Rally Energy Corp.
FRANKFURT : RLE
TSX VENTURE : RAL

Rally Energy Corp.

May 30, 2005 21:52 ET

Rally Energy Announces First Quarter Results and Production Targets

CALGARY, ALBERTA--(CCNMatthews - May 30, 2005) - Rally Energy Corp. (TSX VENTURE:RAL) (FWB:RLE):

Annual Meeting

Rally Energy wishes to inform shareholders and other interested parties of a change of meeting location for the Corporation's Annual Meeting due to a fire at the Calgary Petroleum Club. The Annual Meeting, originally scheduled for 3:00 pm on Thursday, June 16, 2005, will now be held in the offices of McCarthy Tetrault LLP, 33rd Floor, 421 - 7th Avenue S.W., Calgary, Alberta. The Corporation expects to start the meeting at 3:15 p.m. to allow enough time for attendees to make their way to the new location.

Report to our Shareholders

In the first quarter of 2005, while our primary efforts were focused on Egypt, significant progress was made in proving-up our assets in Pakistan and in developing our Western Canada production base.

- In Egypt, we concentrated on implementing drilling, completion and production techniques best suited to achieving optimal production. These efforts have resulted in a material increase in Issaran oil sales through April and into May with current sales of approximately 2,800 bbls/d.

- In Pakistan, initial testing of the first Safed Koh Block re-entry well, Rodho 3, established the presence of significant natural gas accumulations in the Cretaceous Lower Goru Sandstones of the large Rodho structure.

- In Canada, we production tested our 50% working interest, multi-zone oil and gas discovery in the Harmattan area at an average gross flow rate of 600bbls/d of oil and 900 mmcf/d of gas.

- During the first quarter of 2005, oil equivalent sales increased to 2,184 bbls/d, up 26% from 1,739 bbls/d reported in the first quarter of 2004. Sales for the first quarter of 2005, although significantly above levels reported for the same period in 2004, do not reflect the strength and momentum of our efforts to substantially increase production. Our current production, in excess of 2,900 bbls/d, is well above reported first quarter average daily production. As the year progresses, we expect to add significant additional production increases in Egypt and Canada and we expect to be able to more fully delineate the tremendous economic potential of our Pakistan holdings.

Revenue in the first quarter increased 20% to $5.37 million from $4.46 million in the same period in 2004, however, cash flow from operations declined to $0.90 million compared to $1.7 million in the first quarter of 2004. This performance reflects a combination of four adverse factors:

- temporary production curtailments of Issaran wells in close proximity to wells being drilled;

- a widened differential between heavy and light oil prices that severely impacted pricing of January and February deliveries. (Ras Gharib prices averaged only US$26.48 in the first quarter; March 2005 pricing averaged US$33.40);

- An increase in the value of the Canadian dollar; and

- Increased operating expense related to higher diesel fuel costs for field electricity generators.

Operating expense of $1.4 million in the first quarter of 2005 increased 63% from $0.86 million reported for the same period in 2004 due primarily to large diesel fuel cost increases.

In the first quarter of 2005, Rally Energy's capital expenditures increased to $5.88 million, up 93% from 2004 expenditures of $3.05 million. Capital expenditures of $3.3 million in Egypt represented the largest portion of these expenditures, with $2.3 million spent on Canadian programs and the remainder spent in Pakistan. In Egypt, we drilled three wells in the Issaran field and continued to upgrade equipment and facilities. In Western Canada, we production tested our successful Harmattan well and installed production facilities and pipelines to allow production to commence on April 15. In Pakistan, we participated in the Rodho 3 re-entry, on a partially-carried basis, and announced that initial testing had established the presence of significant natural gas accumulations.

Outlook for 2005 - Exit Target of 6,000 boe/d

We intend to achieve significant production growth in Egypt and Canada during 2005 with a base plan target of exiting the year with production of 6,000 boe/d.

In Egypt, we intend to increase production during 2005 through:

- an active drilling program in the Issaran oilfield;

- twinning of up to six existing wellbores for production from different formations;

- co-mingling of production from different formations in up to nine existing wellbores, good oilfield practice permitting; and

- utilization of more aggressive production practices using existing equipment and, in particular, through the installation of larger capacity pumps and equipment on several existing wellsites.

Drilling during 2005 will be focused primarily in the Northern Area of the Issaran oilfield targeting multi-layered, fracture enhanced pay zones.

In Western Canada, we commenced drilling of our third Harmattan well, located approximately 1.6 kilometres east of our first discovery well, in mid-May We intend to drill at least two additional wells on our Harmattan holdings during 2005. We expect that our active drilling program, focused on the Harmattan area, will add significant new reserves and production during 2005.

In Pakistan, re-entry of the Rodho 2 well commenced on April 10, 2005 and logging operations are currently underway. Drilling results indicate the presence of a full, gas-charged Goru section. Following testing of Rodho 2, we expect to stimulate the Goru formation in the Rodho 2 and Rodho 3 wells through fracing to test the production capability of the Lower Goru formation. In addition, plans are being discussed to drill a new well on the extremely large Afiband structure in the third quarter of this year. We expect to see the Safed Koh Block emerge as an important contributor to our future production and reserves increases.



RALLY ENERGY CORP.
Management's Discussion and Analysis ("MD&A")
For the Three Months ended March 31, 2005


This discussion and analysis outlines management's assessment of the consolidated financial and operating results of Rally Energy Corp. ("Rally Energy" or the "Corporation") and its subsidiaries, including its future opportunities and risks, and should be read in conjunction with the audited consolidated financial statements and MD&A for the year ended December 31, 2004. Additional information regarding the Corporation can be found at http://www.sedar.com and http://www.rallyenergy.com.

The financial information contained herein has been prepared by management of Rally Energy in accordance with Canadian Generally Accepted Accounting Principles ("GAAP"). Unless otherwise indicated, all dollar amounts in this report are in thousands of Canadian dollars. The majority of the Corporation's production is heavy oil (reported in barrels), however, the Corporation also uses the "barrels of oil equivalent" (BOE) reference in this report to reflect Canadian natural gas sales. All BOE conversions are derived by converting gas to oil in the ratio of six thousand cubic feet of gas to one barrel of oil, representing the approximate energy equivalency. This MD&A is dated May 30, 2005.

Non-GAAP Measures

Certain measures in this MD&A do not have any standardized meaning as prescribed by Canadian generally accepted accounting principles ("Canadian GAAP") such as cash flow, cash flow per share - basic, cash flow from operations, and netback from operations. Therefore, they are considered non-GAAP measures and may not be comparable to similar information presented by other issuers. These measures have been described and presented in order to provide shareholders and potential investors with additional information regarding the Corporation's liquidity and its ability to generate funds to finance its operations. Management's use of these measures has been disclosed further in this MD&A as they are discussed and presented.

Forward-Looking Statements

This disclosure contains certain forward-looking statements that involve substantial known and unknown risks and uncertainties, including the impact of general economic conditions in all the jurisdictions in which the Corporation operates, changes in industry conditions, changes in laws and regulations including the adoption of new environmental laws, increased competition, the lack of availability of qualified personnel or management, fluctuations in foreign exchange or interest rates, stock market volatility and the Corporation's ongoing ability to obtain financing for its operations. Rally Energy's actual results, performance or achievement could differ materially from those expressed in or implied by these forward-looking statements. Accordingly, no assurance can be given that any of the events anticipated will transpire or occur, or that benefits, including the amount of revenues or proceeds, will be derived therefrom. These factors, many of which are outside the control of the Corporation, are discussed further in the December 31, 2004 MD&A.



Sales, Revenue and Netback

(thousands of dollars, unless otherwise stated)

2005 2004
-------------- --------------------------------------------
First Fourth Third Second
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Daily Sales:
Oil (bbls/d) 2,177 2,206 2,092 1,794
Natural gas
(mcfd) 41 192 60 210
Total BOE
(boe/d) 2,191 2,238 2,102 1,829
$/boe $/boe $/boe $/boe
----- ----- ----- -----
Gross
revenue $5,370 $27.23 $5,790 $28.12 $6,743 $34.87 $5,400 $32.45
Production
entitlement
- GPC
(Egypt) (1,565) (7.93) (1,978) (9.62) (1,272) (6.58) (1,027) (6.18)
Overriding
royalty (347) (1.76)
Marketing
fees (174) (0.88) (161) (0.78) (124) (0.64) (141) (0.85)
Royalties
(Canada) (5) (0.03) (25) (0.12) (12) (0.06) (21) (0.12)
Operating
expenses (1,405) (7.12) (1,296) (6.29) (961) (4.97) (1,026) (6.16)
-------------- --------------------------------------------
Netback from
operations $1,874 $9.51 $2,330 $11.31 $4,374 $22.62 $3,185 $19.14
-------------- --------------------------------------------
-------------- --------------------------------------------


2004 2003
-------------- --------------------------------------------
First Fourth Third Second
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Daily Sales:
Oil (bbls/d) 1,735 1,648 865 896
Natural gas
(mcfd) 24 - - -
Total BOE
(boe/d) 1,739 1,648 865 896
$/boe $/boe $/boe $/boe
----- ----- ----- -----
Gross
revenue $4,459 $28.18 $4,076 $26.89 $2,086 $26.22 $1,837 $22.53
Production
entitlement
- GPC
(Egypt) (862) (5.45) (752) (4.97) (443) (5.56) (380) (4.66)
Marketing
fees (100) (0.63) (48) (0.32) (27) (0.34) (27) (0.33)
Royalties
(Canada) (6) (0.04) 12 0.08 - - - -
Operating
expenses (858) (5.43) (573) (3.78) (697) (8.76) (702) (8.61)
-------------- --------------------------------------------
Netback from
operations $2,633 $16.63 $2,715 $17.90 $919 $11.56 $728 $8.93
-------------- --------------------------------------------
-------------- --------------------------------------------


Gross revenue for the first quarter 2005 was $5.4 million ($27.23/boe; production of 2,191 boe/d), up 20% from $4.5 million ($28.18/boe; production of 1,739 boe/d) for the comparable 2004 period. The revenue increase is primarily attributable to additional oil sales from the Issaran oilfield in Egypt offset slightly by lower average oil prices. The heavy oil produced from the Issaran oilfield is marketed as the Ras Gharib blend. An increased price differential from Brent oil prices experienced in the first quarter lead to a reduction in realized wellhead oil price in 2005 compared to 2004. In the first three months of 2005 the realized wellhead oil price represented 46% (52% for March) of the Brent oil price as compared for 67% for the comparable 2004 quarter.

Production Entitlements, Marketing Costs and Royalties

For the quarter ended March 31, 2005, the production entitlement of The General Petroleum Co. SAE ("GPC") totaled $1.6 million ($7.94/bbl), representing 29% of gross revenue. For the corresponding 2004 period, GPC's entitlement was $0.9 million ($5.44/bbl), representing 19% of gross revenue. GPC's reported entitlement increased during the fourth quarter of 2004 as a result of GPC's position that "payout" under the terms of the Petroleum Service Agreement had been reached on September 1, 2004. The average GPC entitlement from all wells, at current production levels, is 30% on a post-payout basis. The corporation disagrees with GPC's position since nearly US$3.0 million of drilling related costs have not been recognized by GPC for inclusion in the payout calculation. This issue is under discussion with GPC, however the outcome of this review is not determinable at this time and any adjustments will be reflected as reductions in future GPC production entitlements.

Effective January 1, 2005, the Corporation is required to make revenue-based (overriding royalty) payments from the Issaran oilfield to Gemini Oil and Gas Limited, an independent oil and gas investment fund. The maximum revenue-based entitlement will be US$1.5 million in each of 2005 and 2006 with no minimum payments required. Upon investment payout (US$3.0 million), and continuing until December 31, 2012, the Corporation is required to pay 2.6% of the Issaran oil revenues, net of marketing fees and GPC entitlements, derived from a maximum of 7,000 bbls/d of production.

Pursuant to the terms of certain marketing agreements pertaining to Issaran oil sales, marketing fees, linked to realized oil prices and production, of $174,000 ($0.88/bbl) were paid during the first quarter of 2005 as compared to $100,000 ($0.63/bbl) for the comparable 2004 period as a result of higher oil production.

The royalties incurred on Canadian properties are reported net of the Alberta Royalty Tax Credit; $5,000 and $6,000 for 2005 and 2004 first quarter periods, respectively.

Operating Expenses

Operating expenses for the three months ended March 31, 2005 were $1.4 million ($7.12/boe) as compared to $0.9 million ($5.43/bbl) for the comparable 2004 period. On a general basis, costs have increased commensurate with the higher oil production in 2005. The largest contributor to this cost increase related to higher diesel fuel costs. Diesel fuel is used to power generators to provide electricity for field operations. The Corporation is exploring access to natural gas from nearby sources as an alternative to diesel fuel for generators.



General and Administrative Expenses

(thousands of dollars, unless otherwise stated)

Three months ended March 31
---------------------------------------------
Total Capitalized Expensed $/boe
---------------------------------------------
2005
Canada $ 628 $ 110 $ 518 $ 2.63
Egypt $ 375 - $ 375 $ 1.90
Pakistan $ 46 $ 35 $ 11 $ 0.06
---------------------------------------------
Total $ 1,049 $ 145 $ 904 $ 4.59
---------------------------------------------
---------------------------------------------
2004
Canada $ 439 $ 68 $ 371 $ 2.34
Egypt $ 238 - $ 238 $ 1.50
Pakistan $ 92 $ - $ 92 $ 0.59
Other $ 101 $ - $ 101 $ 0.64
---------------------------------------------
Total $ 870 $ 68 $ 802 $ 5.07
---------------------------------------------
---------------------------------------------


For the quarter ended March 31, 2005, consolidated general and administrative expenses were $904,000 ($4.59/boe) as compared to $802,000 ($5.07/bbl) for the comparable 2004 quarter. The increased cost is primarily attributable to increased charges related to stock-based compensation, staff additions and annual wage increases. Non-cash expenses related to the valuation of share options granted during the first quarter of 2005 were $201,000 as compared to $21,000 for 2004 comparable period.



Interest and Finance Charges

(thousands of dollars, unless otherwise stated)

Three months ended
March 31
--------------------------
2005 2004
--------------------------
Interest expense $ 203 $ 207
Accretion expense on debentures 36 36
Amortization of deferred charge 36 36
--------------------------
Total expense 275 279
--------------------------
Interest income 9 9
Gain (loss) on foreign exchange (121) 70
--------------------------
Total income (expense) (112) 79
--------------------------
Net expense $ 387 $ 200
--------------------------
--------------------------
$/boe $1.96 $1.26
--------------------------
--------------------------


Total interest and finance charges increased to $387,000 during the first quarter of 2005 from $200,000 in the comparable 2004 quarter primarily as a result of fluctuations in foreign exchange rates. During the first quarter of 2005, $2.2 million of the Corporation's 12% unsecured convertible debentures were converted into common shares. This resulted in lower interest expense associated with the debentures, however, increased utilization of the bank credit facility contributed to the interest amount being similar on a quarterly basis. Included in the 2005 amount is $72,000 (2004 - $72,000) of non-cash charges pertaining to the convertible debentures issued in 2003. Additional details are disclosed in Note 7 of the consolidated financial statements.



Depletion, Depreciation and Accretion

(thousands of dollars, unless otherwise stated)

Three months ended
March 31
--------------------------
2005 2004
--------------------------
Depletion and depreciation $ 1,473 $ 2,185
Accretion 5 5
--------------------------
Total $ 1,478 $ 2,190
--------------------------
--------------------------
$/boe $ 7.49 $ 13.83
--------------------------
--------------------------


Total depletion, depreciation and accretion ("DD&A") charges for the first quarter of 2005 were $1.5 million ($7.49/boe), of which depletion pertaining to producing properties in Egypt represented $1.2 million. The remainder represents depletion charges of $135,000 for the Canadian production and fixed asset depreciation of $119,000. DD&A charges for the first quarter of 2004 were $2.2 million ($13.83/bbl). The significant increase in our proved reserve base at December 31, 2004, as evaluated by DeGolyer and MacNaughton Canada Limited, an independent reservoir evaluation firm, resulted in a lower 2005 depletion rate.

Cash Flow from Operations

Cash flow represents funds from operations as detailed on the consolidated statements of cash flows. For the quarter ended March 31, 2005, Rally Energy's cash flow from operations was $0.9 million ($0.01/share) as compared to $1.7 million ($0.02/share) for the 2004 first quarter.

Net Loss

Rally Energy recorded a net loss of $895,000 ($0.01/share) for the first quarter of 2005 as compared to a net loss of $559,000 ($0.01/share) for the comparable 2004 quarter.



SUMMARY OF QUARTERLY RESULTS

(thousands of dollars, unless otherwise stated)

Revenue Cash flow from operations Income (loss)
---------- --------------------------- ----------------------
$/share - basic $/share - basic
2005: Q1 $ 5,370 $ 856 $ 0.01 $ (895) $ (0.01)
2004: Q4 $ 5,790 $ 1,170 $ 0.02 $ 1,138 $ 0.02
Q3 $ 6,743 $ 3,187 $ 0.05 $ 687 $ 0.01
Q2 $ 5,400 $ 2,202 $ 0.03 $ (28) $ 0.00
Q1 $ 4,459 $ 1,724 $ 0.02 $ (559) $ (0.01)
2003: Q4 $ 4,076 $ 1,635 $ 0.03 $ (1,850) $ (0.03)
Q3 $ 2,086 $ 126 $ 0.00 $ (1,259) $ (0.02)
Q2 $ 1,837 $ 106 $ 0.00 $ (1,208) $ (0.02)


Capital Expenditures

During the 2005 first quarter, Rally Energy drilled 3 wells (3 net) in Egypt and participated in the drilling of one wells (0.7 net) in Canada. Capital expenditures totaled $5.9 million during the first quarter of 2005, up from $3.0 million for the comparable 2004 period.



Three months ended
March 31
--------------------
(thousands of dollars) 2005 2004
--------------------
Egypt
Drill, complete and workovers $ 3,137 $ 2,743
Seismic, evaluation and other 272 106
Inventory change (129) -
Capitalized admin. costs - -
--------------------
Total $ 3,280 $ 2,849
--------------------
Canada
Drill and complete $ 1,464 $ 93
Seismic, evaluation and other 230 39
Lease acquisition 467 -
Capitalized admin. costs 110 68
--------------------
Total $ 2,271 $ 200
--------------------
Pakistan
Drill and complete $ 297 -
Capitalized admin. costs 35 -
--------------------
Total $ 332 -
--------------------
Grand Total
Drill, complete and workovers $ 4,898 $ 2,836
Seismic, evaluation and other 502 145
Lease acquisition 467 -
Inventory change (129) -
Capitalized admin. costs 145 68
--------------------
Total $ 5,883 $ 3,049
--------------------
--------------------


Included in the above amounts are casing and tubing inventory costs of $441,000 at March 31, 2005 (2004 - $1.1 million) to be used in future Issaran drilling programs.

On February 24, 2005, the Corporation completed a transaction with Shannon International Resources Inc. ("Shannon"), whereby the Corporation disposed of its remaining interests in the Prince Edward Island project in exchange for 2.5 million common shares and 500,000 warrants, exercisable at US$0.85 per share with a term of one year, of Shannon. The value associated with the Shannon equity instruments received, after taking into account required hold periods, related fair value discounts and estimated transaction costs, is estimated at $650,000.

At March 31, 2005 the Corporation continued to meet the asset impairment test for the Egyptian and Canadian capitalized costs and no ceiling test write-down was required. The capitalized Pakistan costs are considered to be in the pre-production stage.

Liquidity and Capital Resources

At March 31, 2005, Rally Energy had bank indebtedness of $1.2 million, as compared to cash of $358,000 at December 31, 2004. The working capital shortfall at March 31, 2004 was $4.6 million, as compared to a working capital shortfall of $345,000 at December 31, 2004. Increased drilling activity in the first quarter of 2005, both in Egypt and Canada, resulted in a higher level of accounts payable.

During the 2005 first quarter, Rally Energy received proceeds of $812,000 from the exercise of an aggregate 1.4 million common share options at an average price of $0.57/share.

During the quarter ended March 31, 2005, $2.2 million of the 12% unsecured convertible subordinated debentures were converted into common shares, leaving a balance of $3.8 million at period end, down from $6.0 million at December 31, 2004. The debentures are convertible, at the option of the holder, into common shares at a conversion price of $1.00 per common share ($1.10 per common share subsequent to July 1, 2005).

On March 30, 2005, Rally Energy received approval from its primary banker that its secured credit facility has been increased to US$4.5 million from US$3.0 million to cover working capital requirements.

On May 13, 2005, the Corporation completed the closing of an agency private placement of 1,120,000 common shares issued on a flow-through basis at a price of $1.80 per share. Net proceeds were $1.9 million, after payment of commissions and estimated transaction fees.

NOTICE TO READER OF THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

The financial statements of Rally Energy Corp. (the Corporation) and the accompanying interim consolidated balance sheet as at March 31, 2005 and the interim consolidated statements of operations and deficit and cash flows for the three month period then ended are the responsibility of the Corporation's management.

These consolidated financial statements have not been reviewed on behalf of the shareholders by the independent external auditors of the Corporation, BDO Dunwoody LLP. The interim consolidated financial statements have been prepared by management and include the selection of appropriate accounting principles, judgments and estimates necessary to prepare these financial statements in accordance with Canadian generally accepted accounting principles.



Lamont Tolley, B.A.Sc., M.S.E.. Douglas C. Urch, B.Comm., CMA
Chief Executive Officer Chief Financial Officer
Calgary, Canada Calgary, Canada
May 30, 2005 May 30, 2005



Rally Energy Corp.
Consolidated Balance Sheets

March 31, December 31,
2005 2004
------------------------------------------------------------------------
(unaudited) (audited)
Assets

Current
Cash $ - $ 358,245
Accounts receivable 5,616,933 6,503,769
Cash calls receivable - 104,499
Notes receivable 483,000 740,270
Inventory (Note 2) 389,461 540,447
Prepaid expenses and deposits 304,717 266,361
------------- -------------
6,794,111 8,513,591

Assets held for sale (Note 3) 650,000 650,000
Property and equipment 38,176,484 33,737,226
Deferred charges (Note 4) 114,556 215,466
------------- -------------
$ 45,735,151 $ 43,116,283

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

Liabilities and Shareholders' Equity

Current
Bank indebtedness (Note 5) $ 1,219,614 $ -
Accounts payable - trade 3,476,564 3,137,551
Accounts payable - capital 5,814,179 5,053,800
Cash call obligations 360,817 184,478
Deferred revenue 483,000 483,000
------------- -------------
11,354,174 8,858,829

Asset retirement obligations (Note 1) 324,106 289,846
Convertible debentures (Note 4) 3,648,405 5,784,486
------------- -------------
15,326,685 14,933,161
------------- -------------

Shareholders' equity
Equity instruments (Note 6(a)) 40,910,346 37,991,329
Contributed surplus (Note 6(b)) 828,014 626,620
Deficit (11,329,894) (10,434,827)
------------- -------------
30,408,466 28,183,122
------------- -------------

$ 45,735,151 $ 43,116,283

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


UNAUDITED INTERIM FINANCIAL STATEMENTS

In Accordance with National Instrument 51-102 released by the Canadian Securities Administrators, the Corporation discloses that its auditors have not reviewed the unaudited financial statements for the period ended March 31, 2005.

The accompanying notes are an integral part of these consolidated financial statements.



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

Rally Energy Corp.
Consolidated Statements of Operations and Deficit

Three months ended March 31
----------------------------
2005 2004
------------------------------------------------------------------------
(unaudited) (unaudited)

Oil and gas revenue $ 5,369,585 $ 4,459,423
Less: Royalties and related credits (2,091,165) (968,080)
------------- -------------
3,278,420 3,491,343
Operating expenses 1,404,394 858,554
------------- -------------

Netback from oil and gas operations 1,874,026 2,632,789
------------- -------------

Expenses
Administrative expenses:
Legal, professional and audit 69,252 41,267
Shareholder reporting and communication 4,679 18,287
Administration 617,575 527,295
Pakistan administrative costs 11,561 92,341
Project evaluation costs - 101,041
Stock-based compensation 201,394 21,416
------------- -------------
904,461 801,647
Interest expense 202,690 207,376
Depletion, depreciation and accretion 1,478,061 2,189,833
Accretion expense on convertible debentures 35,919 35,919
Amortization of deferred charge 35,910 35,910
------------- -------------
2,657,041 3,270,685
------------- -------------

Income (loss) before under noted items (783,015) (637,896)
------------- -------------

Other items
Interest income 9,278 9,463
Gain (loss) on foreign exchange (121,330) 69,836
------------- -------------
(112,052) 79,299
------------- -------------
Loss for the period (895,067) (558,597)

Deficit, beginning of period (10,434,827) (11,673,317)
------------- -------------


Deficit, end of period $ (11,329,894) $(12,231,914)

------------------------------------------------------------------------
------------------------------------------------------------------------
Loss per share (Note 6(a)) $ (0.01) $ (0.01)


The accompanying notes are an integral part of these consolidated
financial statements.


Rally Energy Corp.
Consolidated Statements of Cash Flows

Three months ended March 31
----------------------------
2005 2004
------------------------------------------------------------------------
(unaudited) (unaudited)

Cash flows from operating activities
Loss for the period $ (895,067) $ (558,597)
Non-cash items:
Stock-based compensation 201,394 21,416
Accretion expense on convertible debentures 35,919 35,919
Amortization of deferred charges 35,910 35,910
Depletion, depreciation and accretion 1,478,061 2,189,833
------------- -------------
Cash flow from operations 856,217 1,724,481

Changes in non-cash working capital balances
Accounts receivable 991,335 (1,432,548)
Notes receivable 257,270 -
Inventory 150,986 45,349
Prepaid expenses and deposits (38,356) (60,292)
Accounts payable 1,734,966 379,511
------------- -------------
3,952,418 656,501
------------- -------------

Cash flows from investing activities
Oil and gas assets, net (5,883,059) (3,048,615)
Changes in non-cash working capital 760,379 480,739
------------- -------------
(5,122,680) (2,567,876)
------------- -------------

Cash flows from financing activities
Issuance of equity instruments, net 812,017 19,004
------------- -------------
812,017 19,004
------------- -------------

Decrease in cash (358,245) (1,892,371)
------------- -------------

Cash, beginning of period 358,245 2,260,426

Cash, end of period $ - $ 368,055

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

The accompanying notes are an integral part of these consolidated
financial statements.


Rally Energy Corp.

Selected Notes to Consolidated Financial Statements

Three months ended March 31, 2005 (unaudited)

The interim consolidated financial statements of Rally Energy Corp. (the "Corporation") have been prepared by management in accordance with accounting principles generally accepted in Canada. The interim consolidated financial statements have been prepared following the same accounting policies and methods of computation as the consolidated financial statements for the fiscal year ended December 31, 2004, unless otherwise stated below. The disclosure which follows is incremental to the disclosure included with the annual consolidated financial statements. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto in the Corporation's annual report for the year ended December 31, 2004.

1. Asset Retirement Obligations

The Corporation's asset retirement obligations in Egypt result from the Petroleum Service Agreement ("PSA") terms related to interests in petroleum assets including well sites and roads. The Corporation estimates the total undiscounted amount of cash flows required to settle its asset retirement obligations is approximately $596,251, which can reasonably be expected to be incurred between 2005 and 2017. The majority of these costs will be incurred between 2010 and 2017. A creditadjusted risk-free rate of 7% and an inflation rate of 2% were used to calculated the fair value of the asset retirement obligations.

The Corporation's asset retirement obligations in Canada result from net ownership interests in petroleum and natural gas assets including well sites, gathering systems and processing facilities. The Corporation estimates the total undiscounted amount of cash flows required to settle its asset retirement obligations is approximately $47,917, which can reasonably be expected to be incurred between 2005 and 2016. The majority of these costs will be incurred between 2006 and 2016. A credit-adjusted risk-free rate of 7% and an inflation rate of 2% were used to calculate the fair value of the asset retirement obligations.

The Corporation's asset retirement obligations in Pakistan result from net ownership interests in petroleum and natural gas assets including well sites, gathering systems and processing facilities. The Corporation estimates the total undiscounted amount of cash flows required to settle its asset retirement obligations is approximately $11,000.

A reconciliation of the asset retirement obligations is provided below:



Three months ended March 31
---------------------------
Asset retirement obligations 2005 2004
---------------- --------
Balance, beginning of period 289,846 168,128
Liabilities incurred in period 29,094 -
Accretion expense 5,166 4,804
---------------- --------
Balance, end of period 324,106 172,932
---------------- --------
---------------------------


2. Inventory

At March 31, 2005, the Corporation held $830,688 (March 31, 2004 - $1,396,000) of inventory available for use in the Issaran oilfield in Egypt. Of this amount, (i) $441,227 relates to capital equipment, primarily pipe, and is included in Property and Equipment and (ii) $389,461 represents consumable supplies to be used in oilfield operations and is recorded as inventory under current assets.

3. Assets Held for Sale

On February 24, 2005, the Corporation completed a transaction with Shannon International Resources Inc. ("Shannon"), whereby the Corporation disposed of its remaining interests in the PEI project in exchange for 2.5 million common shares and 500,000 warrants, exercisable at US$0.85 per share with a term of one year, of Shannon. The value associated with the Shannon equity instruments received, after taking into account required hold periods in order to register the equity instruments, related fair value discounts and estimated transaction costs, is estimated at $650,000.

4. Convertible Debentures

On June 13, 2003, the Corporation issued $6.0 million, 12% unsecured convertible subordinated debentures which are entitled to semi-annual interest payments and mature on July 1, 2006. The debentures are convertible, at the option of the holder, at any time prior to July 1, 2005, into common shares at a conversion price of $1.00 per common share. After July 1, 2005, the conversion price increases to $1.10 per common share. The debentures are not redeemable by the Corporation prior to January 1, 2005. Thereafter, the debentures are redeemable at par, in whole or in part, if the closing price of the Corporation's common shares are at or above $2.00 for 30 consecutive trading days. An agent's commission of $420,000 was paid in relation to debenture subscriptions. The legal fees and cash commissions incurred to secure the debenture financing were recorded as deferred charges and the related amortization charges have been included in interest and related charges.

As the convertible debentures are considered to be compound financial instruments, the principal amount has been allocated between liability and equity components, which are then classified separately on the balance sheet. The liability component has been determined using an interest rate for comparable debt instruments having no conversion rights. The difference between the liability component and the principal amount of the notes has been allocated to equity. The equity component is accreted over the term of the notes such that at maturity the liability will be equivalent to the principal amount.

The equity portion of the convertible note represented $437,000 as determined using a Black-Scholes model. The fair value of the conversion right was estimated using the following assumptions: Dividend yield (nil), volatility (0.18), risk-free interest rate (5%), and weighted average life of 1.5 years.

During the first three months of 2005, $2,172,000 of the 12% Convertible Debentures were converted to an equal number of common shares of the Corporation at $1.00 per share, pursuant to the conversion terms contained therein. Accordingly, $65,000 of deferred charges related to the issuance of the converted debentures have been reclassified as share issue costs.

5. Bank Indebtedness

At March 31, 2005, the Corporation has utilized $1,219,614 (US$1,008,000) (March 31, 2004 - nil) of the US$3.0 million credit facility with a major Canadian bank which is secured by trade receivable insurance provided by Export Development Canada ("EDC"). Funds drawn on this facility bear interest at the US prime rate and a standby fee of 0.25% per annum applies to the unused portion of the facility. On March 30, 2005, the Corporation received approval for its secured credit facility to be increased to US$4.5 million from US$3.0 million until March 30, 2006.

6. Equity Instruments



(a) Issued and outstanding

Number
of Shares Amounts
---------- -------------
Common shares
Balance, December 31, 2004 74,350,379 $ 38,332,943
Stock options exercised 1,425,667 812,017
Debentures converted (Note 4) 2,172,000 2,172,000
---------- -------------
Balance, March 31, 2005 77,948,046 41,316,960
Add: Equity portion of convertible
debentures - 437,000
Less: Share issue costs - (843,614)
---------- -------------
Balance, Common stock 77,948,046 $ 40,910,346
---------- -------------
---------- -------------

Weighted average number of common shares
for the three months ended March 31, 2005 75,799,306
----------
----------


(b) Options

The shareholders of the Corporation have annually approved a formal stock option plan under which directors, officers, employees and consultants are eligible to receive grants. Stock option agreements have vesting periods varying from immediate to three years and expiration terms varying from two to five years.

The Corporation recorded an expense of $201,394 for options issued in the first quarter of 2005 (March 31, 2004 - $21,416). The stock-based compensation expense associated with the value ascribed to options granted is recorded as contributed surplus.



Weighted Average
Share Options Exercise Price
-------------------------------
Outstanding, beginning of year 6,327,757 $0.63
Granted 758,000 $1.80
Exercised (1,425,667) $0.57
-------------------------------
Outstanding, end of period 5,660,090 $0.80
-------------------------------
-------------------------------


7. Related Party Transactions

For the three months ended March 31, 2005, the Corporation paid consulting fees to companies, whose principals are directors and officers of the Corporation. The transactions occurred in the normal course of business operations and represent consideration established and agreed to by the related parties which is similar to those negotiated with third parties.



Three months ended March 31
---------------------------
2005 2004
--------------- ---------
Included in general and administrative
expenses $ 82,349 $ 67,500
Capitalized 124,226 83,100
--------------- ---------
$ 206,575 $ 150,600
--------------- ---------
--------------- ---------


8. Comparative Amounts

Certain comparative amounts have been reclassified to conform to the presentation adopted for the current year.

9. Measurement Uncertainty

The amounts recorded for depletion and depreciation of property and equipment, the asset retirement obligations and the ceiling test calculation are based on estimates of proved reserves, production rates, commodity prices, future costs, foreign currency exchange rates and other relevant assumptions. By their nature, these estimates are subject to measurement uncertainty and the effect on the consolidated financial statements of changes in such estimates in future periods could be significant.

10. Segmented Information

The Corporation operates in the oil and gas industry. Its reportable segments are identified on a geographic basis.

Geographic Segments:

The Corporation has operations in Egypt, Pakistan and Canada. Gross revenue for the three months ended March 31 and capital assets are summarized on a country basis below:



March 31, 2005 Egypt Canada Pakistan Total
---------------------------------------------------------------------
Gross revenue $ 5,212,429 $ 157,156 - $ 5,369,585
---------------------------------------------------
---------------------------------------------------
Property and
equipment $ 19,124,909 $ 18,692,842 $ 358,733 $ 38,176,484
---------------------------------------------------
---------------------------------------------------

March 31, 2004 Egypt Canada Pakistan Total
---------------------------------------------------------------------
Gross revenue $ 4,421,377 $ 38,046 $ - $ 4,459,423
---------------------------------------------------
---------------------------------------------------
Property and
equipment $ 15,662,667 $ 14,198,521 $ - $ 29,861,188
---------------------------------------------------
---------------------------------------------------


11. Subsequent Events

(a) Subsequent to March 31, 2005, the following changes occurred with respect to the Corporation's stock options:



Number of Options Exercise Price
------------------------------------
Exercised (56,000) $0.60
Granted 250,000 $1.54
------------------
Net Change 194,000
------------------
------------------


(b) On May 13, 2005, the Corporation completed the closing of an agency private placement of 1,120,000 common shares issued on a flow-through basis at a price of $1.80 per share. Net proceeds were $1.9 million, after payment of commissions and estimated transaction fees.

12. Statement of Cash Flows and Non-Cash Transactions

During the first three months of 2005, $2,172,000 of the 12% Convertible Debentures were converted to an equal number of common shares of the Corporation at $1.00 per share, pursuant to the conversion terms contained therein.

The TSX Venture Exchange has not reviewed and does not accept responsibility for the adequacy or accuracy of this release.

Contact Information

  • Rally Energy Corp.
    Lamont Tolley
    President & CEO
    (403) 538-0000
    or
    Rally Energy Corp.
    Douglas C. Urch
    Vice President, Finance & CFO
    (403) 538-0000
    (403) 538-3705 (FAX)
    Website: http://www.rallyenergy.com