Hawk Energy Corp.
TSX VENTURE : HK.B
TSX VENTURE : HK.A

Hawk Energy Corp.

March 24, 2006 15:09 ET

Hawk Announces 2005 Results

CALGARY, ALBERTA--(CCNMatthews - March 24, 2006) - Hawk Energy Corp. (TSX:HK.A) (TSX:HK.B) ("Hawk" or "the Company") is pleased to announce its operating and financial results for the year ended December 31, 2005. Hawk has experienced strong growth this past year and has accomplished the following:

- Increased production over 2004 by 55%;

- Generated cash flow of $16,897,855 ($1.11 per diluted share) and net income of $6,754,786 ($0.44 per diluted share);

- Drilled 43 (37.6 net) wells, 44% of which were classified as exploration, resulting in 38 (34.4 net) producers for an overall success rate of 88% in 2005;

- Discovered 11 new gas pools and 2 new oil pools;

Analysis of the financial condition and the results of operations should be read in conjunction with the audited financial statements and related notes for the year ended December 31, 2005.

Production information is commonly reported in units of barrel of oil equivalent or boe. For the purposes of computing such units, natural gas is converted to equivalent barrels of oil using a conversion factor of six thousand cubic feet to one barrel of oil. The conversion ratio of 6:1 is based on an energy equivalency conversion method, which is primarily applicable at the burner tip. It does not represent equivalent wellhead value for the individual products. Such disclosure of boes may be misleading, particularly if used in isolation.

All amounts are in Canadian dollars unless otherwise stated.

This disclosure contains certain forward-looking estimates that involve substantial known and unknown risks and uncertainties, certain of which are beyond Hawk's control, including the impact of general economic conditions in Canada and the United States; industry conditions; changes in laws and regulations including the adoption of new environmental laws and regulations and changes in how they are interpreted and enforced; increased competition; the lack of availability of qualified personnel or management; fluctuations in commodity prices; foreign exchange or interest rates; stock market volatility and obtaining required approvals of regulatory authorities. Hawk's actual results, performance or achievement could differ materially from those expressed in, or implied by, these forward-looking estimates and, accordingly, no assurances can be given that any of the events anticipated by the forward-looking estimates will transpire or occur, or if any of them do so, what benefits, including the amounts of proceeds, that Hawk will derive therefrom.

The term "cash flow from operating activities" or "cash flow", which is expressed before changes in non-cash working capital, is used by the Company to analyze operating performance, leverage and liquidity. The term "netback", which is calculated as the average unit sales price, less royalties and operating expenses, represents the cash margin for every barrel of oil equivalent sold. These terms do not have any standardized meaning prescribed by the Canadian Generally Accepted Accounting Principles (GAAP) and, therefore, might not be comparable with the calculation of a similar measure for other companies.



Production

Year ended December 31 % Change
2005 2004
------------ -----------
Natural Gas (mcf/d) 6,628 3,932 69
Oil (bbls/d) 580 433 34
NGL's (bbls/d) 22 13 69
------------ -----------
Total (boe/d) 1,707 1,101 55


The Company added production during 2005 exclusively through drilling and optimization activities. Twelve new gas wells were tied in and brought on production in the Retlaw, Edmonton, Chinook, Birch and Veteran areas. Also, thirteen new oil wells have been drilled and placed on production in the Retlaw, Veteran, Lloydminster and southeast Saskatchewan areas.



Petroleum and Natural Gas Sales ($)

Year ended December 31 % Change
2005 2004
------------ -----------
Oil sales 11,898,952 7,210,187 65
Per barrel 56.22 45.65 23
Natural gas sales 20,499,179 8,912,613 130
Per mcf 8.47 6.21 36
NGL sales 447,740 216,262 107
Per barrel 55.72 46.93 19
------------ -----------
Total Sales 32,845,870 16,339,062 101


During 2005, Hawk received $56.22 per barrel for its oil production, a 23% increase over the average oil price received in 2004. Hawk's 2005 oil production was comprised of 71% light oil originating from southeast Saskatchewan, where the Company received an average price of $60.85 per barrel; 10% heavy oil originating from Lloydminster, western Saskatchewan, where the Company received an average price of $33.75 per barrel and 19% from light - medium oil originating from its Veteran, Endiang, Wood River and Retlaw properties in east central and southern Alberta, where the Company received an average price of $51.15 per barrel. In 2005, the Company received $8.47/mcf for its gas production, a 36% increase over the average gas price received in 2004. Approximately 95% of Hawk's gas was produced from Alberta properties, 1% was produced from western Saskatchewan and 4%, primarily associated gas from the oil production, was produced from southeast Saskatchewan. The Company received $55.72 per barrel for its NGL production. Hawk produced 8,036 barrels of NGL's in conjunction with gas production from thirteen of its properties.

The Company had no hedging contracts during 2005.



Royalties

Year ended Year ended
December 31, 2005 December 31, 2004
Royalty Royalty
($) Rate (%) ($) Rate (%)
----------- -------- ----------- --------
Crown 5,567,846 17.0 2,832,855 17.3
Freehold 1,717,816 5.2 1,155,534 7.1
Gross Overriding 1,280,987 3.9 804,613 4.9
Royalty Income nil 0.0 (19,547) (0.1)
ARTC (500,000) (1.5) (500,000) (3.1)
----------- -------- ----------- --------
Total 8,066,649 24.6 4,273,455 26.1


Hawk's 2005 gas royalties were 27.7% compared with 28.2% in 2004. Hawk's gas royalties are predominantly Crown and attract the ARTC. During 2005, Hawk's oil royalties, which are comprised of Crown, freehold and gross overriding royalties, were 18.7%. Over the same period in 2004, Hawk's oil royalty rate averaged 23.4%. Hawk's oil royalties decreased in 2005 as a result of drilling numerous new oil wells which attracted royalty holidays. Hawk's average royalty rate for NGL production in 2005 was 38.7% as compared with 33.2% in 2004.



Operating Expenses

Year ended Year ended
December 31, 2005 December 31, 2004
($) ($/boe) ($) ($/boe)
----------- -------- ----------- --------
Production expense 5,340,209 8.57 3,152,326 7.85
Processing income (42,889) (0.07) (74,433) (0.19)
----------- -------- ----------- --------
Operating expense 5,297,320 8.50 3,077,893 7.66
Transportation expense 651,802 1.05 259,613 0.65
----------- -------- ----------- --------
Total production expense 5,949,122 9.55 3,337,506 8.31


During 2005 Hawk's total unit operating cost was $9.55/boe. This compares with the Company's 2004 unit operating cost of $8.31/boe. Hawk's 2005 natural gas expense was $0.97/mcf or $5.82/boe compared with $0.78/mcf for the same period in 2004. Increased gas gathering and processing fees accounted for the majority of the increase. The Company's oil and NGL operating expense in 2005 was $13.96/boe and compared with $12.38/boe for the same period in 2004. A large portion of the increase in oil related operating costs can be attributed to increased fuel and power costs as well as a increase in the frequency of workovers required. Hawk's transportation expense was $1.05/boe in 2005 and compares with $0.65/boe for the similar period in 2004. The increase in transportation expense is attributed to longer hauling distances with the new wells brought onstream as well as increases in the unit hauling rate.



Field Netbacks

Year ended Year ended
December 31, 2005 December 31, 2004
Oil & Oil &
NGL Gas Boe NGL Gas Boe
Netback Netback Netback Netback Netback Netback
($/bbl) ($/mcf) ($/boe) ($/bbl) ($/mcf) ($/boe)
Sales price 56.20 8.47 52.73 45.68 6.21 40.67
Royalties (10.91) (2.34) (12.95) (10.83) (1.75) (10.64)
Production expense (16.55) (1.01) (9.55) (13.71) (0.77) (8.31)
Field Netback 28.74 5.12 30.23 21.14 3.69 21.72


The Company's field netbacks are derived from subtracting royalties and production expense from the sales price. The Company's field netback increased 39% over 2004.



General and Administrative Expense (G&A)

Year ended Year ended
December 31, 2005 December 31, 2004
($) ($/boe) ($) ($/boe)
----------- -------- ----------- --------
Gross G&A Expense 1,816,360 2.92 1,260,942 3.14
Capitalized Overhead (551,146) (0.89) (422,645) (1.05)
----------- -------- ----------- --------
Net G&A Expense 1,265,214 2.03 838,297 2.09


The Company's Gross G&A Expense was $1,816,360 in 2005, an increase of 44% over the same period in 2004. The increase is partially attributable to the management of a higher production base. Hawk capitalized the portion of its G&A expense which was directly related to the geological and geophysical work performed to generate exploration prospects. During 2005, the Company's net G&A was $1,265,214 or $2.03/boe. On a unit basis this represents a 3% reduction in comparison to 2004.

Interest and Stock-Based Compensation Expense

The Company incurred a net interest expense of $302,453 in 2005 compared to a net interest expense of $37,025 generated in 2004. The interest expense was higher in 2005 because the Company utilized a larger portion of its credit facility to partially fund the 2005 drilling program.

Hawk's stock-based (non-cash) compensation expense was $473,118 or $0.76 per boe in 2005 compared to $604,598 or $1.50 per boe in 2004. These values were calculated using the Black-Scholes option-pricing model. The assumptions used in the Black-Scholes model were expected volatility of 150%, risk free interest rate of 4% with an estimated life of 3 years.



Depletion, Amortization and Accretion Expense

Year ended Year ended
December 31, 2005 December 31, 2004
($) ($/boe) ($) ($/boe)
----------- ------- ----------- ------

Depletion Expense 4,516,471 7.25 2,296,010 5.72
Amortization Expense 1,308,806 2.10 679,006 1.69
Accretion Expense 139,328 0.23 121,639 0.30
Total 5,964,605 9.58 3,096,655 7.71


Hawk follows the full cost method of accounting as described in the CICA's Accounting Guideline 16, "Oil and Gas Accounting - Full Cost". Accordingly, the cost of all wells, both successful and unsuccessful, are added to the Company's capital base and are depleted at the rate of production over the remaining proven reserves as determined by the independent engineering report. During 2005, the Company's depletion, amortization and accretion expense was $5,964,605 or $9.58/boe versus $7.71/boe in 2004. The majority of the increase is attributable to the higher costs of adding reserves in 2005.

Income Taxes

On June 9, 2003, the Canadian government substantially enacted federal income tax changes for the oil and natural gas sector as it had outlined in its 2003 budget. Resource tax rates will decline from the current 27 percent to 21 percent by 2007. Concurrently, the 100 percent deductibility of the resource allowance is being phased out and Crown charges will become 100 percent deductible.

During 2005, Hawk incurred current taxes of $364,577 and made a provision for future income taxes of $3,705,346. The current tax expense is the result of the Saskatchewan tax and resource surcharge.

The Company had the following income tax pools available at December 31, 2005:



Annual Deduction Tax
Available Pools
----------------- -------------
Canadian exploration expenses (CEE) 100% $ 2,551,299
Canadian development expenses (CDE) 30% 8,447,901
Canadian oil and gas property expenses (COGPE) 10% 7,342,135
Undepreciated capital costs 25% 12,623,478
Share Issue Cost 100% 855,010
Non-capital losses carried forward 100% 0
-------------
Total $31,819,823
-------------
-------------


Cash Flow from Operations

Year ended Year ended
December 31, 2005 December 31, 2004
$ $/boe $ $/boe
----------- ------- ----------- ------
Petroleum and natural gas
revenue 32,845,870 52.73 16,339,062 40.67
Royalties, net of ARTC (8,066,649) (12.95) (4,273,455) (10.63)
Net Interest (expense) (302,453) (0.49) (37,025) (0.09)
Operating costs and
transportation (5,949,122) (9.55) (3,337,506) (8.31)
General and administrative (1,265,214) (2.03) (838,297) (2.09)
Current taxes (364,577) (0.58) (236,257) (0.59)
----------- ------- ----------- ------
Cash flow from Operations 16,897,855 27.13 7,616,522 18.96


In 2005, the Company generated cash flow from operating activities of $16,897,855 ($1.11 per diluted share). This represents an increase of 122% versus 2004. The increase resulted from increased production rates and stronger commodity prices.

Net Income and Cash Flow from Operating Activities

Net Income is derived from cash flow from operating activities less stock-based compensation, depletion, amortization & accretion expense and future income tax. There has been a substantial increase in net income due to production growth and to a lesser extent an increase in the commodity price.



Year ended Year ended
December 31, 2005 December 31, 2004
$/ $/
diluted diluted
$ share $ share
----------- -------- ----------- -------
Cash flow from operating
activities 16,897,855 1.11 7,616,522 0.50
Less: Stock-based
compensation 473,118 0.03 604,598 0.04
Depletion,
amortization & Accretion
expense 5,964,605 0.39 3,096,655 0.20
Future income taxes 3,705,346 0.24 1,407,556 0.09
----------- -------- ----------- -------
Net income 6,754,786 0.44 2,507,713 0.17


Capital Expenditures ($)

Year ended Year ended
December 31, 2005 December 31, 2004
Land and lease retention 2,530,975 2,342,092
Seismic 1,715,892 2,279,769
Drilling and completions 18,811,405 11,336,462
Geological and geophysical salaries
capitalized 551,146 422,645
Facilities 7,130,961 4,524,421
Corporate assets (1) 5,910 6,546
------------------ ------------------
Total Gross Expenditures 30,746,289 20,911,935
Dispositions nil (1,255,581)
------------------ ------------------
------------------ ------------------
Total Net Expenditures 30,746,289 19,646,354

(1) Corporate assets include office improvements, equipment, computer
hardware and software.


The Company incurred gross capital expenditures of $30,746,289 in 2005 drilling a total of 43 (38.3 net) wells.

Liquidity and Capital Resources

On August 5, 2005, the Company entered into a revolving demand credit facility agreement with a bank for $16,000,000 at an interest rate of prime plus one-quarter percent per year. This credit facility is collateralized by a general assignment of book debts and a $25,000,000 debenture with a floating charge over all assets of the Company and will be reviewed periodically. As at December 31, 2005, $12,800,000 was drawn on the bank facility and consequently the Company was not in compliance with the working capital covenant required by the bank. Subsequent to the year end, the bank waived this covenant breach in writing and increased its demand credit facility to $22,000,000 at an interest rate of prime plus one-eighth percent per year effective January 13, 2006.



Contractual Obligations

The Company is committed to the following minimum annual lease payment
plus operating cost under a rental agreement for office space until
September 30, 2007.


2006 $50,197
2007 $38,766


Dividend Policy

Hawk pays no dividends as all cash generated from operations is used to finance the drilling operations, acquisition activities and fund the debt costs of the Company.

Quarterly Results ($)

The following table summarizes certain quarterly financial information relating to the Company.



Petroleum and Net Income
Quarter Ended Natural Gas Revenue Cash Flow (loss) (loss)
December 31, 2005 9,872,331 4,931,877 1,806,133
September 30, 2005 8,835,494 4,787,387 2,115,720
June 30, 2005 6,968,954 3,428,671 1,305,707
March 31, 2005 7,169,091 3,749,920 1,527,226
December 31, 2004 6,238,091 2,846,830 1,046,223
September 30, 2004 4,169,515 2,062,758 632,357
June 30,2004 3,345,385 1,540,429 449,721
March 31, 2004 2,586,071 1,166,507 408,841
December 31, 2003 1,334,781 475,015 55,482
September 30, 2003 249,103 118,139 1,950
June 30, 2003 50,639 (24,406) (25,091)
March 31, 2003 - (10,750) (10,750)


Summary of Fourth Quarter Information ($)

Quarter ended December 31 % Change
2005 2004
---------- ----------
Production (boe/d) 1,711 1,576 9
Revenue 9,872,331 6,238,091 58
Per boe 62.73 43.03 46
Royalty 2,559,385 1,853,759 38
Per boe 16.26 12.79 27
Operating Costs 1,626,723 1,145,089 42
Per boe 10.34 7.90 31
G&A Expense 529,279 287,846 84
Per boe 3.36 1.98 70
Net Interest 120,559 42,170 186
Per boe 0.77 0.29 166
Current Tax 104,508 62,396 67
Per boe 0.66 0.43 53
Cash Flow 4,931,877 2,846,830 73
Per boe 31.34 19.64 60
------------------------------------------------------------------------
------------------------------------------------------------------------


In comparing the fourth quarter of 2005 with the same period in 2004:

- production increased by only 9% due to difficulties tieing in gas wells. The majority of these wells came on production during late December or earlier 2006;

- per unit revenue received increased by 46% due to stronger oil and natural gas prices;

- per unit royalty increased by 27% as a result of increased prices received;

- per unit G&A increased by 70% as a result of increased corporate activity associated with the sale of the Company;

- per unit cash flow increased by 60%, largely as a result of higher commodity prices.



2005 Stock Price and Trading Activity


Class A 1st Q 2nd Q 3rd Q 4th Q 2005
--------- -------- ------- -------- ----------
High $5.00 $5.31 $6.75 $6.10 $6.75
Low 3.59 4.16 4.91 5.05 3.59
Close 4.90 5.15 5.90 6.00 6.00
Volume 2,380,195 321,477 532,325 387,770 3,621,767

Class B 1st Q 2nd Q 3rd Q 4th Q 2005
--------- -------- ------- -------- ----------
High $8.50 $8.10 $8.50 $8.60 $8.60
Low 7.10 7.54 8.05 8.12 7.10
Close 7.35 8.10 8.50 8.12 8.12
Volume 17,000 52,688 7,800 18,230 95,718
------------------------------------------------------------------------
------------------------------------------------------------------------


Disclosure Controls and Procedures

As at the financial year ended December 31, 2005, an evaluation was carried out under the supervision of and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company's disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective as at December 31, 2005 to provide reasonable assurance that material information relating to the Company would be made known to them by others within those entities.

Critical Accounting Policies

A summary of significant accounting policies is presented in Note 2 to the financial statements. In accounting for oil and natural gas activities, the Company has a choice between two acceptable accounting policies: full cost and successful efforts. Hawk follows the full cost method.

Critical Accounting Estimates

Preparing financial statements in accordance with GAAP requires management to make certain judgments and estimates. Changes to these judgments and estimates could have a material effect on the Company's financial statements and financial position. The estimates of proved and probable reserves is critical to many aspects of the Company's financial statements, including net income through the calculation of depletion, the determination of the asset retirement obligation and the application of the ceiling test calculation. Management's judgment of fair value is also critical. The carrying amount of property, plant and equipment, as well as the amount recorded for depletion, depreciation and accretion (DD&A) can be affected by these judgments. Actual results will vary and the variations may be significant.

Business risks

The oil and natural gas industry is subject to numerous risks that can affect the amount of cash flow from operating activities and the ability to grow. These risks include but are not limited to:

- fluctuations in commodity price, exchange rates and interest rates;

- government and regulatory risk in respect of royalty and income tax regimes;

- operational risks that may affect the quality and recoverability of reserves;

- geological risk associated with accessing and recovering new quantities of reserves;

- transportation risk in respect of the ability to transport oil and natural gas to market;

- capital markets risk and the ability to finance future growth;

- weather risk in respect of the ability to enter and drill wells in some wet areas;

- gas processing risk in respect of the ability to process gas into third party owned facilities; and

- regulatory risk in respect of the ability to license and produce sour wells in populated areas.

Hawk strives to minimize these business risks by:

- employing management and technical staff with extensive industry experience;

- adhering to a strategy of exploring, developing, acquiring and optimizing quality, low-risk reserves in areas where we have technical and operational expertise;

- developing a diversified, balanced asset portfolio that generally offers developed operational infrastructure, year-round access and close proximity to markets;

- maintaining a low cost structure to maximize cash flow and profitability;

- maintaining prudent financial leverage and developing strong relationships with the investment community and capital providers;

- adhering to strict guidelines and reporting requirements with respect to environmental, health and safety practices;

- maintaining an adequate level of property, casualty, comprehensive and directors' and officers' insurance coverage;

- scheduling the drilling of wells in wet areas in the winter months;

- securing gas processing agreements before gas wells are drilled; and

- investigating anticipated well licensing difficulties before land is purchased.

2006 Outlook

On March 6, 2006, Hawk entered into a definitive agreement with Flagship Energy Inc. ("Flagship") whereby Flagship will, subject to certain conditions, make a formal take-over bid offer (the "Offer") to acquire all of the issued and outstanding Class A and Class B shares of Hawk.

Hawk Class A shareholders will, at their election, subject to the maximum amounts set forth below, receive either $8.25 cash or 1.5566 Flagship Class A shares or 1.2692 Flagship Class B shares, or some combination thereof. Hawk Class B shareholders will, at their election, subject to the maximum amounts set forth below, receive either $10.00 cash or 1.8868 Flagship Class A shares or 1.5385 Flagship Class B shares, or some combination thereof. The total consideration offered by Flagship is subject to a maximum of $33.6 million cash, 16 million Flagship Class A shares and 3 million Flagship Class B shares. In no event shall Flagship issue more than 17.2 million Flagship Class A and Class B shares, in aggregate.

The total acquisition cost is $141 million, including approximately $126 million for all of the outstanding Hawk shares and the assumption of $15 million of net debt, at closing.

The Offer will be subject to certain conditions, including the deposit of not less than 90% of the outstanding Class A shares of Hawk and 90% of the outstanding Class B shares of Hawk, on a fully-diluted basis, receipt of all required regulatory approvals and other customary conditions.

Additional information is filed on SEDAR at www.sedar.com.

This MD&A is dated March 24, 2006.

SHAREHOLDER INFORMATION



DIRECTORS OFFICE

Steve Fitzmaurice, P. Eng. Suite 490, 734 - 7th Avenue S.W.
President, Chief Executive Officer & Calgary, Alberta T2P 3P8
Chairman of the Board
Hawk Energy Corp. Telephone: (403) 262-1204
Fax: (403) 313-4295
Dave Bonnar, P. Geol.
Vice President, Corporate Development AUDITORS
Hawk Energy Corp.
PricewaterhouseCoopers LLP
Thomas Buchanan, CA(1,2,3) Calgary, Alberta
Chief Executive Officer
Provident Energy Ltd. BANKERS

John Wright, P. Eng., CFA(1,2,3) National Bank of Canada
President and Chief Executive Officer Calgary, Alberta
Petrobank Energy and Resources Ltd.
TRANSFER AGENT
Greg Turnbull, LLB(1,2)
Partner Computershare Investor Services
McCarthy Tetrault LLP Calgary, Alberta

OFFICERS SOLICITORS

Steve Fitzmaurice, P. Eng. McCarthy Tetrault LLP
President & Chief Executive Officer Calgary, Alberta
Erik DeWiel, P. Land STOCK EXCHANGE LISTING
Vice President, Land and Corporate
Secretary
The TSX Venture Exchange
Randy Deobald, P. Geol. Trading Symbol: HK.A & HK.B
Vice President, Exploration
ENGINEERING CONSULTANTS
Dave Bonnar, P. Geol.
Vice President, Corporate Development Gilbert Laustsen Jung
Associates Ltd.
Calgary, Alberta
M.H.(Mike) Shaikh, C.A.
Chief Financial Officer

(1) members of the audit committee
(2) members of the reserve committee
(3) members of the compensation committee

HAWK ENERGY CORP.
Financial Statements
December 31, 2005 and 2004


AUDITORS' REPORT

To the Shareholders of Hawk Energy Corp.

We have audited the balance sheets of Hawk Energy Corp. as at December 31, 2005 and 2004 and the statements of operations and retained earnings (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

In our opinion, these financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2005 and 2004 and the results of its operations and its cash flows for the years ended in accordance with Canadian generally accepted accounting principles.



Calgary, Alberta
March 20, 2006 Chartered Accountants


HAWK ENERGY CORP.

Balance Sheet

December 31
(All amounts in Canadian Currency)

2005 2004
------------ ------------

ASSETS

Current
Cash $ - $ 491,606
Accounts receivable 6,005,847 3,904,957
Prepaid expenses 109,774 81,669
------------ ------------
6,115,621 4,478,232

Property, plant and equipment,
net (Note 3) 56,700,025 31,093,025
------------ ------------

$ 62,815,646 $ 35,571,257
------------ ------------
------------ ------------

LIABILITIES AND SHAREHOLDERS' EQUITY

Current
Bank indebtedness $ 275,756 $ -
Bank loan (Note 4) 12,800,000 -
Accounts payable and accrued
liabilities 11,010,404 8,529,032
Income taxes payable 126,080 197,384
------------ ------------
24,212,240 8,726,416

Future income taxes (Note 5) 8,105,376 4,400,030

Asset retirement obligations (Note 6) 2,536,946 1,711,631
------------ ------------
34,854,562 14,838,077
------------ ------------
Shareholders' equity
Share capital (Note 7) 17,521,514 17,521,514
Contributed surplus (Note 7(b)) 1,155,480 682,362
Retained earnings 9,284,090 2,529,304
------------ ------------
27,961,084 20,733,180
------------ ------------

$ 62,815,646 $ 35,571,257
------------ ------------
------------ ------------
Commitments (Note8)

Approved on behalf of the Board

_____________________________ Director

_____________________________ Director

See Accompanying Notes


HAWK ENERGY CORP.

Statement of Operations and Retained Earnings (Deficit)

For the Year Ended December 31,
(All amounts in Canadian Currency)

2005 2004
---------------------------

Revenue
Petroleum and natural gas sales $ 32,845,870 $ 16,339,062
Royalties (8,066,649) (4,273,455)
Interest income 1,300 45,371
---------------------------
24,780,521 12,110,978
---------------------------

Expenses
Operating 5,297,320 3,077,893
Transportation 651,802 259,613
General and administrative 1,265,214 838,297
Stock-based compensation (Note 7(b)) 473,118 604,598
Interest 303,753 82,396
Depletion, amortization and accretion 5,964,605 3,096,655
---------------------------
13,955,812 7,959,452
---------------------------

Income before income taxes 10,824,709 4,151,526
---------------------------

Provision for income taxes (Note 5)
Current 364,577 236,257
Future 3,705,346 1,407,556
---------------------------
4,069,923 1,643,813
---------------------------

Net income 6,754,786 2,507,713
---------------------------

Retained earnings (deficit), beginning of
period 2,529,304 (12,753)
Adjustment for change in accounting policy
(Note 6) - 34,344
---------------------------
2,529,304 21,591
---------------------------

Retained earnings, end of period $ 9,284,090 $ 2,529,304
---------------------------
---------------------------

Income per share, basic (Note 9) $ 0.47 $ 0.17
---------------------------
---------------------------

Income per share, diluted (Note 9) $ 0.44 $ 0.17
---------------------------
---------------------------

See Accompanying Notes


HAWK ENERGY CORP.

Statement of Cash Flows

For the Year Ended December 31,
(All amounts in Canadian Currency)

2005 2004
------------- -------------

Cash provided by operating activities
Net income $ 6,754,786 $ 2,507,713
Items not affecting cash:
Stock-based compensation 473,118 604,598
Depletion, amortization and accretion 5,964,605 3,096,655
Future income taxes 3,705,346 1,407,556
------------- -------------

Cash flow from operating activities before
changes in non-cash working capital 16,897,855 7,616,522
------------- -------------

Changes in non-cash working capital:
Accounts receivable (1,439,065) (1,741,828)
Prepaid expenses (28,105) 38,636
Accounts payable and accrued liabilities 584,100 2,461,299
Income taxes payable (71,304) 159,658
------------- -------------
(954,374) 917,765
------------- -------------
15,943,481 8,534,287
------------- -------------
Cash used in investing activities
Additions of property, plant and equipment (30,746,289) (20,911,935)
Proceeds on disposition of property, plant
and equipment - 1,255,581
Changes in non-cash working capital for
investing activities 1,235,446 2,383,064
------------- -------------
(29,510,843) (17,273,290)
------------- -------------
Cash provided by financing activities
Issuance of share capital - 4,999,999
Share issue cost - (389,921)
Advance from bank loan 12,800,000 -
------------- -------------
12,800,000 4,610,078
------------- -------------

Decrease in cash and cash equivalents (767,362) (4,128,925)

Cash and bank indebtedness, beginning of year 491,606 4,620,531
------------- -------------

Cash and bank indebtedness, end of year $ (275,756) $ 491,606
------------- -------------
------------- -------------

Supplementary information
Interest paid $ 303,753 $ 46,506
------------- -------------
------------- -------------
Income taxes paid $ 435,881 $ 76,599
------------- -------------
------------- -------------

See Accompanying Notes


HAWK ENERGY CORP.

Notes to Financial Statements

For the Year Ended December 31, 2005
(All amounts in Canadian Currency)


1. Incorporation and operations

Hawk Energy Corp. (the "Company") was incorporated under the Business Corporations Act (Alberta) on January 16, 2003. The principal business of the Company is exploration, exploitation, development and production of oil and natural gas reserves. All activity is conducted in Western Canada and comprises a single business segment.

2. Accounting policies

Property, plant and equipment

Petroleum and natural gas (P&NG) properties and production equipment

The Company follows AcG 16 "Full Cost Accounting", whereby all costs associated with the exploration for and development of petroleum and natural gas reserves are capitalized and charged against earnings as described below. Capitalized costs include lease acquisition costs, the costs of geological and geophysical activities, the costs of drilling both productive and non-productive wells, carrying charges of non-producing properties and overhead costs directly related to exploration and development activities.

Proceeds from the disposal of properties are applied as a reduction of the cost of the remaining assets, except when such a disposal would alter the rate of depletion by more than 20%, in which case a gain or loss on disposal is recorded.

Depletion of oil and gas properties and production equipment is provided using the unit of production method which is based upon gross proven reserve volumes. For this purpose, gas volumes are converted to equivalent oil volumes based upon the relative energy content where six thousand cubic feet of gas equates to one barrel of oil.

Costs of acquisition and evaluation of unproved properties are initially excluded from the depletion calculation. The Company periodically reviews costs associated with unproved properties to determine whether they are likely to be recovered. When such costs are not likely to be recovered, or when proved reserves are found to be attributable to the properties, the values of these properties are moved to the depletion pool.

The Company places a limit on the aggregate carrying value of property, plant and equipment. Impairment is recognized if the carrying amount of the property, plant and equipment exceeds the sum of the undiscounted cash flows expected to result from the Company's proved reserves. Cash flows are calculated based on third party quoted forward prices. Upon recognition of impairment, the Company would measure the amount of impairment by comparing the carrying amounts of the property, plant and equipment to an amount equal to the estimated net present value of future cash flows from proved plus risked probable reserves. The Company's risk-free interest rate is used to arrive at the net present value of the future cash flows. Any excess carrying value above the net present value of the Company's future cash flows would be recorded as a permanent impairment.

Furniture and equipment

Furniture and equipment is recorded at cost. Amortization is provided thereon at a rate of 20% per annum on a declining balance basis.

Asset retirement obligation

The Company follows the Canadian Institute of Chartered Accountants standard for Asset Retirement Obligation ("ARO"). Under this standard, the fair value of a liability for an ARO is recorded in the period where a reasonable estimate of the fair value can be determined. When the liability is recorded, the carrying amount of the related asset is increased by the same amount of the liability. The asset recorded is depleted over the useful life of the asset. Additions to asset retirement obligations due to the passage of time are recorded as accretion expense. Actual expenditures incurred are charged against the obligation.

Joint ventures

Substantially all of the Company's petroleum and natural gas activities are conducted jointly with others and, accordingly, the accounts reflect only the Company's proportionate interest in such activities.

Income taxes

The liability method is used in accounting for income taxes. Under this method, future tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities, and measured using the substantively enacted tax rates and laws that will be in effect when the differences are expected to reverse. The effect on future tax assets and liabilities of a change in tax rates is recognized in income in the period in which the change occurs.

Flow-through shares

The Company will from time to time issue flow-through shares to finance a portion of its capital expenditure program. Pursuant to the terms of flow-through share agreements, the tax deductions associated with the expenditures are renounced to the subscribers. Accordingly, share capital will be reduced and a future tax liability will be recorded equal to the estimated amount of the future income tax liability of the Company as a result of the renunciations, when the renunciations are made.

Stock options

The Company has a stock option plan, which is described in note 7. Consideration paid by directors, officers and key employees and consultants on the exercise of stock options is credited to share capital together with the amount previously recognized in contributed surplus.

Awards of stock options to employees and non-employees are accounted for in accordance with the fair value method of accounting for stock-based compensation. The fair value of stock options is determined using the Black-Scholes option pricing model. Under the fair value method, the amount to be recognized as expense is determined at the time the options are issued and is deferred and recognized in earnings over the vesting period of the options with a corresponding increase in contributed surplus.

Revenue recognition

Revenues from petroleum and natural gas sales are recognized when title passes from the Company to its customer.

Per share data

The Company utilizes the treasury stock method in the determination of diluted per share amounts. Under this method, the diluted weighted average number of shares is calculated assuming the proceeds that arise from the exercise of outstanding, in-the-money options are used to purchase common shares of the Company at their average market price for the period. Unrecognized stock-based compensation from current grants is treated as proceeds used to purchase common shares.

Measurement uncertainty

The amounts recorded for depletion and amortization of oil and natural gas properties and equipment and the provision for asset retirement obligations are based on estimates. The ceiling test is based on estimates of proved reserves, production rates, oil and gas prices, future costs and other relevant assumptions. By their nature, these estimates are subject to measurement uncertainty and the effect on the financial statements of changes in such estimates in future periods could be significant.



3. Property, plant and equipment

2005
------------------------------------------
Accumulated Net
Cost amortization book value
------------ ------------ ------------
P&NG properties and
production equipment $ 65,782,025 $ 9,099,683 $ 56,682,342
Furniture and equipment 27,145 9,462 17,683
------------ ------------ ------------

$ 65,809,170 $ 9,109,145 $ 56,700,025
------------ ------------ ------------
------------ ------------ ------------


2004
------------------------------------------
Accumulated Net
Cost amortization book value
------------ ------------ ------------

P&NG properties and
production equipment $ 34,355,658 $ 3,278,065 $ 31,077,593
Furniture and equipment 21,235 5,803 15,432
------------ ------------ ------------

$ 34,376,893 $ 3,283,868 $ 31,093,025
------------ ------------ ------------
------------ ------------ ------------


The Company has capitalized $551,146 (2004 - $422,645) of general and administrative costs during the year ended December 31, 2005.

Unproved property costs of $5,368,860 (2004 - $3,613,282) and estimated salvage value of $1,709,050 (2004 -$1,377,950) have been deducted from and future capital cost of $8,127,000 (2004 - $3,554,000) has been added to costs subject to depletion and amortization for the year ended December 31, 2005.

3. Property, plant and equipment (continued)

An impairment test calculation was performed on the Company's property, plant and equipment at December 31, 2005 in which the estimated undiscounted future net cash flows based on estimated future prices associated with the proved reserves exceeded the carrying amount of the Company's petroleum and natural gas properties.



The following table outlines prices used in the impairment test at
December 31, 2005:

Year Oil ($/bbl) Gas ($/Mcf) NGL ($/bbl)

2006 $ 48.91 $ 10.17 $ 53.86
2007 45.27 8.62 49.53
2008 43.16 7.86 45.77
2009 42.83 7.30 42.74
2010 43.08 6.99 41.09
2011 42.28 6.68 39.35
2012 45.19 6.68 39.26
2013 46.51 6.84 40.23
2014 48.41 6.99 40.99
2015 51.19 7.22 42.29
2016 51.90 7.39 43.16


4. Bank indebtedness

On August 5, 2005, the Company entered into a revolving demand credit facility agreement with a bank for $16,000,000 at an interest rate of prime plus one-quarter percent per year. This credit facility is collateralized by a general assignment of book debts and a $25,000,000 debenture with a floating charge over all assets of the Company and will be reviewed periodically. As at December 31, 2005, $12,800,000 was drawn on the bank facility and consequently the Company was not in compliance with the working capital covenant required by the bank. Subsequent to the year end, the bank waived this covenant breach in writing and increased its demand credit facility to $22,000,000 at an interest rate of prime plus one-eighth percent per year effective January 13, 2006.

Also, the Company has a $20,000 letter of guarantee issued to the Government of Saskatchewan which expires February 11, 2006. This letter of guarantee will be renewed periodically until the wells in Saskatchewan are abandoned. As of year end, the Company's guarantees were negligible.



5. Income taxes

The liability for future income taxes on the Company's balance sheet is
comprised of the following temporary differences:

2005 2004
------------- -------------
Future income tax liabilities
Property, plant and equipment $ 9,332,565 $ 5,482,608
Future income tax assets
Share issue costs (315,157) (456,938)
Asset retirement obligation (912,032) (612,512)
Non-capital losses carried forward - (13,128)
------------- -------------

$ 8,105,376 $ 4,400,030
------------- -------------
------------- -------------


The income tax provision differs from the expected amount computed by
applying the Canadian combined Federal and Provincial income tax rate
of 39.97% (2004 - 40.97%) as follows:

Computed "expected" income tax expense $ (4,326,636) $ (1,700,880)
Add back:
Stock-based compensation (189,105) (247,704)
Non-deductible Crown charges (1,488,822) (901,186)
Non-deductible meals and entertainment (3,929) (5,874)
Deduct:
ARTC 199,850 204,850
Resource allowance 1,650,989 845,874
Saskatchewan capital tax 60,407 30,138
Change in tax rate and other 391,900 367,226
------------- -------------
(3,705,346) (1,407,556)
Saskatchewan tax and resource surcharge (364,577) (236,257)
------------- -------------

$ (4,069,923) $ (1,643,813)
------------- -------------
------------- -------------


As of year end, the Company has tax pools as follows:

Undepreciated capital cost $ 12,623,478 $ 5,492,205
Canadian exploration expenses 2,551,299 3,305,197
Canadian development expenses 8,447,901 1,624,219
Canadian oil and gas property expenses 7,342,135 5,626,954
Share issue costs 855,010 1,207,523
Non-capital losses carried forward - 32,844
------------- -------------
$ 31,819,823 $ 17,288,942
------------- -------------
------------- -------------


6. Asset retirement obligations

In 2004, the Company adopted the recommendations of the Canadian Institute of Chartered Accountants on accounting for asset retirement obligations. These recommendations replaced the previous policy on future site restoration, and as a result, have been treated as a change in accounting policy. The Company adopted this policy retroactively with the restatement of the 2003 financial statements. Implementation of this accounting standard did not affect the Company's cash flow or liquidity.

The effect of this change on the January 1, 2004 balance sheet was an increase in property, plant and equipment of $1,255,224 and the recognition of an asset retirement obligation of $1,261,663. The change in accounting for asset retirement obligations as compared to the site restoration approach resulted in an increase in retained earnings of $34,344 and an increase in future income tax liability of $13,070. The following table reconciles the asset retirement obligation associated with the retirement of petroleum and natural gas properties:



Asset retirement obligation, December 31, 2003 $ 1,261,663

Liabilities incurred 328,329

Accretion expense 121,639
--------------

Asset retirement obligation, December 31, 2004 1,711,631

Liabilities incurred 685,988

Accretion expense 139,327
--------------

Asset retirement obligation, December 31, 2005 $ 2,536,946
--------------
--------------


The Company estimates the undiscounted cash flows related to asset retirement obligations, adjusted for inflation, to be incurred over the estimated reserve life of the underlying assets to total approximately $5,514,715. The fair value at December 31, 2005 is $2,536,946 using a discount rate of eight percent and an inflation rate of two percent. The expected period until settlement ranges from 2 years to 22 years.

7. Share capital

(a) Authorized

Unlimited Class A common voting shares

Unlimited Class B common voting shares



Issued
Number
of Shares Amount
----------- -------------
Class A common shares
For cash as initial private placement 4,000,000 $ 1,000,000
Issuance of flow through shares 3,700,000 925,000
Share issuance 3,500,000 7,000,000
Share issue cost, net of tax effect - (313,918)
Tax effect on flow through shares - (356,125)
----------- -------------
Class A common shares, as of December
31, 2003 11,200,000 8,254,957

Share issuance 1,785,714 4,999,999
Share issue cost, net of tax effect - (243,700)
----------- -------------
Class A common shares, as of December
31, 2004 and 2005 12,985,714 13,011,256
----------- -------------

Class B common shares
Issuance of flow-through shares 832,500 8,325,000
Share issue cost, net of tax effect - (609,617)
Tax effect on flow-through shares - (3,205,125)
----------- -------------
Class B common shares, as of December
31, 2003, 2004 and 2005 832,500 4,510,258
----------- -------------

Balance, end of period $ 17,521,514
-------------
-------------


As of year end, no shares were held in escrow. The Class B shares are convertible at the option of the Company at any time after June 30, 2006 and before June 30, 2008 into Class A shares. The conversion is calculated by dividing $10 by the greater of $1 and the then current market price of Class A shares. If conversion has not occurred by the close of business on June 30, 2008, the Class B shares become convertible at the option of the shareholder into Class A shares on the same basis. Effective August 1, 2008, all remaining Class B shares will be deemed to be converted into Class A shares on the same basis.

7. Share Capital (Continued)

b) Stock options

The Company has a Stock Option Plan that is granted by the board of directors to directors, officers, employees of and consultants to the Company. Under the terms of the plan, the Company has reserved an amount of Class A shares for options equal to 10% of the issued and outstanding Class A shares. Options granted under the Plan will have an exercise price which is not less than the price allowed by regulatory authorities, will be non-transferable and will be exercisable for a period not to exceed five years. The options will vest one-third on each of the first, second and third anniversaries of the date of grant. No one optionee is permitted to hold options entitling such optionee to purchase more than 5% of the issued and outstanding Class A shares.



For the Year Ended For the Year Ended
December 31, 2005 December 31, 2004
-------------------- --------------------
Weighted Weighted
Number of Average Number of Average
Options Exercise Options Exercise
---------- --------- ---------- ---------
Outstanding, beginning
of period 1,277,500 $ 1.34 770,000 $ 0.35
Granted - - 522,500 2.76
Cancelled (5,000) 2.40 (15,000) 0.35
---------- --------- ---------- ---------
Outstanding, end of period 1,272,500 1.33 1,277,500 1.34
---------- --------- ---------- ---------
Exercisable, end of period 675,833 $ 0.97 251,677 $ 0.35
---------- --------- ---------- ---------
---------- --------- ---------- ---------


Since January 16, 2003, the Company calculated the non-cash compensation
expense using the Black-Scholes option-pricing model based on the
following assumptions:

Number of
Date Options Risk free Time to Fair Value
of Granted Expected Interest Exercise of Granted
Grant (Net) Volatility Rate (Years) Options
---------------- ---------- ----------- ---------- --------- -----------
June 6, 2003 755,000 150% 4% 3 $ 218,950
January 6, 2004 310,000 150% 4% 3 659,153
March 19, 2004 25,000 150% 4% 3 49,067
September 9, 2004 182,500 150% 4% 3 462,674
-----------
1,389,844
Stock-based compensation expense recognized in 2003 (77,764)
Stock-based compensation expense recognized in 2004 (604,598)
Stock-based compensation expenses recognized in 2005 (473,118)
-----------
Amount for future recognition $ 234,364
-----------
-----------


8. Commitments

The Company is committed to the following minimum annual lease payments
plus operating cost under a rental agreement for office space until
September 30, 2007.


2006 $ 50,197
2007 38,766


9. Per share data

Basic per share data per Class A and Class B shares is based upon the weighted average number of Class A shares and the weighted average number of Class B shares outstanding during the year. For the purpose of per share data calculation, it is assumed that the Class B shares are converted into Class A shares using the December 31, 2005 trading price of $6 (December 31, 2004 - $3.59). Diluted per share data is based upon the weighted average number of Class A and Class B shares outstanding during the year after giving effect to the exercise of the share options. The total weighted average number of Class A and Class B shares is as follows:



For the year ended For the year ended
December 31, 2005 December 31, 2004
------------------- -------------------

Weighted average number of
Class A shares 12,985,714 12,109,980
Deemed conversion of Class B
shares to Class A shares
(Weighted average number of
Class B shares times $10
divided by period end trading
price) 832,500 x $10/$6
(2004- 832,500 x $10/$3.59) 1,387,500 2,318,942
------------------- -------------------
Equivalent Class A Basic shares 14,373,214 14,428,922
------------------- -------------------
------------------- -------------------

Equivalent Class A Diluted shares 15,269,661 15,161,170
------------------- -------------------
------------------- -------------------


10. Financial instruments

The Company's financial instruments consist of accounts receivable, bank loan and accounts payable and accrued liabilities. Unless otherwise noted, it is management's opinion that the Company is not exposed to significant interest, currency or credit risks arising from these financial instruments. The fair values of financial instruments that are included in the balance sheet approximate their carrying amount due to the short-term maturity or the floating rate nature of those instruments.

Substantially all of the Company's accounts receivable are due from customers in the oil and gas industry and are subject to the normal industry credit risks.

At December 31, 2005, the Company was exposed to interest rate fluctuation as interest on the Company's loan varies with changes in prime rate. A one percent variation in the interest rate would result in $128,000 variation in the interest expense.

11. Subsequent event

On March 6, 2006, Flagship Energy Inc. (Flagship), an oil and gas corporation, shares of which trade in TSX Venture Exchange, and the Company entered into a pre-acquisition agreement pursuant to which Flagship will make a formal take-over bid offer to acquire all of the Company's issued and outstanding shares. The total acquisition cost is $141 million, including approximately $126 million for all of the outstanding shares of the Company and the assumption of $15 million net debt. Shareholders of the Company's Class A common shares will receive either $8.25 cash or 1.5566 Class A shares of Flagship or 1.2692 Class B shares of Flagship or some combination thereof. Shareholders of the Company's Class B common shares will receive either $10 cash or 1.8868 Class A shares of Flagship or 1.5385 Class B shares of Flagship or some combination thereof. The total consideration offered by Flagship is subject to a maximum of $33.6 million cash, 16 million Class A shares of Flagship and 3 million Class B shares of Flagship. In no event shall Flagship issue more than 17.2 million Class A and Class B shares in total. Also, this take-over bid offer will be subject to the deposit of not less than 90% of all outstanding Class A and Class B common shares of the Company on a fully-diluted basis.

Pursuant to the pre-acquisition agreement, the Company has accelerated the vesting of all of the stock options to its directors, officers, employees of and consultants to the Company. Consequently, 1,272,500 shares were issued after the pre-acquisition agreement was signed, resulting in total proceeds of $1,696,000.


Contact Information

  • Hawk Energy Corp.
    Steve Fitzmaurice
    President and Chief Executive Officer
    (403) 262-1204 ext. 1
    Email: stevef@hawkenergy.ca
    or
    Hawk Energy Corp.
    Erik DeWiel
    Vice-President, Land
    (403) 262-1204 ext. 2
    (403) 313-4295 (FAX)
    Email: erikd@hawkenergy.ca