220867 Sound Oil R&A 2010 Cover 26/05/2011 12:25 Page iv Sound Oil plc Riverbridge House Guildford Road Leatherhead, Surrey KT22 9AD www.soundoil.co.uk Annual Report 2010 220867 Sound Oil R&A 2010 Cover 26/05/2011 12:25 Page ii Sound Oil Sound is an independent oil and gas exploration Company listed on the AIM market of the London Stock Exchange. Our strategy is to add significant value from a portfolio of exploration and production assets. 1 3 4 6 12 13 15 17 18 19 20 21 22 23 24 25 26 27 51 Highlights Chairman’s Statement Financial Review Technical Review Board of Directors Report of the Directors Report on Directors’ Remuneration Corporate Governance Report Statement of Directors’ Responsibilities Independent Auditor’s Report Consolidated Income Statement Consolidated Balance Sheet Company Balance Sheet Consolidated Statement of Changes in Equity Company Statement of Changes in Equity Consolidated Cash Flow Statement Company Cash Flow Statement Notes to the Financial Statements Dealing Information, Financial Calendar and Addresses Cover picture: Gas production facilities at Marciano on the Fonte San Damiano Concession, Basilicata, southern Italy. 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 1 Annual Report 2010 Highlights (cid:129) Successful Acquisition of Italian business (cid:129) (cid:129) 13 Discoveries 16 Exploration prospects (cid:129) Mainly operated (cid:129) 8 Planned Wells 2011/12 Italy (cid:129) (cid:129) 1 Production well 2 Exploration/appraisal wells Indonesia (cid:129) 5 Exploration wells (cid:129) £11 Million Funds Raised (cid:129) Funding Commitments Reduced 1 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 2 Sound Oil 2 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 3 Annual Report 2010 Chairman’s Statement This year has been the most successful since the Company was formed. At the start of 2011 we acquired Consul Oil & Gas Ltd, a private UK company with a number of exciting assets in Italy. We now own 98% of the Consul shares through the issue of 275 million new Sound shares and a cash payment of £1.40 million - representing a total cost of £4.64 million at the time. The Italian assets have given the Company a second geographic area of focus and access to 17 permits containing a variety of promising opportunities. Since we took over in early January we have already commissioned a drilling rig to undertake the development at Marciano where an existing gas well needs to be completed as a producer. During the remainder of the year we shall be working up a number of exploration and appraisal prospects with a view to operating up to three wells over the next 12 to 18 months. The Company also considers that Italy offers further opportunities for expansion which we are actively pursuing. In Indonesia, three substantial new exploration prospects have been identified on the Citarum permit where we have a 20% interest. These are the result of the extensive seismic programme which was finally completed after a two year effort. The terrain and environmental conditions made the work very difficult for the operator but the last of the 865km was finally acquired in the middle of 2010. The operator has scheduled the drilling of the three wells in the latter part of 2011 and these will fulfil the remaining work obligations on this Production Sharing Contract (PSC). In Kalimantan, our PSC at Bangkanai (Sound 5%, carried) has seen a change of operator and it is their intention to drill two previously identified exploration prospects, again in the second half of this year. The new operator is also actively progressing the development of the Kerendan Gas accumulation on the same PSC and expects to bring this on stream within three years. In the last five months, Sound has made a series of fundraising transactions and now has approximately £13 million in cash and no debt. In January 2011, as part of the Consul acquisition, 311 million new shares were issued at a price of 1.2p to raise £3.7 million and a further £3.2 million was raised by issuing 230 million new shares at a price of 1.4p. In late 2010 we entered into a £10 million standby equity distribution facility with Yorkville Advisors LLC whereby we can issue shares to them during the next three years in return for cash. In January 2011 the Company received shareholder authority to issue up to 100 million shares for this purpose. In March, 39 million shares were placed with Yorkville at an average price of 2.58p raising £1 million and in April a further 54 million shares at a price of 5.15p raising 2.8 million. Sound now has a small staff of proven capability in Rome who have shown already that they can weld together an impressive portfolio of assets in short order. In Jakarta, over the last several years our colleagues have worked hard to progress our interests and I expect this year to be the most active for the Company in Indonesia. I wish to thank all of them and also the UK staff and my Board colleagues for their continuous efforts on behalf of the Company. Finally I wish to thank our shareholders for their support. I believe Sound has plenty of exciting activity coming up in the next year or so. Altogether we expect around seven wells to be drilled and we shall also be investigating other ways of giving shareholders greater value. Yours sincerely, Gerry Orbell Chairman 24 May 2011 3 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 4 Sound Oil Financial Review Accounting standards The Group has prepared its 2010 full year accounts under International Financial Reporting Standards (IFRS), as adopted by the European Union. Income statement Prior to the write down of the Bangkanai asset following its partial farm-down, the Group incurred a loss after tax of £1,758,000 which was £889,000 lower than in the previous year. The write down was £14,210,000 giving a total loss after tax for 2010 of £15,968,000 (2009: £2,620,000). Trading loss at £1,932,000 was almost the same as in 2009. This included higher exploration costs of £430,000 (2009: £334,000) but administration costs were lower at £1,502,000 (2009: £1,596,000). Due to the weakness of sterling, there was a foreign exchange gain of £211,000 compared with a loss of £786,000 in 2009. Cash flow/financing Net cash outflow before foreign exchange movements was £6,242,000 (2009: £3,086,000). Of this, exploration expenditure was £1,165,000 (2009: £953,000). However, there was a foreign exchange gain of £104,000 (2009: loss £917,000) due to the fall in sterling increasing the sterling value of the US$ cash deposits, as a result of which the Group’s cash balance was £6,138,000 lower at £4,484,000 (2009: £10,622,000). The Group continues to have no borrowings. 4 Going concern – Forward cash flow calculations show that the Group would have sufficient financial resources for the foreseeable future. The Group’s financial statements have been prepared on the assumption that the Group will be able to realise its assets and discharge its liabilities in the normal course of business rather than through a process of forced liquidation. The Group currently has no operating revenues and during the year ended 31 December 2010 generated a Group trading loss of £1.9 million from continuing operations. At 31 December 2010 the Group held cash and cash equivalents of £4.5 million. The directors have considered the Group’s cash flow forecasts for the period to the end of June 2012. Forward cash flow projections show that forecast expenditure (12 months through 30 June 2012) will be less than the funds available as at 31 December 2010; together with the £10.7 million raised in January, March and April 2011 from share placings and the £6 million undrawn element of the Yorkville facility. As a result, the Group has sufficient cash resources to undertake its work program in the next 12 months. Balance sheet Exploration and evaluation expenditure in 2010 was £1,165,000 (2009: £953,000) mainly on seismic work on the Citarum licence in Indonesia. Currency movement increased the balance in sterling terms by £745,000. However the write down of the Bangkanai asset by £14,210,000 left the year end balance at £9,954,000 (2009: £22,185,000). The deferred tax liability and the matching goodwill balance arising from the tax provision were both reduced by £3,662,000 due to the Bangkanai farm down. After allowing for exchange adjustments of £390,000, this left the end 2010 balance at £1,525,000 (2009: £4,797,000). 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 5 Annual Report 2010 Other debtors of £2,861,000 at end 2010 included £2,413,000 of cash held in escrow relating to the acquisition of Consul Oil & Gas Ltd which was paid to the vendors on 4 January 2011. Impairment – Under IFRS 6, the cost carried in the balance sheet may be carried forward if exploration activities have not reached a stage to allow reasonable assessment of economically recoverable reserves. As this remains the situation with all of the Group’s licences, with only one exploration well having been drilled and extensive prospective areas remaining to be explored, no impairment charge has been recorded and accordingly an update of the estimated monetary value shows that the value exceeds the carrying value of our intangible evaluation and exploration assets and goodwill. Shareholders equity was reduced by the loss for the year, partly offset by an increase of £711,000 in the foreign currency reserve. The Bangkanai write down of £14,210,000 caused a further reduction to £17,715,000 at end 2010 (2009: £32,956,000). Post balance sheet event The provisional effect of the Company’s acquisition on 4 January 2011 of Consul Oil & Gas Ltd is shown in note 25. This shows that the total cost of £4.7 million was funded as to £3.3 million by the issue of 275 million ordinary shares in Sound at 1.2p and £1.4 million by cash. Exploration and evaluation assets are increased by £5.9 million and Deferred Tax and Goodwill by £1.6 million. 5 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 6 Sound Oil Technical Review Note: The commentary in this Technical Review reflects the acquisition on 4 January 2011 of Consul Oil & Gas Ltd. Licence Interests The Group holds licence interests in two countries, Italy and Indonesia. In Italy, Sound Oil has acquired 98% of Consul Oil & Gas Ltd which, through its wholly-owned Italian subsidiary company Apennine Energy srl, gave Sound participating interests in sixteen new licences, mostly as operator: one concession, eight permits and seven assigned permits. In addition Apennine has two exclusive applications for pending awards lodged with the Italian Ministry of Industry. In Indonesia, the Group participates in two Production Sharing Contract (PSC) areas in Java and Kalimantan through its subsidiary company Mitra Energia Limited. Our working interests are 20% in the Citarum PSC and 5% carried in the Bangkanai PSC. Italian Assets The Apennine portfolio offers multiple opportunities for production, appraisal and development of existing oil and gas discoveries and exploration drilling. It is Sound’s intention over the coming 12-18 months to complete one production well and to drill three new wells targeting several of the exploration and appraisal opportunities in our portfolio. Where necessary the Company will achieve these objectives by selective farm-out of high equity positions. The projects for implementation are currently being discussed with our various partners and will be selected from the assets described below. Production Fonte San Damiano Concession (Apennine 99%, Operator) The Concession is located in Basilicata in southern Italy (Figure 1). It contains the Marciano-01ST gas discovery which was drilled by Apennine in 2007. The well encountered two thin gas bearing sand intervals, MAR-4 at 1283-1288m and MAR-5 at 1325-1331m which have been cased-off ready for production. - Figure 1 6 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 7 Annual Report 2010 Fugro-Robertson1 has estimated the gross P50 contingent resources2 of the Marciano-01ST discovery to be 2.5 Bscf3. In March the Company signed a contract with Hydro Drilling International to supply a drilling rig to undertake the completion of the two zones. It is expected that the operation will commence in May, with first commercial revenues to follow 2-3 months after the well’s completion. The gas produced will be fed to on-site generators and electricity exported to the local grid. Appraisal and Development Carita Permit (Apennine 50% interest, Operator) The permit is located in Veneto Province, northeast Italy (Figure 2). The permit contains the Nervesa structure that was drilled by ENI in 1985 with two wells (Nervesa-1 and Nervesa-1dir A) and proved gas- bearing in at least 13 sand intervals. Of these intervals only one was completed and put in production between 1989 and 1991. The Nervesa field has the potential of five further completions of the remaining 12 sand intervals at 1829m to 1964m depth. Gross remaining P50 contingent resources have been estimated by Fugro-Robertson to be 12.5 Bscf. Apennine’s strategy would be to drill two new wells to re-develop the gas field leading to early revenue generation. Sambucheto Permit (Apennine 95% interest, Operated) The permit is located in Ancona and Macerata in central Italy (Figure 3). Six wells were drilled in the permit area between 1971 and 1994, two of which were gas discoveries (Saletta-1 and Montefano-1dir) that were never developed. Montefano-1dir encountered 5m gas pay at 1190m and Saletta-1 found two 2m gas zones at 1321m and 1368m in the same formation. Gross P50 contingent resources for Montefano have been estimated by Fugro-Robertson to be 4.0 Bscf. Apennine’s strategy would be for early development of the Montefano gas discovery. Figure 2 Figure 3 Torrente Alvo Permit (Apennine 50% interest) The Permit is located in Potenza in southern Italy (Figure 4). The permit area was initially explored by Figure 4 7 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 8 Sound Oil Technical Review continued Italian Assets (continued) Italmineraria (now ENI) and a number of wells were drilled between 1965 and 1998. The well Strombone- 2dir found oil in Miocene carbonates at 1508-1562m and tested 750 bopd4 with variable water-cut. The oil accumulation is also partially overlain by a non- commercial gas pool, located in Pliocene sands; neither of these two discoveries was developed. Fugro- Robertson has estimated the gross P50 contingent resources of the Strombone discovery to be 4.4 MMbo5. Apennine’s intention would be to develop the Strombone oil discovery in order to generate early cash-flow from the asset. Villa Gigli Permit (Apennine 50% interest, Operator) The permit is located in Ancona and Macerata on the Adriatic coast in central Italy (Figure 5). Six wells have been drilled on the permit between 1933 and 1993. Two discoveries were made by Agip (Musone-1dir, oil and Moretti-1, gas), but neither was developed. Musone-1dir tested 15°API oil from the interval 1259- 1295m in the Miocene Scaglia limestone at up to 1170 bpd with variable water content. Moretti-1 encountered 11m gas pay at 358-369m in the Pliocene sands; the zone flowed at 0.7 MMscfd6. Gross P50 contingent resources of the Musone discovery have been estimated by Fugro-Robertson to be 1.7 MMbo. Apennine’s strategy would be to re-appraise the Musone oil discovery and consider techniques such as horizontal drilling to enhance potential productivity from the reservoir. Exploration Badile Permit (Apennine 100%) The Badile Permit is situated in the Piedmont Lombard Basin in northern Italy (Figure 6), where the principal play is oil, gas and condensate in deep Triassic dolomites and limestones. The permit is adjacent to ENI’s Gaggiano oil field and a short distance from the giant Villafortuna-Trecate and Malossa oil fields with total proven recoverable reserves over 400 MMboe7. Two large ready-to-drill prospects have been mapped in the permit area, Badile and Zibido, with gross P50 prospective resources estimated by Fugro-Robertson to be 153 Bscf and 130 Bscf respectively. Apennine’s strategy is to purchase legacy 3D seismic data over selected areas of the permit in order to define optimum drilling locations. 8 Figure 5 Figure 6 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 9 Annual Report 2010 Colle Ginestre Permit (Apennine 50% interest, Operator) The permit is located in Campobasso (Molise) and Chieti (Abruzzo) on the Adriatic coast of central Italy. The area falls within the Bradano Basin where the main plays are for gas in Pliocene sands and Miocene- Cretaceous carbonates. The area lies adjacent to the Cupello-S.Salvo field which has produced over 330 Bscf from the Pliocene. Ten wells were drilled in the permit area between 1958 and 1988 targeting the Pliocene objective. Colle Turchese-1dir encountered gas shows on the flank of a structure characterised by a weak flat spot on seismic data which could be indicative of a hydrocarbon accumulation. Apennine’s strategy is to mature leads, including the Turchese structure, for drilling recognising that new seismic data might be necessary. Monteluro Permit (Apennine 95% interest, Operator) The permit is located in Pesaro and Rimini in central Italy. The permit area is poorly explored with the principal hydrocarbon play being for biogenic gas in sand bodies in the basal Pliocene-Miocene clastic section. Apennine’s strategy is to mature leads recognised at 2000-3000m recognizing that new seismic data will be necessary to define drillable prospects Montenegro Permit (Apennine 50% interest) The permit is located in Potenza in southern Italy. The exploration plays are primarily biogenic gas in sand bodies within the shallow section and thermogenic gas in the deeper carbonates. In 1986 Agip drilled the Cicorva-1 well which encountered gas in the interval 818-837m in Pleistocene sands. The zone tested 0.9 MMscfd, but the discovery was not developed. Apennine’s strategy is to re-interpret the Cicorva discovery, currently estimated to be ~3 Bscf, and to address additional potential in deeper Pliocene and Mesozoic targets. Other Opportunities Assigned Permits Apennine has interests in seven other licences which are awaiting approval of Environmental Impact Assessments (EIA) before being fully awarded as permits for seismic and drilling operations to commence. Two offshore licences contain existing gas discoveries. D150 DR-CS, located in the Ionia Sea Zone D offshore Calabria, presently falls within the exclusion zone for offshore drilling as announced by the Italian Environment Ministry. Pending outcome of this matter further work on the EIA has been suspended. The licence contains the Laura-1 gas discovery in two separate zones (Pleistocene and Messinian sands 1306-1343m and 1437-1452m; the upper interval tested at 11 MMscfd). Gross P50 contingent resources for the Laura discovery have been estimated by Fugro- Robertson, to be 30 Bscf. D503 BR-CS, located in Zone B of the central Adriatic Sea, is outside the current exclusion zone. The well Dora-1 was drilled in 1972 as a gas-condensate discovery in the Miocene Scaglia limestones, testing 20.2 MMscfd from the interval 1361-1393m. The Dora-2 appraisal well was drilled in 1996 as a gas discovery but the reservoir quality was inferior to that of Dora-1, testing only 0.6 MMscfd from the interval 1397-1410m. Gross P50 contingent resources for the Dora discovery have been estimated by Fugro- Robertson to be 17.6 Bscf. Both of these projects are operated 100% by Apennine and it is our strategy to purchase legacy seismic data covering these two offshore structures with a view to drilling the existing discoveries in optimum locations for commercial exploitation of their reservoirs. Exclusive Applications Apennine has two exclusive applications lodged with the Ministry of Economic Development which are slated for award in 2011. The Costa Del Sole permit, southern onshore Sicily, contains the Manfria-1bis heavy oil (12.26°API) discovery. The well flowed at a rate of 150 bopd with an average water-cut of 20% and produced a total of 6,000 barrels of oil during testing. Recoverable reserves are estimated to be 4.5 MMbo. On award, Apennine’s strategy will be to evaluate the resource potential of the Manfria discovery for development 9 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 10 Sound Oil Technical Review continued Italian Assets (continued) and other prospects for drilling. A major refinery of heavy oil is located at Gela some 10 km from the discovery. The Rapagnano Concession, located in Ascoli Piceno central Italy, contains the Rapagnano-1 shut-in gas production well and supporting facilities. The Rapagnano field was abandoned by ENI in 2002 when production was 140,000 scfd. Senergy have estimated that ~2 Bscf gas is potentially recoverable from the well dependent on various interventions. On award, Apennine’s intention is to work-over the well and resume production by export of gas to the local grid or by on-site electricity generation. Indonesian Assets Sound has non-operated interests in two licences in Indonesia through its wholly-owned subsidiary Mitra Energia Ltd. Operators’ plans for 2011 include drilling of five exploration commitment wells, three in Java and two in Kalimantan. Citarum PSC (Sound 20% interest) During the last year the acquisition of an extensive 865 km seismic survey was completed satisfying outstanding seismic work commitments on the PSC. Interpretation of its results has identified several large prospects in the geologically complex overthust zone in the east of the block (Figure 7). Three structures (Cataka, Jatayu and Lodaya) (Figure 8) have been selected for drilling commencing in 3Q2011. Collectively the three prospects offer the opportunity to target P50 prospective resources of 1460 Bscf (Operator’s estimate; 292 Bscf net to Sound). Each well will be drilled to ~2500m with the principal target in the Miocene Parigi limestone. Additional prospectivity remains undrilled in the west of the block where Senergy have identified gross P50 prospective resource potential of 304 Bscf (61 Bscf net to Sound) in three prospects, mainly in shallow reservoir objectives. Some of the structures show seismic anomalies indicative of hydrocarbon charge. Figure 7 Figure 8 10 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 11 Annual Report 2010 Bangkanai PSC (Sound 5% carried interest) In December 2010 Bangkanai PSC was subject to a change of Operator. The new Operator has indicated to the Partnership that it will drill the two outstanding exploration commitment wells on the PSC in 2011. The PSC remains in force by the approval of a Plan of Development (POD) for the Kerendan gas field. The Kerendan field, first discovered in the 1980s, will be developed to supply gas to a local, new-build integrated power plant. The POD calls for the supply of 133 Bscf over 20 years at a maximum rate of 20 MMscfd. The development plan will include re-entry of existing wells and up to five new development wells. An independent assessment of Kerendan Field contingent recoverable resources was undertaken by Senergy in December 2009. Sound’s net contingent recoverable resources at 5.00% working interest based on this assessment are: Gross Net to Sound (5.00%) Gas Contingent Resources (Bscf): Low Estimate Best Estimate High Estimate 189.3 243.2 310.8 Oil & Liquids Contingent Resources (MMbo): Low Estimate Best Estimate High Estimate 1.98 2.50 3.17 9.5 12.2 15.5 0.10 0.13 0.16 Formal negotiations for a Gas Sales and Purchase Agreement with PLN8 are ongoing and expected to be concluded in 1H2011. Assuming a successful conclusion to these negotiations, it is now estimated that first gas could be delivered by 2014. In any event the project is recognised by PLN as part of its ‘Phase 2 10,000 MW Crash Program’ for implementation across Indonesia, 2010-2014. Senergy, in a Competent Person’s Report on Sound Oil’s assets in December 2009 identified gross P50 prospective resource potential on Bangkanai PSC of 4550 Bscf (227.5 Bscf net to Sound) in four prospects. These resources include the Kerendan Deep prospect (P50 1425 Bcf gross potential) located beneath the Kerendan field which can be drilled cost-effectively by the deepening of a planned development well as already approved by BPMigas9 as part of the outstanding firm commitment. A separate larger, shallower structure identified as the Jupoi prospect (P50 2964 Bscf gross potential) will probably form the target for the other commitment well. 1 Fugro-Robertson Limited and Senergy (GB) Limited are independent petroleum consultancy companies providing resource and reserve assessments. The figures quoted here are taken from their Competent Person’s Reports. 2 Contingent and prospective resources, consistent with SPE (The Society of Petroleum Engineers) guidelines, are quantified in terms of the statistical probability to describe a given recoverable hydrocarbon (oil or gas) volume in a subsurface structure considering all the geological variables involved. The P50 figure indicates a 50% chance of finding a given volume and is generally considered as the best or most-likely estimate. Contingent resources refer to already discovered, but not produced, hydrocarbons and prospective resources refer to hydrocarbons yet to be discovered. The figures quoted in this report have been verified by Sound Oil’s Chief Operating Officer, Dr. M. J. Cope BSc PhD CGeol FGS, a qualified petroleum geologist. 3 Billion standard cubic feet of gas. 4 Barrels of oil per day 5 Million barrels of oil. 6 Million standard cubic feet of gas per day. 7 Million barrels of oil equivalent (6,000 standard cubic feet of gas = 1 barrel of oil). 8 PLN (PT Perusahaan Listrik Negara) is the Indonesian state electricity company. 9 BPMigas (Badan Pelaksana Kegitan Hulu Minyak Dan Gas Bumi) is the Indonesian Government regulatory authority for petroleum exploration and production activities. 11 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 12 Sound Oil Board of Directors The Board of Directors of the Company is currently comprised as follows: Gerald Orbell Chairman and Chief Executive Gerald Orbell is a petroleum geologist with over 30 years of technical, managerial and director level experience in the hydrocarbon and utilities sectors. Gerald has previously held the position of executive director of Fina Exploration, Fina Development, Premier Oil plc and United Utilities plc. Gerald is currently the chairman of Antrim Energy Inc. where he oversees that company’s business in the UK. He is also a member of the board, and chairman of the audit committee, at the compliance company Valpak Limited. Michael Nobbs Non-executive Director Chairman of Audit Committee Member of Remuneration Committee Michael Nobbs has a thirty year track record in investment banking, with a focus on corporate and project finance. He was a managing director and senior credit officer for Citigroup/Citibank and the group finance director for Tishman International Companies, a major global real estate development and investment business. Ilham Habibie Non-executive Director Chairman of Remuneration Committee Member of Audit Committee Ilham is a co-founder and shareholder of PT. ILTHABI Rekatama, a private investment company in Indonesia, which he joined as a President Director in 2002. Through ILTHABI he invested in, and is director of, various companies in the fields of energy, mining, manufacturing and transportation. Ilham’s previous professional background is largely with aerospace companies (IPTN, Indonesia; Boeing, USA). He holds a Dr.-Ing. (PhD) in Aeronautical Engineering from Technical University of Munich, and a M.B.A. from the University of Chicago, USA. Andrew Hockey Non-executive Director Andrew has 29 years technical and managerial experience in the oil and gas industry gained in the UK and internationally with Petrofina, Triton, Monument, Lasmo, Eni and Fairfield Energy. Andrew holds a BA in Geology from Oxford University and an MSc in Petroleum Geology from Imperial College. 12 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 13 Annual Report 2010 Report of the Directors The directors submit their report and the audited accounts for the year ended 31 December 2010. Results and dividends The Group’s loss after tax for the year amounted to £15,968,000 (2009 loss: £2,620,000). A dividend is not proposed. Activities The principal activities of the Group are oil and gas exploration, development and production. A review of activities, prospects for the future and key performance indicators is included in the Chairman’s Statement and Technical Review. Post balance sheet event On 4 January 2011 the Group acquired 96% of Consul Oil & Gas Ltd and a further 2% on 29 January 2011, a company with assets in Italy. Details are shown in the Chairman’s Statement, the Financial and Technical Reviews and in Note 25 of the Financial Statements. Key performance indicators The Company’s main business is the acquisition of interests in prospective exploration acreage, the discovery of hydrocarbons in commercial quantities and the crystallisation of value whether through production or disposal of reserves. The Company tracks its non- financial performance through the accumulation of licence interests in proven and prospective hydrocarbon producing regions, the level of success in encountering hydrocarbons and the development of production facilities. In parallel, the Company tracks its financial performance through management of expenditures within resources available, the cost-effective exploitation of reserves and the crystallisation of value at the optimum point. Business risk and uncertainties Sound, like all exploration companies in the oil and gas industry, operates in an environment subject to inherent risks. Many of these risks are beyond the ability of a company to control, particularly those associated with the exploring for and developing of economic quantities of hydrocarbons. Principal risks can be classified into four main categories: operational, commercial, regulatory and financial. Operational risks include drilling complications, delays and cost over-run on major projects, well blowouts, failure to encounter hydrocarbons, construction risks, equipment failure and accidents. Commercial risks include access to markets, access to infrastructure, volatile commodity prices and counterparty risks. Regulatory risks include governmental regulations, licence compliance and environmental risks. Financial risks include access to equity funding and credit. Share capital At the end of the year the number of shares in issue was 692,427,348. The authority given to the directors to allot shares at the 2010 Annual General Meeting was granted for a period of one year. A resolution will be put to the Annual General Meeting to renew this authority. A resolution will also be put to the Annual General Meeting to give to the directors authority for one year to allot shares for cash as if statutory pre-emption did not apply, although at the present time the directors do not have plans for any issue of shares. At the Annual General Meeting, authority will be sought for the directors to grant options up to 5% of the issued share capital. Directors Directors of Sound holding office during the year were: Patrick Alexander Simon Davies Ilham Habibie Tony Heath Michael Nobbs Gerald Orbell Jossy Rachmantio (resigned on 30 June 2010) (resigned on 12 June 2010) (resigned on 30 June 2010) (resigned on 30 June 2010) Substantial Shareholders At 30 April 2011 the Company had received notification of the following interests in excess of 3% of the Company’s issued ordinary shares: Notified number of Notified % of voting rights voting rights Credit Suisse Client Nominees (UK) Limited 169250538 Barclayshare Nominees Limited Pershing Nominees Limited 165571669 163967164 TD Waterhouse Nominees (Europe) Limited 148516134 Iltheabie SDN – BHD HSDL Nominees Limited Iweb L R Nominees Limited HSDL Nominees Limited James Capel (Nominees) Limited 147288696 94427706 92276113 91408939 64477014 10.47% 10.24% 10.14% 9.19% 9.11% 5.84% 5.71% 5.66% 3.99% Directors’ interests The interests, all of which are beneficial, of directors holding office at the year-end, and of their families, in Ordinary Shares of the Company are set out below. Ordinary Shares Name Michael Nobbs Gerald Orbell Ilham Habibie* 31 Dec 2009 1,945,545 5,879,717 147,288,696 31 Dec 2010 1,945,545 4,224,545 147,288,696 30 April 2011 1,945,545 12,248,418 147,288,696 * Shares registered in the name of Ilthabie SDN-BHD, a company jointly owned by Ilham Habibie and his brother Thareq Habibie. 13 220867 Sound Oil R&A 2010 pg01-14 26/05/2011 12:28 Page 14 Sound Oil Report of the Directors continued Details of the remuneration and information on indemnity provisions of all directors who served during the period are shown in the Report on Directors’ Remuneration on page 15. Directors’ interests in share options are shown in the Report on Directors Remuneration on page 15. Financial risk management objectives and policies The Group’s principal financial instruments comprise cash and short term deposits. The main purpose of these financial instruments is to finance the Group’s operations. In addition the Group has various financial liabilities in the form of short term, non interest bearing sundry payables. The main risks arising from the Group’s financial instruments are interest rate risk and currency exchange rate risk. The board reviews and agrees policies for managing these risks. The Group’s exposure to the risk from changes in market interest rates and changes in currency exchange rates relates primarily to the Group’s cash and term deposits which are subject to floating interest rates and are mainly held in US$. A high proportion of the Group’s expenditure is in US$ so the Group’s policy is to minimise the risk of a fall in the value of sterling by maintaining a high percentage of its cash in US$. The Group’s exposure to commodity price risk and credit risk is considered minimal at this stage of the Group’s development. Going concern Details of going concern considerations are shown in the Financial Review on page 4. Directors Mr Andrew Hockey joined the board as non-executive directive on 9 May 2011. Director election Mr. Michael Nobbs is the Director retiring by rotation and, being eligible, will offer himself for re-election at the Annual General Meeting. Mr Andrew Hockey will retire as Director at the end of the Annual General Meeting and, being eligible, will offer himself for re-election. Suppliers and employees The Group’s policy in respect of its suppliers is to establish terms of payment when agreeing the terms of 14 business transactions and to abide by the terms of payment, usually up to 30 days. The Group places considerable value on the involvement of its employees and keeps them informed on matters affecting them as employees and on the various factors affecting the performance of the Group. Applications for employment by disabled persons are always fully considered, bearing in mind the aptitudes of the applicant concerned. In the event of members of staff becoming disabled, evey effort is made to ensure that their employment with the Group continues and that appropriate training is arranged. Charitable contributions During the period the Group made no charitable contributions. Auditors Mazars LLP resigned as auditors on 17 February 2011 and the Directors have appointed Crowe Clark Whitehill LLP as the Company’s auditors until the next Annual General Meeting. Crowe Clark Whitehill LLP have confirmed their willingness to continue in office and a resolution to reappoint them as auditors will be put to shareholders at the forthcoming Annual General Meeting. Each of the persons who is a director at the date of approval of this Annual Report and Financial Statements confirms that: (cid:129) (cid:129) so far as the director is aware, there is no relevant audit information of which the Company’s auditors are unaware; and the director has taken all the steps that he ought to have taken as director in order to make himself aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of s418 of the Companies Act 2006. By order of the Board Stephen Ronaldson Company Secretary 24 May 2011 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 15 Annual Report 2010 Report on Directors’ Remuneration Compliance It is the Committee’s current intention to continue The remuneration of all executive directors is with the above remuneration approach for 2011 and determined by the Remuneration Committee (the subsequent years although the Committee will keep ‘Committee’) and ratified by the Board. The Committee the matter under review. The Committee’s current is composed entirely of non-executive directors, and intention with regard to share options is that they comprises Mr Ilham Habibie, who chairs the may be awarded but only in special circumstances. Committee and Mr Michael Nobbs. None of the executive directors of the Company is involved in Remuneration structure determining his own remuneration. The executive directors’ remuneration is basic salary. The Committee consults with the Chief Executive and schemes with a deferred element, benefits, longer- takes independent advice from MM&K Limited, a leading term incentives or pension provision. There are no formal annual performance related bonus firm of remuneration consultants, which is appointed as an advisor to the Committee in respect of executive Base salary remuneration and share schemes. MM&K Limited does Base salary is reviewed each year against other not provide any other services to the Company. No other comparable companies in the oil sector and general person or company materially assisted the Committee market data on the basis of companies in similar during the year. Remuneration approach industries and those of a similar size. The objective is to ensure that the base salary provides a competitive remuneration package. The base salaries of the The Company’s remuneration policy is to provide executive directors are currently positioned between the remuneration packages which ensure that directors median and the upper quartile. While salary is reviewed and senior management are fairly and responsibly by reference to market conditions, the performance of rewarded for their contributions. the Company and the performance of the individual, the The Committee endorses the principle of mitigation of remuneration as directly performance related. damages on early termination of a service contract. Committee would not regard this element of 15 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 16 Sound Oil Report on Directors’ Remuneration continued Summary of actual remuneration of directors Executive directors Gerry Orbell Tony Heath Jossy Rachmantio Non-executive directors Simon Davies Michael Nobbs Ilham Habibie Patrick Alexander Salary and fees 2009 £’000’s 2010 £’000’s 184 105 137 25 25 25 25 184 53* 57* 12* 27 27 17* Total for all directors 526 377 * up to retirement dates shown on page 13. Contracts of employment The details of the executive director’s contract of employment and non-executive directors’ letters of appointment are set out below: (cid:129) Gerald Orbell has a contract of employment with a notice period for termination of 12 months. (cid:129) Non-executive directors have letters of appointment with a notice period for termination of 2 months. (cid:129) (cid:129) The Company has granted an indemnity to all its directors under which the Company will, to the fullest extent permitted by applicable law and to the extent provided by the Articles of Association, indemnify them against all costs, charges, losses and liabilities incurred by them in the execution of their duties. In the event of a change of control of the Company, Gerald Orbell and the Non-Executive Directors have the option to give notice and receive a lump sum equivalent to 12 months salary. Share Options At 31 December 2010 the Directors held options over the Ordinary Shares of the Company as follows: G. Orbell Date of Grant Exercisable Acquisition Price per share (pence) Dates Options held at Options held at 1 January 2010 31 December 2010 13.07.06 28.02.07 28.02.07 28.02.07 27.05.10 26.12.07 – 13.07.12 28.02.08 – 28.02.17 28.02.09 – 28.02.17 28.02.10 – 28.02.17 26.05.11 – 26.05.13 7.25 4.38 4.38 4.38 1.50 1,400,000 666,667 666,667 666,666 – 1,400,000 666,667 666,667 666,666 1,725,000 16 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 17 Annual Report 2010 Corporate Governance Report The Board recognises the importance of sound corporate now identifies and reviews the key areas of business governance and the guidelines set out in the Corporate risk facing the Group. Governance Code (the “Code”). Companies on the AIM market of the London Stock Exchange (“AIM”) are not required to comply with the Code, and due to its size, the Company is not in full compliance. However, the Company intends to comply so far as is practicable and appropriate. There is close, day-to-day involvement by the executive directors in all of the Group’s activities. This includes the comprehensive review of both management and technical reports, the monitoring of foreign exchange and interest-rate fluctuations, government and fiscal- policy issues and cash-control procedures. Regular In accordance with the Code no director has an attendance at joint-venture meetings and frequent site employment contract of more than one year. visits are made. In this way, the key-risk areas can be The Board is responsible for overall strategy, acquisition policy, major capital expenditure projects, corporate monitored effectively and specialist expertise applied in a timely and productive manner. overhead costs and significant financing matters. No Any system of internal control can provide only one individual has unfettered powers of decision. There reasonable, and not absolute, assurance that the risk is an experienced chairman and chief-executive and of failure to achieve business objectives is eliminated. two non-executive directors one of whom is The directors acknowledge that they are responsible independent. Ten board meetings were held during the year, all of which were attended by Messrs. Nobbs and Habibie. Mr. Orbell attended nine, Messrs. Heath and Alexander six, Mr. Rachmantio five and Mr. Davies three. The Board has an Audit Committee comprising the two non-executive directors. The Audit Committee receives and reviews reports from management and external auditors relating to the published accounts and the system of internal financial control. The Board has established levels of authorisation of financial commitments and cheque signing procedures appropriate to the size of the business. The Board receives monthly reports on income and expenditure and on the Company’s financial position. On the wider aspects of internal control, relating to operational and compliance controls and risk management as included in provision C.2.1 of the Code, the Board, in setting the control environment, for the Company’s system of internal control and for reviewing its effectiveness. The directors, having reviewed the effectiveness of the system of internal controls and risk management, consider that the system of internal control operated effectively throughout the financial year and up to the date that the financial statements were signed. The Company has less than twenty employees and the directors do not believe the Company is sufficiently complex to warrant the establishment of an internal audit function. The directors will review this policy as and when the Company’s circumstances warrant. The Board has a Remuneration Committee as described in the Report on Directors’ Remuneration. In addition to directors’ remuneration, the Committee is responsible for assessing directors’ performance, planning succession for the Chairman and Chief Executive and for new nominees to the Board. 17 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 18 Sound Oil Statement of Directors’ Responsibilities The directors are responsible for preparing the (cid:129) prepare the financial statements on the going Directors' Report and the financial statements in concern basis unless it is inappropriate to presume accordance with applicable law and regulations. that the company will continue in business. Company law requires the directors to prepare The directors are responsible for keeping adequate financial statements for each financial year. Under accounting records that are sufficient to show and that law the directors have elected to prepare the explain the company’s transactions and disclose with financial statements in accordance with International reasonable accuracy at any time the financial position Financial Reporting Standards (IFRSs') as adopted by of the company and enable them to ensure that the the EU and applicable law. financial statements comply with the Companies Act 2006. They are also responsible for safeguarding the Under company law the directors must not approve assets of the company and hence for taking the financial statements unless they are satisfied that reasonable steps for the prevention and detection of they give a true and fair view of the state of affairs of fraud and other irregularities. the company and the group and of the profit or loss of the group for that period. In preparing these financial They are further responsible for ensuring that the statements, the directors are required to: Report of the Directors and other information included (cid:129) select suitable accounting policies and then apply prepared in accordance with applicable law in the them consistently; United Kingdom. in the Annual Report and Financial Statements is (cid:129) make judgments and accounting estimates that are reasonable and prudent; (cid:129) state whether applicable accounting standards have been followed, subject to any material departures disclosed and explained in the financial statements; 18 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 19 Annual Report 2010 Independent Auditor’s Report to the members of Sound Oil plc We have audited the financial statements of Sound Oil plc for the year ended 31 December 2010 which comprise the Consolidated Income Statement, Consolidated and Parent Company Balance Sheet, Consolidated and Parent Company Statement of Changes in Equity and Consolidated and Parent Company Cash Flow Statement and the related notes. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European Union and, as regards the parent company financial statements, as applied in accordance with the provisions of the Companies Act 2006. Respective responsibilities of directors and auditors As explained more fully in the Statement of Directors’ Responsibilities set out on page 18, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s (APB’s) Ethical Standards for Auditors. This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body for our audit work, for this report, or for the opinions we have formed. Scope of the audit of the financial statements A description of the scope of an audit of financial statements is provided on the APB’s web-site at www.frc.org.uk/apb/scope/UKNP. Opinion on the financial statements In our opinion: (cid:129) (cid:129) the financial statements give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 31 December 2010 and of the Group’s loss for the year then ended; the Group financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union; (cid:129) (cid:129) the parent company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and the financial statements have been prepared in accordance with the requirements of the Companies Act 2006. Opinion on the other matters prescribed by the Companies Act 2006 In our opinion the information given in the Directors’ Report for the financial year for which the financial statements are prepared is consistent with the financial statements. Matters on which we are required to report by exception We have nothing to report in respect of the following matters where the Companies Act 2006 requires us to report to you if, in our opinion: (cid:129) (cid:129) (cid:129) adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or the parent company financial statements are not in agreement with the accounting records and returns; or certain disclosures of directors’ remuneration specified by law are not made; or (cid:129) we have not received all the information and explanations we require for our audit. Stephen Bullock (Senior statutory auditor) for and on behalf of Crowe Clark Whitehill LLP, Chartered Accountants (Statutory auditors) St. Bride’s House 10 Salisbury Square London EC4Y 8EH 24 May 2011 Note: The maintenance and integrity of the Sound Oil plc website is the responsibility of the directors. The work carried out by the auditors does not involve consideration of these matters and accordingly the auditors accept no responsibility for any changes that may have occurred to the financial statements since they were originally presented on the website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. 19 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 20 Sound Oil Consolidated Income Statement for the year ended 31 December 2010 Notes 3 6 12 7 Exploration costs Gross loss Administrative expenses Group trading loss Other income/(loss) Group operating loss from continuing operations Finance revenue Foreign exchange gain/(loss) Loss on disposal of farmout interest Loss before income tax Income tax credit Loss for the period attributable to the equity holders of the parent Other comprehensive loss: Foreign currency translation (loss)/gain Total comprehensive loss for the period attributable to the equity holders of the parent 2009 £’000’s (334) (334) (1,596) (1,930) 50 (1,880) 19 (786) – (2,647) 27 (2,620) 2010 £’000’s (430) (430) (1,502) (1,932) (58) (1,990) 21 211 (14,210) (15,968) – (15,968) (2,258) 711 (4,878) (15,257) Loss per share basic and diluted for the period attributable to the equity holders of the parent (pence) 8 (0.38) (2.31) The Company has elected to take the exemption under section 408 of the Companies Act 2006 to not present the parent Company income statement. The result of the parent Company for the year was a loss of £3,004,000 (2009; £2,059,000). 20 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 21 Annual Report 2010 Consolidated Balance Sheet as at 31 December 2010 Group Non-current assets Property, plant and equipment Intangible assets Exploration and evaluation assets Other debtors Current assets Other debtors Prepayments Current tax receivable Cash and short term deposits Total assets Current liabilities Trade and other payables Current tax payable Non-current liabilities Deferred tax liabilities Provisions Total liabilities Net assets Capital and reserves attributable to equity holders of the Company Equity share capital Foreign currency reserve Accumulated deficit Total equity Approved by the Board on 24 May 2011 G Orbell Director M Nobbs Director Notes 2009 £’000’s 2010 £’000’s 9 10 11 14 14 7 15 16 7 17 18 19 19 32 4,797 22,185 792 27,806 192 108 27 10,622 10,949 38,755 897 – 897 4,797 105 4,902 5,799 32,956 36,456 3,030 (6,530) 32,956 12 1,525 9,954 621 12,112 2,940 65 26 4,484 7,515 19,627 284 – 284 1,525 103 1,628 1,912 17,715 36,456 3,741 (22,482) 17,715 21 The accounting policies on pages 27 to 31 and notes on pages 27to 50 form part of these financial statements . 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 22 Sound Oil Company Balance Sheet as at 31 December 2010 Company Non-current assets Property, plant and equipment Investment in subsidiaries Other debtors Current assets Other debtors Prepayments Current tax receivable Cash and short term deposits Total assets Current liabilities Trade and other payables Current tax payable Total liabilities Net assets Capital and reserves Equity share capital Retained earnings/(accumulated deficit) Total equity Approved by the Board on 24 May 2011 G Orbell Director M Nobbs Director Notes 9 13 14 14 15 16 19 19 2009 £’000’s – 24,833 – 24,833 34 33 27 9,854 9,948 34,781 333 – 333 2010 £’000’s – 24,337 4 24,341 2,891 37 26 4,331 7,285 31,626 166 – 166 34,448 31,460 36,456 (2,008) 34,448 36,456 (4,996) 31,460 The accounting policies on pages 27 to 31 and notes on pages 27 to 50 form part of these financial statements . 22 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 23 Annual Report 2010 Consolidated Statement of Changes in Equity for the year ended 31 December 2010 Group At 1 January 2010 Total loss for the year Total comprehensive gain Share capital £’000’s Share Accumulated deficit £’000’s premium £’000’s Note Foreign currency reserve £’000’s 692 35,764 (6,530) 3,030 – – – – – – – – (15,968) – (15,968) 16 – 711 711 – Total equity £’000’s 32,956 (15,968) 711 (15,257) 16 Total comprehensive income/(loss) Share based payments 23 At 31 December 2010 692 35,764 (22,482) 3,741 17,715 Share capital £’000’s Share Accumulated deficit £’000’s premium £’000’s Note At 1 January 2009 Total loss for the year Total comprehensive loss Total comprehensive income/(loss) Share based payments 23 692 35,764 – – – – – – – – At 31 December 2009 692 35,764 (3,927) (2,620) – (2,620) 17 (6,530) Foreign currency reserve £’000’s 5,289 – (2,259) (2,259) – Total equity £’000’s 37,818 (2,620) (2,259) (4,879) 17 3,030 32,956 23 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 24 Sound Oil Company Statement of Changes in Equity for the year ended 31 December 2010 Company At 1 January 2010 Total loss for the year Other comprehensive (loss)/income Total comprehensive income/(loss) Share based payments At 31 December 2010 At 1 January 2009 Total loss for the year Other comprehensive (loss)/income Total comprehensive income/(loss) Share based payments At 31 December 2009 Share capital £’000’s Share premium £’000’s 692 35,764 – – – – – – – – 692 35,764 Share capital £’000’s Share premium £’000’s 692 35,764 – – – – – – – – Accumulated retained earnings/ (deficit) £’000’s (2,008) (3,004) – (3,004) 16 (4,996) Accumulated retained earnings/ (deficit) £’000’s 33 (2,058) – (2,058) 17 Total equity £’000’s 34,448 (3,004) – (3,004) 16 31,460 Total equity £’000’s 36,489 (2,058) – (2,058) 17 692 35,764 (2,008) 34,448 Note 23 Note 23 24 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 25 Annual Report 2010 Consolidated Cash Flow Statement for the year ended 31 December 2010 Cash flow from operating activities Cash flow from operations Interest received Net cash flow from operating activities Cash flow from investing activities Capital expenditure and disposals Exploration expenditure Payment in escrow – acquisition of subsidiaries Net cash flow from investing activities Notes 6 9 Net cash flow from financing activities Net decrease in cash and cash equivalents Net foreign exchange difference Cash and cash equivalents at the beginning of the year Cash and cash equivalents at the end of December 15 Notes to cash flow Cash flow from operations reconciliation Profit/(loss) after tax Finance revenue Foreign exchange (gain)/loss Loss on disposal of farmout interest Exploration expenditure written off Income tax charge (credit) Increase/(decrease) in accruals and short term creditors Depreciation Share based payments charge (Decrease)/increase in long term provisions (Increase)/decrease in long term debtors (Increase)/decrease in short term debtors Cash flow from operations Notes 6 3 23 2009 £’000’s (2,145) 19 (2,126) (7) (953) – (960) – (3,086) (917) 14,625 10,622 2009 £’000’s (2,620) (19) 786 – (63) (27) (210) 36 17 11 (204) 148 (2,145) 2010 £’000’s (2,683) 21 (2,662) (2) (1,165) (2,413) (3,580) – (6,242) 104 10,622 4,484 2010 £’000’s (15,968) (21) (211) 14,210 3 – (630) 15 16 (5) 194 (286) (2,683) 25 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 26 Sound Oil Company Cash Flow Statement for the year ended 31 December 2010 Notes 6 9 Cash flow from operating activities Cash flow from operations Interest received Net cash flow from operating activities Cash flow from investing activities Capital expenditure and disposals Payment in escrow – acquisition of subsidiaries Investment in subsidiary undertakings Net cash flow from investing activities Cash flow from financing activities Proceeds from equity issue Net cash flow from financing activities Net increase/(decrease) in cash and cash equivalents Net foreign exchange differences Cash and cash equivalents at the beginning of the year Cash and cash equivalents at the end of December 15 Notes to cash flow Cash flow from operations reconciliation Profit/(loss) after tax Increase in provisions against investments Finance revenue Foreign exchange (gain)/loss Income tax charge (credit) Income tax payments Increase/(decrease) in accruals and short term creditors Depreciation Share based payments Decrease/(increase) in short term debtors Cash flow from operations Notes 9 23 2009 £’000’s (961) 19 (942) – – (2,202) (2,202) – – (3,144) (781) 13,779 9,854 2009 £’000’s (2,059) – (19) 782 (27) 27 78 3 17 237 (961) 2010 £’000’s (1,803) 21 (1,782) – (2,413) (1,538) (3,951) – – (5,733) 210 9,854 4,331 2010 £’000’s (3,004) 2,030 (21) (211) – – (167) – 16 (446) (1,803) 26 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 27 Annual Report 2010 Notes to the Financial Statements 1 Accounting policies Sound Oil plc is a public limited company registered and domiciled in England and Wales under the Companies Act 2006. (a) Basis of preparation The financial statements of the Group and its parent have been prepared in accordance with: above, the current business environment is challenging and access to new equity and debt remains uncertain. Based on current management plan, management believe that the Group will remain a going concern for the next 12 months from the date of the authorisation of the financial statements on the basis of forecast expenditure (12 months through 30 June 2012) will be less than the funds available as at 31 December 2010 together with the £10.7 million raised in January, March and April 2011 from share placings (1) International Financial Reporting Standards (IFRS) and the £6 million undrawn element of the Yorkville facility. adopted by the International Accounting Standards Board Management will also continue to pursue farm-out and (IASB) and interpretations issued by the International financing strategies to reduce/fund Sound’s future Financial Reporting Interpretations Committee (IFRIC) as obligations. endorsed by the European Commission (EC) for use in the European Union (EU); and (2) those parts of the Companies Act 2006 applicable to companies reporting under IFRSs. The consolidated financial statements have been prepared under the historical cost convention, except to the extent that the following policies require fair value adjustments. Use of estimates and key sources of estimation uncertainty The preparation of financial statements in conformity with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as the disclosure of contingent assets and liabilities at the balance sheet date and the reported amounts of revenues and expenses during the reporting The Group and its parent company’s financial statements are period. Actual outcomes could differ from those estimates. presented in sterling (£) and all values are rounded to the nearest thousand (£’000) except when otherwise indicated. The key sources of estimation uncertainty that has a significant risk of causing material adjustment to the The principal accounting policies set out below have been carrying amounts of assets and liabilities within the next consistently applied to all financial reporting periods financial year are the impairment of intangible presented in these consolidated financial statements and exploration assets (E&E assets), investments and goodwill by all Group entities, unless otherwise stated. All amounts and the estimation of share based payment costs. classified as current are expected to be settled/recovered in less than 12 months unless otherwise stated in the notes to these financial statements. The Group determines whether E&E assets are impaired in cost pools when facts and circumstances suggest that the carrying amount of a cost pool may exceed its The Group and its parent company’s financial statements recoverable amount. As recoverable amounts are for the year ended 31 December 2010 were authorised for determined based upon risked potential, or where issue by the board of directors on 24 May 2011. relevant, discovered oil and gas reserves, this involves The financial position of the Group, its cash flows and available debt facilities are described in the Financial Review above. As at 31 December 2010 the Group had £4.484 million of available cash. After the balance sheet estimations and the selection of a suitable discount rate. The capitalisation and any write off of E&E assets necessarily involve certain judgements with regard to whether the asset will ultimately prove to be recoverable. date but before the date of approval of these financial In determining the treatment of E&E assets and statements, the Group raised a further £10.7 million from investments the directors are required to make estimates equity fundraisings. The Directors are required to consider and assumptions as to future events and circumstances. the availability of resources to meet the Group and There are uncertainties inherent in making such Company’s liabilities for the foreseeable future. As described assumptions, especially with regard to: oil and gas 27 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 28 Sound Oil Notes to the Financial Statements continued reserves and the life of, and title to, an asset; recovery The Group uses the purchase method of accounting for the rates; production costs; commodity prices and exchange acquisition of subsidiaries. The cost of an acquisition is rates. Assumptions that are valid at the time of estimation measured as the fair value of the assets given, equity may change significantly as new information becomes instruments issued and liabilities incurred or assumed at available and changes in these assumptions may alter the the date of exchange, plus costs directly attributable to the economic status of an E&E asset and result in resources or acquisition. reserves being restated. The estimation of recoverable amounts, based on risked potential and the application of value in use calculations, are dependent upon finance being available to fund the development of the E&E assets. Goodwill is tested annually and at other times when impairment indications exist. When value in use calculations are undertaken, management estimates the expected futures cash-flows from the asset and chooses a suitable discount rate in order to calculate the present value of those cash- flows. In undertaking these value in use calculations, Joint ventures The Group conducts oil and gas exploration and production activities jointly with other venturers who each have direct ownership in and jointly control the assets of the ventures. These are classified as jointly controlled assets and consequently, these financial statements reflect only the Group’s proportionate interest in such activities. Associates Entities, other than subsidiary undertakings or joint management is required to make use of estimates and arrangements, in which the Group has a participating assumptions similar to those described in the treatment of interest and over whose operating and financial policies the E&E assets above. Further details are given in note 10. Group exercises a significant influence are treated as The estimation of share-based payment costs requires the selection of an appropriate valuation model, consideration as to the inputs necessary for the valuation model chosen and the estimation of the number of awards that will ultimately vest, inputs for which arise from judgements relating to the continuing participation of key employees (see note 23). (b) Basis of consolidation The Group financial statements consolidate the Income Statements and Balance Sheets of the Company and its subsidiary undertakings. Joint venture undertakings are accounted for using the proportionate consolidation associates. In the Group’s financial statements associates are accounted for using the equity method. Separate financial statements Investments in subsidiaries, joint ventures and associates are recorded at cost, subject to impairment testing in the Group’s financial statements. Foreign currency translation (c) The functional currency of the Company is pound sterling. The functional currency of the Indonesian subsidiaries is US$. Transactions in foreign currencies are initially recorded in method from the date that significant influence or joint the functional currency by applying the spot exchange rate control (respectively) commences until the date this ceases. ruling at the date of the transaction. Monetary assets and Associates are accounted for using the equity method. liabilities denominated in foreign currencies are Investments in subsidiaries Subsidiaries are all entities over which the Group has the power to govern the financial and operating policies. Such retranslated at the functional currency rate of exchange ruling at the balance sheet date. All differences are taken to the income statement. power, generally but not exclusively, accompanies a The assets and liabilities of foreign operations are shareholding of more than one half of the voting rights. translated into sterling at the rate of exchange ruling at Subsidiaries are fully consolidated from the date on which the balance sheet date. Income and expenses are translated control is transferred to the Group, until the date that at weighted average exchange rates for the year. The control ceases. 28 resulting exchange differences are taken directly to a separate component of equity. On disposal of a foreign 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 29 Annual Report 2010 entity, the deferred cumulative amount recognised in carrying value, after any impairment loss, of the relevant equity relating to that particular foreign operation is E & E assets is then reclassified as development and recognised in the income statement. production assets. If, however, commercial reserves have (d) Oil and gas assets The Group’s entire capitalised oil and gas costs relate to properties that are in the exploration and evaluation stage. As allowed under IFRS 6 the Group has continued to apply its existing accounting policy to exploration and evaluation activity, subject to the specific requirements of the standard. The Group will continue to monitor the application of not been found, the capitalised costs are charged to expense after conclusion of appraisal activities. Development and production assets Development and production assets are accumulated generally on a field-by-field basis and represent the cost of developing the commercial reserves discovered and bringing them into production, together with the E & E expenditures incurred in finding commercial reserves transferred from intangible E & E assets as outlined in the these policies in the light of expected future guidance on accounting policy above. accounting for oil and gas activities. The Group applies the successful efforts method of accounting for exploration and evaluation (E & E) costs. Exploration and evaluation assets Under the successful efforts method of accounting, all licence acquisition, exploration and appraisal costs are initially capitalised in well, field or specific exploration cost centres as appropriate, pending determination. Expenditure incurred during the various exploration and appraisal phases is then written off unless commercial reserves have been established or the determination process has not been completed. Exploration and evaluation costs Costs are initially capitalised as exploration and The cost of development and production assets also includes the cost of acquisitions and purchases of such assets, directly attributable overheads, finance costs capitalised, and the cost of recognising provisions for future restoration and decommissioning. Impairment of development and production assets An impairment test is performed whenever events and circumstances arising during the development or production phase indicate that the carrying value of a development or production asset may exceed its recoverable amount. The carrying value is compared against the expected recoverable amount of the asset, generally by reference to the present value of the future net cash flows expected to be derived from production of commercial reserves. The evaluation assets. Payments to acquire the legal right to cash generating unit applied for impairment test purposes explore, costs of technical services and studies, seismic is generally the field, except that a number of field acquisition, exploratory drilling and testing are capitalised interests may be grouped as a single income generating as exploration and evaluation assets. unit where the cash flows of each field are inter- Treatment of exploration and evaluation expenditure dependent. at the end of appraisal activities Intangible E & E assets relating to each exploration Acquisitions, asset purchases and disposals Acquisitions of oil and gas properties are accounted for licence/prospect are carried forward, until the existence under the purchase method where the transaction meets (or otherwise) of commercial reserves has been the definition of a business combination or joint venture. determined subject to certain limitations including review for indications of impairment. If commercial reserves have been discovered and development has been approved, the Transactions involving the purchase of an individual field interest, or a group of field interests, that do not qualify as a business combination are treated as asset purchases, 29 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 30 Sound Oil Notes to the Financial Statements continued irrespective of whether the specific transactions involve the transfer of the field interests directly, or the transfer Deferred tax Deferred tax is provided using the Balance Sheet liability of an incorporated entity. Accordingly, no goodwill arises, method, on temporary differences arising between the tax and the consideration is allocated to the assets and bases of assets and liabilities and their carrying amounts liabilities purchased on an appropriate basis. in the consolidated financial statements. Deferred tax (e) Expenses recognition Expenses are recognised on the accruals basis unless otherwise stated. (f) Property, plant and equipment Fixtures, fittings and equipment are recorded at cost as tangible assets. The straight-line method of depreciation is used to depreciate the cost of these assets over their estimated useful lives, which is estimated to be four years. (g) Goodwill Goodwill on acquisition is initially measured at cost being the excess of the cost of the business combination over the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities. Following initial recognition, goodwill is measured at its original value, less any accumulated impairment losses subsequently incurred. Goodwill is not amortised. Goodwill is reviewed for impairment annually, or more frequently if events or changes in circumstances indicate the carrying value may be impaired. Impairment is determined by assessing the recoverable amount of the cash-generating unit to which the goodwill relates. Where the recoverable amount of the cash-generating unit or group of cash generating units is less than the carrying amount, an impairment loss is recognised. Income tax (h) Current tax The current tax expense is based on the taxable results for the year, using tax rates enacted or substantively enacted at the Balance Sheet date, including any adjustments in respect of prior years. Amounts are charged or credited to the Income Statement or equity as appropriate. 30 assets are recognised to the extent that it is probable that future taxable results will be available against which the temporary differences can be utilised. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities. Temporary differences arising from investments in subsidiaries give rise to deferred tax in the Company Balance Sheet only to the extent that it is probable that the temporary difference will reverse in the foreseeable future or the Company does not control the timing of the reversal of that difference. Deferred tax is provided on un-remitted earnings of subsidiaries to the extent that the temporary difference created is expected to reverse in the foreseeable future. Deferred tax is recognised in the Income Statement except when it relates to items recognised directly in the Statement of Changes in Equity in which case it is credited or charged directly to Retained Earnings through the Statement of Changes in Equity. (i) Cash and cash equivalents Cash and cash equivalents include cash in hand and deposits held at call with banks. Financial instruments (j) Financial assets and financial liabilities are recognised on the Group’s balance sheet when the Group becomes a party to the contractual provisions of the instrument. Trade and other receivables are initially measured at fair value and are subsequently reassessed at the end of each accounting period. Cash and cash equivalents comprise cash on hand and demand deposits, and other short-term highly liquid investments that are readily convertible to a known amount of cash and are subject to an insignificant risk of changes in value. Financial liabilities and equity instruments issued by the Group are classified according to the substance of the contractual arrangements entered 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 31 Annual Report 2010 into and the definitions of a financial liability and an (cid:129) IFRS 1 First-time Adoption of International equity instrument. An equity instrument is any contract Financial Reporting Standards that evidences a residual interest in the assets of the Amendment to limited exemption from IFRS7 Group after deducting all of its liabilities. The accounting Disclosures for First-time Adopters, effective for policies adopted for specific financial liabilities and equity financial periods beginning on or after 1 July 2010. instruments are set out below. Trade payables are initially measured at fair value and are subsequently measured at amortised cost, using the effective interest rate method. Equity instruments issued by the Company are recorded at the proceeds received, net of direct issue costs. Shares issued are held at their fair value. (k) Share based payments The Group issues equity-settled share-based payments to certain employees. The fair value of each option at the date of the grant is estimated using the binomial option- pricing model based upon the option price, the share price at the date of issue, volatility and the life of the option. The estimated fair value of the option is amortised (cid:129) IFRIC 14 Defined Benefit Assets and Minimum Funding Requirements Amendment to prepayments of a minimum funding requirement, effective for financial periods beginning on or after 1 January 2011. (cid:129) (cid:129) Annual improvements to IFRS issued May 2010, effective for financial periods beginning on or after 1 July 2010. Annual improvements to IFRS issued May 2010, effective for financial periods beginning on or after 1 January 2011. to expense over the options’ vesting period with a The directors do not anticipate that the adoption of these corresponding increase to equity. No expense is standards and interpretations will have a material impact recognised for awards that do not ultimately vest, except on the financial statements in the year of initial for awards where vesting is conditional upon a market application. condition, which are treated as vesting irrespective of whether or not the market condition is satisfied, provided that all other performance and/or service conditions are satisfied. Standards, interpretations and amendments to published standards that are not yet effective and have not been early adopted by the Group IAS 24 Related Party Disclosures Revised definitions (m) Earnings per share Earnings per share are calculated using the weighted average number of ordinary shares outstanding during the period per IAS 33. Diluted earnings per share are calculated based on the weighted average number of ordinary shares outstanding during the period plus the weighted average number of shares that would be issued on the conversion of all potentially dilutive shares to ordinary shares. It is assumed that any proceeds obtained on the exercise of any options and warrants would be of related parties effective for financial years used to purchase ordinary shares at the average price beginning on or after 1 January 2011. during the period. Where the impact of converted shares IAS 32 Financial Instruments: Presentation Amendments relating to classification of rights issues, effective for financial years beginning on or after 1 February 2010. would be anti-dilutive, these are excluded from the calculation of diluted earnings. (n) Provisions Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events, (l) (cid:129) (cid:129) (cid:129) IFRIC 19 Extinguishing Financial Liability with it is probable that an outflow of resources embodying Equity Instruments Effective for financial years economic benefits will be required to settle the beginning on or after 1 July 2010. obligation, and a reliable estimate of the amount of the obligation can be made. 31 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 32 Sound Oil Notes to the Financial Statements continued Segment information 2 The Group has adopted IFRS 8, Operating Segments which requires information on the separate segments of a business. The Group’s activity in 2010 consisted of a single operating segment, being the exploration for oil and gas in Indonesia. The Group’s exploration activities are carried out under two Production Sharing Contracts (PSC’s), Bangkanai and Citarum. To date there has been no development activity, production or turnover. As required by IFRS 8 operating segments are based on internal reports about components of the Group which are regularly reviewed and used by Chief Operating Decision Maker (“CODM”) for strategic decision making and resource allocation, in order to allocate resources to the segment and to assess its performance. The CODM is considered to be the Board of Directors. Capitalised exploration expenditure in the Balance Sheet is £10.0 million, which is comprised of £0.3 million for the Bangkanai PSC, £3.7 million for the Citarum PSC and £6.0 million for the fair value uplift which arose on acquisition of the company which owned the PSC’s, (at end 2009 £3.8 million, £2.4 million and £10.0 million respectively). The decreases for the Bangkanai PSC and the fair value uplift were due to the write down associated with the reduction of the interest in the Bangkanai PSC. The non current assets all relate to the one geographical location in which the Group operated in 2010, which was Indonesia. The Group has not provided information on revenue and products and services as it is not yet trading. 3 Operating loss Operating loss is stated after charging/(crediting): Auditors’ remuneration Depreciation Employee costs Impairment charge/(write back) 4 Auditors’ remuneration Audit of financial statements Other services relating to taxation All other services Charged to income statement Notes 4 9 5 11 Notes 3 2009 £‘000’s 119 36 952 (63) 2009 £‘000’s 114 5 – 119 2010 £‘000’s 89 15 1,009 3 2010 £‘000’s 84 5 – 89 32 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 33 Annual Report 2010 5 Employee costs Staff costs, including executive directors Share based payments Wages and salaries Social security costs Total Notes 23 3 Number of employees (including executive directors) at the end of the year Technical and operations Management and administration Total 2009 £‘000’s 18 824 110 952 5 11 16 Details of the directors’ emoluments are shown in the Report of Directors Remuneration on page 15. 6 Finance revenue Interest on cash at bank and short-term deposits Total 2009 £‘000’s 19 19 2010 £‘000’s 16 883 110 1,009 4 10 14 2010 £‘000’s 21 21 33 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 34 Sound Oil Notes to the Financial Statements continued 2009 £‘000’s Group 2010 £‘000’s Group – 27 – 27 – – 27 2009 £‘000’s Group (2,647) 769 (6) (559) – (177) 27 2009 £‘000’s Group 27 – – – – – – – – 2010 £‘000’s Group (15,968) 4,471 (3,979) (273) – (219) – 2010 £‘000’s Group 26 – 7 Taxation (a) Analysis of the tax charge for the year: Current tax United Kingdom corporation tax (charge)/credit Adjustment to tax expense in respect of prior years Overseas tax Total current tax (charge)/credit Deferred tax Deferred tax income arising in the current year Total deferred tax Total tax (charge)/credit (b) Reconciliation of tax charge: (Loss)/profit before tax Tax (charge)/credit at UK corporation tax rate of 28% (2009: 29%) Effects of: Expenses not deductible for tax purposes Temporary differences not recognised Utilisation of previously unrecognised deferred tax assets Differences in overseas tax rates Total tax (charge)/credit (c) Tax account: Current tax receivable Current tax payable 34 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 35 Annual Report 2010 8 Profit/(loss) per share The calculation of basic profit/(loss) per Ordinary Share is based on the profit/(loss) after tax and on the weighted average number of Ordinary Shares in issue during the period. Basic profit/(loss) per share is calculated as follows: (Loss)/profit after tax Weighted average shares in issue (Loss)/profit per share (basic) 2009 £‘000’s (2,620) 2009 million 692 2009 Pence (0.38) 2010 £‘000’s (15,968) 2010 million 692 2010 Pence (2.31) Diluted loss per share has not been disclosed as inclusion of unexercised options would be anti-dilutive. After the balance sheet date, the Company has issued additional shares, details of which are included in note 25, which will impact on the weighted average number of shares in issue in future periods. 35 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 36 Sound Oil Notes to the Financial Statements continued 9 Property plant and equipment Group Notes 3 Notes 3 Fixtures, fittings and office equipment £’000’s 204 5 2 (72) 139 172 12 15 (72) 127 12 Fixtures, fittings and office equipment £’000’s 216 (19) 7 204 151 (15) 36 172 32 Total £’000’s 204 5 2 (72) 139 172 12 15 (72) 127 12 Total £’000’s 216 (19) 7 204 151 (15) 36 172 32 Cost At 1 January 2010 Exchange adjustments Additions Disposals At 31 December 2010 Depreciation At 1 January 2010 Exchange adjustments Charge for the year Disposals At 31 December 2010 Net book amount at 31 December 2010 Cost At 1 January 2009 Exchange adjustments Additions At 31 December 2009 Depreciation At 1 January 2009 Exchange adjustments Charge for the year At 31 December 2009 Net book amount at 31 December 2009 36 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 37 Annual Report 2010 9 Property plant and equipment - continued Company Cost At 1 January 2010 At 31 December 2010 Depreciation At 1 January 2010 Charge for the year At 31 December 2010 Net book amount at 31 December 2010 Cost At 1 January 2009 At 31 December 2009 Depreciation At 1 January 2009 Charge for the year At 31 December 2009 Net book amount at 31 December 2009 Fixtures, fittings and office equipment £’000’s 9 9 9 – 9 – Fixtures, fittings and office equipment £’000’s 9 9 6 3 9 – Total £’000’s 9 9 9 – 9 – Total £’000’s 9 9 6 3 9 – 37 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 38 Sound Oil Notes to the Financial Statements continued 10 Intangible assets Goodwill Cost At 1 January Exchange adjustments Acquisitions Disposals At 31 December Impairment losses At 1 January Impairment in the year At 31 December 2009 £‘000’s 5,277 (480) – – 4,797 – – – 2010 £‘000’s 4,797 390 – (3,662) 1,525 – – – Net book amount at 31 December 4,797 1,525 Group The goodwill balance that had arisen on the acquisition of the Mitra group in July 2006 has been allocated to the cash generating unit (‘CGU') identified according to business segment. In assessing whether goodwill has been impaired, the carrying amount of the CGU, including goodwill, is compared with the recoverable amount of the CGU. The recoverable amount of each CGU is based on value in use calculations. The methodology to arrive at the value in use calculation was based on Net Present Value (NPV) for proven contingent resources, in this case the Kerendan Field, and Estimated Monetary Value (EMV) for prospective resources on Bangkanai PSC and Citarum PSC. In addition, EMV includes an assessment of risk for the geological uncertainties of undrilled prospects as indicated in the Competent Person’s Report in respect of Sound’s assets in December 2009. The calculation of value in use is most sensitive to the assumptions for production and operating expenditure and is entirely reliant on the availability of finance to fund capital expenditure on the development of E&E assets. These assumptions are based on the assumptions as defined in the Plan of Development for the Kerendan gas field. The 2007 fair value less costs to sell calculations are based on a gas price of $2.98/MMBtu which was obtained from the Heads of Agreement (HOA) of the sales contract between Elnusa and PT Medco Power. A final sales agreement has not yet been signed. The 2010 calculations are based on a significantly higher expected gas price of $4.75 per MMBtu, which is based on current negotiations between the Bangkanai Partners and PLN, the Indonesian state electricity utility, and corresponding Capex revisions. However, even if the 2010 calculations were sensitised to a gas price of $2.98/MMBtu, no impairment would be required. Estimates of the NPV of any project, and particularly of projects like the Group’s interests in the Bangkanai PSC and the Citarum PSC, are always subject to many factors and wide margins of error. The directors believe that the estimates and calculations supporting their conclusions have been carefully considered and are a fair representation of the projected financial performance of the projects. The NPV calculations have been prepared over the period of the PSC and the duration of the sales contract. A discount rate of 10% has been used (2009: 10%), which the directors believe to be standard industry practice and approximates to the Company’s weighted average cost of capital. The EMV for unappraised and undiscovered resources is a risked estimate of the value of prospective resources at $0.25 per mcf for gas. Company The Company has no goodwill. 38 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:29 Page 39 Annual Report 2010 2009 £’000’s 26,248 953 – (2,078) 25,123 2,941 (63) 60 2,938 22,185 2010 £’000’s 25,123 1,165 (14,051) 745 12,982 2,938 3 87 3,028 9,954 11 Exploration and evaluation assets Cost At 1 January Additions Disposals Exchange adjustments At 31 December Impairment At 1 January Additions (write back) Exchange adjustments At 31 December Net book amount at 31 December The recoverable amount is the value in use of the asset. A discount factor of 10% has been used in the current estimate of value in use. Considerations in relation to potential impairment of E&E assets are similar to those in relation to potential impairment of goodwill described in note 10 above. The Parent Company has no exploration and evaluation assets. 12. Farm out disposal On 25 May 2010, the company entered into an agreement under which it assigned part of its interest in the Bankanai PSC to Elnusa Bangkanai Energy Limited, the operator of the PSC. Under the agreement, the Group’s existing 34.99% interest was reduced to 5% on a carry basis such that the Group is carried through the costs of two forthcoming obligatory exploration wells and also through the costs of developing the Kerendan gas field up to the point of the first production of gas. The book value of the Company’s 34.99% interest in the Bangkanai PSC was £16.5 million as at 25 May 2010. Since the Group will not receive any cash consideration pursuant to the farm out agreement (other than its share of future net revenues receivable under the retained 5% carry) the carrying value of the Company’s interest in the Bangkanai PSC has been written down accordingly in these accounts by £14.2 million. The amounts written down were: Non current assets Property, plant and equipment Intangible assets Exploration and evaluation assets Other debtors Current assets Other debtors Prepayments Current liabilities Trade and other payables Non current liabilities Deferred tax liabilities Net written down £'000 7 3,661 14,051 304 43 14 (209) (3,661) 14,210 39 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 40 Sound Oil Notes to the Financial Statements continued 13 Investment in subsidiaries Company At 1 January Adjustments to original cost of investment At 31 December 2009 £‘000’s 22,631 2,202 24,833 2010 £‘000’s 24,833 (496) 24,337 The subsidiary undertakings of the Company at 31 December 2010 which are all 100% owned by the Company are: Name Sound Oil International Limited Sound Oil Asia Limited* Mitra Energia Limited* Mitra Energia Citarum Limited* Mitra Energia Bankanai Limited* Incorporated Principal activity British Virgin Islands British Virgin Islands Mauritius Mauritius Mauritius Holding company Holding company Holding and services company Exploration company Exploration company *The investments in Mitra Energia Limited, Mitra Energia Citarum Limited, Mitra Energia Bankanai Limited and Sound Oil Asia Limited are held indirectly via Sound Oil International Limited through non-current, non-interest bearing loans from Sound Oil plc. Given that Sound Oil plc has no intention to call on the loans in the foreseeable future, the loans are treated as “permanent as equity”. As a result, Sound Oil plc has classified these loans as investments which represent the carrying value of the investment in the Mitra group of companies. 14 Other debtors Group Indonesian VAT recoverable from future production UK VAT recoverable Deferred expenditures Other receivables Total Currency analysis US Dollar GBP Sterling Total 40 2009 2010 Current £’000’s Non-current £’000’s Current £’000’s Non-current £’000’s – 28 – 164 192 692 – – 100 792 – 29 2,861 50 2,940 591 – – 30 621 2009 2010 Current £’000’s Non-current £’000’s Current £’000’s Non-current £’000’s 131 61 192 792 – 792 24 2,916 2,940 617 4 621 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 41 Annual Report 2010 14 Other debtors - continued Company UK VAT recoverable Deferred expenditure Other receivables Total Currency analysis US Dollar GBP Sterling Total 2009 2010 Current £’000’s Non-current £’000’s Current £’000’s Non-current £’000’s 28 – 6 34 – – – – 29 2,861 1 2,891 – – 4 4 2009 2010 Current £’000’s Non-current £’000’s Current £’000’s Non-current £’000’s – 34 34 – – – – 2,891 2,891 – 4 4 Indonesian VAT is recoverable on commencement of production. Other current receivables are due within thirty days and non-current receivables are due within one to two years. 15 Cash and short term deposits Group Cash at bank and in hand Cash equivalents: Short term deposits Cash in hands of joint venture operators Carrying amount at 31 December Company Cash at bank and in hand Cash equivalents: Short term deposits Carrying amount at 31 December 2009 £‘000’s 1,627 8,699 10,326 296 10,622 2009 £‘000’s 1,155 8,699 9,854 Included in cash and short term deposits at 31 December 2010 were amounts of £3.77 million denominated in US$(2009: £7.2 million). 2010 £‘000’s 870 3,614 4,484 – 4,484 2010 £‘000’s 717 3,614 4,331 41 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 42 Sound Oil Notes to the Financial Statements continued 2009 Current £’000’s 328 78 226 265 897 2009 Current £’000’s 564 333 897 2009 Current £’000’s 149 20 164 – 333 2009 Current £’000’s – 333 333 2010 Current £’000’s 60 32 154 38 284 2010 Current £’000’s 118 166 284 2010 Current £’000’s 34 20 112 – 166 2010 Current £’000’s – 166 166 16 Trade and other payables Group Trade payables Payroll taxes and social security Accruals Other payables Total Currency analysis US Dollar GBP Sterling Total Company Trade payables Payroll taxes and social security Accruals Other payables Total Currency analysis US Dollar GBP Sterling Total All current liabilities are due within thirty days and are carried at amortised cost. 42 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 43 Annual Report 2010 17 Deferred tax assets and liabilities 1 January Acquisitions Released on disposals Unrealised foreign exchange (decrease)/increase 31 December 2009 £‘000’s 5,277 – – (480) 4,797 2010 £‘000’s 4,797 – (3,413) 141 1,525 The deferred tax liability arose on the tax difference between the carrying value of the exploration and evaluation assets and the tax value of those assets. Unrecognised deferred tax assets Deferred tax assets have not been recognised in respect of the following items: Tax losses 2009 £’000’s 551 2010 £’000’s 772 Deferred tax assets have not been recognised in respect of the losses due to uncertainty of utilisation of these losses. 18 Non-current provisions Employee post employment benefits At 1 January Addition Utilised Unrealised foreign exchange (decrease)/increase At 31 December 2009 £’000’s 104 11 – (10) 105 2010 £’000’s 105 5 – (7) 103 The Group’s principal subsidiary provides employee post employment benefits in accordance with Indonesian law. This provision is measured using a projected unit credit method. The liability for long service and annual leave is recognised in the provision for employee benefits and measured as the present value of expected future payments to be made in respect of services provided by employees up to the reporting date. Consideration is given to expected future wage and salary levels, experience of employee departures, and periods of service. Expected future payments are discounted using market yields at the reporting date on national government bonds with terms to maturity and currencies that match, as closely as possible, the estimated future cash outflows. There are no provisions in the parent Company. 43 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 44 Sound Oil Notes to the Financial Statements continued 19 Capital and reserves Group Ordinary shares – 0.1p Issued Company Ordinary shares – 0.1p Issued Number of shares Number of shares 2009 £’000s 692,427,348 692 692,427,348 Number of shares Number of shares 2009 £’000s 692,427,348 692 692,427,348 2010 £’000s 692 2010 £’000s 692 Share option schemes Options to subscribe for the Company’s shares were granted to certain executives in 2006, 2007 and 2010 (note 23). No Share Accumulated retained premium earnings/(deficit) £’000’s £’000’s 35,764 – – – 35,764 35,764 – – – 35,764 (6,530) (15,968) – 16 (22,482) (3,927) (2,620) – 17 (6,530) Total £’000’s 32,956 (15,968) 711 16 17,715 37,818 (2,620) (2,259) 17 32,956 options were granted in 2008 and 2009. Reserves Group Foreign currency reserve £’000’s 3,030 – 711 – 3,741 5,289 – (2,259) – 3,030 Share capital £’000’s 692 – – – 692 692 – – – 692 At 1 January 2010 (Loss) for the year Foreign currency translation Share based payments At 31 December 2010 At 1 January 2009 (Loss) for the year Foreign currency translation Share based payments At 31 December 2009 44 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 45 Annual Report 2010 19 Capital and reserves - continued The foreign currency reserve represents accumulated exchange differences relating to the translation of net assets of the Group’s foreign operations from their functional currency to the Group’s presentational currency which are recognised directly in other comprehensive income and accumulated in the foreign currency reserve. Company At 1 January 2010 (Loss) for the year Share based payments At 31 December 2010 At 1 January 2009 (Loss) for the year Share based payments At 31 December 2009 Share capital £’000’s 692 – – 692 692 – – 692 Share Accumulated retained premium earnings/(deficit) £’000’s £’000’s 35,764 – – 35,764 35,764 – – 35,764 (2,008) (3,004) 16 (4,996) 33 (2,059) 18 (2,008) Total £’000’s 34,448 (3,004) 16 31,460 36,489 (2,059) 18 34,448 20 Related party disclosures For the year ended 31 December 2010 The financial statements include the financial statements of Sound Oil plc (the parent) and the subsidiaries listed in the following table: Name Country of incorporation % equity interest Sound Oil International Limited Sound Oil Asia Limited Mitra Energia Limited Mitra Energia Bangkanai Limited Mitra Energia Citarum Limited British Virgin Islands British Virgin Islands Mauritius Mauritius Mauritius 2009 100 100 100 100 100 2010 100 100 100 100 100 The Company’s only direct subsidiary was Sound Oil International Limited and its investment is carried at cost. The Group has investments in joint venture undertakings which operate the Bangkanai PSC and the Citarum PSC in Indonesia. The Group’s interest in the former at the end of 2010 was 5.00% (2009: 34.99%) and in the latter 20% (2009: 20%). Terms and conditions of transactions with related parties There were no sales or purchases to or from related parties (2009: none). There have been no guarantees provided or received for any related party receivables or payables. For the year ended 31 December 2010, the Group has not recorded any impairment of receivables relating to amounts owed by related parties (2009: none). This assessment is undertaken each financial year through examining the financial position of the related party and the market in which it operates. There were no transactions with other related parties, directors’ loans and other directors’ interests. 45 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 46 Sound Oil Notes to the Financial Statements continued 20 Related party disclosures - continued Compensation of key management personnel of the Group There are three key management personnel other than directors of the Company (none in 2009). Details of the remuneration of the Directors are set out in the Report of Directors’ Remuneration (page 15). Remuneration of the key management personnel was £310,000 in 2010. Directors’ interest in employee share options Share options held by the executive members of the Board of Directors have the following expiry dates and exercise prices: Issue date 2006 2007 2007 2007 2010 Expiry date Exercise price pence 2012 2017 2018 2019 2013 7.25 4.38 4.38 4.38 1.50 Number 2006 1,400,000 - - - - Number 2007 - 667,667 667,667 667,666 – Key management’s interest in employee share options Issue date Expiry Exercise price pence date 2006 2006 2007 2010 2012 2011 2017 2013 7.25 4.75 4.38 1.50 Number 2008 Number 2009 Number 2010 - - - - - – – – – – Number 2006 700,000 500,000 - - Number 2009 - – 2,250,000 – 1,725,000 Number 2010 – – – 3,105,000 21 Financial instruments risk management objectives and policies Capital Management The Group’s objectives when managing capital are to safeguard the Group’s ability to continue as a going concern in order to provide returns for shareholders, benefits for other stakeholders and to maintain optimal capital structure to reduce the cost of capital. Management considers, as part of its capital, the financial sources of funding from shareholders and third parties. In order to ensure an appropriate return for shareholder capital invested in the Group, management thoroughly evaluates all material projects and potential acquisitions and has them approved by the Board where applicable. The Group’s principal financial instruments comprise of trade payables, receivables, cash and short term deposits. The fair value of the financial instruments is their carrying value. The main risks arising from the Group’s financial instruments are interest rate risk and foreign currency risk. The Board of Directors reviews and agrees policies for managing each of these risks which are summarised below: Interest rate risk The Group’s exposure to the risk of changes in market interest rate risks relates primarily to the Group’s deposit accounts and short term debt instruments. The Group’s policy is to manage this exposure by investing in short term low risk bank deposits. 46 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 47 Annual Report 2010 21 Financial instruments risk management objectives and policies - continued Interest rate risk table The following table demonstrates the sensitivity to a reasonably possible change in interest rates, with all other variables held constant, of the Group’s profit before tax. There is no impact on the Group’s equity. 2010 Sterling US Dollar Sterling US Dollar 2009 Sterling US Dollar Sterling US Dollar Increase/ (decrease) (%) Effect on profit before tax £’000’s 10 10 (10) (10) 10 10 (10) (10) 2 – (2) – 1 1 (1) (1) Foreign currency risk As a result of the bulk of the Group’s operations being denominated in US dollars, the Group’s balance sheet can be impacted by movements in the GBP/$USD exchange rates. Such movements will result in book gains or losses which are unrealised and will be offset if the currencies involved move in the opposite direction. The sterling cost of the assets being acquired with the US dollar deposits rises or falls pro rata to the currency movements, so the purchasing power of the US dollar deposits remains the same. The following table demonstrates the sensitivity to a reasonably possible change in the US dollar exchange rate, with all other variables held constant, of the Group’s profit or loss before tax. 2010 2009 Increase/ (decrease) in US dollar rate Effect on profit or loss before tax £’000’s 5% (5%) 5% (5%) (171) 189 (306) 339 Credit risk The Group currently has no sales or customers. The maximum credit exposure at reporting date of each category of financial assets above is the carrying value as detailed in the relevant notes. The Group only holds deposits in highly rated financial institutions. There are no significant concentrations of credit risk within the Group or the Company. Liquidity risk The Group and Company have significant liquid assets and are not materially exposed to liquidity risk. All financial liabilities are expected to mature within one year. 47 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 48 Sound Oil Notes to the Financial Statements continued 22 Financial instruments Interest rate risk and currency risk profiles The interest rate risk profile and the currency risk profile of the financial assets of the Group as at 31 December were: Currency 2010 Cash and short term deposits GBP Sterling US$ Total 2009 Cash and short term deposits GBP Sterling US$ Total Floating rate £’000’s Interest-free £’000’s Total Weighted average interest rate £’000’s 711 2,903 3,614 3,413 5,286 8,699 – 870 870 – 1,627 1,627 711 3,773 4,484 3,413 6,913 10,326 0.53% 0.15% US$ cash balances have been converted at the exchange rate on 31 December 2010 of US$1.5471 (2009: US$1.5928/£1.00) The floating rate cash and short-term deposits comprise of cash held in interest bearing accounts and deposits placed on the money markets for periods ranging from overnight to three months. Financial instruments exposed to interest rate risk (e.g. US Federal Rate and UK Base Rate) were floating rate cash assets maturing within 3 months £3,614,000: (2009: £8,699,000). Cash on which no interest is received of £870,000 (2009: £1,627,000) relates to balances available to meet immediate operating payments and was therefore only held for short periods interest-free. 48 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 49 Annual Report 2010 23 Share based payments The Group has no formal share options plan but share options have been granted to senior executives. The exercise prices of the options were equal to the market prices of the shares on the date of grant. The contractual life of each option granted ranged between five and nine years. The expense recognised for employee services received in the Consolidated Income Statement is as follows: Group Expense arising from equity settled share options Company Expense arising from equity settled share options 2009 £‘000’s 17 2009 £‘000’s 17 2010 £‘000’s 16 2010 £‘000’s 16 The fair value of equity-settled share options granted is estimated at the date of grant using a binomial model, taking into account the terms and conditions upon which the options were granted. In 2010, 7,220,000 share options were granted at 1.5p for a three year period. No options were granted in 2009. The expected life of the options is based on the maximum option period and is not necessarily indicative of exercise patterns that may occur. The expected volatility reflects the assumption that historical volatility is indicative of future trends, which may not necessarily be the actual outcome. No other features of options grant were incorporated into the measurement of fair value. No share options were forfeited or exercised in 2009 or 2010. Share options outstanding at end December 2010 were 14,070,000 and 2009 were 6,850,000. The weighted average exercise prices at end 2010 were 3.35 pence (2009: 5.30 pence). The weighted average contractual lives were 6.3 years at end 2010 and 9.7 years at end 2009. 24 Commitments and guarantees At 31 December 2010 the Group had capital commitments of £1,820,000 (2009: £10,552,000) on exploration and development licences. The Company had no capital commitments in 2010 (2009: Nil). Under the terms of the Citarum PSC the Company is required to spend US$3 million to fulfil its three year minimum work obligations. The Company has granted RAB Octane (Master) Fund Limited (“RAB”) the option to put to the Company the entire issued and allotted share capital, namely two ordinary shares, of Sound Oil Bangladesh Limited at any time up to 17 May 2086. If the put option is exercised, the maximum price payable by the Company will be 2,195,222 Ordinary Shares of the Company or, with the consent of both the Company and RAB, US$300,000 in cash. 49 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 50 Sound Oil Notes to the Financial Statements continued 25 Post balance sheet events Acquisition On 4 January 2011, the Company completed the acquisition of 96% of the issued share capital of Consul Oil & Gas Ltd (“Consul”), an unquoted company with interests in Italy, for a total consideration of £4.64 million and made an offer to acquire the remaining 4%. The consideration was satisfied by the payment in cash of approximately US$2.19 million (£1.39 million) and the issue of 269,127,983 ordinary shares to the vendors. In addition the Company purchased an existing loan from RAB to Consul of €1.5 million. On 29 January 2011 the Company acquired a further 2% of the issued share capital of Consul, satisfied by the payment in cash of US$46,667 and the issue of 5,555,555 new ordinary shares. A further 5,555,555 ordinary shares will be issued and payment of US$46,667 in cash if the remaining 2% of Consul is acquired. The provisional fair value of 100% of the assets of Consul is as follows: Intangible exploration & evaluation costs Tangible fixed assets Current debtors Non-current debtors Cash Current creditors Non-current creditors Deferred tax liabilities Net assets Book value IFRS £’000’s 3,446 10 254 29 45 (278) (926) – 2,580 Adjustments and/or revaluation £’000’s Fair value to the Company £’000’s 2,220 – – – – – – (688) 1,532 5,666 10 254 29 45 (278) (926) (688) 4,112 The directors consider that goodwill of approximately £690,000 will arise on the acquisition, consisting largely of the synergies expected from combining the operations of the Group and Consul. Share issues On 4 January 2011, the Company placed 311,251,000 new ordinary shares at 1.2p per share, raising approximately £3.7 million, and entered into a £10 million SEDA equity placing facility which can be drawn upon at the discretion of the Company. On 17 January 2011, the Company placed 230,000,000 new ordinary shares at 1.4p per share, raising approximately £3.22 million. On 12 March 2011, the Company drew down £1.0 million of the SEDA equity placing facility by way of the issue of 38,800,485 new ordinary shares at 2.557p per share. On 18 April 2011, the Company drew down a further £2.80 million of the SEDA equity placing facility by way of the issue of 54,337,384 new ordinary shares at 5.153p per share. The proceeds of the above share issues will be used to fund the enlarged group’s combined work programme and ongoing costs. 50 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 51 Annual Report 2010 Dealing Information FT Share Price Index – Telephone 0906 8433711 SEAQ short code – SOU Financial Calendar Announcements Interim – September 2011 Preliminary – May 2012 Addresses Registered Office Sound Oil plc, 55 Gower St, London, WC1E 6HQ Business Address Sound Oil plc, Riverbridge House, Guildford Road, Leatherhead, Surrey, KT22 9AD Website www.soundoil.co.uk Auditors Crowe Clark Whitehill LLP, St Bride’s House, 10 Salisbury Square, London, EC4Y 8EH Solicitors Ronaldsons LLP, 55 Gower St, London, WC1E 6HQ Stockbrokers finnCap Ltd, 60 New Broad Street, London, EC2M 1JJ Nominated Advisers finnCap Ltd, 60 New Broad Street, London, EC2M 1JJ Registrars Share Registrars Limited, Suite E, First Floor, 9 Lion and Lamb Yard, Farnham, Surrey GU9 7LL 51 220867 Sound Oil R&A 2010 pg15-end 26/05/2011 12:30 Page 52 Perivan Financial Print 220867 220867 Sound Oil R&A 2010 Cover 26/05/2011 12:25 Page iv Sound Oil plc Riverbridge House Guildford Road Leatherhead, Surrey KT22 9AD www.soundoil.co.uk Annual Report 2010