered by us will be affected by numerous factors beyond our control. We will be affected by the differential between the price paid by refiners for light quality oil and the grades of oil produced by us. Our ability to market our natural gas may depend upon our ability to acquire space on pipelines which deliver natural gas to commercial markets. We will also likely be affected by deliverability uncertainties related to the proximity of our reserves to pipelines and processing facilities and relating to price, taxes, royalties, land tenure, allowable production, the export of oil and natural gas and many other aspects of the oil and natural gas business. We have limited direct experience in the marketing of oil and natural gas.

We compete directly with independent, technology-driven exploration and service companies, and indirectly (through our joint venture partnerships) with major and independent oil and natural gas companies in our exploration for and development of commercial oil and natural gas properties. We will experience competition from numerous oil and natural gas exploration competitors offering a wide variety of geological and geophysical services. Many of these competitors have substantially greater financial, technical, sales, marketing and other resources than we do, and may be able to devote greater resources to the development, promotion and sales of their services than our company. We cannot give any assurance that our competitors will not develop exploration technologies that are superior to our SFD technology, or that these technologies will not achieve greater market acceptance than our SFD technology. Increased competition could impair our ability to attract viable industry participants, and to negotiate favorable participations and joint ventures with such parties, which could materially and adversely affect our business, consolidated financial condition and results of operations.

The oil and natural gas industry is highly competitive. Many companies and individuals are engaged in the business of acquiring interests in and developing oil and natural gas properties in the United States and Canada, and the industry is not dominated by any single competitor or a small number of competitors. Our joint venture partners will compete with numerous industry participants for the acquisition of land and rights to prospects, and for the equipment and labor required to drill and develop those prospects. Many of these competitors have financial, technical and other resources substantially in excess of those available to us or our joint venture partners. These competitive disadvantages could adversely affect our or our joint venture partners' ability to participate in projects with favorable rates of return.

There is limited market acceptance for our SFD technology, and it must compete with established geological and geophysical technologies which have already achieved market acceptance. As is typical in the case of any new technology, demand and market acceptance for our SFD technology by industry partners is subject to a high level of uncertainty and risk. Because the market for our SFD technology is new and evolving, it is difficult to predict the future growth rate, and the size of the potential market. We cannot give you any assurance that a market for our exploration technology will develop, or be sustainable. If the market fails to develop, or if our exploration technology does not achieve or sustain market acceptance, our business, financial condition and results of operations would be materially and adversely affected.

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Our success is dependent upon the continued efforts of Mr. George Liszicasz, the inventor of our SFD technology and our Chief Executive Officer, who is responsible for the continuing development of our SFD technology and SFD interpretation activities. The loss of Mr. Liszicasz would likely have a material adverse effect on our business, consolidated financial condition and results of operations. While we have entered into an employment and non-competition agreement with Mr. Liszicasz, he nevertheless cannot be prevented from leaving NXT so long as he does not employ SFD technology for oil and natural gas exploration purposes. We also do not carry key person life insurance policies on Mr. Liszicasz.

In addition, our President, a professional geologist, has recently left our company leaving this position vacant. Also, our Vice President of Exploration (U.S.), a professional geologist, will depart our company at the end of August 2002. Our success will depend to a significant extent on our ability to engage one or more qualified oil and gas professionals to replace these executives and to work with Mr. Liszicasz. Although we are currently engaged in discussions with qualified candidates to fill these executive positions, we can give you no assurance that these positions will be satisfactorily filled. Our inability to fill these positions could have a material adverse effect on our business, consolidated financial condition and results of operations.

Our ability to implement our longer-term growth strategies depends upon our continuing ability to attract and retain highly qualified geological, technical, scientific, information management and administrative personnel. Competition for these types of personnel is intense and we cannot give you any assurance that we will be able to retain our key managerial, professional and technical employees, or that we will be able to attract and retain additional highly qualified managerial, professional and technical personnel in the future. Our inability to attract and retain the necessary personnel could impede our growth.

We are a recently organized corporation with an unproven technology and a limited operating history. Our activities through the date of this quarterly report have encompassed:

We are subject to all the risks and issues inherent in the establishment and expansion of a new business enterprise including, among others, problems of using a new and unproven technology, hiring and training personnel, acquiring reliable facilities and equipment, and implementing operational controls. In general, startup businesses are subject to levels of risk that are often greater than those encountered by companies with established operations and relationships. Startups often require significant capital from sources other than operations. The management and employees of a startup business 

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shoulder the burdens of the business operations and a workload associated with company growth and capitalization that is disproportionately greater than that for an established business. Our limited operating history makes it difficult, if not impossible, to predict future operating results. We cannot give any assurance that we will successfully address these risks. Our failure to successfully address these risks could have a material, adverse effect on our business, financial condition and results of operations.

Our success will depend upon the expansion of our business. Expansion will place a significant strain on our financial, management and other resources, and will require us, among other things, to:

We cannot give you any assurance that we will be able to manage the expansion of our business effectively. Our inability to effectively manage our growth, including the failure of any new personnel we hire to achieve anticipated performance levels, would have a material adverse effect on our business, consolidated financial condition and results of operations.

We currently operate within the United States and Canada and anticipate we will also operate outside of these countries in the foreseeable future. These operations will subject us to several potential risks, including risks associated with:

We cannot give you any assurance that any of these risks will not have a material adverse effect upon our business. We do not currently engage in activities to mitigate the effects of foreign currency fluctuations. If earnings from international operations increase, our exposure to fluctuations in foreign currencies may increase, and we may utilize forward exchange rate contracts or engage in other efforts to mitigate foreign currency risks. We can give you no assurance as to the effectiveness of these efforts in limiting any adverse effects of foreign currency fluctuations on our consolidated financial condition and results of operations.

One our shareholders, Mr. George Liszicasz, beneficially own approximately 30% of the common shares outstanding, and therefore have the power to influence the election of a majority of our board of directors. Our board of directors, in turn, has the power to appoint our officers and to determine, in accordance with their fiduciary duties and the business judgment rule, our direction, objectives and policies, such as:

While our series 'A' preferred shareholder generally does not have the right to vote, we cannot effectuate any of the following transactions or actions without that shareholder's consent and approval:

• declare or pay any dividend (other than a stock split);

• redeem or purchase outstanding shares of our capital stock;

• sell our principal assets or business;

• merge or consolidate with any other company; or

• liquidate or dissolve.

An investment in the common shares will entail entrusting these and similar decisions to our present management, including Mr. Liszicasz, subject to their fiduciary duties.

The licensor of our SFD technology, Momentum Resources, claims common law ownership of that technology, but has not obtained patent or copyright protection for those rights. Momentum Resources and our company each believe that the disclosure risks inherent in patent or copyright registration of our SFD technology outweigh the legal protections which might be afforded by that registration. In the absence of significant patent or copyright protection, we may be vulnerable to competitors who attempt to imitate the SFDs, or to develop functionally similar technologies.

Although we believe that we have all rights necessary to market our services without infringing upon any patents or copyrights held by others, we cannot give any assurance that conflicting patents or copyrights do not exist. We rely upon trade secret protection and confidentiality and non-disclosure agreements with our employees, consultants, joint venture partners and others to protect our proprietary rights. Furthermore, we do not believe, were Momentum Resources to apply for and receive patent protection, that the patent would necessarily protect Momentum Resources or our company from competition. Momentum Resources and our company therefore anticipate continued reliance upon contractual rights and on common law to protect our trade secrets. The steps taken by our company and Momentum Resources to protect our respective rights may not be adequate to deter misappropriation, or to preclude an independent third party from developing functionally similar technology.

We cannot give any assurance that others will not independently develop substantially equivalent proprietary information and techniques, or otherwise gain access to Momentum Resources' or our trade secrets, or otherwise disclose aspects of the SFD device, or that we will be able to meaningfully protect our trade secrets. We also cannot give you any assurance that Momentum Resources or our company will not be required to defend against litigation or to enforce or defend intellectual property rights relating to SFD devices. Legal and accounting costs relating to prosecuting or defending intellectual property rights may be substantial.

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The market price for the common shares on the OTC Bulletin Board has been and we anticipate will continue to be extremely volatile and subject to significant price and volume fluctuations in response to a variety of external and internal factors. This is especially true with respect to emerging companies such as ours. Examples of external factors, which can generally be described as factors that are unrelated to the operating performance or financial condition of any particular company, include changes in interest rates and worldwide economic and market conditions, as well as changes in industry conditions, such as changes in oil and natural gas prices, oil and natural gas inventory levels, regulatory and environment rules, and announcements of technology innovations or new products by other companies. Examples of internal factors, which can generally be described as factors that are directly related to our consolidated financial condition or results of operations, would include release of reports by securities analysts and announcements we may make from time-to-time relative to our operating performance, drilling results, advances in technology or other business developments.

Because we have a limited operating history and limited revenues or profits to date, the market price for the common shares is more volatile than that of a seasoned issuer. Changes in the market price of the common shares, for example, may have no connection with our operating results or prospects. No predictions or projections can be made as to what the prevailing market price for the common shares will be at any time, or as to what effect, if any, that the sale of shares or the availability of common shares for sale at any time will have on the prevailing market price.

Sales of substantial amounts of the common shares on the public market, or the perception that substantial sales could occur, could adversely affect the prevailing market prices for those shares and also, to the extent the prevailing market price for the common shares is reduced, adversely impact our ability to raise additional capital in the equity markets. In addition, employees, directors and consultants of NXT currently hold vested options entitling them to acquire 1,382,525 common shares. Should these persons exercise these options, it is likely they would sell some or all of the underlying common shares on the public markets in order to procure liquidity to pay taxes as well as other reasons they may deem pertinent. The 800,000 series 'A' preferred shares outstanding are also each convertible into approximately 2.91 common shares as of the date of this quarterly report.

Trading in the common shares on the OTC Electronic Bulletin Board is subject, to the extent the market price for the common shares is less than $5 per share, to a number of regulations known as the "penny stock rules". The penny stock rules require a broker-dealer to deliver a standardized risk disclosure document prepared by the SEC, to provide the customer with additional information including current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, monthly account statements showing the market value of each penny stock held in the customer's account, and to make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. To the extent these requirements may be applicable they will reduce the level of trading activity in the secondary market for the common shares and may severely and adversely affect the ability of broker-dealers to sell the common shares.

NXT has never paid any cash dividends on shares of our capital stock, and we do not anticipate that we will pay any dividends in the foreseeable future. Our current business plan is to retain any future earnings to finance the expansion of our business. Any future determination to pay cash dividends will be 

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at the discretion of our board of directors, and will be dependent upon our consolidated financial condition, results of operations, capital requirements and other factors as our board of directors may deem relevant at that time.

If we were to wind-up or dissolve our company and liquidate and distribute our assets, our common shareholders would share ratably in our assets only after we satisfy any amounts we would owe to our creditors and any amounts we would owe to our series 'A' preferred shareholders as a liquidation preference ($7.50 per share, or $6,000,000 in the aggregate). If our liquidation or dissolution were attributable to our inability to profitably operate our business, then it is likely that we would have material liabilities at the time of liquidation or dissolution. Accordingly, we cannot give you any assurance that sufficient assets will remain available after the payment of our creditors and preferred shareholders to enable you to receive any liquidation distribution with respect to any common shares you may hold.

We are authorized under our Articles of Incorporation to issue up to 50,000,000 common shares. Subject to compliance with applicable corporate and securities laws, we may issue these shares under such circumstances and in such manner and at such times, prices, amounts and purposes as our management may, in their discretion, determine to be necessary and appropriate. The sale of common shares under certain prices may also result in the issuance of additional common shares to the holders of our series 'A' preferred shares should they elect to convert those shares into common shares pursuant to certain anti-dilution rights they hold. Your proportionate ownership and voting rights as a common shareholder could be adversely affected by the issuance of additional common shares, including a substantial dilution in your net tangible book value per share.

As of the date of this quarterly report, there are:

• no material pending legal or governmental proceedings relating to our company or properties to which we are a party, or to our knowledge any proceeding of this nature which are being contemplated or threatened; and

• to our knowledge, no material proceedings to which any of our directors, executive officers or affiliates are a party adverse to us or which have a material interest adverse to us.

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Not Applicable

Not Applicable

Not Applicable

Not Applicable

None

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this quarterly report on form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated at Calgary, Alberta, this 13th day of May, 2002.