Pearl Exploration and Production Ltd.



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  Nov 14, 2007 - 08:00 ET
Pearl Announces Financial Results for Interim Period Ended September 30, 2007

  CALGARY, ALBERTA--(Marketwire - Nov. 14, 2007) - Pearl Exploration and Production Ltd. ("Pearl" or the "Company") (TSX VENTURE:PXX)(FIRST NORTH:PXXS) is pleased to announce the results of the three and twelve months ended September 30, 2007.



Financial Highlights and Operational Highlights:

--------------------------------------------------------------------------
($000s, except per share data) Three months ended Twelve months ended
September 30, 2007 September 30, 2007
--------------------------------------------------------------------------

--------------------------------------------------------------------------
Revenue 24,916 73,176
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Net loss (13,683) (43,799)
--------------------------------------------------------------------------
Net loss per share basic (0.09) (0.37)
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Total assets 654,543 654,543
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Three months ended September 30, 2007
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Oil - net production, bopd 6,973
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Gas - net production, mcf/day 12,608
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Total net production, boe/d(i) 9,093
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Oil - average selling price per bbl $ 41.94
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Gas - average selling price per mcf $ 5.01
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(i) gas production converted at 6:1

 


PRESIDENT'S MESSAGE

The third quarter of 2007 has been the busiest and most productive in Pearl's brief history. We set new production and drilling records while acquiring four new heavy oil opportunities in Canada and the United States. This demonstrates our two-tier approach to building Company value by acquiring low cost, large-scale heavy oil resources by upgrading those resources into reserves and building stable production and cash flow. We believe that the conversion of captured heavy oil resources into Proven and Probable reserves is the most important value driver and we therefore have ongoing appraisal and development projects designed to accomplish this goal in the shortest time frame possible.

On the drilling and production front, the Company drilled at total of 35 wells during the quarter with the majority of these wells being drilled at Onion Lake (25). This brings the total number of wells drilled this year to 121. In August 2007, we received regulatory approval for a reduced drilling spacing at Onion Lake, which has now added 43 new well locations in the heart of this field. Approvals for drilling locations are being advanced in order to use a second drilling rig to achieve our goal of drilling over 100 wells by the end of the first quarter of 2008. Drilling is also being accelerated in our other fields with five additional active rigs operating in our Mooney, Fishing Lake, Fiddler Creek, Serrano Joint Venture and Saskatchewan properties. We have also initiated an aggressive workover program at our smaller Saskatchewan fields to increase production at very low incremental cost.

Average production during the quarter has increased 15% over the previous quarter from 7,910 barrels of oil equivalent per day ("boe/d") to 9,093 boe/d, and we are currently producing 10,500 boe/d, which represents a 527% increase over the average production rate from the fourth quarter of 2006. Onion Lake production growth will continue over the coming months as additional new wells are brought on stream and production improves in existing wells as sand production is reduced. Although we continue to have confidence of achieving our previously announced year-end exit production rate target of 12,000 to 14,500 boe/d, we currently expect to be within a range of 12,000 to 13,000 boe/d. The Company is also undergoing an internal review of our cost structures with a goal of being in the upper quartile of the heavy oil industry from an operating and G&A cost per barrel perspective by the end of 2008.

We continue to focus on projects designed to move our large-scale resources into reserves. At present, implementing steam flood pilot projects is the primary way we are working to accomplish this. At our heavy oil pilot in San Miguel Texas we are expanding the existing pilot, in the southern portion of the field, with the delivery of an additional 25 MMBtu steam generation unit and the drilling of 4 additional wells in the fourth quarter of this year. Additionally, in order to establish the commercial viability of the project, we have commenced design and procurement for a 16 well production pilot project in the northern portion of the field scheduled to begin in the first half of 2008. At Onion Lake, a cyclic steam pilot is now under construction for operational readiness by year-end. Through our ownership in Serrano Energy Ltd. we also participate in the Blackrod project in Alberta. A regulatory application to conduct a steam assisted gravity drainage (SAGD) scheme is presently being prepared for submission to enable a two well pilot project in 2008. The Company expects that positive results from these pilots will result in a significant reclassification of the identified resources into reserves categories.

On the acquisition front, the Company announced (subsequently closed) or formally closed on four new acquisitions during the quarter, (three in Canada and one in the United States). The first of these deals announced was in Canada and involved the acquisition of approximately a 24% working interest in the Mooney property from Ravenwood Energy Corp. This field, which accounts for approximately 25% of our current production, is also one of our most prospective. The deal increased our working interest to over 98% and provides greater operational flexibility. A proposed water flood or pilot polymer flood project has the potential to significantly increase the reserves associated with this property. This field will continue to be a focus of our efforts in 2008.

The second acquisition announced was the acquisition of Watch Resources Ltd. whose primary asset is its interest in the Fishing Lake field in Alberta, which closed on October 19th. This field is proximal to our Onion Lake field and provides the possibility of adding significant near term production at low cost due to operational synergies with Onion Lake. There is additional upside in this field in terms of secondary recovery and addition zones similar to the nearby, adjacent oil fields. An eight well drilling program is currently underway to appraise the field and to assist with future development planning.

The third acquisition was a acquisition of lands in the Blackrod area which was obtained at an Alberta Provincial Lease Sale through our ownership in Serrano Energy Ltd. The Company spent a total of $5 million to obtain a 35% working interest and the option to operate and was able to book 88 million barrels of Possible reserves as audited by DeGolyer and MacNaughton Canada, our independent reserve auditors. This prospective deposit is located in the Athabasca oil sand region and as mentioned previously, a SAGD project is underway with the goal of demonstrating the commercial and economic aspects of the project by year-end 2008.

The fourth and final acquisition was an asset purchase of heavy oil properties in Montana and Utah from PetroHunter Energy Corporation, which closed on November 6th. The primary property is the Fiddler Creek field located in southern Montana near Billings, which we anticipate will add significant proven and probable reserves to the Company. The two other properties, Promised Land in Montana and West Rozel / Gunnison Wedge in Utah, are more speculative in nature but appear to potentially have very large amounts of oil in place, consistent with our strategy of gaining access to large resources. The drilling of an appraisal well has already commenced on the Fiddler Creek field and we expect this acquisition to become one of our primary producing areas in the years to come with the possibility of contributing significant low cost reserve additions.

To fund the Company's very significant development and acquisition efforts in 2007, $60.6 million was raised during the quarter through a private placement, and an additional $110 million was raised through an equity financing in early October. These funds will be used to continue to grow the Company's asset base and has significantly strengthened the Company's balance sheet. The Company plans to grow production and reserves exclusively from its generated cash flow and has no immediate plans for additional equity financing.

Subsequent to the quarter end, the Alberta government announced their intentions with regard to modifications to the Alberta royalty regime. We have had our reserve engineers review the impact of these changes on our major Alberta properties. The preliminary results of that review are that we will be very modestly impacted by these changes in Mooney and Blackrod and positively impacted in Fishing Lake and our Southern Alberta gas properties. As a general view we would consider these impacts to be immaterial to the Company.

The success of the Company in meeting its corporate objectives hinges on our ability to attract additional, highly trained and motivated personnel as they are our most important asset. In this context, we are please to welcome two new members to our executive management team. Mr. Randy Neely has assumed the role of Chief Financial Officer and has a very strong background in growing oil and gas companies as well as experience in the financial sector. Mr. Dean Tucker has joined us as Vice-President of the Canadian Business Unit and will be focused on efficiently growing our Canadian production and decreasing our operating costs.

In summary, I am quite pleased with our progress during the quarter and think we are well on our way to becoming one of the premier independent heavy oil companies in North America. With the recent rise in oil prices and the world market indications that heavy oil is becoming increasingly important in the energy mix, I think we are well positioned to reap the benefits of the growing world demand for energy.


Keith C. Hill ,President and CEO

November 7, 2007

PEARL EXPLORATION AND PRODUCTION LTD.

MANAGEMENT'S DISCUSSION AND ANALYSIS

(Amounts in Canadian Dollars unless otherwise indicated)

Three and twelve months ended September 30, 2007 and 2006

Management's discussion and analysis ("MD&A") of Pearl Exploration and Production Ltd.'s (the "Company" or "Pearl") financial condition and results of operations should be read in conjunction with the unaudited consolidated financial statements for the three and twelve months ended September 30, 2007 and 2006 and related notes therein prepared in accordance with Canadian generally accepted accounting principles. The effective date of this MD&A is November 7th, 2007. Additional information relating to the Company is available on SEDAR at www.sedar.com and on the Company's web-site at www.pearleandp.com.

OVERVIEW

Pearl is a Canadian-based oil and gas company whose common shares are traded on the TSX Venture Exchange under the symbol "PXX". Pearl's main focus is large, heavy oil projects in Canada and the USA. The Company also holds interests in a number of natural gas properties.

Prior to September 30, 2005, Pearl was a Calgary based mining company known as Newmex Minerals Inc. and traded on the TSX Venture Exchange under the symbol "NMM". During the quarter ended December 31, 2005, the Company began its transition into an oil and gas company, and completed several significant acquisitions which are described more fully in the Company's Annual Report dated September 30, 2006 and filed on SEDAR. In February 2006, the Company changed its name to Pearl.

Pearl's main properties in Canada include:

- Onion Lake, Saskatchewan - heavy oil;

- Mooney, Alberta - heavy oil;

- Druid, Saskatchewan - heavy oil;

- Celtic, Saskatchewan - heavy oil;

- Pike's Peak, Saskatchewan - heavy oil;

- Salt Lake, Saskatchewan - heavy oil;

- Southern Alberta - natural gas;

- Ear Lake, Saskatchewan - heavy oil;

- Broad Acres, Saskatchewan - natural gas.

- Blackrod, Alberta - heavy oil;

The Company is also involved with two major projects in the USA: the San Miguel heavy oil development project and the Palo Duro Basin shale gas exploration project, both in Texas. The Company anticipates beginning a thermal (steam) pilot project at San Miguel in the fourth quarter.

CHANGE OF FINANCIAL YEAR END

The Company changed its financial year end from September 30 to December 31 effective October 1, 2006. The Company made this change in order that its financial results would be more comparable to its peers in the oil and gas industry. As a result of this change, the Company will have a transitional 15-month financial year ending December 31, 2007.

TRADING ON FIRST NORTH, STOCKHOLM

On June 20, 2007, the Company commenced trading Swedish depository receipts ("SDRs") on the First North list of the OMX Nordic Exchange.

Each SDR represents one issued common share of the Company on deposit with a designated depository and is exchangeable into common shares on a one-for-one basis subject to the payment of an exchange fee.

SIGNIFICANT EVENTS

On July 10, 2007 the Company sold on a non-brokered, private placement basis an aggregate of 12 million common shares at a price of $5.05 per share for gross proceeds of $60.6 million. A 4 percent finder's fee was paid on the gross proceeds of the private placement.

On August 2, 2007, the Company announced that it had closed the acquisition of a 24% working interest in the Mooney oil field from Ravenwood Energy Corp. ("Ravenwood"), a private oil and gas company for $20.0 million net of standard industry adjustments. The acquisition increased Pearl's working interest in the Mooney field to over 98% and added approximately 625 boepd of production.

On August 23, 2007 the Company acquired a 35% working interest in 2,816 contiguous hectares of oil sands leases located south of Fort McMurray, in the Athabasca Oil Sands region of northern Alberta. The purchase price was $5.0 million.

On October 17, 2007, the Company sold, on a bought-deal, private placement basis, an aggregate of 29.4 million common shares at a price of $3.75 per share for gross proceeds of $110.3 million. The net proceeds of the private placement will be used to fund the acquisition of heavy oil assets from PetroHunter and the Company's ongoing development programs as well as for general working capital purposes.

On October 18, 2007, the Company closed the previously announced acquisition of all of the issued and outstanding shares of Watch Resources Ltd. ("Watch") in an all-share transaction at an exchange ratio of 0.23 common shares of Pearl for each common share of Watch pursuant to a Plan of Arrangement (the "Arrangement"). In connection with the Arrangement, 10,542,927 common shares of Pearl were issued to former Watch shareholders. The deemed consideration, including transaction costs, for the acquisition is approximately $52.0 million. Included in the assets of Watch is a $5.0 million term deposit which is part of the non-bank-sponsored Asset Backed Commercial Paper ("ABCP"). The liquidity and settlement of the ABCP has been suspended pending the restructuring of the notes as determined by the Montreal Accord. At this time the plan for such restructuring is unknown.

On November 6, 2007, the Company closed the previously announced agreement with PetroHunter Energy Corporation ("PetroHunter") to purchase its heavy oil assets in Montana and Utah. The purchase price will be a maximum of US $30 million, payable as follows: (a) US $7.5 million in cash at closing; (b) the issuance of the number of common shares of Pearl equivalent to US $10 million; and (c) US $12.5 million in cash at such time as either: (i) production from the assets reaches 5,000 bopd; or (ii) proven reserves from the assets is greater than 50 million barrels of oil.

SELECTED QUARTERLY INFORMATION

The following is a summary of selected financial information for the Company for the periods indicated:



--------------------------------------------------------------------------
Sep 30 Jun 30 Mar 31 Dec 31
($000s, except per share data) 2007 2007 2007 2006
--------------------------------------------------------------------------
Revenue 24,916 23,520 19,422 5,318
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Net loss (13,683) (7,225) (17,628) (5,263)
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Net loss per share basic
and diluted (0.09) (0.05) (0.13) (0.08)
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Total assets 654,543 620,792 586,276 640,195
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--------------------------------------------------------------------------
Sep 30 Jun 30 Mar 31 Dec 31
($000s, except per share data) 2006 2006 2006 2005
--------------------------------------------------------------------------
Revenue 1,924 1,422 425 28
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Net loss (1,990) (3,742) (2,486) (735)
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Net loss per share basic
and diluted (0.04) (0.09) (0.07) (0.03)
--------------------------------------------------------------------------
Total assets 129,067 97,982 26,068 24,307
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The increase in revenue for the quarter ended September 30, 2007 is mainly due to an increase in oil production volumes compared to the prior quarter. Development drilling activities at Onion Lake and Mooney fields are the main reason for the increase in production volumes as well as the increase in production due to the Mooney acquisition from Ravenwood.

The significant increase in revenue for the quarter ended March 31, 2007 is a result of the Company's acquisition of Atlas Energy Ltd. ("Atlas") which closed on December 22, 2006. The Atlas acquisition added approximately 5,300 boepd to the Company's production for the quarter ended March 31, 2007.

Prior to September 30, 2005, the Company was a mining company and had limited operational activities. Subsequent to September 30, 2005, the Company changed its strategic direction to become an oil and gas exploration and development company by acquiring a variety of oil and gas interests in the USA and Canada. Beginning with the quarter ended March 31, 2006, revenues include oil and gas sales. The amount of revenues has increased each quarter as the Company has added additional production through oil and gas acquisitions and development activities.

The increase in total assets in the quarter ended December 31, 2006 is due to the Atlas acquisition. The increase in total assets in the prior quarters is mainly the result of the Company's acquisition activities.

OPERATIONS UPDATE

Onion Lake Heavy Oil Project - Saskatchewan

The Company continued its multi-well development drilling program of this heavy oil trend in the third quarter of 2007. Of the 50 wells drilled thus far in 2007, 40 wells have been placed on production. The Company received down-spacing approval from the regulatory authorities. This has resulted in an additional 43 drilling locations in the current producing area. Drilling of these locations commenced in mid-October. A 3-D seismic survey is being designed and permitted to further evaluate the Company's southern acreage and prioritize 2007 and 2008 development drilling locations. At the end of September 2007, production was approximately 1,900 boepd net to the Company. Plans are proceeding with the thermal recovery pilot. To facilitate an operational start-up in late 2007, the pilot facilities design has been completed and procurement is now underway. The Company is continuing with the engineering design of centralized production facilities for sand and oil handling. Based on the positive results of the drilling campaign in the first half of 2007, the Company elected to shift wells from the contingent budget to the firm budget which will result in the drilling of 80 wells in the 2007 drilling season; subject to regulatory approvals and weather conditions. At this time we anticipate that the remaining infill locations will be drilled in the first quarter of 2008.

Mooney Heavy Oil Project - Alberta

Development drilling continued at the Mooney Bluesky "A" oil pool throughout the summer period. As of the end of September 2007, a total of 20 new horizontal oil wells had been drilled and are on production. The field production net to the Company at the end of September 2007 was approximately 2,800 boepd. Three additional Bluesky horizontal wells and four vertical stratigraphic test wells are planned for the fourth quarter of 2007. The water injection and potential pilot polymer injection development projects are continuing.

San Miguel Heavy Oil Project - Maverick Basin, South Texas

The Company is continuing with the San Miguel Heavy Oil Project's steam injection pilot operations to determine the technical and economic feasibility of cyclic steam injection to enhance oil recovery. Both pilot wells are presently on a third cycle of injection and production, and additional cycles will continue into 2008. Expansion of the current pilot prior to the end of 2007 is underway as are arrangements for the drilling of additional wells and the procurement of long-lead items for facility modifications. Planning is also underway for a second, 16 well production pilot project to the north of the existing steam injection pilot facility. The production pilot is presently projected to be operational in the second quarter of 2008.

Palo Duro Shale Gas Exploration Project - North Texas

No additional drilling was undertaken during the quarter ended September 30, 2007 on the Palo Duro Shale Gas Project. Discussions with our partners focus on the building of a required pipeline and facilities to tie-in and test the long term performance of the two existing MacIntosh wells. The Company will continue to monitor the results of the extended production testing as well as the results of other operators in the basin in order to evaluate the long term economic viability of the Palo Duro Shale Gas Project.

Other Area Properties - Alberta, Saskatchewan

Drilling and other production enhancement projects continued on the Company's heavy oil producing properties in Alberta and Saskatchewan. The greatest efforts were placed on the Ear Lake/Salt Lake area where the largest short term production additions are expected. The Company has also completed the drilling of a horizontal production well on the Druid field to test the reserves potential of this field which has a significant amount of oil-in-place, and has the potential for a water cycling project in the first half of 2008.

RESULTS OF OPERATIONS



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(000's) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
----------------------------------------------------------------
Net loss $(13,683) $ (7,225) $ (17,628) $ (5,263) $ (43,799) $ (8,953)
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The Company had a net loss of approximately $13.7 million for the three months ended September 30, 2007. The Company has incurred a loss in the current quarter primarily as a result of its provision for depletion, depreciation and accretion, as well as higher general and administrative costs and operating expenses. The Company believes that as further production volumes are added and reserves increase from the Company's development activities in 2007, depletion expense will decrease and income from oil and gas revenues will increase.

Oil and Gas Sales and Production



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(000's) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
------------------------------------------ ---------------------
Oil & gas
sales $ 32,786 $ 29,801 $ 24,464 $ 6,223 $ 93,274 $ 3,635
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Oil (net
bopd) 6,973 5,934 4,622 1,238 4,689 96

Natural
gas (net
mcf/d) 12,608 11,757 13,923 2,620 10,203 626
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NGLs (net
bbls/d) 19 17 23 - 15 -
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Total
(net boe/d)
(i) 9,093 7,910 6,966 1,674 6,404 201
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Oil -
average
selling
price
per bbl $ 41.94 $ 41.29 $ 35.89 $ 34.28 $ 40.14 $ 50.21
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Gas -
average
selling
price
per mcf $ 5.01 $ 6.81 $ 7.32 $ 6.62 $ 6.43 $ 5.97
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(i) gas production converted at 6:1

 


The Company's oil and gas sales have increased approximately 10% over the prior quarter mainly as a result of higher oil production volumes. These increases were partially offset by a significant reduction in gas prices compared to the prior quarter.

For the prior year three and twelve month periods, the Company's oil and gas sales were much lower. The Company acquired Pan-Global in late April 2006 and Nevarro Energy Ltd. ("Nevarro") in September, 2006, therefore, production from these properties is reflected only from the dates of acquisition.

As of the date of this report, production had risen to 10,500 boepd, net to the Company.

Royalties



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(000's) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
------------------------------------------ ---------------------
Royalties $ 7,889 $ 6,322 $ 5,285 $ 1,171 $ 20,667 $ 583
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As a
percent
of sales 24% 21% 22% 19% 22% 16%
--------------------------------------------------------------------------

 


Royalties include Crown, freehold and gross overriding royalties. As a percentage of sales, royalties have increased from 21% in the prior quarter to 24%. The increase is due to a disposal during the quarter of a lower royalty based area coupled with new wells coming on in an area of higher royalty rates.

In the prior year periods, low royalties on the production from Pearl's Texas Queen City wells has impacted the overall royalty rate. The US royalty rates that pertain to this production averaged 6%.

Production Costs



--------------------------------------------------------------------------
(000's) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
------------------------------------------ ---------------------
Production
costs $ 12,245 $ 10,949 $ 10,132 $ 2,370 $ 35,696 $ 847
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Per boe $ 14.64 $ 15.21 $ 16.16 $ 15.38 $ 15.27 $ 11.57
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Operating costs on a per boe basis averaged $14.64 for the most recent quarter. The Company is focused on increasing its efficiency and as production increases from drilling and development activities, per barrel operating costs are expected to decline.

For the prior year periods, operating costs relate only to Onion Lake and the Texas Queen City gas wells. The Texas gas wells have a very low operating cost on a per boe basis. Due to the lower volumes in the prior year quarters, the Texas operating costs had a more pronounced impact on reducing the total operating cost per boe.

Transportation Costs



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(000's) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
------------------------------------------ ---------------------
Trans-
portation
costs $ 498 $ 1,074 $ 999 $ 168 $ 2,738 $ -
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Per boe $ 0.59 $ 1.49 $ 1.59 $ 1.09 $ 1.17 $ -
--------------------------------------------------------------------------

 


Transportation costs are incurred to move marketable crude oil and natural gas to their selling points. The decrease in transportation costs for the quarter ended September 30, 2007 is due to transportation credits received from the Alberta Petroleum Marketing Commission that related to prior periods. Transportation costs are currently averaging $1.17 per boe for the Company.

For the prior twelve month period ended September 30, 2006, the Company had minimal oil and gas revenues from its operations. Transportation costs were minimal and were therefore netted against revenue by the operator.

Interest Income



--------------------------------------------------------------------------
(000's) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
------------------------------------------ ---------------------
Interest
income $ 19 $ 40 $ 243 $ 266 $ 568 $ 746
--------------------------------------------------------------------------

 


Interest income represents bank interest earned on excess cash.

In the prior quarters, the Company earned higher interest income due to its higher excess cash balances as a result of its equity issues through private placements.

General and Administrative Expenses



--------------------------------------------------------------------------
(000's) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
------------------------------------------ ---------------------
G&A $ 4,268 $ 3,953 $ 2,559 $ 2,006 $ 12,786 $ 3,987
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Per boe $ 5.10 $ 5.49 $ 4.08 $ 13.02 $ 5.47 $ 54.45
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General and administrative expenses have decreased on a per boe basis compared to the prior quarter due to increased production. The Company expects general and administrative costs on a per boe basis to decrease as production volumes increase, certain costs are reduced and efficiencies realized. Included in general and administrative expenses in the current quarter is a $1.3 million provision against old accounts receivable balances that were assumed from an acquired company in the prior year.

For the prior year periods, general and administrative expenses were very high on a per boe basis as a result of minimal production volumes. The Company had minimal production volumes from Onion Lake and the Texas Queen City wells during those periods.

Depletion, Depreciation and Accretion ("DD&A")



--------------------------------------------------------------------------
(000's) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
------------------------------------------ ---------------------
DD&A $ 23,406 $ 22,076 $ 17,238 $ 6,475 $ 69,804 $ 5,632
--------------------------------------------------------------------------
Per boe $ 27.98 $ 30.67 $ 27.49 $ 42.03 $ 29.86 $ 76.92
--------------------------------------------------------------------------

 


The DD&A expense significantly increased to $69.8 million for the twelve months ended September 30, 2007 from $5.6 million for the twelve months ended September 30, 2006. The higher DD&A expense reflects the impact of the Company's 2007 capital spending, the impact of the numerous acquisitions that were completed during the period and significantly higher production.

The Company's independent reserve evaluation as of December 31, 2006 allocated a small amount of proved reserves, due to the minimal amount of capital activity in 2006. The low amount of proved reserves coupled with increased production contributed to the higher DD&A expense in 2007. The Company expects to see a significant increase in proved reserves as part of the December 31, 2007 reserve report reflecting the numerous acquisitions and significant drilling completed in 2007. As a result, the DD&A rate per boe in 2008 is expected to decrease.

Stock-Based Compensation



--------------------------------------------------------------------------
(000's) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
------------------------------------------ ---------------------
Stock-
based
compensa-
tion $ 778 $ 918 $ 958 $ 563 $ 3,217 $ 3,412
--------------------------------------------------------------------------

 


The Company uses the fair value method of accounting for stock options granted to directors, officers, employees and consultants whereby the fair value of all stock options granted is recorded as a charge to operations. The fair value of common share options granted is estimated on the date of grant using the Black-Scholes option pricing model. For the three months ended September 30, 2007, the Company issued 620,000 options at prices ranging from $3.42 to $5.13.

Interest Expense



--------------------------------------------------------------------------
(000's) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
------------------------------------------ ---------------------
Interest
expense $ 1,247 $ 1,240 $ 399 $ 116 $ 3,001 $ 114
--------------------------------------------------------------------------
Per boe $ 1.49 $ 1.72 $ 0.64 $ 0.79 $ 1.28 $ 1.55
--------------------------------------------------------------------------

 


Included in interest expense is $204,000 of interest accrued on the Company's unspent flow-through share obligation. The remaining $1,043,000 of interest expense relates to the Company's bank debt. For the quarter ended September 30, 2007, the Company had an average debt level of $58.2 million and an effective interest rate of 7.19%.

Change in Fair Market Value of Gas Pricing Contracts



--------------------------------------------------------------------------
(000's ) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
------------------------------------------ ---------------------
Change in
FMV of
gas
contracts $ - $ - $ 488 $ 48 $ 536 $ -
--------------------------------------------------------------------------

 


The Company acquired the gas contracts as part of the Atlas acquisition which closed on December 22, 2006. For the quarter ended March 31, 2007, the change in the fair market value of the gas pricing contracts represents the change in fair market value from December 31, 2006 to March 31, 2007. For the quarter ended December 31, 2006, the change in the fair market value represents the change in fair market value from December 22, 2006 to December 31, 2006. All gas contracts expired at the end of March 2007.

Foreign Currency Exchange Loss



--------------------------------------------------------------------------
(000's ) Three months ended Twelve months ended
------------------------------------------ ---------------------
Sep 30, Jun 30, Mar 31, Dec 31, Sep 30, Sep 30,
2007 2007 2007 2006 2007 2006
------------------------------------------ ---------------------
Foreign
currency
exchange
loss $ 119 $ 97 $ 172 $ 54 $ 441 $ 292
--------------------------------------------------------------------------

 


The foreign currency exchange loss relates to the revaluation of the US dollar bank balances into Canadian dollars for financial reporting purposes.

FINANCIAL CONDITION

As at September 30, 2007, the Company had total assets of $654.5 million compared to $129.1 million at September 30, 2006.

Accounts receivable were $23.0 million at September 30, 2007 compared to $4.4 million at September 30, 2006. The September 30, 2007 accounts receivable balance includes approximately $14.3 million relating to oil and gas revenue receivables and accruals for the period, and approximately $5.4 million for joint interest receivables relating to capital and operating costs owed by partners and $3.3 million relating to GST receivable from the Canada Revenue Agency.

Investments at September 30, 2007 were $12.0 million compared to $3.0 million at September 30, 2006. The investments include shares in Serrano Energy Ltd. ("Serrano") and Bayou Bend. The Company holds common shares of Serrano, a private oil and gas exploration and development company, which is in the initial stages of acquiring and drilling oil and gas exploration and development prospects. These shares represent an ownership of 25.93% in Serrano. Initially, the Company subscribed for six million shares in Serrano in conjunction with the acquisition of Nevarro Energy Ltd. in September 2006. In June 2007, the Company subscribed for an additional 2,074,689 shares of Serrano. In July, Serrano consolidated the shares on a 2:1 basis.

The Company also owns five million shares of Bayou Bend. The Company received ten million common shares of Bayou Bend in consideration for the sale of its Gulf of Mexico leases (described more fully in the June 30, 2007 Interim Report) and in June 2007, sold five million of these shares. At September 30, 2007, the market value of the Bayou Bend shares was $1.29 per share.

Long-term accounts receivable were $nil at September 30, 2007 compared to $1.1 million at September 30, 2006. Prior to the Company's acquisition of Pan-Global in April 2006, Pan-Global had advanced $3 million to the Onion Lake First Nation ("OLFN"). The total receivable amount was being set-off against the OLFN's share of net revenue from production from the pre-existing Onion Lake oil and gas producing wells. As a result of the new joint venture operating agreement entered into with OLFN, the Company has assumed the remaining receivable balance and reclassified the capital and operating portions accordingly.

Prepaid expenses and deposits were $4.1 million at September 30, 2007 compared to $0.8 million at September 30, 2006. Approximately $2.0 million of the balance relates to deposits for office space, equipment and Crown royalties. The remaining $2.1 million includes cash call advances to partners, lease rentals and other prepayments.

Accounts payable and accruals were $55.1 million at September 30, 2007 compared to $12.6 million at September 30, 2006. Included in the balance is $24.3 million of trade payables (operating and capital), $3.0 million for joint venture payables and $27.8 million for operating and capital accruals.

The Company has a credit facility with a Canadian chartered bank in the amount of $60 million of which $50 million was drawn at September 30, 2007. In addition, on September 25, 2007 the Company received a $10.0 million bridge loan which was subsequently repaid on October 17, 2007.

During the quarter, the Company sold on a non-brokered, private placement basis an aggregate of 12 million common shares at a price of $5.05 per share for gross proceeds of $60.6 million. A 4 percent finder's fee was paid on the gross proceeds of the private placement. Subsequent to the end of the quarter, the Company raised an additional $110.3 million gross from the issuance of 29.4 million shares at a price of $3.75 per share.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2007, the Company had a working capital deficit of $87.6 million compared to a working capital deficit of $3.8 million at September 30, 2006. On October 17th, 2007, the Company sold, on a bought-deal, private placement basis, an aggregate of 29.4 million common shares at a price of $3.75 per share for gross proceeds of $110.3 million. The net proceeds of the private placement will be used to fund the acquisition of heavy oil assets from PetroHunter, repayment of the outstanding debt and contribute towards the Company's ongoing development programs as well as for general working capital purposes. This private placement eliminated the Company's working capital deficit. As at June 30, 2007 the Company was in breach of the working capital ratio under the terms of the Credit Facility. The bank issued a waiver to the Company that they would not demand repayment of the loan as a result of the breach. On September 25, 2007 there was an amendment to the loan agreement whereby the Company was issued a waiver in advance for any potential breach of the working capital ratio for the quarter ended September 30, 2007.

Funds from operations were $3.2 million for the three months ended September 30, 2007 compared to $1.5 million for the prior year three month period. Funds used in operations for the twelve months ended September 30, 2007 were $2.7 million compared to $1.0 million for the prior year twelve month period.

Net cash from financing activities for the three months ended September 30, 2007 was $44.4 million compared to net cash from financing activities of $0.2 million for the prior year three month period. During the current quarter, the Company obtained a bridge loan advance of $10.0 million, which was repaid on October 17, 2007, and received cash proceeds, net of issuance costs, of $58.4 million from the issuance of 12.0 million common shares. During July and August, the Company repaid $24.0 million of its credit facility.

Net cash from financing activities for the twelve months ended September 30, 2007 was $142.5 million compared to $55.7 million for the prior year twelve month period. During the current twelve month period, the Company received approximately $165.0 million net proceeds from equity financings, of which $109.7 million was used to repay bank loans, predominantly debt assumed as part of the Atlas acquisition in December 2006. The Company also received bank loan advances totaling $76.5 million, $10 million from the sale of Bayou Bend shares and $0.6 million from the exercise of stock options during this twelve month period.

Net cash used in investing activities was $42.8 million for the three months ended September 30, 2007 compared to $31.0 million for the prior year three month period. During the current quarter, the Company used cash of $47.4 million to add to its oil and gas interests through exploration, development and lease acquisition activities.

Net cash used in investing activities for the twelve months ended September 30, 2007 was $139.2 million compared to $47.6 million for the prior twelve month period. During the current twelve month period, the Company's exploration, development and lease acquisition activities totaled $155.5 million and corporate acquisition costs totaled $11.7 million. The Company also used $2.5 million of cash to acquire additional shares in Serrano, a privately held oil and gas exploration and development company, in which the Company has an ownership of 25.93%.

Contributed surplus at September 30, 2007 has increased $2.6 million over the balance at September 30, 2006. The increase is due to the stock-based compensation for the twelve month period ended September 30, 2007. When options are granted, the Black-Scholes option value method is used to calculate a value for the stock options. The offset to the amount that is recorded as stock compensation expense is a credit to contributed surplus. When stock options are exercised, a proportionate amount of the value recorded on the granting of options is moved from contributed surplus to share capital. If any unvested stock options are cancelled, the amount previously credited to contributed surplus is reversed and stock-based compensation expense is reduced in the period of the cancellation. For the twelve months ended September 30, 2007, contributed surplus was reduced by $1.0 million for stock options that were exercised and for unvested stock options that were cancelled. During the twelve months ended September 30, 2007, 175,000 stock options were exercised and 519,833 unvested stock options were cancelled.

To date, the Company has not generated sufficient cash flow from its oil and gas operations to fund its entire oil and gas exploration, development and acquisition activities. The Company has relied upon the issuance of common shares and debt financing to provide additional funding. The Company may consider additional issuances of common shares or debt instruments to assist with financing its ongoing oil and gas exploration, development and acquisition activities to the extent that sufficient cash flow from operations is unavailable in the future. In addition, the Company may consider divesting of non-core oil and gas assets or farming out interests in oil and gas properties to finance its operations. Accordingly, the Company's consolidated financial statements are presented on a going-concern basis.

FINANCIAL INSTRUMENTS

The carrying amounts of financial instruments comprising cash, accounts receivable, investments, accounts payable and loans payable approximate their fair value due to the immediate or short-term nature of these financial instruments. Long-term receivables approximate their present value.

OFF-BALANCE SHEET ARRANGEMENTS

The Company has no off-balance sheet arrangements.

OUTSTANDING SHARE DATA

As at November 7, 2007, the Company had 189,241,716 common shares outstanding and 5,769,357 stock options outstanding under its stock-based compensation plan.

RELATED PARTY TRANSACTIONS

Tanganyika Oil Company Ltd. ("Tanganyika") provides administrative and technical services to the Company from time to time based upon time and expenses incurred by Tanganyika. For the three and twelve months ended September 30, 2007, Tanganyika charged the Company $37,000 and $206,000, respectively. Tanganyika and Pearl have certain directors and officers in common.

Namdo Management Services Ltd. ("Namdo") provides executive and support services to the Company. For the three and twelve months ended September 30, 2007, the Company paid Namdo $39,000 and $78,000, respectively. Namdo is a private corporation owned by Lukas H. Lundin, a director of the Company.

ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES

Other than the adoption of Section 3855 - Financial Instruments Recognition and Measurement as of October 1, 2006, the accounting policies utilized in the preparation of the Company's September 30, 2007 unaudited interim consolidated financial statements are unchanged from those as set out in note 2 to the audited consolidated financial statements in the Company's Annual Report for the period ended September 30, 2006. The adoption of Section 3855 is described in note 3 of the September 30, 2007 unaudited interim consolidated financial statements.

RISKS AND UNCERTAINTIES

The Company is exposed to a number of risks and uncertainties inherent in exploring for, developing and producing crude oil and natural gas. These risks and uncertainties include, but are not limited to, the following: economic risk of finding and producing reserves at a reasonable cost; cost of capital risk associated with securing the needed capital to carry out the Company's operations; risk of fluctuating foreign currency exchange rates; risk of carrying out operations with minimal environmental impact; risk of governmental policies, social instability or other political, economic or diplomatic developments in its operations; market risks associated with investing the Company's cash reserves in interest bearing depository instruments; and environmental risks related to its oil and gas properties. Many of the previously mentioned risks are beyond the Company's control, and it is impossible to ensure that any exploration drilling program will result in commercial operations. The Company does not currently utilize derivative instruments to hedge its commodity price, foreign currency exchange or interest rate risks.

INTERNAL CONTROLS OVER FINANCIAL REPORTING

The discussion and conclusion with respect to the Company's internal controls over financial reporting included in the September 30, 2006 MD&A disclosed in the Company's Annual Report remain unchanged as at September 30, 2007.

OUTLOOK

The Company plans to continue pursuing North American heavy oil opportunities to add to its portfolio of exploration and development properties, and to focus on the development of its existing interests in the USA and Canada.

FORWARD-LOOKING STATEMENTS

Certain information regarding the Company contained herein may constitute forward-looking statements. Forward-looking statements may include estimates, plans, expectations, opinions, forecasts, projections, guidance or other statements that are not statements of fact. By their nature, forward-looking statements and information involve assumptions, inherent risks and uncertainties, many of which are difficult to predict, and are usually beyond the control of management, that could cause actual results to be materially different from those expressed by these forward-looking statements and information. The Company does not undertake to update or re-issue the forward-looking statements and information that may be contained herein, whether as a result of new information, future events or otherwise. The Company's forward-looking statements are expressly qualified in their entirety by this cautionary statement.

NON-GAAP MEASURES

Certain measures in this MD&A do not have any standardized meaning as prescribed by Canadian GAAP such as "funds from operations" and "cash flows" and therefore are considered non-GAAP measures. These measures may not be comparable to similar measures presented by other issuers. These measures have been described and presented in this MD&A in order to provide shareholders and potential investors with additional information regarding the Company's liquidity and its ability to generate funds to finance its operations. Management's use of these measures has been disclosed further in this MD&A as these measures are discussed and presented.

BOES

Throughout this MD&A the calculation of barrels of oil equivalent (boe) is calculated at a conversion rate of six thousand cubic feet (mcf) of natural gas for one barrel of oil and is based on an energy equivalence conversion method. BOEs may be misleading, particularly if used in isolation. A boe conversion ratio of 6 mcf:1 bbl is based on an energy equivalence conversion method primarily applicable at the burner tip and does not represent a value equivalence at the wellhead.



PEARL EXPLORATION AND PRODUCTION LTD.

Consolidated Balance Sheet
(unaudited)
--------------------------------------------------------------------------
September 30,2007 September 30,2006
--------------------------------------------------------------------------

Assets
Current assets
Cash $ 9,259,301 $ 8,717,568
Accounts receivable 23,019,632 4,417,816
Prepaid expenses and deposits 4,106,859 788,394
----------------- -------------------
36,385,792 13,923,778

Investments (note 5) 11,950,000 3,000,000
Long-term accounts receivable - 1,144,136
Petroleum and natural gas
properties (note 6) 446,344,072 92,069,058
Goodwill (note 4) 159,863,578 18,930,509
----------------- -------------------
$ 654,543,442 $ 129,067,481
----------------- -------------------

Liabilities
Current liabilities
Accounts payable and
accrued liabilities $ 55,062,921 $ 12,559,545
Bank loan (note 7) 60,000,000 4,976,200
Income taxes and
capital taxes payable 8,910,838 145,372
----------------- -------------------
123,973,759 17,681,117
----------------- -------------------

Long-term liabilities
Asset retirement
obligation (note 13) 14,511,928 3,772,479
Future income tax 15,175,460 5,523,339
----------------- -------------------
153,661,147 26,976,935

Shareholders' equity
Share capital (note 9) 557,115,147 112,613,584
Contributed surplus (note 9) 7,430,267 4,791,060
Cumulative other
comprehensive income (note 3) (4,550,000) -
Deficit (59,113,119) (15,314,097)
----------------- -------------------
500,882,295 102,090,546
----------------- -------------------
$ 654,543,442 $ 129,067,481
----------------- -------------------
----------------- -------------------

Commitments (note 10)
Contingencies (note 14)

See accompanying notes to financial statements


PEARL EXPLORATION AND PRODUCTION LTD.

Consolidated Statement of Operations and Deficit
(unaudited)
--------------------------------------------------------------------------
For the three months ended For the twelve months ended
September 30 September 30
------------- ------------- ------------- --------------
2007 2006 2007 2006
------------- ------------- ------------- --------------

Revenue
Oil and
gas sales $ 32,786,237 $ 1,876,409 $ 93,274,370 $ 3,634,821
Interest
income 18,802 412,929 568,308 746,240
Royalties (7,888,734) (365,509) (20,666,563) (582,550)
------------- ------------- ------------- --------------
24,916,305 1,923,829 73,176,115 3,798,511
------------- ------------- ------------- --------------

Expenses
Production
costs 12,245,376 526,673 35,696,441 846,946
Transportation
costs 497,724 - 2,738,442 -
General and
administrative 4,268,083 2,279,722 12,785,686 3,987,234
Depletion,
depreciation
and accretion 23,406,095 2,136,639 69,804,128 5,673,989
Stock-based
compensation 777,877 520,487 3,216,620 3,411,784
Interest 1,246,596 - 3,000,913 113,817
Change in
unrealized
loss of gas
pricing
contracts
(note 3) - - 536,000 -
Foreign
currency
exchange
loss 118,534 21,792 440,686 292,201
------------- ------------- ------------- --------------
42,560,285 5,485,313 128,218,916 14,325,971
------------- ------------- ------------- --------------

Other items
Write-downs - 25,000 - 21,626
Gain on sale
of assets - - (13,270,044) -
------------- ------------- ------------- --------------
- 25,000 (13,270,044) 21,626
------------- ------------- ------------- --------------

Loss before
income taxes (17,643,980) (3,586,484) (41,772,757) (10,549,086)
------------- ------------- ------------- --------------

Income taxes
Future income
taxes
(recovery) (5,400,712) (1,693,611) (6,379,991) (1,693,611)
Income taxes and
capital taxes 1,439,267 97,398 8,406,256 97,398
------------- ------------- ------------- --------------
(3,961,445) (1,596,213) 2,026,265 (1,596,213)
------------- ------------- ------------- --------------

------------- ------------- ------------- --------------
Net loss for
the period (13,682,535) (1,990,271) (43,799,022) (8,952,873)
------------- ------------- ------------- --------------

Deficit,
beginning of
period (45,430,584) (13,323,826) (15,314,097) (6,361,224)
------------- ------------- ------------- --------------

Deficit,
end of period $ (59,113,119) $ (15,314,097) $ (59,113,119) $ (15,314,097)
------------- ------------- ------------- --------------
------------- ------------- ------------- --------------

Basic and
diluted loss
per share $ (0.09) $ (0.04) $ (0.37) $ (0.23)
Weighted
average number
of common shares
used in
computing
earnings per
share:
basic 145,615,529 50,421,633 118,623,666 38,648,736
diluted 145,880,287 50,790,364 119,010,015 38,992,416

See accompanying notes to financial statements


--------------------------------------------------------------------------
Consolidated Statement of Comprehensive Loss and
Cumulative Other Comprehensive Income
(unaudited)
--------------------------------------------------------------------------
For the three months ended For the twelve months ended
September 30 September 30
------------- ------------- ------------- --------------
2007 2006 2007 2006
------------- ------------- ------------- --------------

Net loss $ (13,682,535) $ (1,990,271) $ (43,799,022) $ (8,952,873)
Other
comprehensive
income, net
of tax
Mark-to-market
loss on
available-
for-sale
financial
asset (5,300,000) - (4,550,000) -

------------- ------------- ------------- --------------
Comprehensive
loss $ (18,982,535) $ (1,990,271) $ (48,349,022) $ (8,952,873)
------------- ------------- ------------- --------------
------------- ------------- ------------- --------------

Cumulative
other
comprehensive
income,
beginning of
period $ 750,000 $ - $ - $ -
Other
comprehensive
income, net
of taxes (5,300,000) - (4,550,000) -


------------- ------------- ------------- --------------
Cumulative
other
comprehensive
income, end of
period $ (4,550,000) $ - $ (4,550,000) $ -
------------- ------------- ------------- --------------
------------- ------------- ------------- --------------

See accompanying notes to financial statements


PEARL EXPLORATION AND PRODUCTION LTD.

Consolidated Statements of Cash Flows
(unaudited)
--------------------------------------------------------------------------
For the three months ended For the twelve months ended
September 30 September 30
------------- ------------- ------------- --------------
2007 2006 2007 2006
------------- ------------- ------------- --------------

Operating
activities
Comprehensive
loss $ (18,982,535) $ (1,990,271) $ (48,349,022) $ (8,952,873)
Items not
involving cash:
Mark to
market loss
on available-
for-sale
financial
asset 5,300,000 - 4,550,000 -
Depletion,
depreciation
and accretion 23,406,095 2,136,639 69,804,128 5,673,989
Writedown of
accounts
receivable 1,285,098 - 2,537,098 -
Gain on sale
of assets - - (13,270,044) -
Write-downs - 25,000 - 21,626
Stock-based
compensation 777,877 520,487 3,216,620 3,411,784
Future
income tax
(recovery) (5,400,712) (1,693,611) (6,379,991) (1,693,611)
Change in
unrealized
loss of gas
pricing
contracts
(note 3) - - 536,000 -
Foreign
exchange loss 118,534 21,792 440,686 292,201
Abandonment
costs (236,612) - (1,047,950) -
------------- ------------- ------------- --------------
6,267,745 (979,964) 12,037,525 (1,246,884)
------------- ------------- ------------- --------------

Changes in
non-cash working
capital balances
related to
operations (3,100,923) 3,602,275 (15,872,544) 1,428,573
Long term
accounts
receivable - (1,144,136) 1,144,136 (1,144,136)
------------- ------------- ------------- --------------
3,166,822 1,478,175 (2,690,883) (962,447)
------------- ------------- ------------- --------------

Financing
activities
Advances of
bank loan - 2,037,566 66,532,316 2,037,566
Advance of
bridge loan 10,000,000 - 10,000,000 -
Repayments of
bank loan (24,000,000) (16,160,999) (109,670,719) (16,160,999)
Repayments
of debenture - 14,123,433 - -
Proceeds from
equity
financings,
net of issue
costs 58,364,871 - 164,994,945 57,173,576
Proceeds from
sale of
investments - - 10,000,000 -
Exercise of
stock options 34,100 182,500 605,325 337,251
Exercise of
warrants - - - 12,316,008
------------- ------------- ------------- --------------
44,398,971 182,500 142,461,867 55,703,402
------------- ------------- ------------- --------------

Investing
activities
Acquisition
of Atlas
Energy Ltd. - - (2,926,017) -
Acquisition
of Cipher
Exploration Inc. - - (8,809,049) -
Acquisition
of Pan-Global
Energy Ltd. - - - 238,929
Acquisition
of Nevarro
Energy Ltd. - (24,251,745) - (24,251,745)
Acquisition
of Serrano
shares - (3,000,000) (2,500,000) (3,000,000)
Additions to
petroleum and
natural gas
properties (47,445,666) (3,782,258) (155,540,914) (20,618,883)
Changes in
non-cash working
capital from
investing 4,673,781 - 30,546,730 -
------------- ------------- ------------- --------------
(42,771,885) (31,034,003) (139,229,250) (47,631,699)
------------- ------------- ------------- --------------

Net increase
(decrease)
in cash 4,793,908 (29,373,328) 541,733 7,109,256
Cash,
beginning
of period 4,465,393 38,090,896 8,717,568 1,608,312
------------- ------------- ------------- --------------
Cash,
end of period $ 9,259,301 $ 8,717,568 $ 9,259,301 $ 8,717,568
------------- ------------- ------------- --------------
------------- ------------- ------------- --------------

Supplementary
Information
Interest paid $ 1,245,596 $ - $ 2,945,714 $ -
Capital
taxes paid $ - $ - $ 80,460 $ -


See accompanying notes to financial statements

 


PEARL EXPLORATION AND PRODUCTION LTD.

Notes to the Consolidated Financial Statements

(unaudited)

1. NATURE OF OPERATIONS

Pearl Exploration and Production Ltd. (collectively with its subsidiaries, the "Company" or "Pearl") is listed and traded on the TSX Venture Exchange under the trading symbol "PXX". The Company is engaged in the business of oil and gas exploration and development in North America.

2. BASIS OF PRESENTATION

The interim consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: Pearl E&P Canada Ltd., Pearl Exploration and Production USA Ltd., Newmex Energy (USA) Inc., Valkyries Texas Corp., Valkyries Texas Gas Ltd. and Cipher Exploration Inc.

The interim consolidated financial statements for the Company have been prepared in accordance with accounting principles generally accepted in Canada, using the same accounting policies and methods of computation as set out in note 2 to the audited consolidated financial statements in the Company's Annual Report for the period ended September 30, 2006. The disclosures provided herein are incremental to those included with the audited consolidated financial statements. The interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the period ended September 30, 2006.

3. CHANGES IN ACCOUNTING POLICIES

As of October 1, 2006, the Company adopted Section 3855 - Financial Instruments Recognition and Measurement, and Section 1530 - Comprehensive Income. In accordance with these standards, the Company adopted the following accounting policies:

(a) Derivatives that are not designated as hedges continue to be carried at market values. Changes in these market values are recorded in net income of the Company. In the event that the Company chooses to designate derivative instruments as cash flow hedges, changes in market values for the effective portion of the hedge will be recorded in Other Comprehensive Income. Changes in the market value for the ineffective portion of the hedges will be recorded in Net Income.

(b) Investments in private companies are recorded at cost. Investments in public companies are recorded at fair value. Changes in the fair value of public companies that are available-for-sale are recognized in Other Comprehensive Income while changes in the fair value of public company investments that are held-for-trading are recognized in Net Income.

4. ACQUISITIONS

(i) Atlas Acquisition - On December 22, 2006 the Company acquired all of the issued and outstanding shares of Atlas Energy Ltd. ("Atlas"), on the basis of 0.82 of a Pearl share for each Atlas share, and Atlas became a wholly-owned subsidiary of the Company. The Company issued 55,670,226 common shares and paid $157,000 in cash to the Atlas shareholders upon closing of the Atlas Arrangement. On January 1, 2007 Atlas was amalgamated with Pearl E&P Canada Ltd.

The deemed consideration, including transaction costs, for the Atlas acquisition totaled $267,011,172. The allocation of the purchase price for Atlas is as follows:



Petroleum and natural gas properties $ 243,001,173
Working capital deficiency (92,046,077)
Asset retirement obligation (9,389,295)
Future income tax (12,745,082)
Goodwill 138,190,453
------------------------------------------------------------
$ 267,011,172
------------------------------------------------------------

 


The purchase price for Atlas was adjusted from the amounts disclosed in the December 31, 2006 quarterly financial statements. The adjustments were made as a result of an updated internal oil and gas reserves assessment. The adjustments resulted in a decrease to petroleum and natural gas properties of $65,128,918, a decrease to future income tax of $19,613,899 and an increase to goodwill of $45,515,019.

(ii) Cipher Acquisition - On March 1, 2007, the Company acquired all the issued and outstanding shares of Cipher Exploration Inc. ("Cipher") for a gross purchase price of $20,000,000 in common shares of the Company reduced by an amount equal to the aggregate of all outstanding long and short term debt of Cipher. At closing, the Company issued 2,047,502 common shares to the Cipher shareholders and assumed $10,675,724 of debt.

The deemed consideration, including transaction costs, for the Cipher acquisition totaled $10,307,319. The allocation of the purchase price for Cipher is as follows:



Petroleum and natural gas properties $ 20,000,000
Working capital deficiency (10,675,724)
Asset retirement obligation (1,578,543)
Future income tax (181,030)
Goodwill 2,742,616
------------------------------------------------------------
$ 10,307,319
------------------------------------------------------------

 


(iii) Ravenwood Acquisition - On August 2nd, 2007, the Company purchased a 24% working interest in the Mooney oil field from Ravenwood Energy Corp. ("Ravenwood") for $20 million. After standard industry adjustments, the net purchase price was paid 50 percent in cash and 50 percent by the issuance of 1,475,108 Pearl common shares at a price of $5.12 per share.



Goodwill Continuity

September 30, 2007 September 30, 2006
--------------------------------------------------------------------------
Opening balance $ 18,930,509 $ -
Acquired during period 140,933,069 18,930,509
--------------------------------------------------------------------------
Closing balance $ 159,863,578 $ 18,930,509
--------------------------------------------------------------------------

 


5. INVESTMENTS



---------------------------------------
September 30, 2007 September 30, 2006
---------------------------------------

Investment in Serrano Energy Ltd. $ 5,500,000 $ 3,000,000
Investment in Bayou
Bend Petroleum Ltd. 6,450,000 -
---------------------------------------
$ 11,950,000 $ 3,000,000
---------------------------------------

 


On June 13, 2007 the Company acquired an additional 2,074,689 shares of Serrano Energy Ltd. ("Serrano") at a price of $1.205 per share. In July, 2007 Serrano consolidated its shares on a 2:1 basis. These shares represent an ownership interest of 25.93% in Serrano.

On May 8, 2007 the Company closed the sale of its Gulf of Mexico assets to Bayou Bend Petroleum Ltd. ("Bayou Bend") as announced on January 18, 2007. In consideration for ten million common shares of Bayou Bend, the Company sold to Bayou Bend a 100% working interest in five Gulf of Mexico offshore exploration blocks, farm-in rights to acquire a 25% working interest in a sixth offshore block and all material contracts, physical data, work products and files and records associated with these blocks. On June 8, 2007 the Company sold five million of its shares of Bayou Bend for $10 million. At September 30, 2007, the market value of the Bayou Bend shares was $1.29 per share.

6. PETROLEUM AND NATURAL GAS PROPERTIES



----------------------------------------------------
September 30, 2007
----------------------------------------------------
Accumulated
depreciation and
Cost depletion Net book value

Petroleum and natural
gas properties $ 519,532,243 $ 74,328,029 $ 445,204,214
Office equipment 1,368,887 229,029 1,139,858
----------------------------------------------------
$ 520,901,130 $ 74,557,058 $ 446,344,072
----------------------------------------------------

----------------------------------------------------
September 30, 2006
----------------------------------------------------
Accumulated
depreciation and
Cost depletion Net book value

Petroleum and natural
gas properties $ 97,669,414 $ 5,626,440 $ 92,042,974
Office equipment 31,840 5,756 26,084
----------------------------------------------------
$ 97,701,254 $ 5,632,196 $ 92,069,058
----------------------------------------------------

 


The depletion and ceiling test calculations have excluded the cost of unproved properties of $103.5 million (September 30, 2006 - $6.9 million) and included the cost of future development costs of $47.5 million (September 30, 2006 - $1.6 million).

7. BANK CREDIT FACILITY

The Company has a credit facility with a Canadian chartered bank which is comprised of a $50 million revolving 364 day extendible term facility, and a $10 million demand revolving operating facility. The Company may borrow, repay and re-borrow advances with the aggregated outstanding not to exceed the total credit facility. The facility bears interest at the bank prime rate payable monthly and is secured by a general securities agreement.

The facility is subject to semi-annual reviews. The next scheduled review will take place on November 30, 2007.

During the twelve months ended September 30, 2007 the Company repaid and cancelled two credit facilities that were acquired through the Nevarro Energy Ltd. and the Atlas acquisitions. In addition, on September 25, 2007 the Company received a $10.0 million bridge loan which was subsequently repaid on October 17, 2007.

8. RELATED PARTY TRANSACTIONS

During the twelve months ended September 30, 2007, the Company entered into the following transactions with related parties in the normal course of business, which are recorded at the exchange amount established and agreed to by the related parties:

(a) the Company paid $206,649 (2006 - $205,928) to Tanganyika Oil Company Ltd. ("Tanganyika") for administrative and other services. The Company and Tanganyika have certain officers and directors in common.

(b) the Company borrowed $3,000,000 on October 27, 2006 from Tanganyika which was repayable on or before November 30, 2006. Interest was charged at a rate equal to prime plus 2% per annum. The Company repaid the loan in full on November 22, 2006 plus accrued interest of $18,195.

(c) the Company paid $78,000 to Namdo Management Services Ltd. ("Namdo") for executive and support services pursuant to a services agreement. Namdo is a private corporation owned by Lukas H. Lundin, a director of the Company.

9. SHARE CAPITAL

(a) Authorized:
The Company is authorized to issue an unlimited number of common shares.

(b) Common Shares Issued:



Number of Shares Attributed Value
---------------- ------------------
Balance as at September 30, 2006 51,913,016 $ 112,613,584
Shares issued through Nov 15, 2006
equity financing(i) 24,153,845 110,999,994
Shares issued through July 10, 2007
equity financing(ii) 12,000,000 60,600,000
Shares issued for
Atlas acquisition(iii) 55,670,226 264,085,155
Shares issued for
Cipher acquisition(iv) 2,047,502 9,792,174
Shares issued for
property acquisition(v) 1,475,108 7,552,552
Shares issued upon
exercise of options 175,000 1,182,738
Tax effect of December
2006 flow-through(vi) - (3,106,000)
Equity financing share issue costs - (6,605,050)
---------------- ------------------
Balance as at September 30, 2007 147,434,697 $ 557,115,147
---------------- ------------------

 


(i) On November 15, 2006, the Company completed an equity financing of common shares and flow-through shares for gross proceeds of $111 million. 22,444,444 common shares were issued at a price of $4.50 each and 1,709,401 of flow-through common shares were issued at a price of $5.85 each. A 3.9 percent underwriters fee was paid to qualified persons in respect of a portion of the equity financing.

(ii) On July 10, 2007 the Company sold on a non-brokered, private placement basis an aggregate of 12 million common shares at a price of $5.05 per share for gross proceeds of $60.6 million. A 4 percent finder's fee was paid on the gross proceeds of the private placement.

(iii) The Company issued 55,670,226 common shares to Atlas shareholders pursuant to the Atlas Arrangement which provided for the acquisition by the Company of all the issued and outstanding Atlas shares (see note 4).

(iv) The Company issued 2,047,502 common shares to Cipher shareholders for the acquisition of all the issued and outstanding shares of Cipher (see note 4).

(v) On August 2nd, 2007, the Company purchased a 24% working interest in the Mooney oil field from Ravenwood for $20 million, and after standard industry adjustments, the net purchase price was paid 50 percent in cash and 50 percent through the issuance of 1,475,108 of Pearl common shares at a price of $5.12 per share (see note 4).

(vi) Pursuant to the flow-through Common Share offering, the Company renounced $10.0 million of qualifying oil and natural gas expenditures effective December 31, 2006. The future income tax effect and reduction to share capital has been recorded in the first quarter of 2007, the period in which the Company filed the renouncement documents with the tax authorities.

(c) Warrants Outstanding:



--------------------------------------------------------------------------
Weighted average
Number of whole exercise price
warrants per share
--------------------------------------------------------------------------
Balance as at September 30, 2007
and September 30, 2006 4,091,800 $ 0.98
--------------------------------------------------------------------------

 


(i) Four million warrants were issued pursuant to the San Miguel acquisition in November 2005. Each warrant entitles the holder thereof to purchase an additional common share of the Company at a price of $1.00, exercisable from the date the San Miguel heavy oil project achieves an average daily producing rate of 5,000 barrels of oil per day, averaged over 30 consecutive days, until November 18, 2008.

(ii) In connection with the December, 2005 Palo Duro acquisition, the Company issued 270,000 warrants. This number was subsequently reduced by 66% to 91,800 when the vendor exercised a back-in right on March 3, 2006. Each remaining warrant provides the warrant holder with the right to receive an additional common share of the Company, within 75 days of September 15, 2008, for no additional consideration, if the average production rate per well drilled in the Palo Duro shale gas project is at least 1.5 million cubic feet equivalent per day, based on the initial 60 days of production. The number of warrants ultimately issued will be reduced pro rata to the actual average production rate if the actual average production rate per well drilled by September 15, 2008 is less than 1.5 million cubic feet equivalent per day.

(d) Stock Options

The Company has a stock option plan (the "plan") for directors, officers, consultants and employees of the Company and its subsidiaries. A total of 14,743,470 stock options are authorized to be issued under the plan. The plan is administered by the Board of Directors. In accordance with the policies of the TSX Venture Exchange, the option exercise price, when granted, reflects current trading values of the Company's shares and all of the options are subject to a four-month "hold" period. The exercise period of the options is fixed by the Board of Directors and is not to exceed the maximum period permitted by the TSX Venture Exchange. Vesting rights are determined at the discretion of the Board of Directors.

The continuity of incentive stock options issued and outstanding is as follows:



Stock option continuity

Weighted Average
Number of Options Exercise Price $
----------------- ------------------
Outstanding September 30, 2006 1,752,500 4.11
Granted 3,536,000 4.93
Exercised (175,000) 3.46
Cancelled (519,833) 5.10
----------------- ------------------
Outstanding at September 30, 2007 4,593,667 4.65
----------------- ------------------

 


Stock-based compensation

Compensation expense for the twelve month period of $3,216,620, net of recovery of $390,340 for cancelled stock options, has been recorded in the Consolidated Statements of Operations and Deficit for the period ended September 30, 2007 (2006 - $3,411,784). The fair value of common share options granted is estimated on the date of grant using the Black-Scholes option pricing model. The weighted average fair value of options granted during 2007 and the assumptions used in their determination are as noted below:



Twelve Months Ended
September 30, 2007
-------------------
Weighted average fair value of stock options
granted (per option) $ 2.271
Expected life of stock options (years) 3.03
Volatility (weighted average) 65%
Risk free rate of return (weighted average) 4.00%
Expected dividend yield 0%


Contributed surplus continuity September 30, 2007 September 30, 2006
---------------------------------------
Balance, beginning of the period $ 4,791,060 $ 816,444
Stock-based compensation 3,606,960 3,411,784
Stock-based compensation allocated
to contributed surplus as part of
Pan-Global acquisition - 800,957
Recovery of expense on cancelled
stock options (390,340) -
Transfer to share capital on
exercise of options (577,413) (238,125)
------------------ ------------------
Balance, end of period $ 7,430,267 $ 4,791,060
------------------ ------------------

 


10. COMMITMENTS AND CONTRACTUAL OBLIGATIONS

The Company enters into commitments and contractual obligations in the normal course of business, including the purchase of services, farm-in agreements, royalty agreements, operating agreements, transportation agreements, processing agreements, right of way agreements and lease agreements for vehicles.

(a) On January 1, 2006, the Company entered into a consulting agreement with Rincon Energy, LLC ("Rincon") whereby Rincon provided consulting services for the purpose of generating oil and gas prospects in the Gulf of Mexico and California and any other areas as mutually agreed upon by the Company and Rincon. Under the agreement, the Company committed to spend US $7.5 million per year for the initial two year term of the contract. For the 2006 calendar year, the Company met its obligations under the agreement. In May 2007, the Company closed the sale of its interests in all of its Gulf of Mexico assets, including the Rincon consulting agreement, to Bayou Bend Petroleum Ltd. and the Company has no further commitments under the Rincon consulting agreement.

(b) The Company has a 10 year operating lease which it renegotiated with the provision that the terms could be cancelled with a 30 day notice. This back-out provision allowed the Company to enter into a nine year operating lease for a new larger office space. The Company expects to move sometime in the first quarter of 2008. The estimated future commitments are as follows:



--------------------------------------------------------------------------
Subsequent
2007 2008 2009 2010 2011 to 2011
--------------------------------------------------------------------------
Office
rent $ 180,459 $1,091,967 $1,091,967 $1,091,967 $1,160,215 $5,835,199
--------------------------------------------------------------------------

 


(c) The Company renounced $10.0 million of qualifying oil and natural gas expenditures effective December 31, 2006 pursuant to the flow-through share offering which closed on November 15, 2006. By September 30, 2007, the Company had incurred $4.0 million of qualifying expenditures and has an additional commitment to expend $6.0 million on qualifying expenditures by December 31, 2007.

(d) As part of a joint venture agreement with Serrano the Company has a contingent commitment to expend up to $10,000,000 in each calendar year, terminating December 31, 2011 in connection with the acquisition of assets and the exploration and development of prospects.

11. FINANCIAL INSTRUMENTS

The Company does not utilize derivative instruments to manage risks. The Company is exposed to the following risks related to financial assets and liabilities:

(a) Foreign currency exchange risk

The Company is exposed to risks arising from fluctuations in foreign currency exchange rates and the volatility of those rates. This exposure primarily relates to: (i) certain expenditure commitments, deposits, accounts receivable, and accounts payable which are denominated in US dollars, and (ii) its operations in the United States.

(b) Fair values

The carrying amounts of financial instruments comprising cash, accounts receivable, advances and loans receivable, investments and accounts payable approximate their fair value due to the immediate or short-term nature of these financial instruments.

12. SEGMENTED INFORMATION

The Company presently has one reportable business segment, that being oil and gas exploration and development. The Company's operations are carried on in the following geographic locations:



Three Months Ended September 30, 2007
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
--------------------------------------------------------------------------
Total revenues,
net of royalties $ 24,679,954 $ 236,351 $ 24,916,305

Expenses 42,322,872 118,879 42,441,751
Foreign currency loss (8,623) 127,157 118,534
------------- ------------- --------------
Net income (loss) before
income taxes (17,634,295) (9,685) (17,643,980)
Income taxes (recovery) (4,796,159) 834,714 (3,961,445)
------------- ------------- --------------
Net income (loss) $ (12,838,136) $ (844,399) $ (13,682,535)
------------- ------------- --------------
------------- ------------- --------------

Segment assets $ 618,850,780 $ 35,692,662 $ 654,543,442
------------- ------------- --------------
Goodwill $ 159,863,578 $ - $ 159,863,578
------------- ------------- --------------
Segment petroleum and
natural gas properties $ 418,180,234 $ 28,163,838 $ 446,344,072
------------- ------------- --------------
Capital additions,
net of disposals $ 56,665,020 $ 1,805,063 $ 58,470,083
------------- ------------- --------------


Twelve Months Ended September 30, 2007
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
--------------------------------------------------------------------------
Total revenues,
net of royalties $ 71,890,443 1,285,672 73,176,115

Expenses 125,825,900 1,952,330 127,778,230
Foreign currency loss 313,529 127,157 440,686
Gain on sale of assets - (13,270,044) (13,270,044)
------------- ------------- --------------
Net income (loss) before
income taxes (54,248,986) 12,476,229 (41,772,757)
Income taxes (recovery) (5,260,075) 7,286,340 2,026,265
------------- ------------- --------------
Net income (loss) $ (48,988,911) $ 5,189,889 $ (43,799,022)
------------- ------------- --------------
------------- ------------- --------------

Segment assets $ 618,850,780 $ 35,692,662 $ 654,543,442
------------- ------------- --------------
Goodwill $ 159,863,578 $ - $ 159,863,578
------------- ------------- --------------
Segment petroleum and
natural gas properties $ 418,180,234 $ 28,163,838 $ 446,344,072
------------- ------------- --------------
Capital additions $ 415,945,455 $ 7,254,421 $ 423,199,876
------------- ------------- --------------


Three Months Ended September 30, 2006
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
--------------------------------------------------------------------------
Total revenues,
net of royalties $ 1,440,143 $ 483,686 $ 1,923,829

Expenses 5,186,211 302,310 5,488,521
Foreign currency loss 21,792 - 21,792
Gain on sale - - -
------------- ------------- --------------
Loss before income taxes (3,767,860) 181,376 (3,586,484)
Income taxes (recovery) (1,592,288) (3,925) (1,596,213)
------------- ------------- --------------
Net loss $ (2,175,572) $ 185,301 $ (1,990,271)
------------- ------------- --------------
------------- ------------- --------------

Segment assets $ 106,150,258 $ 22,917,223 $ 129,067,481
------------- ------------- --------------
Segment petroleum and
natural gas properties $ 70,177,774 $ 21,891,223 $ 92,069,058
------------- ------------- --------------
Capital additions $ 34,281,380 $ 2,870,439 $ 37,151,819
------------- ------------- --------------


Twelve Months Ended September 30, 2006
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
--------------------------------------------------------------------------
Total revenues,
net of royalties $ 2,269,625 $ 1,528,886 $ 3,798,511

Expenses 11,627,053 2,406,717 14,033,770
Foreign currency loss 292,201 - 292,201
Write-downs 21,626 - 21,626
------------- ------------- --------------
Loss before income taxes (9,671,255) (877,831) (10,549,086)
Income taxes (recovery) (1,592,288) (3,925) (1,596,213)
------------- ------------- --------------
Net loss $ (8,078,967) $ (873,906) $ (8,952,873)
------------- ------------- --------------
------------- ------------- --------------

Segment assets $ 106,150,258 $ 22,917,223 $ 129,067,481
------------- ------------- --------------
Segment petroleum and
natural gas properties $ 70,177,774 $ 21,891,223 $ 92,069,058
------------- ------------- --------------
Capital additions $ 72,877,549 $ 23,795,716 $ 96,673,265
------------- ------------- --------------

 


13. ASSET RETIREMENT OBLIGATION

The total future asset retirement obligation was estimated based on the Company's net ownership interest in all wells and facilities, the estimated costs to abandon and reclaim the wells and facilities and the estimated timing of the costs to be incurred in future periods. The total undiscounted amount of the estimated cash flows required to settle the asset retirement obligations is approximately $28.5 million which will be incurred over the next 47 years with the majority of costs incurred between 2008 and 2025. A credit adjusted risk-free rate of 8 percent and an inflation factor of 1.5 percent was used to calculate the fair value of the asset retirement obligation.

Changes to asset retirement obligation were as follows:



--------------------------------------------------------------------------
September 30, 2007 September 30, 2006
--------------------------------------------------------------------------
Asset retirement obligation at
beginning of period $ 3,772,479 $ -
--------------------------------------------------------------------------
Liabilities acquired through
acquisitions, net of
dispositions 8,844,383 3,490,224
--------------------------------------------------------------------------
Liabilities incurred
during the period 2,063,740 240,462
--------------------------------------------------------------------------
Actual remediation expenses (1,047,950) -
--------------------------------------------------------------------------
Accretion 879,276 41,793
--------------------------------------------------------------------------
Asset retirement obligation at
end of period $ 14,511,928 $ 3,772,479
--------------------------------------------------------------------------

 


14. CONTINGENCIES

Pursuant to the January 20, 2006 acquisition agreement between the Company and Valkyries Petroleum Corp. ("Valkyries"), the Company may be required to pay additional consideration to Valkyries if specified properties have additional net proved reserves within two years of the closing of the transaction. The additional consideration would be calculated as US $1.00 per barrel of additional reserves. The only remaining contingency for the Company is related to the Topanga prospect.

15. SUBSEQUENT EVENTS

On October 17th, 2007, the Company sold, on a bought-deal, private placement basis, an aggregate of 29.4 million common shares at a price of $3.75 per share for gross proceeds of $110.3 million. The net proceeds of the private placement will be used to fund the acquisition of heavy oil assets from PetroHunter and the Company's ongoing development programs as well as for general working capital purposes.

On October 18th, 2007, the Company closed the previously announced acquisition of all of the issued and outstanding shares of Watch Resources Ltd. ("Watch") in an all-share transaction at an exchange ratio of 0.23 common shares of Pearl for each common share of Watch pursuant to a Plan of Arrangement (the "Arrangement"). In connection with the Arrangement, 10,542,927 common shares of Pearl were issued to former Watch shareholders. The deemed consideration, including transaction costs, for the acquisition is approximately $52.0 million. Included in the assets of Watch is a $5.0 million term deposit which is part of the non-bank-sponsored Asset Backed Commercial Paper ("ABCP"). The liquidity and settlement of the ABCP has been suspended pending the restructuring of the notes as determined by the Montreal Accord. At this time the plan for such restructuring is unknown.

On October 25th, 2007, the Alberta government announced their intentions with regard to modifications to the Alberta royalty regime. The Company's reserve engineers have reviewed the impact of these changes on our major Alberta properties and, based on the preliminary results of that review, have determined that we will be very modestly impacted by these changes in Mooney and Blackrod and positively impacted in Fishing Lake and our Southern Alberta gas properties. As a general view we would consider these impacts to be immaterial to the Company.

On November 6th, 2007, the Company closed the previously announced agreement with PetroHunter Energy Corporation ("PetroHunter") to purchase its heavy oil assets in Montana and Utah. The purchase price will be a maximum of US $30 million, payable as follows: (a) US $7.5 million in cash at closing; (b) the issuance of the number of common shares of Pearl equivalent to US $10 million; and (c) US $12.5 million in cash at such time as either: (i) production from the assets reaches 5,000 bopd; or (ii) proven reserves from the assets is greater than 50 million barrels of oil.

16. SUMMARY OF SIGNIFICANT DIFFERENCES BETWEEN CANADIAN GAAP AND INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)

The Company's consolidated financial statements have been prepared in accordance with Canadian GAAP, which differ in certain material respects from International Financial Reporting Standards ("IFRS"). The principal difference between Canadian GAAP and IFRS from a measurement perspective, as applied to the Company's consolidated financial statements, is asset impairment.

(a) Impairment of petroleum and natural gas properties

Under Canadian GAAP, each cost centre should be assessed for impairment as at each annual balance sheet date or whenever events or changes in circumstances indicate that its carrying amount of a cost centre is not recoverable and exceeds its fair value. The carrying amount is not recoverable if the carrying amount exceeds the sum of the undiscounted cash flows expected to result from its use and eventual disposition. Unproved properties and major development projects are included in this recoverability test. A cost centre impairment loss should be measured as the amount by which the carrying amount of assets capitalized in a cost centre exceeds the sum of: the fair value of proved and probable reserves; and the costs (less any impairment) of unproved properties that have been subject to a separate test for impairment and contain no probable reserves. IFRS requires (i) an impairment to be recognized when the recoverable amount of an asset (cash generating unit) is less than the carrying amount; (ii) the impairment loss is determined as the excess of the carrying amount above the recoverable amount ( the higher of fair value less costs to sell and value in use, calculated as the present value of future cash flows from the asst); and (iii) the reversal of an impairment loss when the recoverable amount changes. The differences in accounting policy described above had no impact on these consolidated financial statements.

(b) Petroleum and natural gas properties

The Company follows the full cost method of accounting for petroleum and natural gas properties, as set out in AcG 16 issued by the CICA. Under this method, all costs related to exploration and development of oil and gas reserves are capitalized and accumulated in country-by-country cost centres. For purposes of reporting in accordance with IFRS, the Company has early adopted IFRS 6, Exploration For and Evaluation of Mineral Resources, which permits an entity to continue applying its existing policy in respect of exploration and evaluation costs. Under IFRS, once commercial reserves are established and technically feasibility for extraction is demonstrated, the related capitalized costs are allocated to cash generating units. This difference in accounting policy had no significant impact on the Company's consolidated financial statements.

(c) Impairment of long lived assets

Under Canadian GAAP, a long lived asset should be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. An impairment loss should be recognized when the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. Under IFRS, the carrying amounts of the Company's assets, other than petroleum and natural gas properties, are reviewed at each balance sheet date to determine whether there is any indication of impairment. If any such indication exists, the assets' recoverable amounts are estimated. An impairment loss is recognized when the carrying amount of an asset exceeds the sum of the undiscounted cash flows expected to result from its use and eventual disposition. This assessment is based on the carrying amount of the asset at the date it is tested for recoverability, whether it is in use or under development. Under IFRS, the recoverable amount of the Company's assets, other than petroleum and natural gas properties, is the greater of their net selling price and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. For an asset that does not generate cash inflows largely independent of those from other assets, the recoverable amount is determined for the cash generating unit to which the asset belongs. In respect of impairment of assets other than petroleum and natural gas properties, under Canadian GAAP, an impairment loss is not reversed if the fair value subsequently increases. For IFRS, an impairment loss may be reversed if there has been a change in the estimates used to determine the recoverable value. An impairment loss, on assets other than petroleum and natural gas properties, is only reversed to the extent that the asset's carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized. The differences in accounting policy described above had no impact on these consolidated financial statements.



----------------------------------- -------------------------------------
DIRECTORS CORPORATE INFORMATION
----------------------------------- -------------------------------------

Lloyd Arnason
Director CORPORATE OFFICE
Calgary, Alberta Suite 2500, 111 - 5th Avenue S.W.
Calgary, Alberta
T2P 3Y6 Canada
Brian D. Edgar Telephone: (403) 215-8313
Director Facsimile: (403) 265-8324
Vancouver, British Columbia Website: www.pearleandp.com


Gary S. Guidry BANKER
Director CIBC
Calgary, Alberta ATB Financial
Calgary, Alberta


Gordon D. Harris AUDITOR
Director PricewaterhouseCoopers LLP
Calgary, Alberta 111-5th Avenue S.W.
Calgary, Alberta

Keith C. Hill
Director TRANSFER AGENT
Vancouver, British Columbia Computershare Trust Company of Canada
600, 530-8th Avenue S.W.
Calgary, Alberta
John W. Ladd
Director
Houston, Texas STOCK EXCHANGE LISTING
TSX Venture Exchange
Trading Symbol: PXX
Lukas Lundin
Director
Vancouver, British Columbia COMPANY REGISTRATION NUMBER
409596-1

A. Murray Sinclair
Director The report for the quarter ending
Vancouver, British Columbia December 31, 2007 will be published
on or before February 29, 2008.

-----------------------------------
OFFICERS
-----------------------------------

Gary S. Guidry
Chairman
Calgary, Alberta


Keith C. Hill
President & Chief Executive Officer
Vancouver, British Columbia


Gary G. Hyde
Chief Operating Officer
Calgary, Alberta


Randy Neely
Chief Financial Officer
Calgary, Alberta


Diane Phillips
Corporate Secretary
Calgary, Alberta

----------------------------------- -------------------------------------

 


FOR FURTHER INFORMATION PLEASE CONTACT:


Pearl Exploration and Production Ltd.
Sophia Shane
Corporate Development
(604) 689-7842
(604) 689-4250 (FAX)
Email: sophias@namdo.com
Website: www.pearleandp.com
 
 

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