**U.S.
SECURITIES AND EXCHANGE COMMISSION**


**Washington,
D.C. 20549**


**FORM
10-KSB/A**





(Mark
One)


x
    ANNUAL
      REPORT PURSUANT SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934. For the fiscal year ended**May
      31, 2004.**





o
    TRANSITION
      REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934. For the transition period from _______________ to
      _______________





Commission
file number 0-27063





**AQUATIC
CELLULOSE INTERNATIONAL CORP.**


(Name of
small business issuer in its charter)








Nevada
    
    82-0381904(State
      or other jurisdiction of
    
    (I.R.S.
      Employer Identification No.)incorporation
      or organization)








2504
      - 43rdStreet, suite 5, Vernon, British Columbia, Canada
    VIT
      6L1(Address
      of principal executive offices)
    (Zip
      Code)





Registrant's
Telephone number, including area code: (250)
558-4216





Securities
registered under 12(b) of the Exchange Act:  None





Securities
registered under Section 12(g) of the Act:   Common
Stock





Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


Yes   x No o


Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 Regulation
S-B is not contained herein, and will not be contained, to the best of
Registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.   o





The
issuer had net earnings from its working interest in the Hamill lease of $33,053
for the fiscal year ended May 31, 2004.





The
aggregate market value of the voting stock held by non-affiliates on May 31,
2004 was approximately $350,260 based on the average of the bid and asked prices
of the issuer’s common stock in the over-the-counter market on such date as
reported by the OTC Bulletin Board. As of September 29, 2004, 100,000,000 shares
of the issuer’s common stock were outstanding.





DOCUMENTS
INCORPORATED BY REFERENCE














**PART
I**





**ITEM
1.**  **DESCRIPTION
OF BUSINESS**





*AQUATIC
CELLULOSE INTERNATIONAL CORP.* *("* Aquatic")
is a Nevada Corporation originally organized as Aquatic Cellulose Ltd. ("ACL")
and was incorporated in March of 1996. Aquatic is an independent oil and gas
investment, development and production company, engaged in the acquisition and
development of crude oil and natural gas reserves and production principally in
the state of Texas of the United States.





Located
in Vernon, British Columbia, Canada, Aquatic Cellulose International was
originally organized as a forest-based company focusing on accessing and
recovering submerged timber. Aquatic’s principal activity was the procurement of
contracts for the salvage and harvest of submerged timber and the sale of lumber
derived from such timber. In March of 2003, new management decided on the new
business direction in Oil and Gas due to continued losses from operations and
lack of progress in underwater wood project development.





Aquatic
plans to grow its business by investing in acquisitions, development, and
production and sale of natural gas and crude oil. Aquatic plans to further
expand its investments and cash flow by capitalizing on modern technological
developments in the area of oil and gas production development. New technology
since the development of the computer industry has allowed for better
identification of by-passed reserves in previously discovered oil and gas
fields. Geological analysis using “Direct Hydrocarbon Indicator” (DHI) tools and
methods, as well as improved 3D seismic data processing have been successfully
used to enhance and revitalize previously developed and currently developed oil
and gas producing sites.





Aquatic’s
overall goal is to maximize corporate value through profitable growth in our oil
and gas reserves. This will be achieved through balanced portfolio consisting
of;





·
    Development
      of existing production wells.


·
    Application
      of new technology to historically producing reservoirs targeting
      significant by-passed reserves.


·
    Acquisitions
      of producing reserves.


·
    Acquisitions
      of working production interests and
royalties.





**Property
Interests**





*-
Hamill Lease*





In March
of 2004, Aquatic acquired a 20 percent ownership position and a 16 percent net
revenue interest in the Hamill Lease, a natural gas producing property located
in Matagorda County Texas and operated by Century Resources Inc. of Houston
Texas. The purchase was made on the basis of the property having existing
production and revenues as compared to an exploration property with no
production.  Thus, the
Company agreed to assume an increased percentage of the costs for a lesser
percentage of the revenue on a 1/3 to 1/4 ratio, resulting in the 20 percent
ownership stake and 16 percent net revenue interest before
royalty expense.  The
agreement also includes an exclusive, optional, “New Project and Exploration
Drilling Participation’ agreement with Century, which has three successive
one-year terms, with the Company holding the exclusive option on each year. The
3645-acre property lease is secured by the property’s natural gas production
from three of the seven existing wells. W ith a
regulatory well spacing requirement of 40 acres per well the property has
approximately 300 developed acres with the remaining 3,345 acres undeveloped.
The property has historically produced natural gas from multiple stacked pay
sands supported by a 10 square mile area of mutual interest.





*-
Prado Field*


(Subsequent
Events - See Note 20 - Notes to Consolidated Financial Statements)





In
August, 2004, the Company’s, through its New Project Joint Participation
agreement with Century Resources Inc. of Houston Texas, acquired a 50 percent
interest in a 1,400-acre property lease in the Prado oil field, and located in
Jim Hogg County Texas, with the remaining 50 percent owned by Century. This
lease has 20 existing wells that were originally produced in the 1960’s. The
Prado Field produces oil and gas from the down dip margin of the Jackson-Yegua
barrier/sandplain sandstone play. Although most Jackson fields were discovered
in the 1920’s and 1930’s Prado Field was discovered in 1956, late in the
exploration history of the Jackson group. The field has had extensive
development, producing from the late 1950’s and early 1960’s a cumulative 23
million barrels of oil and greater than 32 billion cubic feet of natural gas.
The Company has detailed studies pertaining to this field that show strong
potential for development of significant by-passed reserves of both oil and
natural gas.





- 2
-











**Risk
Factors of the Oil and Gas Industry**








Volatile
Oil and Gas Prices Can Materially Affect The Company.





The
Company's future financial condition and results of operations will depend upon
the prices received for the Company's oil and natural gas production and the
costs of acquiring, finding, developing and producing reserves. Prices for oil
and natural gas are subject to fluctuations in response to relatively minor
changes in supply, market uncertainty and a variety of additional factors that
are beyond the control of the Company. These factors include worldwide political
instability (especially in the Middle East and other oil-producing regions), the
foreign supply of oil and gas, the price of foreign imports, the level of
drilling activity, the level of consumer product demand, government regulations
and taxes, the price and availability of alternative fuels and the overall
economic environment. A substantial or extended decline in oil and gas prices
would have a material adverse effect on the Company's financial position,
results of operations, quantities of oil and gas that may be economically
produced, and access to capital. Oil and natural gas prices have historically
been and are likely to continue to be volatile. This volatility makes it
difficult to estimate with precision the value of producing properties in
acquisitions and to budget and project the return on development projects
involving the Company's oil and gas properties. In addition, unusually volatile
prices often disrupt the market for oil and gas properties, as buyers and
sellers have more difficulty agreeing on the purchase price of
properties.





Uncertainty
in Calculating Reserves; Rates of Production; Development Expenditures; 
Cash Flows:





There are
numerous uncertainties inherent in estimating quantities of oil and natural gas
reserves of any category and in projecting future rates of production and timing
of development expenditures, which underlie the reserve estimates, including
many factors beyond the Company's control. Reserve data represent only
estimates. In addition, the estimates of future net cash flows from the
Company's proved reserves and their present value are based upon various
assumptions about future production levels, prices and costs that may prove to
be incorrect over time. Any significant variance from the assumptions could
result in the actual quantity of the Company's reserves and future net cash
flows from them being materially different from the estimates. In addition, the
Company's estimated reserves may be subject to downward or upward revision based
upon production history, results of future development, prevailing oil and gas
prices, operating and development costs and other factors.





Oil
and Gas Operations Involve Substantial Costs and Are Subject to Various Economic
Risks:





The oil
and gas operations of the Company are subject to the economic risks typically
associated with development and production activities, including the necessity
of significant expenditures to locate and acquire producing properties and to
drill exploratory wells. In conducting development activities, the presence of
unanticipated pressure or irregularities in formations, miscalculations or
accidents may cause the Company’s development and production activities to be
unsuccessful. This could result in a total loss of the Company’s investment. In
addition, the cost and timing of drilling, completing and operating wells is
often uncertain.





Significant
Capital Requirements:





The
Company must make a substantial amount of capital expenditures for the
acquisition, and development of oil and gas reserves. To date, the Company has
paid for acquisitions and expenditures with cash from the issuance of debt,
convertible notes and operating activities. The Company's revenues or cash flows
could be reduced because of lower oil and gas prices or for some other reason.
If the Company's revenues or cash flows decrease, it may not have the funds
available to replace its reserves or to maintain production at current levels.
If this occurs, it would reduce production over time. Other sources of financing
may not be available if the Company's cash flows from operations are not
sufficient to fund its capital expenditure requirements. Where the Company is
not the majority owner or operator of an oil and gas project, it may have no
control over the timing or amount of capital expenditures associated with the
particular project. If the Company cannot fund its capital expenditures, its
interests in some projects may be reduced or forfeited.





Costs
Incurred To Conform to Government Regulation of the Oil and Gas
Industry.





Costs
incurred due to changes at the federal or state level of the oil and natural gas
regulatory environment could adversely affect the Company’s ability to conduct
business.





- 3
-








Costs
Incurred Related to Environmental Matters.





The
Company, as a part owner or lessee of oil and gas properties, is subject to
various federal, state and local laws and regulations relating to discharge of
materials into, and protection of, the environment. These laws and regulations
may, among other things, impose liability on the lessee under an oil and gas
lease for the cost of pollution clean-up resulting from operations, subject the
lessee to liability for pollution damages, and require suspension or cessation
of operations in affected areas.





The
Company is not aware of any environmental claims existing as of September 29,
2004, which would have a material impact upon the Company's financial position
or results of operations.





Development
hazards:





Production
development of oil and natural gas can be hazardous, involving unforeseen
occurrences such as blowouts, cratering, fires and loss of well control, which
can result in damage to or destruction of wells or equipment, injury to persons,
loss of life, or damage to property or the environment.





General
Economic Conditions:





Virtually
all of the Company's operations are subject to the risks and uncertainties of
adverse changes in general economic conditions, the outcome of pending and/or
potential legal or regulatory proceedings, changes in environmental, tax, labor
and other laws and regulations to which the Company is subject, and the
condition of the capital markets utilized by the Company to finance its
operations.





**Seasonality
of Business**





Weather
conditions affect the demand for and prices of natural gas and can also delay
drilling activities, disrupting our overall business plans. Demand for natural
gas is typically higher in the second and third quarters due to increased
heating demands resulting in higher natural gas prices. Due to these seasonal
fluctuations, results of operations for individual quarterly periods may not be
indicative of results that would be realized on an annual basis.








**Competitive
Conditions in the Business**





The
petroleum and natural gas industry is highly competitive and we compete with a
substantial number of other companies that have greater resources, such as,
GulfWest Energy Inc. and TransTexas Gas Corp. Many such companies, not only
explore, produce and market petroleum and natural gas but also carry on refining
operations and market the resultant products on a worldwide basis. There is also
competition between petroleum and natural gas producers and other industries
producing energy and fuel. Furthermore, competitive conditions may be
substantially affected by various forms of energy legislation and/or regulation
considered from time to time by the governments (and/or agencies thereof) of the
United States and Canada; however, it is not possible to predict the nature of
any such legislation and/or regulation which may ultimately be adopted or its
effects upon our future operations. Such laws and regulations may, however,
substantially increase the costs of exploring for, developing or producing oil
and gas and may prevent or delay the commencement or continuation of a given
operation. The exact effect of these risk factors cannot be accurately
predicted.





**Distribution**





Aquatic
sells its production through contracts with existing pipeline operating
companies and crude oil brokers. Due to the consistent demand for domestic
energy as well as the maturity of the industry, Aquatic is able to achieve 100
percent sales of its production and have little to no difficulty in renewing
distribution contracts as required.








- 4
-








**Important
Events**








·
    On
      February 28th,
      2003 AQCI cancelled the arrangement regarding the planned purchase of the
      fleet of Boats owned by Raymond Lefebvre. The Company has had difficulty
      in retrieving the original restricted share certificates due to the death
      of Mr. Raymond Lefebvre. As
      of May 31, 2004, the Company has received from the executor of Mr.
      Lefebvre’s estate a letter informing the Company that they are unable to
      return the original stock certificates due to their being lost or
      destroyed and instructions to the Company’s transfer agent to cancel the
      certificates. The Company is moving ahead with the cancellation of the
      original stock certificates with the transfer agent.





·
    On
      March 26th,
      2003 Gary J. Ackles resigned as Director, President and CEO of AQCI and
      was succeeded by Sheridan B. Westgarde, a C.A.S. Tech. graduate of UCC
      British Columbia and a well recognized technology specialist in the
      robotics and automation industry.





·
    During
      October 2002, the Company entered into an agreement with Gary Ackles to
      sell the equipment located in Brazil with a net book value of $4,275 in
      addition to a prototype machine with a net book value of $-0- located on
      the Tucurui reservoir. Under the terms of the agreement, the proceeds of
      sale were $70,000 resulting in a pre-tax gain of approximately $65,700.
      The Company applied the value of the machine as an offset to the unpaid
      license fee owed to Legacy Systems Corp. (Notes 9 and 17).





·
    On
      April 1st,
      2003 AQCI acquired a loan in the amount of $44,000 from Legacy Systems
      Corporation owned by Mr. Ackles. As security for this loan AQCI pledged
      the ATH-120 mechanical assembly constructed and stored at Beaver
      Manufacturing in Kamloops British Columbia.





·
    On
      May 31st,
      2003 AQCI’s activities in Brazil, including personnel and maintenance of
      the timber harvesting leases was terminated.





·
    On
      May 31st2003 all manufacturing and licensing agreements with Gary J. Ackles, owner
      of the ATH robotic technology were also cancelled.





·
    On
      September 5th,
      2003 AQCI signed an initial Memorandum of Understanding followed by a
      Letter Of Intent (LOI) with Century Resources Inc. (“Century”) of Houston
      Texas, owned by Edward R. DeStefano, for the acquisition of Century by
      AQCI. In March 2004, this agreement was terminated in favor of the
      acquisition of a 20 percent ownership position in Hamill Lease.





·
    During
      December 2003, the Company entered into an agreement whereby, the
      repayment of the outstanding debentures is intended to be made by an
      Equity Line of Credit instrument negotiated between the convertible
      debenture holders and the Company. Based on this arrangement, the Company
      and the convertible debenture holders further agreed to an additional
      funding of $900,000. While these new funds are secured as a convertible
      debt, the repayment is intended to be managed through the Equity Line of
      Credit. The Company signed a $100,000 convertible promissory note as an
      advance on the $900,000 and paid $80,000 as a deposit to acquire the
      Hamill Lease and Options.





·
    Effective
      March 1, 2004, the Company acquired a 20 percent ownership position with
      16 percent net revenue interest in the Hamill Lease, a 3,645 acre natural
      gas producing property located in Matagorda County, Texas, pursuant to an
      agreement with Century Resources Inc. (“Century”). Century, a privately
      held Texas corporation, has an interest in various oil and natural gas
      properties. Under the agreement, the Company will receive 16 percent of
      net revenue before royalty expense. The agreement also includes an
      exclusive, optional, “New Project and Exploration Drilling Participation’
      agreement with Century. The agreement is for three successive one-year
      terms, with the Company holding the exclusive option on each year. (See
      Note 1 - Notes to Consolidated Financial
Statements)





·
    Effective
      March 1, 2004, the Company has a Lease Operating Agreement in place with
      Century Resources Inc. of Houston Texas. The operating agreement outlines
      the various responsibilities of both the Company and Century in regards to
      the management and operations of Hamill Lease. (See Note 14 - Notes To
      Consolidated Financial Statements)





- 5
-








·
    During
      March 2004, the Company entered into a consulting agreement with Harvey
      Smith to provide oil and gas expertise. The consulting agreement,
      effective February 1, 2004, is for one year and provides for consulting
      fees of $2,000 cash and $2,000 worth of Company common stock. (See Note 14
      - Notes to Consolidated Financial
Statements)





·
    During
      March 2004, the Company entered into consulting agreement with Lonnie
      Hayward who specializes in assisting publicly held companies to find
      acquisition candidates and who was instrumental in the Company acquiring
      the working interest in the Hamill lease. The consulting agreement,
      effective December 15, 2004, is for one year and provides for consulting
      fees of $3,500 cash and $1,500 worth of Company common stock. (See Note 14
      - Notes to Consolidated Financial
Statements)





**Subsequent
Events (after May 31, 2004)**





·
    Beginning
      June 2004, maintenance work was commenced on the Hamill property, which
      resulted in 2 additional wells coming into production. These 2 wells added
      approximately 250 thousand cubic feet of gas per day to over-all lease
      production. Additionally, maintenance work was performed on the original
      producing well, which resulted in that well production rising from
      approximately 700 thousand cubic feet of gas per day to approximately 1.05
      million cubic feet of gas per day.





·
    During
      July 2004, the Company entered into a agreement to exchange amounts due to
      Sheridan Westgarde, as well as stock compensation due Mr. Westgarde under
      the current consulting agreement, for a 27 percent common share equity
      position in the Company post-restructuring and pending shareholders
      approval of the Proxy. As a director of the Company, Mr.
      Westgarde shares would be affiliate status and bearing all restrictions
      according to affiliates as stated in the Securities and Exchange Act of
      1933.





·
    During
      July 2004, the Company entered into an agreement with Gary Ackles, former
      Company CEO and Legacy Systems, a company controlled by Ackles, to settle
      amounts currently owed to both Ackles and Legacy (Note 9). The agreement
      requires the Company to return the Aquatic Timber Harvesting Equipment
      (Note 5) and issue 40,000,000 pre-restructured shares of the Company’s
      common stock in exchange for, forgiveness of the $44,000 borrowed from
      Legacy (Note 9) and the $80,000 due Legacy in un-paid licensing fees (Note
      9). The remaining amount due G. Ackles of $417,000 will be converted into
      13 percentof
      the issued and outstanding post-restructured shares of the Company pending
      shareholder approval of the Proxy. The agreement stipulates that Mr.
      Ackles would be an affiliate of the Company bearing all the restrictions
      of Affiliates according to the Securities and Exchange Act of 1933.





·
    During
      July 2004, the Company received short term loans from Sheridan Westgarde,
      the Company’s CEO, Lonnie Hayward, consultant, and Robert Marchand in an
      amount aggregating $42,000 which was used, along with Company’s available
      cash, to fund the purchase of the 50 percent working interest in the Prado
      Field lease. The Company agreed to repay the loan amount borrowed once
      funding becomes available and agreed to pay an additional 20 percent of
      the amount borrowed over the next 12 months. Following the closing of the
      $250,000 convertible debentures in August 2004, Mr. Westgarde and Mr.
      Hayward were repaid their principal amounts plus 10 percent, while Mr.
      Marchand declined repayment in favor of re-investing his principal and
      proceeds with the Company. The remaining 10 percent will be paid within
      the next 10 months.





·
    During
      July 2004, the Company, together with Century Resources Inc., completed an
      acquisition of an approximately 1,400 acre lease in the Prado Oil Field
      (Prado), located in Jim Hogg County Texas. The total purchase price for
      this acquisition was $140,000, of which the Company’s 50 percent ownership
      position and 45 percent net-revenue interest was $70,000. This lease has
      20 existing wells that were originally produced in the 1960’s 2 of which
      are still producing approximately 30 Barrels of oil per day. In
      cooperation with Century Resources Inc., the Company is planning to
      develop bypassed oil reserves as well as undeveloped natural gas reserves.
      The Company is awaiting the completion of 3D seismic processing that will
      be the basis for future development plans.





- 6
-








·
    During
      July 2004, the Company entered into a preliminary agreement in principle
      to sell a portion of its working interest in the Prado Field to Titan
      Consolidated Inc., a Nevada based corporation. Should this agreement be
      consummated, Titan would be responsible for 40 percent of the development
      and operating costs while receiving 20 percent of the net revenue from all
      Prado production. The purchase price is $500,000 of which the Company
      received, in July 2004, $10,000 of a $40,000 non-refundable deposit. The
      balance of the deposit is due by September 15, 2004 with the final closing
      date and remainder of the purchase price due on November 15, 2004. On
      September 15, 2004 the Company granted an extension of the non-refundable
      deposit due date to October 20, 2004 and the final closing date to
      December 1, 2004.





·
    During
      August 2004, the Company issued $250,000 in convertible debentures and
      warrants to acquire a working interest in Prado and pay a portion of
      outstanding consulting fees as of May 31,
2004.





·
    During
      September 2004, the Company plans to file an amended Preliminary 14/A
      filing with the Securities and Exchange Commission, wherein, the Company
      will announce its intention to seek shareholder approval for an increase
      in the authorized shares to 3,000,000,000 shares. Additionally, the
      Company will seek approval to perform a reverse split on the issued and
      outstanding shares of the Company by a maximum factor of 750:1 (see Note
      21 - Notes to Consolidated Financial
Statements).





**Going
Concern**





Aquatic
Cellulose International Corporation has experienced recurring losses, has a
working capital deficiency of $1,526,189 and an accumulated deficit of
$7,905,082 as of May 31 st , 2004.
At the end of fiscal year ended May 31 st , 2003
the Company had ceased its underwater timber harvesting operations due to the
difficulty associated with the investment and operations of the Brazil project.
These factors, among others, raise substantial doubt as to its ability to
continue as a going concern. Management’s plans in regard to these matters are
also discussed in note 2. The consolidated financial statements do not include
any adjustments that might result from the outcome of this
uncertainty.








**Employees**





As of May
31 st , 2003
the Company had no employees and two consultants under contract. As of May
31 st , 2004
the Company is utilizing consultants to manage 100 percent of the administration
and business development, for which there are three Consultants under
contract.








**ITEM
2.**  **DESCRIPTION
OF PROPERTY**





As of
August 2003, AQCI’s offices are located at 2504 43 rd Street,
Suite 5, Vernon, British Columbia, V1T6L1. There is no lease and the rent is due
on a monthly basis at the rate of $280.00.





Prior to
August 2003, AQCI’s offices were located at 3704 32 nd Street,
Suite 301 Vernon, British Columbia, VIT 5N6. Annual lease payments under this
lease were $12,370 per year.





**ITEM
3.**  **LEGAL
PROCEEDINGS**





AQCI is
not a party to any material pending legal proceedings and, to the best of its
knowledge, no such action by or against AQCI has been threatened.








- 7
-








**ITEM
4.**  **SUBMISSION
OF MATTERS TO A VOTE OF SECURITIES HOLDERS**








The
Company is currently in process to seek approval from shareholders to amend our
certificate of incorporation to increase the number of authorized Common Stock
from 100,000,000 to 3,000,000,000 shares, to amend our certificate of
incorporation to change the Company name to Valor Energy Corporation and to
amend our certificate of incorporation to provide for a stock combination
(reverse split) of the Common Stock in an exchange ratio to be approved by the
Board, ranging from one newly issued share for each two outstanding shares of
Common Stock to a maximum of one newly issued share for each seven hundred and
fifty outstanding shares of Common Stock.





The
increase in authorized shares will allow the Company to facilitate the
conversion of existing convertible debt as well as amounts due to related
parties. The change of our Company name will better identify the Company in the
new business. The stock combination or reverse split will allow the Company to
facilitate the issuance of common shares in connection with the purchase of the
Hamill Natural Gas Lease, meet obligations to industry professionals as well as
to facilitate the conversion of existing convertible debt.





The
Company plans to convert existing convertible debt to reducing the amount
outstanding and then perform a combination of the stock. The Company plan to
allocate shares of the post-consolidated company to key individuals pending
approval of shareholders (see Note 21 - Notes to Consolidated Financial
Statements).





**PART
II**





**ITEM
5.**  **MARKET
FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS**





Our
common stock currently trades on the Pink Sheets, under the trading symbol
“AQCI”. The following table set forth the quarterly high and low bid prices per
share for our common stock. The bid prices reflect inter-dealer prices, without
retail markup, markdown, or commission and may not represent actual
transactions.





High
      Bid
    
    Low
      BidFiscal
      2002First
      Quarter 2002
    
    
    .07
    
    
    .02Second
      Quarter 2002
    
    
    .05
    
    
    .01Third
      Quarter 2002
    
    
    .05
    
    
    .01Fourth
      Quarter 2002 (5/31/02)
    
    
    .14
    
    
    .06Fiscal
      2003First
      Quarter 2003
    
    
    .09
    
    
    .018Second
      Quarter 2003
    
    
    .033
    
    
    .014Third
      Quarter 2003
    
    
    .014
    
    
    .004Fourth
      Quarter (5/31/03)
    
    
    .008
    
    
    .002Fiscal
      2004First
      Quarter 2004
    
    
    .004
    
    
    .004Second
      Quarter 2004
    
    
    .006
    
    
    .004Third
      Quarter 2004
    
    
    .006
    
    
    .006Fourth
      Quarter (5/31/04)
    
    
    .007
    
    
    .004





To date,
AQCI has not declared or paid dividends on its common stock.





As of May
31 st , 2004,
there were approximately 361shareholders of record (that are not in street name)
of AQCI's Common Stock.





- 8
-








**Recent
Sales of Unregistered Securities**








During
the quarter ended August 31 st , 2002,
the Company issued an aggregate of 900,000 shares of restricted stock at $0.029
per share for director fees (price reflected market price) for a total value of
$26,100.





At
various times during the fiscal year ended May 31 st , 2003,
the Company issued an aggregate of 3,868,880 shares of restricted stock to
various investors at $0.05 per share for cash pursuant to various subscription
agreements for a total value of $42,500.





At
various times during the fiscal year ended May 31 st , 2003,
the Company issued an aggregate of 4,189,412 shares of restricted stock at a
price ranging from $0.0091 to $0.01 per share for conversion of debentures
(price reflected market price) for a total value of $40,000.





At
various times during the fiscal year ended May 31 st , 2003,
the Company issued an aggregate of 16,010,100 shares of restricted stock at a
price ranging from $0.027 to $0.04 per share for services rendered (price
reflected market price) for a total value of $482,679.





During
the fiscal year ended May 31 st , 2003,
the Company’s former CEO surrendered 3,620,107 shares of common stock for the
purposes of compensating professionals providing services to the Company. The
shares at date of cancellation had an estimated value of $144,804.





During
the fiscal year ended May 31 st , 2003,
Sheridan Westgarde, the Company’s current CEO surrendered 1,000,000 shares of
common stock for the purposes of compensating professionals providing services
to the Company. The shares at date of cancellation had an estimated value of
$46,360.





During
the fiscal year ended May 31 st , 2003,
William Stephaniuk surrendered 791,209 shares of common stock for the purposes
of compensating professionals providing services to the Company. The shares at
date of cancellation had an estimated value of $31,648.











**Convertible
Notes issued (The investors of the securities were accredited
investors).**





On March
4 th , 2001
Aquatic issued two convertible debentures of $100,000 in cash each for an
aggregate of $200,000 in accordance with § 4(2) and Rule 506 under the
Securities Act of 1933, as amended. The investors of these securities were
accredited investors.





On March
22 th , 2004
Aquatic issued three convertible debentures of $433,333, $433,334 and $33,333
respectively, in cash each for an aggregate of $900,000 in accordance with §
4(2) and Rule 506 under the Securities Act of 1933, as amended. The investors of
these securities were accredited investors.





**Warrants
and options issued (The investors of the securities were accredited
investors).**





During
March 2001, Aquatic issued common stock purchase warrants for the right to
purchase 100,000 shares of Common Stock of AQCI at $.35 per share and expire
March 14, 2003. These warrants were issued in accordance with § 4(2) and Rule
506 under the Securities Act of 1933, as amended. The investors of these
securities were accredited investors. During fiscal year ending May 31, 2004
these warrants have expired.





During
September 2001, Aquatic issued common stock purchase warrants for the right to
purchase 250,000 shares of Common Stock of AQCI at $.69 per share and expire
September 29, 2003. These warrants were issued in accordance with § 4(2) and
Rule 506 under the Securities Act of 1933, as amended. The investors of these
securities were accredited investors. During fiscal year ending May 31, 2004
these warrants have expired.





- 9
-








On March
22 nd , 2004,
Aquatic issued common stock purchase warrants for the right to purchase 900,000
shares of Common Stock of AQCI at $.0004 per share and expire March
22 nd , 2006.
These warrants were issued in accordance with § 4(2) and Rule 506 under the
Securities Act of 1933, as amended. The investors of these securities were
accredited investors.





**Transfer
Agent and Registrar**





The
Company's transfer agent is Oxford Transfer & Registrar located at 317
Southwest Alder, Suite 1120, Portland, Oregon, 92704.





****


**ITEM
6.** **MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS**


**Plan
of Operations**





The
Company has reorganized its core business, shifting from the underwater wood
business to that of investment and development of oil and natural gas. On March
22,  2004, the
Company acquired from Century Resources Inc., retroactive to March 1, 2004, a 20
percent ownership position and a 16 percent net revenue interest in the
Hamill Lease, a 3,645 acre natural gas producing property located in Matagorda
County, Texas. The purchase was made on the basis of the property having
existing production and revenues as compared to an exploration property with no
production.  Thus, the
Company agreed to assume an increased percentage of the costs for a lesser
percentage of the revenue on a 1/3 to 1/4 ratio, resulting in the 20 percent
ownership stake and 16 percent net revenue interest before
royalty expense. The
company’s original plan to acquire Century, a Texas based oil and gas Company,
was replaced with this new acquisition agreement which includes an exclusive,
optional, “New Project and Exploration Drilling Participation” agreement with
Century. This aspect of the agreement has three successive one-year terms, with
the Company holding the exclusive option on each year. (See Note 1 - Notes to
the Consolidated Financial Statements)











*HAMILL
& PRADO PRODUCTION*





Beginning
June 2004, maintenance work was commenced on the Hamill property, which resulted
in 2 additional wells coming into production. These 2 wells added approximately
250 thousand cubic feet of gas per day to over-all lease production.
Additionally, maintenance work was performed on the original producing well,
which resulted in that well production rising from approximately 700 thousand
cubic feet of gas per day to approximately 1.05 million cubic feet of gas per
day resulting in a total lease production of approximately 40 million cubic feet
of gas per month commencing July 10, 2004, an overall increase of 15.5 million
cubic feet of gas over previously reported numbers.





Currently
the Prado Field is producing approximately 900 b arrels of
oil per month from 2 of the 20 existing wells. The
Company is currently waiting on the completion of detailed evaluation of 3D
seismic and other site engineering data, for both Hamill and Prado, that will
further define the reserve potential, as well as future development costs.


As
previously reported, the Company has in the past been seeking to acquire the
Tiger•LynkTM large scale manipulator technology, formerly known as the ATH
technology, as a wholly owned subsidiary. To this effect, in June 2003, the
Company signed a Memorandum of Understanding with Legacy Systems Corp.
("Legacy") to merge the public Company with the Tiger•LynkTM robotic technology
patented and owned by Gary Ackles, former CEO of the Company. During
July 2004, the Company entered into a agreement with Gary Ackles, former Company
CEO, to cancel all plans to merge. The agreement to part ways involves the note
the Company currently has with Legacy Systems, the ATH-120
manipulator arm components currently stored at a manufacturing facility in
Kamloops, British Columbia as well
as settlement of amounts currently owed to Legacy Systems and Mr. Ackles (see
Note 5, 9 & 20 - Notes to Consolidated Financial Statements)





The
short-term objectives of Aquatic are to achieve growth of both oil and natural
gas reserves and revenue by pursuing the following:





1)
    Development
      of its current working interest in the Hamill & Prado Leases in
      Matagorda County and Jim Hogg County, Texas
  respectively.





- 10
-








2)
    Completing
      the acquisition and development of other property and working interest
      opportunities with proven reserve potential, made known to the Company
      through its “New Project and Exploration Drilling Participation” agreement
      with Century.








Aquatic's
long-term objectives are as follows:





Invest in
new oil and gas properties, combined with balanced development of drilling and
exploitation of current reserves. The company has several exclusive
opportunities, available to it through its “New Project and Exploration Drilling
Participation” agreement with Century, to acquire both oil and gas property
interests and development drilling interests.





Over the
next twelve months, management is confident that sufficient working capital will
be obtained from a combination of revenues and external financing to meet the
Company's liabilities and commitments as they become payable (See Notes 2 &
11 - Notes to Consolidated Financial Statements). The Company has in the past
successfully relied on private placements of common stock, bank financing, loans
from private investors and the exercise of common stock warrants, in order to
sustain operations. The Company plans to obtain the approval of its shareholders
to increase the total number of authorized shares as well as perform a reverse
split of the issued and outstanding shares to provide for the conversion of
debentures for equity, use equity positions as incentive for attracting
professionals, payment of professionals, sell additional shares for cash and use
equity as payment for mergers and acquisitions.





By
selling the equipment located in Brazil and the settlement agreement with Mr.
Ackles (see Note 5, 9 & 20 Notes to Consolidated Financial Statements) the
Company currently does not own any significant equipment. (See Note 4- Notes to
the Consolidated Financial Statements) As of May 31 st , 2004
the Company is utilizing consultants to manage 100 percent of the administration
and business development, for which there are three Consultants under
contract.








**Results
of Operations**





**Year
Ended May 31** **st** **,
2004 Compared to Year Ended May 31** **st** **,
2003**





The
company earned revenue of $33,053 for the year ended May 31 st , 2004,
compared with $nil for fiscal 2003 for a increase of $33,053. The increase was
attributable to the acquisition of the Hamill lease natural gas producing
property.







Operating
costs and expenses for the year ended May 31 st , 2004,
were $782,964 and $1,333,314 for the year ended May 31 st , 2003
for a decrease of $550,350. This was mainly attributable to the decrease in
selling, general and administrative expenses in 2004 of $301,930, down from
$1,184,582 in 2003. This decrease is attributable to a decrease in legal and
accounting of $92,845, investor relations of $192,580, licensing fees of
$80,000, director fees of $26,100, and a decrease in travel, auto, meals,
telephone and office supplies of $81,246. Offset by an increase in financing
fees from $147,569 in 2003 to $473,676 in 2004, which is attributable to the new
convertible notes issued in March of 2004 in the amount of $900,000.







The
Company incurred a loss in fiscal 2004 of $749,911 compared with a loss of
$1,247,850 in fiscal 2003.





**Liquidity
and Capital Resources**





Net cash
used in operating activities in fiscal 2004 amounted to $264,583 compared to
$765,151 in fiscal 2003 for a decrease use of cash of $500,568. The use of cash
is attributable to a net loss of $749,911 offset by $7,358 in depreciation,
$27,395 in amortization of deferred financing costs, $274,243 in amortization of
beneficial conversion feature, $195,163 in accounts payable and accrued
liabilities less $18,671 in un-paid equity of Hamill lease and $160 of prepaid
expenses. The Company has the following contractual obligations:


- 11
-








**AQCI****Monthly
      Contractual Obligations****Cash**
    
    **Stock**Sheridan
      Westgarde
    
    $
    5,000
    
    $
    1,500Lonnie
      Hayward
    
    
    3,500
    
    
    1,500Harvey
      Smith
    
    
    2,000
    
    
    2,000Kathy
      Ackes-(See note 1)
    
    
    833Monthly
      Total
    
    $
    11,333
    
    $
    5,000Note
      1: Agreement will terminate after approximatly May
31/05





Financing
activities generated net cash of $947,044 in fiscal 2004 compared with $828,614
in fiscal 2003. The cash from financing activities for fiscal year 2004 was
generated from issuance of notes of $53,000 and convertible debenture of
$900,000 and un-paid fees and expenses due to stockholders of 101,777 less
deferred financing costs.




At May
31 st , 2004
the Company had cash of $58,252 for total current assets of $156,333.





Over the
next twelve months, management is confident that sufficient working capital will
be obtained from a combination of revenues and external financing to meet the
Company's liabilities and commitments as they become payable (See Notes 2 &
11 - Notes to Consolidated Financial Statements). The Company has in the past
successfully relied on private placements of common stock, bank financing, loans
from private investors and the exercise of common stock warrants, in order to
sustain operations. The Company plans to obtain the approval of its shareholders
to increase the total number of authorized shares as well as perform a reverse
split of the issued and outstanding shares to provide for the conversion of
debentures for equity, use equity positions as incentive for attracting
professionals, payment of professionals, sell additional shares for cash and use
equity as payment for mergers and acquisitions.










**Critical
Accounting Policies and Estimates**









Our
discussion and analysis of our financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets liabilities,
revenues and expenses and related disclosures of contingent assets and
liabilities. On an ongoing basis, we evaluate our estimates, including those
related to impairment of long-lived assets. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Significant estimates include DD&A of
oil and gas properties. Oil and gas reserve estimates, which are the basis for
unit of production DD&A and the impairment analysis, are inherently
imprecise and are expected to change as future information becomes available. In
addition, alternatives may exist among various accounting methods. In such
cases, the choice of accounting method mau also have a significant impact on
reporting amounts. Actual results may differ from these estimates under
different assumptions or conditions; however, we believe that our estimates are
reasonable.







- 12
-







There are
numerous uncertainties inherent in estimating quantities of oil and natural gas
reserves of any category and in projecting future rates of production and timing
of development expenditures, which underlie the reserve estimates, including
many factors beyond the Company's control. Reserve data represent only
estimates. In addition, the estimates of future net cash flows from the
Company's proved reserves and their present value are based upon various
assumptions about future production levels, prices and costs that may prove to
be incorrect over time. Any significant variance from the assumptions could
result in the actual quantity of the Company's reserves and future net cash
flows from them being materially different from the estimates. In addition, the
Company's estimated reserves may be subject to downward or upward revision based
upon production history, results of future development, prevailing oil and gas
prices, operating and development costs and other factors.





Oil and
Gas Property Accounting





Oil and
gas companies may elect to account for their property costs using either the
“successful efforts” or “full cost” accounting method. Under the success efforts
method, lease acquisition costs and intangible development costs on successful
wells and development dry holes are capitalized. Selection of the oil and gas
accounting method can have a significant impact on a company’s financial
results. We use the successful efforts methoid of accounting and generally
pursue investments and development of proved reserves as opposed to exploration
activities.





Capitalized
costs relating to producing properties are depleted on the units-of-production
method. Proved developed reserves are used in computing unit rates for drilling
and development costs and total reserves for depletion rates of leasehold,
platform and pipeline costs. Expenditures for geological and geophysical testing
costs are generally changed to expense unless the costs can be specially
attributed to determining the placement for a future developmental well
location. Expenditures for repairs and maintenance are charged to expense as
incurred, renewals and betterments are capitalized. The costs and related
accumulated depreciation, depletion and amortization of properties sold or
otherwise retired are eliminated from the accounts, and gains or losses on
dispostion are reflected in the statements of operation.





Costs
directly associated with the acquisition and evaluation of unproved properties
are excluded from the amortization base until the related properties are
evaluated. Unproved properties are periodically assessed and any impairment in
value is charged to impairment expense. The costs of unproved properties which
are determined to be productive are transferred to proved oil and gas properties
and amortized on a unit of production.





Oil and
Gas Reserves





The
process of estimating quantities of natural gas and crude oil reserves is very
complex, requiring significant decisions in the evaluation of all available
geological, geophysical, engineering and economic data. The data for a given
field may also change substantially over time as a result of numerous factors
including, but not limited to, additional development activity, evolving
production history and continual reassessment of the viability of production
under varying economic conditions. As a result, material revisions to existing
reserve estimates may occur from time to time. Although every reasonable effort
is made to ensure that reserve estimates reported represent the most accurate
assessments possible, the subjective decisions and variances in available data
for various fields make these estimates generally less precise than other
estimates included in the financial statement disclosures. We use the
units-of-production method to amortize our oil and gas properties. This method
requires us to amortize the capitalized costs incurred in developing a property
in proportion to the amount of oil and gas produced as a percentage of the
amount of proved reserves contained in the property. Accordingly, changes in
reserves estimates as described above will cause corresponding changes in
depletion expense recognized in periods subsequent to the reserve estimate
revision.
















- 13
-










**Recent
Accounting Pronouncements**





In July
2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS
No. 141 requires the use of the purchase method of accounting and prohibits the
use of the pooling of interests method of accounting for business combinations
initiated after June 30, 2001. SFAS No. 141 also requires that the Company
recognize acquired intangible assets apart from goodwill if the acquired
intangible assets meet certain criteria. SFAS No. 141 applies to all business
combinations initiated after June 30, 2001, and for purchase business
combinations completed on or after July 1, 2001. Upon adoption of SFAS No. 142,
it also requires that the Company reclassify, if necessary, the carrying amounts
of intangible assets and goodwill, based on the criteria in SFAS No. 141. SFAS
No. 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment, at least annually. In
addition, SFAS No. 142 requires that the Company identify reporting units for
the purpose of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. Adoption of
this statement is not expected to be material.





In August
2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets." SFAS No. 144 supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," in
that it removes goodwill from its impairment scope and allows for different
approaches in cash flow estimation. However, SFAS No. 144 retains the
fundamental provisions of SFAS No. 121 for (a) recognition and measurement of
long-lived assets to be held and used and (b) measurement of long-lived assets
to be disposed of. SFAS No. 144 also supersedes the business segment concept in
APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions," in that it permits presentation
of a component of an entity, whether classified as held for sale or disposed of,
as a discontinued operation. However, SFAS No. 144 retains the requirement of
APB Opinion No. 30 to report discontinued operations separately from continuing
operations. The provisions of this Statement are effective for financial
statements issued for fiscal years beginning after December 15, 2001 with
earlier application encouraged. Company management has determined that
implementation of SFAS No. 144 will not have a material effect on the Company’s
results of operations or financial position.





On April
30, 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS
145 rescinds SFAS No. 4, which required all gains and losses from
extinguishments of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. Early application of the
provisions of SFAS No. 145 may be as of the beginning of the fiscal year or as
of the beginning of the interim period in which SFAS No. 145 is issued. Company
management has determined that implementation of SFAS No. 145 will not have a
material effect on the Company’s results of operations or financial
position.





In July
2002, the Financial Accounting Standards Board issued SFAS, "Accounting for
Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires that a
liability for costs associated with an exit or disposal activity be recognized
and measured initially at fair value only when the liability is incurred. SFAS
No.146 is effective for exit or disposal activities that are initiated after
December 31, 2002. Company management has determined that implementation of SFAS
No. 146 will not have a material effect on the Company’s results of operations
or financial position.





In April
2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities", which amends SFAS No. 133 for certain
decisions made by the FASB Derivatives Implementation Group.  In
particular, SFAS No. 149: (1) clarifies under what circumstances a contract with
an initial net investment meets the characteristic of a derivative, (2)
clarifies when a derivative contains a financing component, (3) amends the
definition of an underlying instrument to conform it to language used in FASB
Interpretation No. 45, "Guarantor’s Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others," and (4)
amends certain other existing pronouncements.  This Statement is effective
for contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. In addition, most provisions of
SFAS No. 149 are to be applied prospectively. As we have no such instruments,
the adoption of this issue did not have an impact on our statement of financial
position or results of operations.





Emerging
Issues Task Force (“EITF”) Issue No. 02-03, “Recognition and Reporting of Gains
and Losses on Energy Trading Contracts” under EITF Issues No. 98-10, “Accounting
for Contracts Involved in Energy Trading and Risk Management Activities” was
issued in June 2002. EITF Issue No. 02-03 addresses certain issues related to
energy trading activities, including (a) gross versus net presentation in the
income statement, (b) whether the initial fair value of an energy trading
contract can be other than the price at which it was exchanged, and (c)
accounting for inventory utilized in energy trading activities. As we have no
such instruments, the adoption of this issue did not have an impact on our
statement of financial position or results of operations.







- 14
-










In May
2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity”. This statement
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. This statement was effective for financial instruments entered into
or modified after May 31, 2003.










**ITEM
7.**  **FINANCIAL
STATEMENTS**





Please
refer to pages beginning with F-1.








**ITEM
8.**  **CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE**





1.    
A Form 8-K was filed on February 28 th , 2002,
reporting a change in accounting firms.





KPMG LLP
was previously the independent auditors for Aquatic Cellulose International
Corporation (the “Registrant”). On February 28 th , 2002,
the Registrant terminated KPMG for financial reasons and engaged Merdinger,
Fruchter, Rosen & Corso, P.C., to serve as the Company’s independent public
accountants and to be the principal accountants to conduct the audit of the
Company’s financial statements for the fiscal year ending May 31 st , 2002.
The decision to change was based on financial considerations and was approved by
the audit committee and the full Board of Directors of the
Registrant.





The audit
reports of KPMG LLP on the financial statements of Aquatic Cellulose
International Corporation as of and for the fiscal years ended May
31 st , 2001
and 2000 did not contain an adverse opinion or disclaimer of opinion and were
not qualified or modified as to uncertainty, audit scope or accounting
principles, except as follows:





KPMG
LLP's report on the consolidated financial statements of Aquatic Cellulose
International Corporation for the years ended May 31 st , 2001
and 2000, contained a separate paragraph stating “As discussed in note 1(a) to
the consolidated financial statements, the Company has a working capital
deficiency of $467,287 as at May 31, 2001 and has suffered recurring losses from
operations that raise substantial doubt about its ability to continue as a going
concern. Management’s plans in regard to these matters are also discussed in
note 1(a). The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.”





During
the Registrant’s fiscal years ended May 31 st , 1997
through May 31 st , 2001,
and the subsequent interim period ending February 28, 2001, there were no
disagreements between the Registrant and KPMG LLP on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope and
procedures, which if not resolved to their satisfaction of KPMG LLP would have
caused KPMG LLP to make reference to the matter in their report. The Company has
requested KPMG LLP to furnish it a letter addressed to the Commission stating
whether it agrees with the above statements. A copy of that letter, dated March
26 th , 2002,
is filed as Exhibit 16 to this Form 8-K.





There
were no other “reportable events” as that term is described in Item 304(a)(1)(v)
of Regulation S-K occurring within the Registrant’s two most recent fiscal years
and the subsequent interim period ending February 28, 2002.





During
the Registrant’s two most recent fiscal years ended May 31 st , 2001
and the subsequent interim period through February 28 th , 2002,
the Registrant did not consult with Merdinger, Fruchter, Rosen & Corso, P.C.
regarding any of the matters or events set forth in Item 304 (a)(2)(i) and (ii)
of Regulations S-K





2.    
A Form 8-K was filed on January 10 th , 2003,
reporting a change in accounting firms.





On
December 18 th , 2002
Merdinger, Fruchter , Rosen and Company, P.C. (the “Former Accountants”)
informed Aquatic Cellulose International Corporation (the “Company”) they have
decided to cease auditing publicly traded companies and have resigned as the
company’s principal accountants.





- 15
-








The
‘Former Accountants’ reports on the financial statements for the fiscal years
ended May 31 st , 2001
and 2000 did not contain an adverse opinion or disclaimer of opinion and were
not qualified or modified as to uncertainty, audit scope or accounting
principles.





The
Company’s Board of Directors has approved the resignation of the Former
Accountants.


During
the last two fiscal years preceding the Former Accountants’ resignation, and for
the interim period from June 1 st , 2002
through January 8 th , 2003,
there were no disagreements with the Former Accountants, whether or not
resolved, on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements, if
not resolved to the satisfaction of the Former Accountants, would have caused it
to make reference to the subject matter of the disagreements in connection with
its reports.





During
the last two fiscal years preceding the ‘Former Accountants’ resignation, and
for the interim period from June 1 st , 2002
through January 8 th , 2003,
there were no “reportable events” as defined by Regulation S-K, Item
304(a)(1)(v)(A) through (D).





On
January 8 th , 2003,
the Company engaged Stonefield Josephson, Inc., (the “New Accountants”) as our
principal accountants to audit our financial statements. The engagement of the
new Accountants was approved by the Company’s Board of Directors.





A letter
from the Former Accountants addressed to the Securities and Exchange Commission
stating the Former Accountants agree with the statements made by the Company in
this report has been filed as an exhibit to this report.





3.    
A Form 8-K was filed on February 23 rd , 2004,
reporting a change in accounting firms.





Stonefield
Josephson, Inc. (the “Former Accountants”) was previously the independent
auditors for Aquatic Cellulose International Corporation (“AQCI”). On or about
May 30 th , 2003,
Aquatic Cellulose International Corporation and Stonefield Josephson, Inc.,
mutually parted ways. AQCI officially engaged Wong Johnson & Associates on
February 16, 2004, to serve as the Company’s independent public accountants and
to be the principal accountants to conduct the audit of the Company’s financial
statements for the fiscal year ending May 31 st , 2002
and May 31 st , 2003.
The decision to change was based on financial considerations and was approved by
the audit committee. There were no disagreements with the Former Accountants,
whether or not resolved, on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of the Former Accountants,
would have caused it to make reference to the subject matter of the
disagreements in connection with the AQCI’s reports.





AQCI’s
Board of Directors has approved the change in Certifying Accountants from the
Former Accountants to Wong Johnson & Associates.





The
Former Accountants’ performed interim reviews of the Form 10QSB’s and did not
participate in auditing AQCI’s financial statements for any fiscal year and
therefore could not extend an opinion of any nature on AQCI. During the most
recent two years ended May 31 st , 2003
and 2002 and until the engagement of Wong Johnson & Associates, the
Registrant has not consulted with Wong Johnson & Associates regarding either
(i) the application of accounting principles to a specified transaction, either
completed or proposed; or the type of audit opinion that might be rendered on
the Registrant's financial statements, and neither a written report was provided
to the Registrant nor oral advice was provided that Wong Johnson &
Associates concluded was an important factor considered by the Registrant in
reaching a decision as to the accounting, auditing or financial reporting issue;
or (ii) any matter that was the subject of a disagreement, as the term is
defined in Item 304(a)(1)(iv) of Regulation S-B and the related instructions to
Item 304 of Regulation S-B.





Fiscal
year 2002 was originally audited by Merdinger, Fruchter , Rosen and Company,
P.C. who decided to cease auditing publicly traded companies and informed ACQI
of their decision on December 18 th , 2002
(see Form 8-K filed January 10 th , 2003).
Fiscal year 2001 was audited by KPMG LLP. AQCI’s decision to change auditors at
this time was based on financial considerations (see Form 8-K filed March
27 th , 2002.
As reported in the referenced Form 8-K’s filed, there were no disagreements with
the former accountants, whether or not resolved, on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure, which disagreements, if not resolved to the satisfaction of the
former accountants, would have caused it to make reference to the subject matter
of the disagreements in connection with its reports.





- 16
-








As a
result of Merdinger, Fruchter , Rosen and Company, P.C. decision to cease
auditing publicly traded companies, Wong Johnson & Associates will be
auditing fiscal year 2002 again and an amended Form 10KSB will be filed shortly.
Subsequently the Form 10KSB for fiscal year 2003 and all interim reports will be
filed.





A letter
from the Former Accountants addressed to the Securities and Exchange Commission
stating the Former Accountants agree with the statements made by the Company in
this report has been filed as an exhibit to this report.


4. A Form
8-K/A was filed on April 1 st , 2004,
correcting the previously filed Form 8-K filed on February 24 th , 2004
and reporting a change in accounting firms.





Stonefield
Josephson, Inc. (the "Former Accountants") was previously the independent
auditors for Aquatic Cellulose International Corporation ("AQCI"). On or about
July 3, 2003, Aquatic Cellulose International Corporation dismissed Stonefield
Josephson, Inc., however they were not informed of such until management engaged
the new accountants. AQCI officially engaged Wong Johnson & Associates on
February 16, 2004, to serve as the Company's independent public accountants and
to be the principal accountants to conduct the audit of the Company's financial
statements for the fiscal year ending May 31, 2002 and May 31, 2003. All filing
stopped until Wong Johnson and Associated were retained. At that time all 10KSB'
and 10QSB's were brought current with Wong Johnson during the audits and
reviews. The decision to change was based on financial considerations and was
approved by the audit committee. There were no disagreements with the Former
Accountants, whether or not resolved, on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of the Former Accountants,
would have caused it to make reference to the subject matter of the
disagreements in connection with the AQCI's reports.





AQCI's
Board of Directors has approved the change in Certifying Accountants from the
Former Accountants to Wong Johnson & Associates.





The
former accounts performed interim reviews for the November 2002 and February
2003 10QSB's and did not participate in auditing AQCI's financial statements for
any fiscal year and therefore could not extend an opinion of any nature on AQCI.
During the most recent two years ended May 31, 2003 and 2002 and until the
engagement of Wong Johnson & Associates, the Registrant has not consulted
with Wong Johnson & Associates regarding either (i) the application of
accounting principles to a specified transaction, either completed or proposed;
or the type of audit opinion that might be rendered on the Registrant's
financial statements, and neither a written report was provided to the
Registrant nor oral advice was provided that Wong Johnson & Associates
concluded was an important factor considered by the Registrant in reaching a
decision as to the accounting, auditing or financial reporting issue; or (ii)
any matter that was the subject of a disagreement, as the term is defined in
Item 304(a)(1)(iv) of Regulation S-B and the related instructions to Item 304 of
Regulation S-B.





Fiscal
year 2002 was originally audited by Merdinger, Fruchter , Rosen and Company,
P.C. who decided to cease auditing publicly traded companies and informed ACQI
of their decision on December 18, 2002 (see Form 8-K filed January 10, 2003).
Fiscal year 2001 was audited by KPMG LLP. AQCI's decision to change auditors at
this time was based on financial considerations (see Form 8-K filed March 27,
2002. As reported in the referenced Form 8-K's filed, there were no
disagreements with the former accountants, whether or not resolved, on any
matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure, which disagreements, if not resolved to the
satisfaction of the former accountants, would have caused it to make reference
to the subject matter of the disagreements in connection with its reports.





As a
result of Merdinger, Fruchter , Rosen and Company, P.C. decision to cease
auditing publicly traded companies, Wong Johnson & Associates will be
auditing fiscal year 2002 again and an amended Form 10KSB will be filed shortly.
Subsequently the Form 10KSB for fiscal year 2003 and all interim reports will be
filed.





A letter
from the Former Accountants addressed to the Securities and Exchange Commission
stating the Former Accountants agree with the statements made by the Company in
this report has been filed as an exhibit to this report.





- 17
-








**ITEM
8A.**  **CONTROL
AND PROCEDURES**





(a)       
Evaluation of Disclosure Controls and Procedures. Our Chief Executive Officer
and Chief Financial Officer have evaluated the effectiveness of our disclosure
controls and procedures (as such term is defined in Rules 13a-15 and 15d-15
under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as
of the end of the period covered by this annual report (the “Evaluation Date”).
Based on such evaluation, such officers have concluded that, as of the
Evaluation Date, our disclosure controls and procedures are effective in
alerting them on a timely basis to material information relating to our Company
(including our consolidated subsidiaries) required to be included in our reports
filed or submitted under the Exchange Act.





(b)       
Changes in Internal Controls over Financial Reporting. During the most recent
fiscal year, there have not been any significant changes in our internal
controls over financial reporting or in other factors that have materially
affected, or are reasonably likely to materially affect, our internal controls
over financial reporting.








PART
III





**ITEM
9.**  **DIRECTORS,
EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A)
OF THE EXCHANGE ACT**





**Executive
Officers and Directors**





Name
    Age
    PositionSheridan
      B. Westgarde
    35
    Director
      & PresidentGary
      J. Ackles * 1
    50
    Director
      & PresidentShane
      Kerpan *1
    33
    Secretary
      & TreasurerClaus
      Wagner-Bartak *2
    65
    Director





*1
Resigned in 2003


*2
Resigned in 2004





The
officers and Directors of Aquatic will devote only such time as they deem
appropriate in the business affairs of our Company. It is, however, expected
that the officers will devote the time deemed necessary to perform their duties
for the business of our Company. The amount devoted by each director is
discussed below.





The
directors of Aquatic are elected to hold office until the next annual meeting of
shareholders and until their respective successors have been elected and
qualified.





**Biographies
of Our Executive Officers and Directors**





Sheridan
B. Westgarde: Mr. Westgarde was appointed to the Board of directors March
27 th 2003. As
a C.A.S. Tech. graduate of UCC British Columbia and a recognized specialist in
the robotics and automation industry, Mr. Westgarde has been extensively
involved in the design and development of the Tiger•LynkTM manipulator
technology. In addition, Mr. Westgarde has valuable knowledge and experience in
the Oil and Gas industry, providing his technical expertise in down-hole tool
management and implementation.


Mr.
Westgarde does not sit on the Board of any other public company. Mr. Westgarde
dedicates approximately 90% of his time to Aquatic.





Gary J.
Ackles: Mr. Ackles was appointed to the Board of Directors on July 1 st , 1997,
to fill a vacancy. Mr. Ackles was President and founder of Aquatic Cellulose
Ltd., and creator of the Aquatic Timber Harvester System. Mr. Ackles has over 25
years experience in industries that manufacture and sell equipment, with
extensive international and domestic experience. Mr. Ackles is recognized as a
creator of aquatic technologies, and has been involved with numerous equipment
based industries including oil and mineral exploration, heavy construction, and
aquatic environmental management. Mr. Ackles has introduced and sold equipment
in Canada, USA, Middle East, Africa, and South America. Mr. Ackles resigned as
Director, President and CEO on March 26 th ,
2003.





- 18
-








Shane
Kerpan: Mr. Kerpan earned a degree in Business Administration from Simon Fraser
University and has worked in a variety of staff management positions in both the
private and non-profit sectors. Mr. Kerpan also possesses experience in project
management and evaluation plus has provided the Company with assistance in
project research, development of multi-media presentations and public relations.
Mr. Shane Kerpan resigned as the Secretary and Treasurer on December
20 th ,
2003.





Claus
Wagner-Bartak--Dr. Claus Wagner-Bartak was appointed to the Board of Directors
in July, 1997, to fill a vacancy. Dr. Wagner-Bartak was the founder of
Spar-Aerospace, the corporation contracted to develop and build the robotic arm
that is presently used on the NASA Space Shuttle, that arm being named the
"Canada-arm". Mr. Bartak resigned as the Director on February 24 th ,
2004.








**Compliance
with Section 16(a) of the Securities Exchange Act of
1934**





Section
16(a) of the Securities Exchange Act of 1934 requires the Company’s directors
and executive officers, and persons who own more than 10% of a registered class
of the Company’s equity securities to file with the Securities and Exchange
Commission initial reports of ownership and reports of changes in ownership of
Common Stock and other equity securities of the Company. Officers, directors and
greater than 10% shareholders are required by SEC regulations to furnish the
Company with copies of all Section 16(a) forms they file.





To the
Company’s knowledge, based solely on its review of the copies of such reports
furnished to the company and written representations that no other reports were
required during the fiscal year ended May 31 st , 2003,
all Section 16(a) filing requirements applicable to its officers, directors and
greater than 10% beneficial owners were complied with.





**Code
of Ethics for Chief Executive Officer and Senior Financial
Officers**





On May
20, 2004, the Board of Directors of the Company adopted the Code of Ethics for
Chief Executive Officer and Senior Financial Officers, which is included in Item
13 as an exhibit 99.








**** **ITEM
10.**  **EXECUTIVE
COMPENSATION**





- 19
-










The
following table sets forth certain summary information regarding compensation
paid by the Company for services rendered during the fiscal year ended May
31 st , 2004 to
the Company’s Chief Executive Officer, Secretary and Director during such
period.





**CHART
- EXECUTIVE COMPENSATION**





**Payouts**
    ****
    **Annual
      Compensation**
    ****
    **Long
      Term Compensation Awards**
    ******(a)**
    ****
    **(b)**
    ****
    **(c)**
    ****
    **(d)**
    ****
    **(e)**
    ****
    **(f)**
    ****
    **(g)**
    ****
    **(h)**
    ****
    **(i)**Name
      and Principal Position
    
    **Year**
    ****
    **Salary**
    ****
    **Bonus**
    ****
    **Other
      Annual Compensation ($)**
    ****
    **Restricted
      Stock Awards ($)**
    ****
    **Securities
      Underlying Options/SAR (#)**
    ****
    **LTIP
      Payouts ($)**
    ****
    **All
      Other Compensation ($)**Sheridan
      B. Westgarde
      President/CEO
    
    
    2004
      2003
      2002
    
    
    82.5K
      15K
      N/A
    
    
    
    
    
    
    
    
    
    
    
    0
      0Gary
      Ackles President/CEO
      *1
    
    
    2004
      2003
      2002
    
    
    49.5K
      100K
      107K
    
    
    
    
    
    
    
    
    
    
    
    0
      0
      1,202,500Shane
      Kerpan
      Secretary
      *1
    
    
    2004
      2003
      2002
    
    
    0
      0
      0
    
    
    
    
    
    
    
    
    
    
    
    0
      0
      117,500Claus
      Wagner-Bartak
      Director
      *2
    
    
    2004
      2003
      2002
    
    
    0
      0
      0
    
    
    
    
    
    
    
    
    
    
    
    0
      0
      105,250





*1
Resigned in 2003


*2
Resigned in 2004








**Chief
Executive Officer Compensation:**





Mr.
Westgarde has a three year consulting agreement commencing April 1, 2003,
providing for an annual compensation of $90,000. In addition, the Board of
Directors has committed to make Mr. Westgarde a significant shareholder in the
Company with a share position of 5% of the authorized share volume of the
Company issued over the course of three years. To the date of this filing these
shares have not been issued. Effective, March 1, 2004, the agreement for Mr.
Westgarde was modified to reduce the cash portion of the consulting fee to
$5,000 per month and include $1,500 per month in stock compensation.
Additionally, during July 2004, the Company entered into an agreement to
exchange the 5 percent of the new authorized share volume, post-proxy, owed to
Mr. Westgarde for a 27 percent common share equity position in the Company post
restructuring **** and
pending and pending shareholders approval of the Proxy. As a director of the
Company, Mr. Westgarde shares would be affiliate status and bearing all
restrictions according to affiliates as stated in the Securities and Exchange
Act of 1933.





Former
Director and President Gary J. Ackles had a three-year employment agreement that
commenced November 1, 2000 and provided for an annual salary of
$107,134, plus
certain benefits. The agreement called for a minimum increase in salary of 10%
per annum, as well as a severance package that was exercised upon his
resignation.





- 20
-








(1)  Long Term
Incentive Plans (Options)





There are
no long- term incentive plans currently in effect. However, the Board of
Directors has granted the directors and officers of the Company stock options
that are intended to place each director and officer in an equity position in
our Company that roughly equates to their original percentage of shares owned in
our Company. These options were issued on February 22, 2000 and are exercisable
in whole or in part for five years from the date of issue at an exercise price
of $0.52. Closing market price of Aquatic’s common stock as quoted on the OTC:BB
on February 22 nd , 2000
was $.5156. The number of above options issued were 1,425,250 and are as
follows:




1.
    Gary
      Ackles -
    1,202,5002.
    Clause
      Wagner-Bartuk -
    117,5003.
    Shane
      Kerpan -
    105,250


To the
date of this filing these options have not been exercised.





**Compensation
of Directors**





Mr.
Westgarde, the Company’s President and Chief Executive Officer, is currently the
sole director of the company with his compensation as detailed above. The
Company is committed to make Mr. Lonnie Hayward a director pending shareholder
approval of the Proxy. (see Note 14 & 21 - Notes to Consolidated Financial
Statements).








**ITEM
11.**  **SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**





The
following table sets forth information as of the date of this Registration
Statement regarding certain Ownership of our Company's outstanding Common Stock
by all officers and directors individually, all officers and directors as a
group, and all beneficial owners of more than five percent of the common
stock.





**Name
      and Address**
    ****
    **Shares
      Owned Beneficially(1)**
    ****
    **Percent
      of Class**Sheridan
      B. Westgarde
    
    
    2,500,000
    
    
    2.5
    %2504
      27thAve.Vernon,
      BC. V1T 1T1Gary
      J. Ackles3498
      Salmon River Bench Rd
    
    
    0
    
    
    0
    %Vernon,
      B.C. V1T 8Z7Claus
      Wagner-Bartak
    
    
    0
    
    
    0
    %4092
      Lee HighwayArlington,
      VA 22207Shane
      Kerpan
    
    
    0
    
    
    0
    %816
      George Ann StreetKamloops,
      B.C. V2C 1L5Officer/Director
      as a Group
    
    
    2,500,000
    
    
    2.5
    %





(1) A
person is deemed to be the beneficial owner of securities that can be acquired
by such person within 60 days from the date of the registration statement upon
the exercise of options or warrants. Each beneficial owner's percentage
ownership is determined by assuming that options or warrants that are held by
such person and which are exercisable within 60 days of the date of this
registration statement have been exercised. Unless otherwise indicated, the
company believes that all persons named in the table have voting and investment
power with respect to all shares of common stock beneficially owned by them.





- 21
-


**ITEM
12.**  **CERTAIN
RELATIONSHIPS AND RELATED TRANSACTION**





On
February 22, 2000, the Board of Directors authorized and granted the issuance of
stock options to certain officers and directors of our Company. The options were
vested immediately and will be exercisable in whole or in part for five years
from the date of issue. The exercise price was pegged at market price on the
date the options were granted. The options granted on February 22, 2000 (at
$0.52 per share) are as follows: 1) 1,202,500 shares of common stock to Gary
Ackles, 2) 105,250 shares of common stock to Shane Kerpan, and 3) 117,500 shares
of common stock to Claus Wagner- Bartak. To the date of this filing these
options have not been exercised.





In
January 2002, Aquatic issued 7,245,000 shares of restricted stock at $.014 per
share to Gary Ackles as per his employment agreement, pursuant to the exemption
provided for under Section 4(2) of the Securities Act of 1933 as amended, as a
"transaction not involving a public offering."





The
Company service agreement with Kathy Ackles, wife of the former president, for
bookkeeping and administrative services for $36,000 per annum expired as of June
1 st , 2003.





The
Company has an employment agreement with Gary Ackles, the Company’s former
president, providing for an annual salary of $107,134 and severance benefits. As
of March 26 th 2003 Mr.
Ackles resigned from the Company and exercised his severance
package.





Effective,
March 1, 2004, the agreement for Mr. Westgarde, the Company’s Director and
President, was modified to reduce the cash portion of the consulting fee to
$5,000 per month and include $1,500 per month in stock compensation.
Additionally, during July 2004, the Company entered into an agreement to
exchange the 5 percent of the new authorized share volume, post-proxy, owed to
Mr. Westgarde for a 27 percent common share equity position in the Company
post-restructuring **** and
pending shareholder approval of the Proxy. As a director of the Company, Mr.
Westgarde shares would be affiliate status and bearing all restrictions
according to affiliates as stated in the Securities and Exchange Act of
1933.





As of
April 1 st , 2003,
the Company has a short-term consulting agreement with former president Gary J.
Ackles to act in an advisory capacity to the Company during the transition to
the new management. This agreement provide for an annual compensation of
$60,000.








The
Company had a license agreement with the Company's former President for the use
of his Patented Robotic Technology. On May 31 st 2003 all
manufacturing and licensing agreements with Gary J. Ackles, owner of the ATH
robotic technology were cancelled.





The
Company borrowed $44,000 from Legacy Systems Corporation, owned by Gary Ackles.
The security for the loan was the ATH-120 mechanical assembly constructed and
stored at Beaver Manufacturing in Kamloops British Columbia.





During
July 2004, the Company entered into an agreement with Gary Ackles, former
Company CEO and Legacy Systems, a company controlled by Ackles, to settle
amounts currently owed to both Ackles and Legacy (see Note 9 - Notes to
Consolidated Financial Statements). The agreement requires the Company to return
the Aquatic Timber Harvesting Equipment (see Note 5 - Notes to Consolidated
Financial Statements) and issue 40,000,000 pre-restructured shares of the
Company’s common stock in exchange for, forgiveness of the $44,000 borrowed from
Legacy and the $80,000 due Legacy in un-paid licensing fees. The remaining
amount due G. Ackles of $417,000 will be converted into 13 percent of the
issued and outstanding post-restructured shares of the Company pending
shareholder approval of the Proxy. The agreement stipulates that Mr. Ackles
would be an affiliate of the Company bearing all the restrictions of Affiliates
according to the Securities and Exchange Act of 1933.





During
October 2002, the Company entered into an agreement with Gary Ackles, former
CEO, to sell the equipment located in Brazil with a net book value of $4,275 in
addition to a prototype machine with a net book value of $-0- located on the
Tucurui reservoir. Under the terms of the agreement, the proceeds of sale were
$70,000 resulting in a pre-tax gain of approximately $65,700. The Company
applied the value of the machine as an offset to the unpaid license fee owed to
Legacy Systems Corp. (see Notes 9 & 17 - Notes to Consolidated Financial
Statements).





- 22
-








During
the fiscal year ended May 31, 2003, approximately $100,000 of loans made to a
Director for the exercise of Company stock options was called by the Company.
The balance owed to the Company was used as an offset against unpaid wages due
to Gary Ackles (see Note 12 - Notes
to Consolidated Financial Statements ). The
remaining loans were forgiven to the two other Directors during January
2003.





**ITEM
13.**  **EXHIBITS,
LIST AND REPORTS IN FORM 8-K**


****


**(a)
Exhibits**


Exhibit
      Number
    Description3.1
    Articles
      of Incorporation of the Company filed February 28th,
      1997. (1)3.2
    Certificate
      Amending Articles of Incorporation filed November 19th,
      1997. (1)3.3
    Bylaws
      of the Company. (1)4.1
    Form
      of Common Stock Certificate. (2)4.2
    Form
      of Warrant Agreement with Form of Warrant Election to Purchase.
      (2)6.1
    Lease
      for the Premises dated November 1st,
      1996. (1)10.1
    Form
      of Secured Convertible Debenture Purchase Agreement. (2)10.2
    Form
      of Registration Rights Agreement. (2)10.3
    Form
      of 12% Convertible Debenture. (2)10.4
    Form
      of Security Agreement. (2)31.1
    Certification
      of the Chief Executive Officer pursuant to Rule
  13a-14(a)(Section
      302 of the Sarbanes-Oxley Act of 2002)31.2
    Certification
      of the Chief Financial Officer pursuant to Rule
  13a-14(a)(Section
      302 of the Sarbanes-Oxley Act of 2002)32.1
    Certification
      of the Chief Executive Officer pursuant to 18
  U.S.C.ss.1350(Section
      906 of the Sarbanes-Oxley Act of 2002)32.2
    Certification
      of the Chief Financial Officer pursuant to 18
  U.S.C.ss.1350(Section
      906 of the Sarbanes-Oxley Act of 2002)99
    Code
      of Ethics for Chief Executive Officer and Senior Financial
      Officers








(1)
    Previously
      filed with the Commission on August 16th,
      1999 as part of Aquatic Cellulose International Corp.’s Registration
      Statement (File N0.000-27063) on Form 10SB12G and incorporated by
      reference herein.(2)
    Previously
      filed with the Commission on August 21st,
      2000 as part of Aquatic Cellulose International Corp.’s Registration (File
      NO: 333-44184) on Form SB-2 filed on August 21st,
      2000 and incorporated by reference herein.





**(b)**  **Reports
on Form 8-K:**





1. Form
8-K dated January 10 th , 2003
reported that on December 18 th , 2002
Merdinger, Fruchter , Rosen and Company, P.C. informed Aquatic Cellulose
International Corporation they have decided to cease auditing publicly traded
companies and have resigned as the company’s principal accountants. On January
8 th , 2003,
AQCI engaged Stonefield Josephson, Inc., as our principal accountants to audit
our financial statements. Stonefield Josephson, Inc.’s accountants’ performed
interim reviews of the Form 10QSB’s and did not participate in auditing AQCI’s
financial statements for any fiscal year.





- 23
-








2. Form
8-K dated March 31 st , 2003
reported Gary Ackles has resigned as Chairman of Board of Directors and CEO of
Aquatic Cellulose International Corporation effective March 26 th , 2003 to
dedicate his time to his technology and corporate development for personal
reasons.





3. Form
8-K dated February 23 rd , 2004
reported that on or about May 30 th , 2003,
Aquatic Cellulose International Corporation and Stonefield Josephson, Inc.,
mutually parted ways. AQCI officially engaged Wong Johnson & Associates, A
Professional Corporation, on February 16 th , 2004,
to serve as the Company’s independent public accountants and to be the principal
accountants to conduct the audit of the Company’s financial statements for the
fiscal year ending May 31 st , 2002
and May 31 st , 2003.
The decision to change was based on financial considerations and was approved by
the Board of Directors.





4. Form
8-K/A dated April 1 st , 2004
was a correction of the previously filed Form 8-K and reported that on or about
July 3, 2003, Aquatic Cellulose International Corporation dismissed Stonefield
Josephson, Inc., however they were not informed of such until management engaged
the new accountants. AQCI officially engaged Wong Johnson & Associates on
February 16, 2004, to serve as the Company's independent public accountants and
to be the principal accountants to conduct the audit of the Company's financial
statements for the fiscal year ending May 31, 2002 and May 31, 2003. All filing
stopped until Wong Johnson and Associated were retained. At that time all 10KSB'
and 10QSB's were brought current with Wong Johnson during the audits and
reviews. The decision to change was based on financial considerations and was
approved by the Board of Directors.








5. Form
8-K dated April 13 th , 2004
reported that on March 22, 2004 Aquatic Cellulose International Corporation
("AQCI") completed a $900,000 financing with a New York based investor group.
The financing has been structured as a convertible debenture. On March 22, 2004
Aquatic Cellulose International Corporation ("AQCI") completed a purchase and
sale agreement with Century Resource Inc. of Houston Texas, for the acquisition
of a 20% working interest and 16% net revenue interest in the 3,645 acre Hamill
Lease natural gas property in Matagorda County, Texas. This agreement, with
three successive one year terms and an exclusive renewal option on each year,
provides Aquatic the exclusive option to participate in purchase or exploration
of any and all future projects by Century. The cost of this acquisition and
exclusive optional participation agreement was $580,000 dollars and a 15%
ownership stake in the company. The decision to approve the terms of the
financing and subsequent working interest acquisition was approved by the Board
of Directors.








**ITEM
14.**  **PRINCIPAL
ACCOUNTANT FEES AND SERVICES**





**1)
Audit Fees & Audit-Related Fees**





During
fiscal year 2002, the Company’s principal accountant billed $39,322 in fees that
were directly associated with the preparation of annual audit reports, quarterly
reports, review and preparation regarding SEC comment letters pertaining to a
Form SB-2 filing and review and discussion regarding 8K and newly appointed
auditors.





During
fiscal year 2003, the Company’s principal accountant billed $36,825 in fees that
were directly associated with the preparation of annual audit reports and
quarterly reports.





During
fiscal year 2004, the Company’s principal accountant billed $83,000 in fees that
were directly associated with the preparation of annual audit reports, quarterly
reports, examination of revenue and direct operating expenses of the Hamill
Lease, read and provide suggestions for pro-forma statements, as well as,
Preliminary Proxy 14/A filing.





**2)
Tax Fees**





During
fiscal year 2002, there were no fees billed associated with the preparation of
tax filings.





During
fiscal year 2003, there were no fees billed associated with the preparation of
tax filings.





During
fiscal year 2004, there were no fees billed associated with the preparation of
tax filings.





- 24
-








**3)
All Other Fees**





During
fiscal year 2002, there were no other fees billed by the Company’s principal
accountant for services other than those reported for audit and audit related
fees.





During
fiscal year 2003, there were no other fees billed by the Company’s principal
accountant for services other than those reported for audit and audit related
fees.





During
fiscal year 2004, there were no other fees billed by the Company’s principal
accountant for services other than those reported for audit and audit related
fees.





**Audit
committee’s pre-approval policies and procedures**





Due to
the fact that Sheridan B. Westgarde is the Company’s only active Officer and
Director the company does not have an audit committee at this time.





**Percentage
of hours expended**





The
amount of hours expended on the principal accountant’s engagement to audit the
registrant’s financial statements for the most recent fiscal year that were
attributed to work performed by persons other than the principal accountant’s
full-time, permanent employees was less than 50%.








- 25
-





**SIGNATURES**





In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.








**Aquatic
      Cellulose International Corp.**By:
    /s/  
      Sheridan WestgardeSheridan Westgarde
      Director,
      Chief Executive Officer
      President
      and Chief Accounting Officer
      
      Date: 
      March 18, 2005








By:
    /s/ Sheridan
      WestgardeSheridan Westgarde
      President
      and Chief Accounting OfficerDate: 
      March 18, 2005




In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.





/s/Sheridan
      Westgarde
    
    Director,
      Chief Executive Officer
    March
      18, 2005/s/Sheridan
      Westgarde
    
    President
      and Chief Accounting Officer
    March
      18, 2005














- 26
-





Consolidated
Financial Statements of





**AQUATIC
CELLULOSE**


**INTERNATIONAL
CORP.**


May 31,
2004 and 2003








Page**Index
      To Audited Financial Statements**Independent
      Auditors’ Report
    F-2Consolidated
      Balance Sheet as of May 31, 2004 and 2003
    F-3Consolidated
      Statement of Operations for the years ended May 31, 2004 and
      2003
    F-4Consolidated
      Statement of Comprehensive Loss for the years ended
    F-5May
      31, 2004 and 2003Consolidated
      Statement of Stockholders' (Deficiency) Equityfor
      the years ended May 31, 2004 and 2003
    F-6Consolidated
      Statement of Cash Flows for the years ended May 31, 2004 and
      2003
    F-8Notes
      to Consolidated Financial Statements
    F-10



















****
 ****
 **REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 
 To the
Board of Directors and Shareholders
 Aquatic
Cellulose International Corp.
 Vernon,
British Columbia, Canada
 
 We have
audited the accompanying consolidated balance sheets of Aquatic Cellulose
International Corporation as of May 31, 2004 and 2003, and the related
consolidated statements of operations, of comprehensive loss, of stockholders’
deficiency and of cash flows for each of the two fiscal years ended May 31,
2004. These consolidated financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about 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. We believe that our audits provide a
reasonable basis for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Aquatic Cellulose
International Corporation, as of May 31, 2004 and 2003, and the results of its
operations and its cash flows for each of the two fiscal years in the period
ended May 31, 2004, in conformity with United States generally accepted
accounting principles.
 
 The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has incurred significant losses from
operations, has negative working capital and stockholders’ deficit. These
factors raise substantive doubt about its ability to continue as a going
concern. Management’s plans in regard to these matters is also disclosed in Note
2. The consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
 
 
 
 WONG
JOHNSON & ASSOCIATES
 A
Professional Corporation
 Temecula,
California
 March 11,
2005










F-2






AQUATIC
      CELLULOSE INTERNATIONAL CORP.Consolidated
      Balance Sheet**May
      31,**
    
    
    
    **2004**
    
    **2003****Assets**Current
      AssetsCash
    
    
    
    
    $
    58,252
    
    $
    13,204Prepaid
      expenses and other current assets
    
    
    
    
    
    450
    
    
    290Deferred
      financing costs, net of accumulatedamortization
      of $10,102
    
    
    
    
    
    97,631
    
    
    -Total
      current assets
    
    
    
    
    
    156,333
    
    
    13,494Property
      and equipment, less accumulateddepreciation
      of $11,404 and $10,787
    
    
    
    
    
    2,638
    
    
    2,566Investment
      in Hamill lease
    
    
    
    
    
    591,930
    
    
    -Advance
      on equipment purchase
    
    
    
    
    
    100,000
    
    
    100,000Total
      Assets
    
    
    
    
    $
    850,901
    
    $
    116,060**Liabilities
      and Stockholders' Deficit**Current
      LiabilitiesAccounts
      payable
    
    
    
    
    $
    87,348
    
    $
    150,290Accrued
      liabilities
    
    
    
    
    
    500,759
    
    
    242,654Amounts
      due to related parties
    
    
    
    
    
    741,174
    
    
    639,397Convertible
      debentures
    
    
    
    
    
    300,241
    
    
    763,507Notes
      payable
    
    
    
    
    
    53,000
    
    
    -Total
      current liabilities
    
    
    
    
    
    1,682,522
    
    
    1,795,848Long
      Term LiabilitiesTotal
      Liabilities
    
    
    
    
    
    1,682,522
    
    
    1,795,848Stockholders'
      DeficitPreferred
      stock,$0.001 par value per share10,000,000
      shares authorized. No sharesissued
      and outstanding at May 31, 2004 and 2003,
    respectively
    
    
    
    
    
    -
    
    
    -Common
      stock, $0.001par value, 100,000,000shares
      authorized, 100,000,000 shares issued andoutstanding
      at May 31, 2004 and 2003, respectively
    
    
    
    
    
    100,000
    
    
    100,000Advance
      on deposit of equipment
    
    
    
    
    
    (125,000
    )
    
    (125,000
    )Additional
      paid in capital
    
    
    
    
    
    7,139,493
    
    
    5,484,691Accumulated
      deficit
    
    
    
    
    
    (7,905,082
    )
    
    (7,155,171
    )Foreign
      currency translation adjustment
    
    
    
    
    
    (41,032
    )
    
    15,692Total
      stockholders' deficit
    
    
    
    
    
    (831,621
    )
    
    (1,679,788
    )Total
      Liabilities and Stockholders' Deficit
    
    
    
    
    $
    850,901
    
    $
    116,060




See accompanying notes.





F-3


****





**AQUATIC
      CELLULOSE INTERNATIONAL CORP.****Consolidated
      Statement of Operations****Period
      from****June
      1, 2003**
    
    **June
      1, 2002****To**
    
    **To****May
      31, 2004**
    
    **May
      31, 2003**Equity
      in earnings of Hamill lease
    
    
    
    
    $
    33,053Operating
      expensesSelling,
      general and administrative
    
    
    
    
    
    301,930
    
    
    1,184,582Financing
      fees
    
    
    
    
    
    473,676
    
    
    147,569Depreciation
      and depletion
    
    
    
    
    
    7,358
    
    
    1,163Total
      operating expenses
    
    
    
    
    
    782,964
    
    
    1,333,314Loss
      from operations
    
    
    
    
    
    (749,911
    )
    
    (1,333,314
    )Other
      income (expense)Gain
      on disposal of equipment
    
    
    
    
    
    
    
    
    65,725Foreign
      currency translation
    
    
    
    
    
    
    
    
    19,739Total
      other income (expense)
    
    
    
    
    
    -
    
    
    85,464Net
      loss
    
    
    
    
    $
    (749,911
    )
    $
    (1,247,850
    )Weighted
      Average Shares
    
    
    
    
    
    100,000,000
    
    
    95,758,155Loss
      Per Common Share
    
    
    
    
    $
    (0.01
    )
    $
    (0.01
    )








**See accompanying notes.**





F-4


****


**AQUATIC
      CELLULOSE INTERNATIONAL CORP.**Consolidated
      Statement of Comprehensive Loss**Period
      from****June
      1, 2003**
    
    **June
      1, 2002****To**
    
    **To****May
      31, 2004**
    
    **May
      31, 2003**Net
      loss
    
    
    
    
    $
    (749,911
    )
    $
    (1,247,850
    )Foreign
      exchange translation adjustment
    
    
    
    
    
    (56,724
    )
    
    (61,097
    )Comprehensive
      loss
    
    
    
    
    $
    (806,635
    )
    $
    (1,308,947
    )





**See accompanying notes.**


F-5











AQUATIC
      CELLULOSE INTERNATIONAL CORP.Consolidated
      Statement of Stockholders' Deficit****
    
    ****
    
    **Paid**
    
    ****
    
    **Foreign**
    
    ****
    
    **Total******
    
    ****
    
    **Common**
    
    **Common**
    
    **In**
    
    **Advance
      on**
    
    **Currency**
    
    **Accumulated**
    
    **Stockholders'******
    
    ****
    
    **Shares**
    
    **Stock**
    
    **Capital**
    
    **Deposit**
    
    **Translation**
    
    **Deficit**
    
    **Deficit**Balance
      at May 31, 2002
    
    
    
    
    
    78,442,715
    
    $
    78,442
    
    $
    4,942,332
    
    
    
    
    $
    76,789
    
    $
    (5,907,321
    )
    $
    (809,758
    )Issued
      upon conversion of debentures
    
    
    
    
    
    4,189,412
    
    
    4,190
    
    
    35,810
    
    
    
    
    
    
    
    
    
    
    
    40,000Issued
      for cash
    
    
    
    
    
    3,868,880
    
    
    3,869
    
    
    38,631
    
    
    
    
    
    
    
    
    
    
    
    42,500Issued
      for services
    
    
    
    
    
    16,010,100
    
    
    16,010
    
    
    466,669
    
    
    
    
    
    
    
    
    
    
    
    482,679Issued
      for repayment of loan
    
    
    
    
    
    2,000,000
    
    
    2,000
    
    
    88,000
    
    
    
    
    
    
    
    
    
    
    
    90,000Issues
      to board members for service
    
    
    
    
    
    900,000
    
    
    900
    
    
    25,200
    
    
    
    
    
    
    
    
    
    
    
    26,100Notes
      receivable
    
    
    
    
    
    
    
    
    
    
    
    105,450
    
    
    
    
    
    
    
    
    
    
    
    105,450Shares
      cancelled
    
    
    
    
    
    (5,411,107
    )
    
    (5,411
    )
    
    (217,401
    )
    
    
    
    
    
    
    
    
    
    
    (222,812
    )Issued
      as deposit on equipment
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (125,000
    )
    
    
    
    
    
    
    
    (125,000
    )Foreign
      currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (61,097
    )
    
    
    
    
    (61,097
    )Net
      loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,247,850
    )
    
    (1,247,850
    )Balance
      at May 31, 2003
    
    
    
    
    
    100,000,000
    
    
    100,000
    
    
    5,484,691
    
    
    (125,000
    )
    
    15,692
    
    
    (7,155,171
    )
    
    (1,679,788
    )Foreign
      currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (56,724
    )
    
    
    
    
    (56,724
    )Benefical
      conversion features
    
    
    
    
    
    
    
    
    
    
    
    1,654,802
    
    
    
    
    
    
    
    
    
    
    
    1,654,802Net
      loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (749,911
    )
    
    (749,911
    )Balance
      at May 31, 2004
    
    
    
    
    
    100,000,000
    
    $
    100,000
    
    $
    7,139,493
    
    $
    (125,000
    )
    $
    (41,032
    )
    $
    (7,905,082
    )
    $
    (831,621
    )





**See accompanying notes.**


F-6


****


AQUATIC
      CELLULOSE INTERNATIONAL CORP.Consolidated
      Statement of Cash Flows**Period
      from****June
      1, 2003**
    
    **June
      1, 2002****To**
    
    **To****May
      31, 2004**
    
    **May
      31, 2003**Cash
      flows from operating activities:Net
      loss
    
    
    
    
    $
    (749,911
    )
    $
    (1,247,850
    )Adjustments
      to reconcile net loss tonet
      cash used by operating activities:Depreciation
      and depletion
    
    
    
    
    
    7,358
    
    
    1,163Amortization
      of defered financing costs
    
    
    
    
    
    27,395
    
    
    19,189Amortization
      of beneficial conversion feature
    
    
    
    
    
    274,243
    
    
    58,325Unpaid
      equity in earnings of Hamill lease
    
    
    
    
    
    (18,671
    )Value
      of shares cancelled
    
    
    
    
    
    
    
    
    (222,812
    )Gain
      on sale of equipment
    
    
    
    
    
    
    
    
    (65,725
    )Write
      off loan from directors
    
    
    
    
    
    
    
    
    5,450Services
      paid by issuance of common stock
    
    
    
    
    
    
    
    
    482,679Increase
      (decrease) in liabilitiesPrepaid
      expenses and other current assets
    
    
    
    
    
    (160
    )
    
    16,484Accounts
      payable and accrued liabilties
    
    
    
    
    
    195,163
    
    
    187,946Net
      cash used by operating activities
    
    
    
    
    
    (264,583
    )
    
    (765,151
    )**Cash
      flows from investing activities:**Purchase
      of working interest in Hamill lease
    
    
    
    
    
    (580,000
    )Acquisition
      of equipment
    
    
    
    
    
    (689
    )Net
      cash used by investing activities
    
    
    
    
    
    (580,689
    )
    
    -**Cash
      flows from financing activities:**Proceeds
      from the issuance of notes payable
    
    
    
    
    
    53,000Issuance
      of convertible debenture payable
    
    
    
    
    
    900,000Unpaid
      fees and expenses due to stockholders
    
    
    
    
    
    101,777
    
    
    742,114Sale
      of common stock
    
    
    
    
    
    
    
    
    42,500Proceeds
      from loan from affiliated entity
    
    
    
    
    
    
    
    
    44,000Deferred
      financing costs
    
    
    
    
    
    (107,733
    )Net
      cash provided by financing activities
    
    
    
    
    
    947,044
    
    
    828,614Effect
      of exchange rate on cash balance
    
    
    
    
    
    (56,724
    )
    
    (61,097
    )Net
      increase in cash
    
    
    
    
    
    45,048
    
    
    2,366Cash
      at beginning of period
    
    
    
    
    
    13,204
    
    
    10,838Cash
      at end of period
    
    
    
    
    $
    58,252
    
    $
    13,204SUPPLEMENTAL
      INFORMATION:Interest
      paid
    
    
    
    
    $
    -
    
    $
    -Taxes
      paid
    
    
    
    
    $
    -
    
    $
    -






See accompanying notes.


F-7
 
  SUPPLEMENTAL
      NON CASH INVESTING AND FINANCING ACTIVITIES:During
      the year ended May 31, 2003, the Company issued common
    stock:16,010,100
      shares, valued at $482,679, for services900,000
      shares, valued at $26,100, for directors fees4,189,412
      shares, valued at $40,000, for conversion of convertible
      debentures2,000,000
      shares, valued at $90,000, for repayment of loan$70,000
      gain on sale of equipment applied against unpaid license
    feesDuring
      the fiscal year ended May 31, 2004, the Company recordedbeneficial
      conversion options of $1,654,802
   See accompanying notes.
 
 
 F-8
 
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 **NOTE
1 - ORGANIZATION AND BUSINESS COMBINATION**
 
 Aquatic
Cellulose International Corp. (the "Company" or "ACIC") was incorporated under
the laws of the State of Nevada in 1996. During the fiscal year ended May 31,
2003, the Company ceased its underwater operations and decided to focus on a new
business direction in the oil and gas industry.
 
 Effective
March 1, 2004, the Company acquired a 20 percent ownership position and a 16
percent net revenue interest in the Hamill lease, a 3,645-acre natural gas
producing property located in Matagorda
County, Texas, pursuant to an agreement with Century Resources Inc. (“Century”). The
purchase was made on the basis of the property having existing production and
revenues as compared to an exploration property with no production. Thus, the
Company agreed to assume an increased percentage of the costs for a lesser
percentage of the revenue on a 1/3 to 1/4 ratio, resulting in the 20 percent
ownership stake and 16 percent net revenue interest before
royalty expense. Century,
a privately held Texas corporation, has an interest in various oil and natural
gas properties . The
agreement also includes an exclusive, optional, “New Project and Exploration
Drilling Participation’ agreement with Century, which has three successive
one-year terms, with the Company holding the exclusive option on each year. The
cost of this acquisition and exclusive optional participation agreement was
$580,000 and a 15 percent ownership stake in the Company. The Company is
currently in the process of conducting a special meeting of shareholders to seek
proxy approval to meet this 15 percent ownership commitment (Note 21).
 
 During
July 2004, the Company completed an acquisition of a 50 percent ownership
position and a 45 percent net revenue interest of an approximately 1,400-acre
lease in the Prado Oil Field (Prado), located in Jim Hogg County Texas. The
Company’s 50 percent portion of the acquisition cost was $70,000 (see Note 20).
 
 The
Company plans to pursue growth in the oil and gas sector by two principle
means:
 
 1)
    Development
      of its current ownership positions in the Hamill & Prado
      leases.
 
 2)
    Completing
      the acquisition and development of other property and working interest
      opportunities with proven reserve potential made known to the Company
      through its “New Project and Exploration Drilling Participation” with
      Century.
 
 As
previously reported, the Company has been seeking to acquire the Tiger-Lynk
large-scale manipulator technology, formerly known as the ATH technology, as a
wholly owned subsidiary. The Company would then seek to develop the
opportunities for the technology in multiple industry sectors. To this effect,
in June 2003, the Company signed a Memorandum of Understanding with Legacy
Systems Corp. (“Legacy”) to merge the public Company with Tiger-Lynk robotic
technology patented and owned by Gary Ackles, former Company CEO. During the
forth quarter of the fiscal year ended May 31, 2004, the Company believes that
the planned acquisition of Tiger-Lynk is likely to be replaced with a negotiated
settlement. During July 2004, the Company entered into an agreement to return
the aquatic timber harvesting equipment and settle the amount due G. Ackles as
of May 31, 2004 (Notes 5, 9 and 20).
 
 The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiary, Aquatic Cellulose Ltd. ("ACL"). All significant
intercompany balances and transactions have been eliminated.
 
  F-9
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 
 **Business
Operations**
 
 As of May
31, 2004, the Company operated primarily in the United States and Canada. The
primary business segments and a description of the business operations of each
company are as follows:
 
 **Corporate**
 
 ACIC
provides management services to its wholly owned subsidiary, ACL and its working
interests in the Hamill lease and Prado properties (Notes 1, 3 and 18).
 
 **ACL**
 
 ACL was
working closely with its manufacturer on the construction of the next generation
ATH 120 robotic harvester. As of May 2003, the manufacturing and license
agreements were cancelled. During July 2004, the Company entered into an
agreement to return the aquatic timber harvesting equipment and settle the
amount due Legacy Systems as of May 31, 2004 (Notes 5, 9 and 20).
 
 **NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**
 
 **Basis
of Presentation**
 
 Aquatic
Cellulose International Corporation (the “Company”) has experienced recurring
losses, has a working capital deficiency of $1,526,189
and an accumulated deficit of $7,905,082 as of May 31, 2004 and at
the end of fiscal year ended May 31, 2003 had ceased its underwater timber
harvesting operations due to the difficulty associated with the investment and
operations of the Brazil project. Its current investments are limited to its
investments in certain oil and natural gas producing properties in Texas. At the
present time, the Company is receiving minimal cash flow from its oil and
natural gas investments. Future realization of the Company’s investment will
depend upon obtaining financing to engage in drilling of the prospects, of which
there can be no assurance. The Company projects that potential future cash flows
related to the prospects will exceed their carrying value.
 
 Accordingly,
the consolidated financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts or the amount
and classification of liabilities or other adjustments that might be necessary
should the Company be unable to continue as a going concern.
 
 **Revenue
Recognition**
 
 The
Company currently has no operating activities but has been acquiring working
interests in oil and gas producing properties (Notes 3 and 20).
 
  F-10
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 
 Previously,
the Company recognized sales when timber was shipped, and the title, risks and
rewards of ownership had been transferred from the Company to the customer. As
previously noted, during the fiscal year ended May 31, 2003 the Company ceased
its underwater timber harvesting operations due to the difficulty associated
with the investment and operations of the Brazil project
 
 
 **Property
and Equipment**
 
 Property
and equipment are stated at cost. Depreciation is computed using declining
balance and straight-line methods over the estimated useful lives of the
depreciable assets. The estimated useful lives used in determining depreciation
are three to four years for computers and five years for furniture and
equipment. Leasehold improvements are amortized over the shorter of the useful
life of the asset or the lease term. Management evaluates useful lives regularly
in order to determine recoverability taking into consideration current
technological conditions. Maintenance and repairs are charged to expense as
incurred; additions and betterments are capitalized. Upon retirement or sale,
the cost and related accumulated depreciation of the disposed assets are
removed, and any resulting gain or loss is credited or charged to
operations.
 
 **Long-Lived
Assets**
 
 The
Company performs a review for impairment of proved natural gas properties on a
depletable unit basis when circumstances suggest there is a need for such review
in accordance with Financial Accounting Standards Board No. 144, *Accounting
for the Impairment or Disposal of Long-Lived Assets* (SFAS No.
144). To determine if a depletable unit is impaired, the Company compares the
carrying value of the depletable unit to the undiscounted future net cash flows
by applying managements’ estimates of ** future
natural gas prices to the estimated future production of natural gas reserves
over the economic life of the property. Future net cash flows are based upon
estimates of proved reserves. In addition, other factors such as probable and
possible reserves are taken into consideration when justified by economic
conditions and actual or planned drilling or other development activities. For a
property determined to be impaired, an impairment loss equal to the difference
between the carrying value and the estimated fair value of the impaired property
will be recognized. Fair value, on a depletable unit basis, is estimated to the
present value of the aforementioned expected future net cash flows. Any
impairment charge incurred is recorded in accumulated depreciation, depletion,
impairment and amortization to reduce the recorded basis in the asset. Each part
of this calculation is subject to a large degree of judgment, including the
determination of the depletable units’ reserves, future cash flows and fair
value. For the fiscal year ended May 31, 2004, no impairments have been recorded
on proved properties.
 
  F-11
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 Unproved
natural gas properties are periodically assessed and any impairment in value is
charged to impairment expense. The costs of unproved properties, which are
determined to be productive, are transferred to proved natural gas properties
and amortized on a unit of production basis. For the fiscal year ended May 31,
2004, no impairments have been recorded on unproved properties
 
 **Investment
in Hamill Lease**
 
 The
Company’s investment in the Hamill lease is recorded using the equity method of
accounting. Under this method, the investment at cost initially, and the
investment is adjusted for the Company’s equity in the Hamill lease profit and
loss. The investment is further adjusted for additional contributions to and
distributions from the Hamill lease.
 
 The
Company depletes the acquisition cost of the Hamill lease using the
units-of-production method as the related gas reserves are produced so that each
unit of gas produced is assigned a pro rata portion of the unamortized
acquisition cost. The unit cost is computed on the basis of the total estimated
units of gas reserves.
 
 The
Hamill lease has an agreement with Harvest Pipeline Company (“Harvest”) to sell
100 percent of its natural gas to Harvest at 90 percent of Inside FERC of the
Houston Shipped Channel Price. The agreement is effective through October 1,
2004. Because alternate purchasers of natural gas are readily available, the
Company believes that the loss of any purchaser would not have a material
adverse effect on the financial results of the Company.
 
 **Income
Taxes**
 
 The
Company utilizes Statement of Financial Accounting Standards ("SFAS") No. 109,
"Accounting for Income Taxes," which requires the recognition of deferred tax
assets and liabilities for the expected future tax consequences of events that
have been included in the financial statements or tax returns. Under this
method, deferred tax assets and liabilities are determined based on temporary
differences between the amount of taxable income and pretax financial income and
between the tax bases of assets and liabilities and their reported amounts in
the financial statements. Deferred tax assets and liabilities are included in
the financial statements at currently enacted income tax rates applicable to the
period in which the deferred tax assets and liabilities are expected to be
realized or settled. Valuation allowances are established, when necessary, to
reduce deferred tax assets to the amount expected to be realized.
 
  F-12
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 **Stock-Based
Compensation**
 
 SFAS No.
123, "Accounting for Stock-Based Compensation," encourages, but does not
require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has elected to continue to account
for employee stock-based compensation using the intrinsic method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations, as permitted by SFAS No. 123;
accordingly, compensation expense for stock options is measured as the excess,
if any, of the quoted market price of the Company's stock at the date of the
grant over the amount an employee must pay to acquire the stock.
 
 For stock
options issued to non-employees, the issuance of stock options is accounted for
based on the fair value of the consideration received or the fair value of the
equity instruments issued, whichever is more reliably measurable. Compensation
expense is recognized in the financial statements for stock options granted to
non-employees in the period in which the consideration is obtained from the
non-employee.
 
 **Earnings
Per Share**
 
 SFAS No.
128, "Earnings Per Share," requires presentation of basic earnings per share
("Basic EPS") and diluted earnings per share ("Diluted EPS").
 
 Basic EPS
is computed by dividing earnings available to common stockholders by the
weighted-average number of outstanding common shares during the period. The
weighted average number of common shares outstanding for computing Basic EPS was
100,000,000 and 95,758,155 for the fiscal years ended May 31, 2004 and 2003,
respectively.
 
 Diluted
EPS reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
The weighted average number of common shares outstanding for computing Diluted
EPS, including dilutive stock options and warrants, was 100,000,000 and
97,533,405 for the fiscal years ended May 31, 2004 and 2003, respectively. For
the fiscal years ended May 31, 2003, 1,775,250 shares attributable to the
exercise of outstanding options and warrants were excluded from the calculation
of Diluted EPS because the effect was antidilutive. There were no dilutive items
as of May 31, 2004 as the Company had already issued all authorized shares. No
adjustments were made to reported net income in the computation of
EPS.
 
  F-13
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 **Warrants
Issued in Conjunction With Convertible Debt**
 
 The
Company allocates the proceeds received from convertible debt between the
liability and the warrants issued in conjunction with the debt, based on their
relative fair values, at the time of issuance. The amount allocated to the
warrants is recorded as additional paid-in capital and as a discount to the
related convertible debt. The discount is amortized to interest expense on a
yield basis over the term of the related convertible debt.
 
 **Comprehensive
Income**
 
 During
June 1999, the Financial Accounting Standards Board issued SFAS No. 130,
“Reporting Comprehensive Income.” This pronouncement established standards for
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements. Comprehensive income consists of net
income and unrealized gains on available-for-sale securities; foreign currency
translation adjustments; change in market value of futures contracts that
qualify as a hedge; and negative equity adjustments recognized in accordance
with SFAS No. 87. The Company evaluated SFAS No. 130 and determined that the
Company’s net income and foreign currency translation adjustments were the only
components of its comprehensive income as of May 31, 2004 and 2003,
respectively.
 
 **Segment
and Geographic Information**
 
 The
Financial Accounting Standards Board issued SFAS No. 131, “Disclosures about
Segments of an Enterprise and Related Information” effective in 1998. SFAS No.
131 requires enterprises to report financial information and descriptive
information about reportable operating segments. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. The Company evaluated SFAS No. 131 and determined that the Company
operates in multiple segments (Note 18).
 
 **Fair
Value of Financial Instruments**
 
 The fair
values of the Company's cash, accounts receivable, accounts payable and accrued
liabilities approximate their carrying values due to the relatively short
periods to maturity of these instruments. The fair value of the convertible
debentures payable approximates their carrying amount due to the fixed interest
rate of the debentures closely approximating floating rates at the financial
statement date.
 
  F-14
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 
 
 **Translation
of Foreign Currency**
 
 The
Company's functional currency is the United States dollar. The Company's
subsidiary, ACL, operates in Canada and its operations are conducted in Canadian
currency. However, its functional currency has been determined to be the United
States dollar. The method of translation applied is as follows: i) Monetary
assets and liabilities are translated at the rate of exchange in effect at the
balance sheet date. ii) Non-monetary assets and liabilities are translated at
the rate of exchange in effect at the date the transactions occurred. iii)
Revenues and expenses are translated at the rate of exchange in effect at the
transaction date. iv) The net adjustment arising from the translation is
included in the consolidated statement of operations. Effective
June 1, 2003, the Company no longer has revenue or expenses paid in Canadian
dollars, thus during the fiscal year ended May 31, 2004 the Company reflected no
foreign currency translation on the Consolidated Statement of
Operations.
 
 **** **Management
Estimates**
 
 The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amount of revenues and expenses during
the period presented. Actual results could differ from those estimates.
 
 The
collectibility of accounts receivable, the use
of estimates for natural gas reserve information and
deferred taxes are based on management estimates. Management reviews its
estimates on a quarterly basis and, where necessary, makes adjustments
prospectively.
 
 **Reclassifications**
 
 The
Company reclassified several 2003 liability amounts to conform to the 2004
presentation.
 
  F-15
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **MAY
31, 2004**
 **Recent
Accounting Pronouncements**
 
 In July
2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS
No. 141 requires the use of the purchase method of accounting and prohibits the
use of the pooling of interests method of accounting for business combinations
initiated after June 30, 2001. SFAS No. 141 also requires that the Company
recognize acquired intangible assets apart from goodwill if the acquired
intangible assets meet certain criteria. SFAS No. 141 applies to all business
combinations initiated after June 30, 2001, and for purchase business
combinations completed on or after July 1, 2001. Upon adoption of SFAS No. 142,
it also requires that the Company reclassify, if necessary, the carrying amounts
of intangible assets and goodwill, based on the criteria in SFAS No. 141. SFAS
No. 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment, at least annually. In
addition, SFAS No. 142 requires that the Company identify reporting units for
the purpose of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. Adoption of
this statement is not expected to be material.
 
 In August
2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets." SFAS No. 144 supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," in
that it removes goodwill from its impairment scope and allows for different
approaches in cash flow estimation. However, SFAS No. 144 retains the
fundamental provisions of SFAS No. 121 for (a) recognition and measurement of
long-lived assets to be held and used and (b) measurement of long-lived assets
to be disposed of. SFAS No. 144 also supersedes the business segment concept in
APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions," in that it permits presentation
of a component of an entity, whether classified as held for sale or disposed of,
as a discontinued operation. However, SFAS No. 144 retains the requirement of
APB Opinion No. 30 to report discontinued operations separately from continuing
operations. The provisions of this Statement are effective for financial
statements issued for fiscal years beginning after December 15, 2001 with
earlier application encouraged. Company management has determined that
implementation of SFAS No. 144 will not have a material effect on the Company’s
results of operations or financial position.
 
 On April
30, 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS
145 rescinds SFAS No. 4, which required all gains and losses from
extinguishments of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. Early application of the
provisions of SFAS No. 145 may be as of the beginning of the fiscal year or as
of the beginning of the interim period in which SFAS No. 145 is issued. Company
management has determined that implementation of SFAS No. 145 will not have a
material effect on the Company’s results of operations or financial
position.
 
  F-16
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 In July
2002, the Financial Accounting Standards Board issued SFAS, "Accounting for
Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires that a
liability for costs associated with an exit or disposal activity be recognized
and measured initially at fair value only when the liability is incurred. SFAS
No.146 is effective for exit or disposal activities that are initiated after
December 31, 2002. Company management has determined that implementation of SFAS
No. 146 will not have a material effect on the Company’s results of operations
or financial position.
 
 In April
2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities", which amends SFAS No. 133 for certain
decisions made by the FASB Derivatives Implementation Group.  In
particular, SFAS No. 149: (1) clarifies under what circumstances a contract with
an initial net investment meets the characteristic of a derivative, (2)
clarifies when a derivative contains a financing component, (3) amends the
definition of an underlying instrument to conform it to language used in FASB
Interpretation No. 45, "Guarantor’s Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others," and (4)
amends certain other existing pronouncements.  This Statement is effective
for contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. In addition, most provisions of
SFAS No. 149 are to be applied prospectively. As we have no such instruments,
the adoption of this issue did not have an impact on our statement of financial
position or results of operations.
 
 Emerging
Issues Task Force (“EITF”) Issue No. 02-03, “Recognition and Reporting of Gains
and Losses on Energy Trading Contracts” under EITF Issues No. 98-10, “Accounting
for Contracts Involved in Energy Trading and Risk Management Activities” was
issued in June 2002. EITF Issue No. 02-03 addresses certain issues related to
energy trading activities, including (a) gross versus net presentation in the
income statement, (b) whether the initial fair value of an energy trading
contract can be other than the price at which it was exchanged, and (c)
accounting for inventory utilized in energy trading activities. As we have no
such instruments, the adoption of this issue did not have an impact on our
statement of financial position or results of operations.
 
 In May
2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity”. This statement
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. This statement was effective for financial instruments entered into
or modified after May 31, 2003.
 
  F-17
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 **NOTE
3 -** **ACQUISITION
OF OWNERSHIP POSITION** **IN HAMILL LEASE**
 
 The
acquisition price for the Hamill lease was $580,000 and a 15 percent ownership
stake in AQCI. The acquisition was accounted for as a step acquisition as
required by Statement of Financial Standard No. 141, *Business
Combinations* as the
date and dollar amount for the issuance of the 15 percent ownership interest
cannot be determined, pending the approval of a Section 14A proxy statement with
the Securities and Exchange Commission.
 
 **NOTE
4- PROPERTY AND EQUIPMENT**
 
 Property
and equipment is summarized as follows at May 31:
 
 2004
    
    2003Computer
      equipment
    
    $
    3,931
    
    $
    3,931Furniture
      and equipment
    
    
    5,258
    
    
    4,569Leasehold
      improvements
    
    
    4,853
    
    
    4,85314,042
    
    
    13,353Less:
      accumulated depreciation
    
    
    11,404
    
    
    10,787$
    2,638
    
    $
    2,566
 
 
 Depreciation
expense was $617 and $1,163 for the fiscal years ended May 31, 2004 and 2003,
respectively.
 
 During
October 2002, the Company entered into an agreement with Gary Ackles, former
CEO, to sell the equipment located in Brazil with a net book value of $4,275 in
addition to a prototype machine with a net book value of $-0- located on the
Tucurci reservoir. Under the terms of the agreement, the unpaid license fees
owed to Legacy Systems Corp. were reduced by $70,000 resulting in a pre-tax gain
of approximately $65,700. (Notes 9 and 17).
 
  F-18
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 **NOTE
5 - ADVANCE ON EQUIPMENT PURCHASES**
 
 Pursuant
to a manufacturing agreement with a company that is controlled by the Company's
former CEO and largest shareholder, the Company is committed to providing the
financing for the construction and acquisition of an Aquatic Timber Harvesting
Machine at a cost of $750,000. During the fiscal year ended May 31, 2001, the
Company had advanced $100,000 towards the purchase of the machine and was
exploring outside financing opportunities to finance the remaining commitment
(Notes 14 and 17). As of May 2003, the manufacturing and license agreements were
cancelled.
 
 During
the fiscal year ended May 31, 2003, the Company was advanced approximately
$44,000 from the Affiliated Company collateralized by the aquatic timber
harvesting equipment (Notes 9 and 17).
 
 During
July 2004, the Company entered into an agreement to return the aquatic timber
harvesting equipment in exchange for a $100,000
reduction in amounts
currently owed to both Ackles and Legacy (Note
20).
 
 **NOTE
6- DEFERRED FINANCING COSTS**
 
 In
connection with the sale of $900,000 convertible debentures on March 22, 2004,
the Company incurred financing fees in the amount of $107,733. These fees are
amortized over the 24-month life of debentures. The unamortized balance of these
fees was $97,631 at May 31, 2004.
 
 **NOTE
7 - INVESTMENT IN HAMILL LEASE**
 
 The
      investment in Hamill lease consists of the following at May 31,
      2004:Initial
      deposit to purchase Century (Notes 1 & 11)
    
    $
    80,000Additional
      payment to acquire working interest
    
    
    500,000Allocation
      of natural gas revenues
    
    
    40,665Allocation
      of lease operating expenses
    
    
    (7,612
    )Receipt
      of earnings in Hamill lease
    
    
    (14,382
    )Depletion
    
    
    (6,741
    )$
    591,930
 
 
  F-19
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 The
Company’s investment in the Hamill lease is recorded using the equity method of
accounting. Under this method, the investment at cost initially, and the
investment is adjusted for the Company’s equity in the Hamill lease profit and
loss. The investment is further adjusted for additional contributions to and
distributions from the Hamill lease. The Company depletes the acquisition cost
of the Hamill lease using the units-of-production method.
 
 Beginning
June 2004, maintenance work was commenced on the Hamill property, which resulted
in 2 additional wells coming into production.  These 2 wells added
approximately 250 thousand cubic feet of gas per day to over-all lease
production. Additionally, maintenance work was performed on the original
producing well, which resulted in that well production rising from approximately
700 thousand cubic feet of gas per day to approximately 1.05 million cubic feet
of gas per day.
 
 **NOTE
8 - ACCRUED LIABILITIES**
 
 Accrued
liabilities consist of the following at May 31:
 
 2004
    
    2003Accrued
      interest
    
    $
    323,165
    
    $
    158,151Amount
      due to consultant for commonstock
      returned to Treasury
    
    
    31,648
    
    
    31,648Accrued
      accounting and legal fees
    
    
    138,635
    
    
    40,200Other
      accruals
    
    
    7,311
    
    
    12,655$
    500,759
    
    
    242,654
 
 
 During
August 2004, in connection with the issuance of $250,000 in convertible
debentures (Notes 10 and 20), the Company remitted payment of approximately
$31,000 in accrued accounting and legal fees outstanding as of May 31, 2004.
 
 
  F-20
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 **NOTE
9 - AMOUNTS DUE TO RELATED PARTIES**
 
 Amounts
due to related parties consist of the following at May 31:
 
 
 2004
    
    2003Due
      to Gary Ackles for unpaidconsulting
      fees; severance; and
      expenses
      paid on behalf of Company
      (Notes
      14 & 17)
    
    $
    298,233
    
    $
    298,233Due
      to Gary Ackles for shares returned
      to
      treasury (Note 15)
    
    
    144,804
    
    
    144,804Unpaid
      license agreement between Legacy
      Systems
      and Company (Notes 4, 14 & 17)
    
    
    80,000
    
    
    80,000Unpaid
      consulting fees due to Sheridan Westgarde
      and
      Gary Ackles (Note 14)
    
    
    114,527
    
    
    26,000Unpaid
      consulting fees to Harvey Smith
      and
      Lonnie Hayward (Note 14)
    
    
    13,250Due
      to Sheridan Westgarde for shares
      returned
      to treasury for professional (Note 15)
    
    
    46,360
    
    
    46,360Funds
      borrowed from Legacy Systems
      (Notes
      5 & 17)
    
    
    44,000
    
    
    44,000$
    741,174
    
    $
    639,397
 
 
  F-21
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 All
amounts due to related parties are non-interest bearing and are payable upon
demand.
 
 During
July 2004, the Company entered into an agreement to return the remaining aquatic
timber harvesting equipment and settle the amount due Legacy Systems as of May
31, 2004 (Notes 20 and 21).
 
 During
July 2004, the Company entered into an agreement to settle all amounts due
Sheridan Westgarde as of May 31, 2004 (Notes 20 and 21).
 
 During
July 2004, the Company entered into an agreement to settle all amounts due Gary
Ackles as of May 31, 2004 (Notes 20 and 21).
 
 **NOTE
10 - CONVERTIBLE NOTES AND WARRANTS**
 
 Convertible
debentures payable bear interest at 12 percent, due on a quarterly basis, and
are secured by a first priority interest in the Company's accounts receivable,
inventory, fixed assets and general intangibles. Any amount of principal or
interest due under the debentures, which is not paid when due will bear interest
at 15 percent per annum from the due date thereof until the amount is paid.
Debentures aggregating $480,800 at May 31, 2003, are convertible into the
Company's common shares at the lesser of $0.60 per share or 70 percent of the
average of the lowest three inter-day sales prices during the twenty trading
days immediately preceding the conversion date. The remaining $300,000 of the
debentures at May 31, 2003 is convertible into common shares at the lesser of
$0.083 per share or 67.67 percent of the average of the lowest three inter-day
sales prices during the twenty days immediately preceding the conversion date.
If unpaid when due, $480,800 of the debentures can automatically convert to
common shares if certain conditions are met. The remaining $300,000 of the
debentures do not automatically convert to common shares on their due dates.
$780,800 of the total debentures was in default at May 31, 2003.
 
 During
December 2003, the Company entered into an amendment to the debentures
outstanding as of May 31, 2003 to extend maturity until March 2006 and to change
the conversion price into the Company's common shares to 40 percent of the
average of the lowest three inter-day sales prices during the twenty trading
days immediately preceding the conversion date.
 
  F-22
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 During
March 2004, the Company issued an additional $900,000 of convertible notes and
warrants. Convertible debentures payable bear interest at 10 percent, due on a
quarterly basis, and are secured by a first priority interest in the Company's
accounts receivable, inventory, fixed assets and general intangibles. Any amount
of principal or interest due under the debentures, which is not paid when due
will bear interest at 15 percent per annum from the due date thereof until the
amount is paid. The debentures are convertible, at the investors’ sole option,
into common shares at the lesser of $0.004 per share (fixed conversion price) or
40 percent of the average of the lowest three inter-day sales prices during the
twenty days immediately preceding the conversion date. If, at any time, the
Company issues or sells any shares of common stock for no or below market
consideration (dilutive issuance), then immediately upon the dilutive issuance,
the fixed conversion price will be reduced to the amount of the consideration
per share received by the Company in such dilutive issuance. The number of
common shares issuable upon the conversion of the debentures is limited to 4.9
percent in beneficial ownership by the debenture holders and its affiliates of
the outstanding shares of common stock. Once the maximum amount of common shares
has been issued, in lieu of any further right to convert the debentures, the
Company shall pay to the debenture holder, an amount equal to 130 percent of the
then outstanding principal amount of the debenture plus accrued and unpaid
interest and other related charges within fifteen business days of the maximum
conversion date. If the Company exercises its right to prepay the debentures,
the Company will make payment to the debenture holders in an amount equal to 150
percent of the sum of the then outstanding principal amount of the debentures
plus accrued and unpaid interest on the unpaid principal amount of the debenture
to the optional prepayment date plus any other related penalties. The debentures
do not automatically convert to common shares on their due dates.
 
 The
debentures are due as follows:
 
 
 Due
      Date
    
    May
      31, 2003
    
    Issued
    
    Converted
    
    May
      31, 2004September
      29, 2001
    
    $
    480,800
    
    
    -
    
    $
    -
    
    $
    480,800March
      14, 2002
    
    
    100,000
    
    
    -
    
    
    -
    
    
    100,000December
      4, 2002
    
    
    200,000
    
    
    -
    
    
    -
    
    
    200,000March
      22, 2006
    
    
    -
    
    
    900,000
    
    
    -
    
    
    900,000780,800
    
    $
    -
    
    
    
    
    $
    $1,680,800Unamortized
      discount relatedto
      warrants granted in conjunctionwith
      the issuance of theconvertible
      debentures payable
    
    
    (17,293
    )Unamortized
      discount related tobeneficial
      conversion options on theconvertible
      debentures payable
    
    
    -
    
    
    
    
    
    
    
    
    (1,380,559
    )$
    763,507
    
    
    
    
    
    
    
    $
    300,241
 
 
 In
conjunction with the above debentures, the Company granted the following common
share purchase warrants to the debenture holders:
 
 
 Expiration
      Date
    
    Exercise
      Price
      per
      Share
    
    Outstanding
      May
      31, 2003
    
    Issued
    
    Expired
    
    Outstanding
      May
      31, 2004September
      29, 2003
    
    
    0.69
    
    
    250,000
    
    
    -
    
    
    250,000
    
    
    -March
      14, 2004
    
    
    0.35
    
    
    100,000
    
    
    -
    
    
    100,000
    
    
    -March
      22, 2009
    
    
    0.004
    
    
    -
    
    
    900,000
    
    
    -
    
    
    900,000350,000
    
    
    900,000
    
    
    350,000
    
    
    900,000
 
 The March
2004 convertible debentures contain a beneficial conversion feature as the
debenture holders are granted common share purchase warrants and the debentures
are convertible into common shares at prices that are less than the market price
at the date of issuance. The debenture proceeds attributable to the warrants was
estimated to be $nil, as the warrants were valued at market value on the date of
issuance. The intrinsic value of the beneficial conversion option relating to
the debentures being convertible into common shares at prices that are less than
the market price at the date of issuance has been calculated at $900,000 which
is recognized in accordance with EITF 98-5, as modified, where applicable, by
EITF 00-27. All debentures and warrants can be exercised anytime after issuance.
Therefore, a total of $112,500 for beneficial conversion features in connection
with the March 2004 debentures and warrants have been charged to operations
during the fiscal year ended May 31, 2004.
 
 Additionally,
in connection with extending the terms of the convertible debentures outstanding
as of May 31, 2003, the Company recorded a beneficial conversion feature as the
debentures are convertible into common shares at prices that are less than the
market price at the date of issuance. Therefore, a total of $161,743 for
beneficial conversion features in connection with the debentures outstanding as
of May 31, 2003 have been charged to operations during the fiscal year ended May
31, 2004.
 
 In
connection with these convertible debentures, the Company had $323,165 and
$158,151 of accrued interest at May 31, 2004 and 2003, respectively (Note
8).
 
  F-23
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 **NOTE
11 - NOTES PAYABLE**
 
 In
September 2003, the Company signed an agreement with an investor to provide a
loan of approximately
$28,000 that would be
exchanged for shares should shareholders approve the increase in authorized
shares in the forthcoming proxy vote. The note is convertible into 200,000
shares of the Company’s common stock. The note will be converted following a
combination (reverse split) of the issued and outstanding shares pending
shareholder approval of the proxy (Note 21).
 
 In
November 2003, the Company signed a loan agreement with an investor for $25,000,
to be repaid in three equal payments over the course of sixty months. The
Company agreed to issue 200,000 shares pending shareholders approval of the
proxy (Note 21). The Company used $15,000 of these investment proceeds to engage
First Line Capital LLC of New York to perform legal services in relation to
future funding and financing of the Company.
 
 In
December 2003, the Company signed a $100,000 convertible promissory note as an
advance on the $900,000 convertible notes and warrants issued March 22, 2004 and
paid $80,000 as a deposit to acquire Century Resources (Notes 1 and
7).
 
 **NOTE
12 - NOTES RECEIVABLE**
 
 During
the year ended May 31, 1999, the Company loaned $105,450 to three Directors for
the exercise of Company stock options. These loans are unsecured, do not bear
interest and were due on July 24, 2002. The notes receivable were recorded as a
reduction of additional paid-in capital in fiscal 1999.
 
 During
the fiscal year ended May 31, 2003, the Company called approximately $100,000 of
such loans and used the amount due as an offset against
unpaid wages due to Gary Ackles, former Director, CEO and President (Note 9).
The remaining loans were forgiven to the two other Directors during January
2003.
 
  F-24
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 **NOTE
13 - INCOME TAXES**
 
 The
components of the provision for taxes based on income for the fiscal years ended
May 31 are as follows:
 
 2004
    
    2003CurrentFederal
    
    $
    -
    
    $
    -State
    
    
    -
    
    
    -Total
      Current
    
    
    -
    
    
    -DeferredFederal
    
    
    -
    
    
    -State
    
    
    -
    
    
    -Total
      Deferred
    
    
    -
    
    
    -Total
      Tax Provision
    
    $
    -
    
    $
    -
 
 
 
 The
reconciliation of the effective income tax rate to the Federal statutory rate is
as follows for the fiscal years ended May 31:
 
 
  F-25
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 
 2004
    
    2003Federal
      Income Tax Rate
    
    
    (34.0
    )%
    
    (34.0
    )%Effect
      of Valuation Allowance
    
    
    34.0
    %
    
    34.0
    %Effective
      Income Tax Rate
    
    
    0.0
    %
    
    0.0
    %
 
 
 At May
31, 2004, the Company had net carry-forward losses of approximately $3,500,000.
Because of the current uncertainty of realizing the benefit of the tax
carry-forwards, a valuation allowance equal to the tax benefit for deferred
taxes has been established. The full realization of the tax benefit associated
with the carry-forwards depends predominantly upon the Company's ability to
generate taxable income during the carry-forward period.
 
 Deferred
tax assets and liabilities reflect the net tax effect of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes. Significant components of the
Company's deferred tax assets and liabilities are as follows:
 
 Deferred Tax
      AssetsLoss
      Carry-forwards
    
    $
    1,408,758Less:
      Valuation Allowance
    
    
    (
      1,408,758
    )Net
      Deferred Tax Asset
    
    $
    -
 
 Net
operating loss carry-forwards expire starting in 2012 through 2024. Per year
availability is subject to change of ownership limitations under Internal
Revenue Code Section 382.
 
 **NOTE
14 - COMMITMENTS AND CONTINGENCIES**
 
 Operating
leases
 
 The
Company leases certain office equipment for varying periods and expects that in
the normal course of business, leases will be renewed or replaced by other
leases.
 
  F-26
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 The
following is a schedule of future minimum lease payments for operating leases
that have initial or remaining non-cancelable lease terms in excess of one year
as of May 31, 2004:
 
 2005
    
    $
    5,5422006
    
    
    3,433$
    8,975
 
 The
Company rents office space on a month-to-month basis for approximately $280 per
month.
 
 Rent
expense was approximately $3,400 and $6,100 for the fiscal years
ended May 31,
2004 and 2003, respectively.
 
 **Service
and Consulting Agreements**
 
 The
Company has entered into various service and consulting agreements as follows:
 
 - A
five-year consulting agreement for investor relations commencing January 1,
2001, providing for annual fees of $36,400, plus 100,000 shares of the Company's
common stock, and 2.5% commission on sales of the Company's common stock. The
agreement was terminated during February 2003.
 
 - A
three-year employment agreement with Gary Ackles, the Company’s former
President, CEO and a Director, commencing November 1, 2000, providing for an
annual salary of $107,134, plus certain benefits. The agreement calls for a
minimum increase in salary of 10% per annum. As of May 31, 2004, approximately
$298,000 was owed to Mr. Ackles for unpaid consulting fees (Note 9). The
agreement was terminated effective March 30, 2003.
 
 - During
March 2003, Gary Ackles resigned as Director, President and CEO of the Company
and was succeeded by Sheridan B. Westgarde. Both Mr. Ackles and Mr. Westgarde
entered into consulting agreements ranging from 18 to 36 months commencing
April 1, 2003, providing for monthly consulting fees of $5,500 and $7,500,
respectively. In addition , the
Board of Directors has committed to make Mr. Westgarde a significant shareholder
in the Company with a share position of 5 percent of the authorized share volume
of the Company issued over the course of three years. Effective, March 1, 2004,
the agreement for Mr. Westgarde was modified to reduce the cash portion of the
consulting fee to $5,000 per month and include $1,500 per month in stock
compensation. The agreement for Mr. Ackles was terminated effective March 1,
2004. As of May 31, 2004, approximately $114,500 was owed to Mr. Westgarde and
Mr. Ackles for unpaid consulting fees (Note 9).
 
  F-27
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 -During
March 2004, the Company entered into consulting agreement with Harvey Smith to
provide oil and gas expertise. The consulting agreement, effective February 1,
2004, is for one year and provides for consulting fees of $2,000 cash and $2,000
worth of Company common stock. The stock will be payable at every six month
anniversary, for as long as the agreement is in place. The issued stock will be
at a 20 percent discount to the average stock price of the 6 proceeding months
of consulting services. In addition, the Company has committed to make Mr. Smith
a significant shareholder pending shareholder approval of the proxy (Note 21).
The Company has also agreed to compensate Mr. Smith 7 percent on any financings
that Mr. Smith brings to the Company.
 
 -During
March 2004, the Company entered into consulting agreement with Lonnie Hayward
who specializes in publicly held companies and who was instrumental in the
Company acquiring the working interest in the Hamill lease. The consulting
agreement, effective December 15, 2004, is for one year and provides for
consulting fees of $3,500 cash and $1,500 worth of Company common stock. In
addition, the Company has committed to make Mr. Hayward a significant
shareholder pending shareholder approval of the proxy (Note 21).
 
 **Lease
Operating Agreement**
 
 The
Company has a Lease Operating Agreement in place with Century. The agreement
requires the Company to pay its 20% share of lease operating fees, amounting to
approximately $14,580 annually. The agreement also details the Company’s
responsibility for 20% of all lease operating expenses, un-scheduled repair,
maintenance or re-completion of the lease or wells on an as required basis and
of all future development costs. The lease agreement continues for as long as
the Company has a working interest in the Hamill lease.
 
 **License
Agreement**
 
 During
the year ended May 31, 2001, the Company advanced $100,000 to finance the
commencement of the construction of the new aquatic timber harvester (Notes 5
and 17).
 
 On
September 28, 2001, the Company signed an exclusive license agreement with the
Company's President for the use of his Patented Robotic Technology. The
technology will remain exclusive to the Company as long as the Company purchases
one robotic system per year. If such purchase does not occur, an exclusivity fee
of 10% of the market value of one ATH 120 will be paid to the President. During
the fiscal year ended May 31, 2003, the Company recorded an exclusivity fee
liability of $150,000 as no purchase had been made.
 
  F-28
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 During
April 2003, the Company desisted from pursuing operations to recover underwater
timber and to focus its efforts on 1) pursue the acquisition of a revenue
generating company or assets in the oil and gas industry and 2) potential
exploration of the ATH large scale underwater technology.
 
 As of May
2003, the manufacturing and license agreements were cancelled.
 
 
 **NOTE
15 - COMMON STOCK**
 
 Common
Stock
 
 The
Company has authorized 100,000,000 shares of $0.001 par common stock. As of May
31, 2004 and 2001, 100,000,000 shares were issued and outstanding. The Company
plans to obtain the approval of its shareholders to increase the total number of
authorized shares to allow for conversion of debentures, conversion of
liabilities to equity and sell additional common shares for cash (see Notes 9,
10, 14, and 17).
 
 During
June 2001, the Company issued 2,500,000 shares of restricted stock at $0.05 per
share for deposit on the purchase of equipment (price reflected market price)
for a total value of $125,000. As of May
31, 2004, the agreement has been formally canceled by the seller. Therefore, the
value of the shares of $125,000 has been presented as a contra equity item, as
the Company determined that the amount no longer represents an asset as defined
in Statement of Financial Accounting Concepts No. 5 “Recognition and Measurement
in Financial Statements of Business Enterprises”. The
Company has had difficulty in retrieving the original restricted share
certificates due to the death of Mr. Raymond Lefebvre. A s of May
31, 2004, the Company has received from the executor of Mr. Lefebvre’s estate a
letter informing the Company that they are unable to return the original stock
certificates due to their being lost or destroyed and instructions to the
Company’s transfer agent to cancel the certificates. The Company is moving ahead
with the cancellation of the original stock certificates with the transfer
agent. ****
 
 During
the quarter ended August 31, 2002, the Company issued an aggregate of 900,000
shares of restricted stock at $0.029 per share for director fees (price
reflected market price) for a total value of $26,100.
 
 At
various times during the fiscal year ended May 31, 2003, the Company issued an
aggregate of 3,868,880 shares of restricted stock to various investors at $0.05
per share for cash pursuant to various subscription agreements for a total value
of $42,500.
 
 At
various times during the fiscal year ended May 31, 2003, the Company issued an
aggregate of 4,189,412 shares of restricted stock at a price ranging from
$0.0091 to $0.01 per share for upon conversion of debentures (price reflected
market price) for a total value of $40,000.
 
  F-29
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 At
various times during the fiscal year ended May 31, 2003, the Company issued an
aggregate of 16,010,100 shares of restricted stock at a price ranging from
$0.027 to $0.04 per share for services rendered (price reflected market price)
for a total value of $482,679.
 
 During
the fiscal year ended May 31, 2003, the Company’s former CEO surrendered
3,620,107 shares of common stock for the purposes of compensating professionals
providing services to the Company. The shares at date of cancellation had an
estimated value of $144,804. The Company also received 1,791,000 additional
surrendered shares from a stockholder and consultant for the purpose of
compensating professionals providing services to the Company. The shares at date
of cancellation had an estimated value of $78,008 (Notes 8 & 9).
 
 In
accordance with the debenture agreement (Note 10), the Company is required to
during the period the conversion rights exists, the Company will reserve from
its authorized and unissued common stock a sufficient number of shares to
provide for the issuance of common stock upon the full conversion of the
debentures.
 
 Preferred
Stock
 
 The Board
of Directors has the authority to issue preferred stock and to fix and determine
its series, relative rights and preferences. As of May 31, 2004 and 2003, no
classes of preferred stock were authorized, issued or outstanding.
 
 **NOTE
16 - STOCK OPTIONS**
 
 As of
July 31, 2000, there were a total of 1,425,250 options outstanding to purchase
the Company’s common stock at an exercise price of $0.52 per share, which was
the market price of the options on the date of grant. The options expire on
February 22, 2005. These options were outstanding as of May 31, 2004 and 2003,
respectively.
 
  F-30
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 The
following table summarizes the option activity for the fiscal year ended May 31,
2004:
 
 
 ****
    **Number
      of**
      **Shares**
    ****
    **Exercise
      Price**
    ****
    **Weighted-**
      **Average**
      **Exercise
      Price**
    ****
    **Weighted-**
      **Average**
      **Value**May
      31, 2003
    
    
    1,425,250
    
    $
    0.52
    
    $
    0.52
    
    $
    0.52GrantedExercisedCanceledMay
      31, 2004
    
    
    1,425,250
    
    $
    0.52
    
    $
    0.52
    
    $
    0.52
 
 
 
 **NOTE
17 - RELATED PARTY TRANSACTIONS**
 The
Company had a service agreement with Kathy Ackles, wife of the former President,
for bookkeeping and administrative services for $36,000 per annum (Note 14).
This agreement was expired as of June 1, 2003.
 
 The
Company had an employment agreement with Gary Ackles, the Company’s former
president, providing for an annual salary of $107,134 and severance benefits
(Note 14). As of March 26 th 2003 Mr.
Ackles resigned from the Company and exercised his severance
package.
 
 The
Company had a license agreement with the Company's former President for the use
of his Patented Robotic Technology. The technology will remain exclusive to the
Company as long as the Company purchases one robotic system per year (Notes 9
& 14). The manufacturing and license agreements were cancelled as of May
2003.
 
  F-31
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 The
Company has a three-year consulting agreement with Sheridan B. Westgarde,
Director and President, commencing April 1, 2003 and providing for monthly
consulting fees of $7,500. In addition, the Board of Directors has committed to
make Mr. Westgarde a significant shareholder in the Company with a share
position of 5 percent of the authorized share volume of the Company issued over
the course of three years. Effective, March 1, 2004, the agreement for Mr.
Westgarde was modified to reduce the cash portion of the consulting fee to
$5,000 per month and include $1,500 per month in stock compensation.
 
 During
July 2004, the Company entered into an agreement to exchange amounts due to
Sheridan Westgarde, as well as stock compensation due Mr. Westgarde under the
current consulting agreement, for a 27 percent common share equity position in
the Company post-restructured and pending shareholder approval of the Proxy.
M r.
Westgarde would be an affiliate of the Company bearing all the restrictions of
affiliates according to the Securities and Exchange Act of 1933 (Note 21).
 
 During
May 2004, the Company borrowed $44,000 from Legacy Systems Corporation, owned by
Gary Ackles. The security for the loan was the ATH equipment (Note
5).
 
 During
June 2003, the Company signed a Memorandum of Understanding with Legacy Systems
Corp. (“Legacy”) to merge the public Company with the Tiger-Lynk robotic
technology, also patented and owned by Mr. Ackles.
 
 During
September 2003, the Company signed a Memorandum of Understanding, followed in
December 2003, by a Letter of Intent with Century Resources Inc. (“Century”) of
Houston, Texas, for the acquisition of Century by the Company. These two
agreements with Century negate and preclude all other agreements between Legacy,
Century and the Company and outline the intent to amalgamate Century and the
TigerLynk technology with the Company.  During
the forth quarter of the fiscal year ended May 31, 2004, the Company believes
that the planned acquisition of Tiger-Lynk is likely to be replaced with a
negotiated settlement. During
July 2004, the Company entered into an agreement to return the aquatic timber
harvesting equipment and settle the amount due Legacy Systems as of May 31, 2004
(Note 21).
 
 During
July 2004, the Company entered into an agreement with Gary Ackles, former
Company CEO and Legacy Systems, a company controlled by Ackles, to settle
amounts currently owed to both Ackles and Legacy (Note 9). The agreement
requires the Company to return the Aquatic Timber Harvesting equipment (Note 5)
and issue 40,000,000 pre-restructured shares of the Company’s common stock in
exchange for, forgiveness of the $44,000 borrowed from Legacy (Note 9) and the
$80,000 due Legacy in un-paid licensing fees (Note 9). The remaining amount due
G. Ackles of $417,000 will be converted into 13 percent of the
issued and outstanding post-restructured shares of the Company pending
shareholder approval of the Proxy. The agreement stipulates that Mr. Ackles
would be an affiliate of the Company bearing all the restrictions of Affiliates
according to the Securities and Exchange Act of 1933.
 
  F-32
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 During
October 2002, the Company entered into an agreement with Gary Ackles, former
CEO, to sell the equipment located in Brazil with a net book value of $4,275 in
addition to a prototype machine with a net book value of $-0- located on the
Tucurui reservoir. Under the terms of the agreement, the proceeds of sale were
$70,000 resulting in a pre-tax gain of approximately $65,700. The Company
applied the value of the machine as an offset to the unpaid license fee owed to
Legacy Systems Corp. (Notes 9 and 17).
 
 During
the fiscal year ended May 31, 2003, approximately
$100,000 of loans made to a Director for the exercise of Company stock options
was called by the Company. The balance owed to the Company was offset against
unpaid wages due to Gary Ackles (Notes 9 and 14). The remaining loans were
forgiven to the two other Directors during January 2003.
 
 **NOTE
18 - SEGMENT INFORMATION**
 
 During
the fiscal years ended May 31, 2004 and 2003, the Company had foreign assets in
Canada. The following geographic area data for trade revenues is based on
product or service delivery location, and property, plant, and equipment is
based on physical location.
 
 Net
earnings from external sources at May 31,:
 
 2004
    
    2003United
      States
    
    $
    33,053
    
    $
    -Canada
    
    
    -
    
    
    -$
    33,053
    
    $
    -Segment
      assets:2004
    
    
    2003United
      States
    
    $
    744,031
    
    $
    -Canada
    
    
    106,870
    
    
    116,060$
    850,901
    
    $
    116,060
 
 
  F-33
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 MAY 31,
2004
 
 **NOTE
19 - LITIGATION**
 
 The
Company is not a party to any material pending legal proceedings and, to the
best of its knowledge, no such action by or against the Company has been
threatened.
 
 
 **NOTE
20 - SUBSEQUENT EVENTS**
 Beginning
June 2004, maintenance work was commenced on the Hamill property, which resulted
in 2 additional wells coming into production. These 2 wells added approximately
250 thousand cubic feet of gas per day to over-all lease production.
Additionally, maintenance work was performed on the original producing well,
which resulted in that well production rising from approximately 700 thousand
cubic feet of gas per day to approximately 1.05 million cubic feet of gas per
day.
 
 During
July 2004, the Company entered into a agreement to exchange amounts due to
Sheridan Westgarde, as well as stock compensation due Mr. Westgarde under the
current consulting agreement, for a 27 percent common share equity position in
the Company post-restructured and pending shareholder approval of the Proxy. As
a director of the Company, M r.
Westgarde shares would be affiliate status and bearing all restrictions
according to affiliates as stated in the Securities and Exchange Act of 1933.
 
 Amounts
Due Westgarde
 
 Description
    Original
      Agreement
    New
      Agreement
      (Pending
      shareholder approval)
      (See
      Note 21)Un-paid
      Consulting Fees (Note 9)
    $81,675
    $0Shares
      Returned to Treasury (Note 9)
    $46,360
    $0Agreement
      for Common Stock (Note 14 & 21)
    150
      Million
      (Based
      on an increase in the authorized shares to 3,000,000,000)
    6.75
      Million
 
 
  F-34
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 During
July 2004, the Company entered into an agreement with Gary Ackles, former
Company CEO and Legacy Systems, a company controlled by Ackles, to settle
amounts currently owed to both Ackles and Legacy (Note 9). The agreement
requires the Company to return the Aquatic Timber Harvesting equipment (Note 5)
and issue 40,000,000 pre-restructured shares of the Company’s common stock in
exchange for, forgiveness of the $44,000 borrowed from Legacy (Note 9) and the
$80,000 due Legacy in un-paid licensing fees (Note 9). The remaining amount due
G. Ackles of $417,000 will be converted into 13 percent of the
issued and outstanding post-restructured shares of the Company pending
shareholder approval of the Proxy. The agreement stipulates that Mr. Ackles
would be an affiliate of the Company bearing all the restrictions of Affiliates
according to the Securities and Exchange Act of 1933.
 
 Amounts
Due Ackles
 
 Description
    Original
      Agreement
    New
      Agreement
      (Pending
      shareholder approval)
      (See
      Note 21)Unpaid
      license agreement between Legacy Systems and Company (Notes 4, 14 &
      17)
      and
      funds borrowed from Legacy Systems. (Notes 5 & 17)
    $124,000
      
      ($80,000
      + $44,000)
    40
      Million common shares (Before reverse split)
      and
      Aquatic
      Timber Harvesting Equipment (Note 5)Un-paid
      Consulting Fees (Note 9) and Shares Returned to Treasury
    $475,879
    $417,000
      or 3.25 Million Shares
      (See
      Note 21)
 
 
 During
July 2004, the Company received short term loans from Sheridan Westgarde, the
Company’s CEO, Lonnie Hayward, consultant, and Robert Marchand in an amount
aggregating $42,000 which was used, along with Company’s available cash, to fund
the purchase of the 50 percent ownership position in the Prado Field lease. The
Company agreed to repay the loan amount borrowed once funding becomes available
and agreed to pay an additional 20 percent of the amount borrowed over the next
12 months. Following the closing of the $250,000 convertible debentures in
August 2004, Mr. Westgarde and Mr. Hayward were repaid their principal amounts
plus 10 percent, while Mr. Marchand declined repayment in favor of re-investing
his principal and proceeds with the Company. The remaining 10 percent will be
paid within the next 10 months.
 
  F-35
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 During
August 2004, the Company completed an acquisition of a 50 percent ownership position and a 45 percent net
revenue interest of an approximately 1,400 acre lease in the Prado Oil Field
(Prado), located in Jim Hogg County Texas. The Company’s 50 percent portion of
the cost of the acquisition was $70,000. This lease has 20 existing wells that
were originally produced in the 1960’s 2 of which are still producing
approximately 30 Barrels of oil per day. In cooperation with Century Resources
Inc., the Company is planning to develop bypassed oil reserves as well as
undeveloped natural gas reserves. The Company is awaiting the completion of 3D
seismic processing that will be the basis for future development
plans.
 
 During
July 2004, the Company entered into a preliminary agreement in principle to sell
a portion of its working interest in the Prado Field to Titan Consolidated Inc.,
a Nevada based corporation. Should this agreement be consummated, Titan would be
responsible for 40 percent of the development and operating costs while
receiving 20 percent of the net revenue from all Prado production. The purchase
price is $500,000 of which the Company received, in July 2004, $10,000 of a
$40,000 non-refundable deposit. The balance of the deposit is due by September
15, 2004 with the final closing date and remainder of the purchase price due on
November 15, 2004. On September 15, 2004 the Company granted an extension of the
non-refundable deposit due date to October 20, 2004 and the final closing date
to December 1, 2004.
 
 During
August 2004, the Company issued $250,000 in convertible debentures and warrants
to acquire a working interest in Prado and pay a portion of outstanding
consulting fees as of May 31, 2004.
 
 **NOTE
21 - PROXY 14A SHAREHOLDER VOTE**
 
 The
Company is currently in process to seek approval from shareholders for the
following;
 
 1.
    To
      amend our certificate of incorporation to increase the number of
      authorized Common Stock from 100,000,000 to 3,000,000,000
      shares;
 
 2.
    To
      amend our certificate of incorporation to change the Company name to Valor
      Energy Corporation;
 
 3.
    Amend
      our certificate of incorporation to provide for a stock restructuring
      (reverse split) of the Common Stock in an exchange ratio to be approved by
      the Board, ranging from one newly issued share for each two outstanding
      shares of Common Stock to one newly issued share for each seven hundred
      and fifty outstanding shares of Common Stock.
 The
increase in authorized shares (Item 1.) will allow the Company to facilitate the
conversion of existing convertible debt as well as amounts due to related
parties (see Notes 9, 10, 14 and 17).
 
 The
change of our Company name (Item 2.) will better identify the Company in the new
business.
 
  F-36
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 The stock
restructuring or reverse split (Item 3.) will allow the Company to facilitate
the issuance of common shares in connection with the purchase of the Hamill
natural gas lease, meet obligations to industry professionals as well as to
facilitate the continued conversion of existing convertible debt. (see Notes 1,
3, 8, 9, 10, 14 and 17)
 
 The
Company plans to convert existing convertible debt to reducing the amount
outstanding and then perform a restructuring or reverse split of the stock. The
following table details the Company’s commitments pending approval of
shareholders.
 
 **Number
      of proposed common share (in millions)**
    **Proposed
      percentage of common stock after reverse**Existing
      Shareholders, certain accounts payables & notes (Note
    8).
    3.278
    13.11%Ed
      Destafano - Century Resources Inc. (Notes1 and 3)
    3.750
    15.00%Lonnie
      Hayward - future Director (Note 14).
    6.750
    27.00%Gary
      Ackles for Amounts Due Related Parties (Notes 9 & 20)
    3.250
    13.00%Harvey
      Smith for expertise & consulting (Note 14)
    1.223
    4.89%Sheridan
      B. Westgarde Director/CEO & for Amounts Due Related Parties (Notes 9,
      14, 17 & 20)
    6.750
    27.00%Totals
    25.000
    100.00%
 
 
  F-37
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 **NOTE
22 - UNAUDITED GAS RESERVE QUANTITIES**
 
 This
section provides information required by Statement of Financial Accounting
Standards No. 69, *Disclosures
about Oil and Gas Producing Activities* .
 
 The
following unaudited natural gas reserve estimates were prepared by Century
Resources Inc. as of February 1, 2004, and adjusted
by the Company for actual production.  There
are many uncertainties inherent in estimated proved reserve quantities and in
projecting future production rates and the timing of development expenditures.
In addition, reserve estimates of new discoveries that have little production
history are more imprecise than those of properties with more production
history. Accordingly, these estimates are expected to change as future
information becomes available.
 
 Proved
natural gas reserves are the estimated quantities of natural gas and natural gas
liquids which geological and engineering data demonstrates with reasonable
certainty to be recoverable in future years from know reservoirs under existing
economic and operating conditions.
 
 Proved
natural gas reserves are those reserves expected to be recovered through
existing wells with existing equipment and operating methods.
 
 Unaudited
net quantities of proved developed reserves of natural gas for the Hamill lease,
all of which are located on the 3,645 property located in Matagorda County,
Texas, are summarized below:
 
 **Billion
      Cubic Feet (BCF)**Changes
      in proved reserves:Estimated
      quantity, March 1, 2004
    
    
    4.990Production
    
    
    .058Acquisitions
    
    
    -Discoveries
    
    
    -Estimated
      quantity, May 31, 2004
    
    
    4.932
 
 
  F-38
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 The
following table presents a standardized measure of the discounted future net
cash flows attributable to the Company’s proved natural gas reserves. Future
cash inflows were computed by applying period end prices of natural gas to the
estimated future production of proved natural gas reserves. The future
production and development costs represent the estimated future expenditures
(based on current costs) to be incurred in developing and producing the proved
reserves, assuming continuation of existing economic conditions. Future
unexpected costs or changes in production could affect discounted future net
cash flows.
 
 A
discount factor of 10 percent was used to reflect the timing of future net cash
flows. The standardized measure of discounted future net cash flows is not
intended to represent the replacement cost or market value of the Company’s
natural gas properties.
 
 
 Standardized
measure of discounted future net cash flows for the Hamill lease as of May 31,
2004:
 
 Future
      cash inflows
    
    $
    3,039,520Future
      production costs
    
    
    421,530Future
      net cash flows
    
    
    2,617,99010
      percent annual discount per annum
    
    
    (507,235
    )Standardized
      measure of discounted future net cash flows
    
    $
    2,110,755
 
 
 Pro-rata
allocation of standardized measure of discounted future net cash flows for the
Company’s 16 percent working interest in Hamill lease as of May 31,
2004:
 
 Future
      cash inflows
    
    $
    486,323Future
      production costs
    
    
    67,445Future
      net cash flows
    
    
    418,87810
      percent annual discount per annum
    
    
    (81,158
    )Standardized
      measure of discounted future net cash flows
    
    $
    337,720
 
 
  F-39
  **AQUATIC
CELLULOSE INTERNATIONAL CORP.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **MAY
31, 2004**
 
 The
Company is currently waiting on the completion of an evaluation of site data
that will define the future development costs. As of May 31, 2004 the property
has 7 wells in total, 2 of which are producing wells.
 
 Due to
recurring net operating losses, which can be utilized to offset projected
discounted future net cash flows, no provision for income taxes is considered
necessary.
 
 No
reserve estimates have been filed with any other Federal authority or
agency.
 
 The
3,645-acre property currently has 7 wells on the property with a regulatory well
spacing requirement of 40 acres per well. This amounts to approximately 300
developed acres and the remaining 3,345 acres undeveloped.
 
 Beginning
June 2004, re-completion work was commenced on the property, which resulted in 2
additional wells coming into production. These 2 wells added approximately 250
thousand cubic feet of gas per day to over-all lease production. Additionally,
re-completion work was performed on the original producing well, which resulted
in that well production rising from approximately 700 thousand cubic feet of gas
per day to approximately 1.05 million cubic feet of gas per day. At this time,
evaluations of available engineering and new 3D Seismic data are being completed
that will formulate the basis for future development.