UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549







FORM
10-Q




x
            QUARTERLY REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
  1934




For the
quarterly period ended March 31,
2010




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:000-50906




ETERNAL
ENERGY CORP.


(Exact
name of registrant as specified in its charter)





Nevada
            20-0237026(State
      or other jurisdiction of
              incorporation
      or organization)
            (I.R.S.
      Employer
              Identification
      No.)




2549
      West Main Street, Suite 202, Littleton, Colorado
            80120(Address
      of principal executive offices)
            (Zip
      Code)





(303)
798-5235


(Registrant’s
telephone number, including area code)





Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 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 xNo o





Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of “large accelerated
filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.





(Check
one):





Large
      accelerated filer o
            Accelerated
      filer oNon-accelerated
      filer o
            Smaller
      reporting company x




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes
o No x





Indicate
the number of shares outstanding of each of the issuer’s classes of common
equity, as of the latest practicable date:


43,506,000
shares of common stock issued and outstanding at May 14, 2010.










ETERNAL
ENERGY CORP.


FORM
10-Q


QUARTERLY
PERIOD ENDED MARCH 31, 2010





INDEX





A
      Note About Forward Looking Statements
            
            
            1PART
      I - FINANCIAL INFORMATIONItem
      1 -   Condensed Financial Statements
      (Unaudited)
            
            
            2Condensed
      Balance Sheets – March 31, 2010 (Unaudited) and December 31,
      2009
            
            
            F-2Condensed
      Statements of Operations (Unaudited) - For Each of the Three-Month Periods
      Ended March 31, 2010 and 2009
            
            
            F-3Condensed
      Statements of Cash Flows (Unaudited) - For Each of the Three-Month Periods
      Ended March 31, 2010 and 2009
            
            
            F-4Notes
      to the Condensed Financial Statements (Unaudited)
            
            
            F-6Item
      2 - Management’s Discussion and Analysis of Financial Condition or Results
      of Operations
            
            
            3Item
      4 - Controls and Procedures
            
            
            6PART
      II - OTHER INFORMATIONItem
      6 – Exhibits
            
            
            7Signatures
            
            
            9











A Note About Forward-Looking
Statements





This
Quarterly Report on Form 10-Q contains “forward-looking statements” within the
meaning of the Private Securities Litigation Reform Act of 1995 that are based
on management’s current expectations. These statements may be identified by
their use of words like “plans,” “expect,” “aim,” “believe,” “projects,”
“anticipate,” “intend,” “estimate,” “will,” “should,” “could” and other
expressions that indicate future events and trends. All statements that address
expectations or projections about the future, including statements about our
business strategy, expenditures, and financial results, are forward-looking
statements. We believe that the expectations reflected in such forward-looking
statements are accurate. However, we cannot assure you that such expectations
will occur.





Actual
results could differ materially from those in the forward looking statements due
to a number of uncertainties including, but not limited to, those discussed in
Management’s Discussion and Analysis of Financial Condition and Results of
Operations. Factors that could cause future results to differ from these
expectations include general economic conditions; further changes in our
business direction or strategy; competitive factors; market uncertainties; and
an inability to attract, develop, or retain consulting or managerial agents or
independent contractors. As a result, the identification and interpretation of
data and other information and their use in developing and selecting assumptions
from and among reasonable alternatives requires the exercise of judgment. To the
extent that the assumed events do not occur, the outcome may vary substantially
from anticipated or projected results, and accordingly, no opinion is expressed
on the achievability of those forward-looking statements. No assurance can be
given that any of the assumptions relating to the forward-looking statements
specified in the following information are accurate, and we assume no obligation
to update any such forward-looking statements. You should not unduly rely on
these forward-looking statements, which speak only as of the date of this
Quarterly Report. Except as required by law, we are not obligated to release
publicly any revisions to these forward-looking statements to reflect events or
circumstances occurring after the date of this report or to reflect the
occurrence of unanticipated events.





1




PART I. FINANCIAL INFORMATION





ITEM
1. FINANCIAL STATEMENTS.


Eternal
Energy Corp.
  Condensed
Financial Statements (Unaudited)
  As
of March 31, 2010 and December 31, 2009 and
 For
Each of the Three-Month Periods ended March 31, 2010 and 2009
  2
 
 Eternal
Energy Corp.
  Index
to the Condensed Financial Statements (Unaudited)
  As
of March 31, 2010 and December 31, 2009 and
 For
Each of the Three-Month Periods ended March 31, 2010 and 2009
 
 Condensed
      Financial Statements of Eternal Energy Corp. (Unaudited):Condensed
      Balance Sheets as of March 31, 2010 (Unaudited) and December 31,
      2009
              
              
              F-2Condensed
      Statements of Operations for Each of the Three-Month Periods Ended March
      31, 2010 and 2009 (Unaudited)
              
              
              F-3Statements
      of Cash Flows for Each of the Three-Month Periods Ended March 31, 2010 and
      2009 (Unaudited)
              
              
              F-4Notes
      to the Condensed Financial Statements (Unaudited)
              
              
              F-6
 
 F-1
  Eternal
Energy Corp.
  Condensed
Balance Sheets
  As
of March 31, 2010 and December 31, 2009
 
 March
      31, 2010
                (Unaudited)
              
              
              December
      31,
                  2009Current
      assets:Cash
              
              $
              1,355,703
              
              
              $
              1,508,754Receivables
              
              
              70,282
              
              
              
              120,927Prepaid
      expenses
              
              
              5,345
              
              
              
              46,384Total
      current assets
              
              
              1,431,330
              
              
              
              1,676,065Spud
      fees receivable
              
              
              -
              
              
              
              20,000Equipment
      and leasehold improvements, net of accumulated depreciation and
      amortization of $111,987 and $100,208, respectively
              
              
              38,429
              
              
              
              49,809Oil
      and gas properties – not subject to amortization
              
              
              406,973
              
              
              
              412,797Assets
      held for sale
              
              
              57,000
              
              
              
              57,000Deposits
              
              
              5,345
              
              
              
              5,345Total
      assets
              
              $
              1,939,077
              
              
              $
              2,221,016Current
      liabilities:Accounts
      payable and accrued liabilities
              
              $
              213,692
              
              
              $
              138,664Accrued
      oil and gas interests
              
              
              -
              
              
              
              25,155Short-term
      asset retirement obligation
              
              
              65,258
              
              
              
              65,258Total
      current liabilities
              
              
              278,950
              
              
              
              229,077Long-term
      asset retirement obligation, net of discount of $32,241, and $36,720,
      respectively
              
              
              182,177
              
              
              
              177,697Total
      liabilities
              
              
              461,127
              
              
              
              406,774Commitments
      and contingenciesStockholders'
      equity:Common
      stock, $.001 par value, 875,000,000 shares authorized, 44,457,000 and
      44,550,000 shares issued and outstanding
              
              
              44,457
              
              
              
              44,550Additional
      paid-in capital
              
              
              9,519,844
              
              
              
              9,524,308Accumulated
      deficit
              
              
              (8,086,351
              )
              
              
              (7,754,616
              )Total
      stockholders' equity
              
              
              1,477,950
              
              
              
              1,814,242Total
      liabilities and stockholders' equity
              
              $
              1,939,077
              
              
              $
              2,221,016
  The
accompanying notes are an integral part of the financial
statements.
  F-2
  Eternal
Energy Corp.
  Condensed
Statements of Operations (Unaudited)
  For
Each of The Three-Month Periods Ending March 31, 2010 and 2009
 
 2010
              
              
              2009Oil
      and gas royalties
              
              $
              71,486
              
              
              $
              -Operating
      expenses:Oil
      and gas operating expenses
              
              
              -
              
              
              
              30,009General
      and administrative expenses
              
              
              233,412
              
              
              
              221,531Stock-based
      compensation
              
              
              -
              
              
              
              110,250Professional
      fees
              
              
              151,855
              
              
              
              136,753Depreciation,
      depletion and amortization
              
              
              16,259
              
              
              
              9,233Total
      operating expenses
              
              
              401,526
              
              
              
              507,778Total
      operating loss
              
              
              (330,040
              )
              
              
              (507,778
              )Interest
      income
              
              
              1,695
              
              
              
              10,292Net
      loss
              
              $
              (331,735
              )
              
              $
              (497,486
              )Net
      loss per common share:Basic
      and diluted
              
              $
              (0.01
              )
              
              $
              (0.01
              )Weighted
      average number of shares outstanding:Basic
      and diluted
              
              
              44,548,141
              
              
              
              44,550,000
 
 The
accompanying notes are an integral part of the financial
statements.
  F-3
  Eternal
Energy Corp.
  Condensed
Statements of Cash Flow (Unaudited)
  For Each of The
Three-Month Periods Ending March 31, 2010 and 2009
 
 2010
              
              
              2009Cash
      flows used for operating activities:Net
      loss
              
              $
              (331,735
              )
              
              $
              (497,486
              )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Non
      cash transactions:Stock-based
      compensation
              
              
              -
              
              
              
              110,250Depreciation,
      depletion and amortization
              
              
              16,259
              
              
              
              9,233Changes
      in operating assets and liabilities:Decrease
      in prepaid expense
              
              
              41,039
              
              
              
              3,415Decrease
      in spud fees receivable
              
              
              20,000
              
              
              
              -(Increase)
      decrease in other receivables
              
              
              72,742
              
              
              
              (50,000
              )Increase
      in accounts payable and accrued liabilities
              
              
              49,873
              
              
              
              93,355Net
      cash used for operating activities
              
              
              (131,822
              )
              
              
              (331,234
              )Cash
      flows used for investing activities:Additions
      to oil and gas properties
              
              
              (16,672
              )
              
              
              (69,603
              )Additions
      to equipment and leasehold improvements
              
              
              -
              
              
              
              (40,500
              )Net
      cash used for investing activities
              
              
              (16,672
              )
              
              
              (110,103
              )Cash
      flows used for financing activities:Repurchase
      and retirement of shares
              
              
              (4,557
              )
              
              
              -Net
      cash used for financing activities
              
              
              (4,557
              )
              
              
              -Net
      decrease in cash
              
              
              (153,051
              )
              
              
              (441,337
              )Cash
      - beginning of period
              
              
              1,508,754
              
              
              
              727,701Cash
      - end of period
              
              $
              1,355,703
              
              
              $
              286,364
 
 F-4
  Eternal
Energy Corp.
  Condensed
Statements of Cash Flow (Unaudited)
  For Each of The
Three-Month Periods Ending March 31, 2010 and
2009
 
 Supplemental
Disclosure of Cash Flow Information
 
 2010
              
              
              2009Cash
      paid for:Interest
              
              $
              -
              
              
              $
              -Income
      taxes
              
              $
              -
              
              
              $
              -
  Non-cash
Investing and Financing Activities
 Accrued
      oil and gas properties
              
              $
              22,097
              
              
              $
              -
 
 F-5
  Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
  1.
              Description of
      Business
  Eternal
Energy Corp. (the “Company”) was incorporated in the state of Nevada in March
2003. The Company engages in the acquisition, exploration, development and
producing of oil and gas properties. At March 31, 2010, the Company has entered
into participation agreements related to oil and gas exploration projects in
Pebble Beach Prospect, located in Divide County, North Dakota, and Sheridan
County, Montana and Saskatchewan, Canada.  The Company also owns a 75%
working interest in certain leases located within the Southwest Extension of the
West Ranch Field, located in Jackson County, Texas. In addition, the Company
owns certain overriding royalty interests in oil and gas leases located in San
Juan County, Utah and San Miguel County, Colorado.
 
 2.
              Summary of Significant
      Accounting Policies
 
 Basis
of Presentation
 
 These
condensed financial statements are presented in United States dollars and have
been  prepared in accordance with accounting principles generally
accepted in the United States for interim financial information and with the
instructions to Securities and Exchange Commission (“SEC”) Form 10-Q and Article
8 of SEC Regulation S-X. The principles for interim financial information do not
require the inclusion of all the information and footnotes required by generally
accepted accounting principles for complete financial statements. Therefore,
these financial statements should be read in conjunction with the Company’s
Annual Report on Form 10-K for the year ended December 31, 2009. The condensed
financial statements included herein are unaudited; however, in the opinion of
management, they contain all normal recurring adjustments necessary for a fair
statement of the condensed results for the interim periods. Operating results
for the three-month period ended March 31, 2010 are not necessarily indicative
of the results that may be expected for the year ending December 31,
2010.
 
 Revenue
Recognition
 
 The
Company records the sale of its interests in prospects as a reduction to the
cost pool when the terms of the transaction are final and the sales price is
determinable. Spud fee revenue is recognized when drilling
commences.  Working interest, royalty and net profit interests are
recognized as revenue when oil and gas is sold.
 
 Concentration
of Credit Risk
 
 At March
31, 2010, the Company had $694,721 on deposit that exceeded United States (FDIC)
federally insurance limit of $250,000 per bank. The Company believes this credit
risk is mitigated by the financial strength of the financial institutions with
which the Company has placed its funds on deposit.
  F-6
  Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
  Receivables
 
 Receivables
are stated at the amount the Company expects to collect. The Company considers
the following factors when evaluating the collectability of specific receivable
balances: credit-worthiness of the debtor, past transaction history with the
debtor, current economic industry trends, and changes in debtor payment terms.
If the financial condition of the Company’s debtors were to deteriorate,
adversely affecting their ability to make payments, additional allowances would
be required.
 
 The
Company maintains an estimated allowance for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments.
Changes to the allowance for doubtful accounts made as a result of management’s
determination regarding the ultimate collectability of such accounts are
recognized as a charge to the Company’s earnings.  Specific receivable
balances that remain outstanding after the Company has used reasonable
collection efforts are written off through a charge to the valuation allowance
and a credit to receivable.
 
 At March
31, 2010, the Company has determined that all receivable balances are fully
collectible and, accordingly, no allowance for doubtful accounts has been
recorded.
 
 Equipment
and Leasehold Improvements
 
 Equipment
and leasehold improvements are recorded at cost. Expenditures for major
additions and improvements are capitalized and depreciated over the estimated
useful lives of the related assets using the straight-line method for financial
reporting purposes. The Company uses other depreciation methods (generally
accelerated) for tax purposes, where appropriate. The estimated useful lives for
significant property and equipment categories are as follows:
 
 Equipment
              3
      yearsLeasehold
      improvements
              lesser
      of useful life or lease term
 
 When
equipment and improvements are retired or otherwise disposed of, the cost and
the related accumulated depreciation are removed from the Company's accounts and
any resulting gain or loss is included in the results of operations for the
respective period.
 Expenditures
for minor replacements, maintenance and repairs are expensed as
incurred.
 
 Oil
and Gas Properties
 
 The
Company follows the full cost method of accounting for its investments in oil
and gas properties. Under the full cost method, all costs associated with the
exploration of properties are capitalized into appropriate cost centers within
the full cost pool.  Internal costs that are capitalized are limited
to those costs that can be directly identified with acquisition, exploration,
and development activities undertaken and do not include any costs related to
production, general corporate overhead, or similar activities.  Cost
centers are established on a country-by-country basis.
  F-7
 Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
 Capitalized
costs within the cost centers are amortized on the unit-of-production basis
using proved oil and gas reserves. The cost of
investments in unproved properties and major development projects are excluded
from capitalized costs to be amortized until it is determined whether or not proved
reserves can be assigned to the properties.Until such a determination is
made, the properties are assessed annually to ascertain whether impairment has
occurred. The costs of drilling exploratory
dry holes are included in the amortization base immediately upon determination
that the well is dry.
 
 As of the
end of each reporting period, the capitalized costs of each cost center are
subject to a ceiling test, in which the costs shall not exceed the cost center
ceiling.  The cost center ceiling is equal to i) the present value of estimated future net
revenues computed by applying current prices of oil and gas reserves (with
consideration of price changes only to the extent provided by contractual
arrangements) to estimated future production of proved oil and gas reserves as
of the date of the latest balance sheet presented, less estimated future
expenditures (based on current costs) to be incurred in developing and producing
the proved reserves computed using a discount factor of ten percent and assuming
continuation of existing economic conditions; plus ii) the cost of properties not being
amortized; plus iii) the lower of cost or
estimated fair value of unproven properties included in the costs being
amortized; less iv) income tax effects
related to differences between the book and tax basis of the
properties. If unamortized costs
capitalized within a cost center, less related deferred income taxes, exceed the
cost center ceiling, the excess is charged to expense and separately disclosed
during the period in which the excess occurs.
 
 Asset
Retirement Obligations
 
 The
Company records asset retirement obligations in the period in which the
obligation is incurred and when a reasonable estimate of fair value can be
determined. The initial recording of an asset retirement obligation results in
an increase in the carrying amount of the related long-lived asset and the
creation of a liability.  The portion of the asset retirement
obligation expected to be realized during the next 12 month period is classified
as a current liability, while the portion of the asset retirement obligation
expected to be realized during subsequent periods is discounted and recorded at
its net present value.  The discount factor used to determine the net
present value of the Company’s asset retirement obligation is 10%, which is
consistent with the discount factor that is applied to oil and gas reserves when
performing the periodic ceiling tests.
 
 Changes
in the noncurrent portion of the asset retirement obligation due to the passage
of time are measured by applying an interest method of allocation. The amount of
change is recognized as an increase in the liability and an accretion expense in
the statement of operations. Changes in either the current or noncurrent portion
of the Company’s asset retirement obligation resulting from revisions to the
timing or the amount of the original estimate of undiscounted cash flows are
recognized as an increase or a decrease to the carrying amount of the liability
and the related long-lived asset.
  F-8
 Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
 Treasury
Stock
 
 The
Company has implemented a stock repurchase program and utilizes the cost method
to account for shares reacquired under the program.  Under the cost
method, common stock is reduced by the par value of the shares
repurchased.  The difference between the total consideration given to
reacquire the shares, including any broker commissions or other transaction
costs, is recorded as a reduction of additional paid in capital.  The
Company immediately retires all repurchased shares.
 
 Fair
Value of Financial Instruments
  Fair
value is defined as the exchange price that would be received for an asset or
paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. Valuation techniques used to
measure fair value must maximize the use of observable inputs and minimize the
use of unobservable inputs.
  The
Company utilizes the market approach to measure fair value for our financial
assets and liabilities. The market approach uses prices and other relevant
information generated by market transactions involving identical or comparable
assets or liabilities. The standard describes a fair value hierarchy based on
three levels of inputs, of which the first two are considered observable and the
last unobservable, that may be used to measure fair value which are the
following:
  Level
1:  Quoted prices (unadjusted) in active markets that are accessible
at the measurement date for assets or liabilities. The fair value hierarchy
gives the highest priority to Level 1 inputs.
  Level
2:  Observable prices that are based on inputs not quoted on active
markets, but corroborated by market data.
  Level
3:  Unobservable inputs are used when little or no market data is
available. The fair value hierarchy gives the lowest priority to Level 3
inputs.
  In
determining fair value, the Company utilizes valuation techniques that maximize
the use of observable inputs and minimize the use of unobservable inputs to the
extent possible as well as the consideration of counterparty credit risk in its
assessment of fair value.
  The
adoption of this statement did not have a material impact on our results of
operations and financial condition. The carrying values of our cash, cash
equivalents and marketable securities, carried at fair value as of March 31,
2010, are classified in the table below in one of the three categories described
above:
  F-9
 Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
  Fair
Value Measurements at March 31, 2010:
  Level
      1
              
              Level
      2
              
              
              Level
      3
              
              
              TotalCash
      & Equivalents
              
              $
              1,355,703
              
              
              
              -
              
              
              
              -
              
              
              $
              1,355,703
  Accounting
for Share-Based Compensation
 
 The
Company measures compensation cost for all stock-based awards at fair value on
the date of grant and recognizes compensation expense in its statements of
operations over the service period that the awards are expected to vest. The
Company has elected to recognize compensation cost for all options with graded
vesting on a straight-line basis over the vesting period of the entire
option.
 
 Basic
and Diluted Loss Per Share
 
 Basic
loss per common share is computed by dividing net loss available to common
shareholders by the weighted average number of common shares outstanding during
the period. Diluted loss per common share for the three-month periods ended
March 31, 2010 and 2009 is computed in the same way as basic loss per common
share, as the inclusion of additional common shares that would be outstanding if
all potential common shares had been issued would be
anti-dilutive.  See Note 7 for the calculation of basic and diluted
weighted average common shares outstanding for the three-month periods ended
March 31, 2010 and 2009.
 
 Income
Taxes
 
 The
Company follows the liability method of accounting for income taxes. Under this
method, deferred income tax assets and liabilities are recognized for the future
tax benefits and consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax balances. Deferred income tax assets and liabilities are measured
using enacted or substantially enacted tax rates expected to apply to the
taxable income in the years in which those differences are expected to be
recovered or settled. The effect on deferred income tax assets and liabilities
of a change in tax rates is recognized in income in the period that includes the
date of enactment or substantive enactment.
 
 Use
of Estimates and Assumptions
 
 The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires the use of estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses and disclosure of contingent obligations in the financial
statements and accompanying notes. The Company’s most significant assumptions
are the estimates used in the determination of the value and timing of the asset
retirement obligation, the deferred income tax asset valuation allowance and the
allocation of proceeds received from the disposition of certain oil and gas
prospects to the remaining prospects included in the Company’s full cost
pool.  The estimation process requires assumptions to be made about
future events and conditions, and as such, is inherently subjective and
uncertain. Actual results could differ materially from these
estimates.
  F-10
 Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
 New
Accounting Pronouncements
 
 In
June 2009, the FASB issued SFAS No. 168, “The FASB Accounting
Standards Codification and the Hierarchy of Generally Accepted Accounting
Principles - a replacement of FASB Statement No. 162,” and also issued
Accounting Standards No. 2009-01, “Generally Accepted Accounting Principles”
(ASC Topic 105-10), which establishes the FASB Accounting Standards
Codification (the “Codification” or “ASC”) as the official single source of
authoritative U.S. generally accepted accounting principles (“GAAP”). All
guidance contained in the Codification carries an equal level of
authority.  The Codification also includes all relevant SEC guidance
organized using the same topical structure in separate sections within the
Codification.  The Codification is not intended to change GAAP, but it
will change the way GAAP is organized and presented.  The Codification
is effective for financial statements issued for interim and annual periods
ending after September 15, 2009.  Except for the disclosure
requirements, the adoption of this statement did not have an impact on the
determination or reporting of the Company’s financial statements.  The
Company is providing the Codification cross-reference alongside the references
to the standards issued and adopted prior to the adoption of the
Codification.  The Codification does not change current US GAAP, but
is intended to simplify user access to all authoritative US GAAP by providing
all the authoritative literature related to a particular topic in one place. All
existing accounting standard documents will be superseded and all other
accounting literature not included in the Codification will be considered
non-authoritative. As it relates to the Company, the Codification is effective
July 1, 2009 and will require future references to authoritative US GAAP to
coincide with the appropriate section of the Codification. Accordingly, this
standard will not have an impact on the Company’s results of operations or
financial condition.
 
 ASC
820-10 establishes a single definition of fair value and a framework for
measuring fair value, sets out a fair value hierarchy to be used to classify the
source of information used in fair value measurements and requires new
disclosures of assets and liabilities measured at fair value based on their
level in the hierarchy. ASC 820-10 is effective for the Company’s year beginning
January 1, 2008 and has been applied prospectively. The adoption of ASC 820-10
has not had a material impact on the Company’s financial position or reported
results of operations.
  F-11
  Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
  In
January 2010, the FASB issued Accounting Standards Update 2010-06, Improving Disclosures about Fair
Value Measurements (“FASB 2010-06”), which amends ASC 820-10 and
requires, among other things, new disclosures regarding the transfers in and out
of hierarchy levels 1 and 2 as well as the gross presentation of changes in
estimated measurements for level 3 measurements.  In addition, FASB
2010-06 provides clarifying direction with respect to disclosures regarding the
various levels of disaggregation and about specific inputs and valuation
techniques.  FASB 2010-06 is effective for interim and annual
reporting periods beginning after December 31, 2009, except for the gross
presentation of level 3 measurement activities, which is effective for fiscal
years beginning after December 15, 2010.  The adoption of FASB 2010-06
is not expected to have a material effect on the Company’s financial
statements.
 
 ASC
825-10 permits an entity to choose, at specified election dates, to measure
eligible financial instruments and certain other items at fair value that are
not currently required to be measured at fair value. An entity is required to
report unrealized gains and losses on items for which the fair value option has
been elected in its results of operations at each subsequent reporting date.
Upfront costs and fees related to items for which the fair value option is
elected shall be recognized in earnings as incurred and not deferred. ASC 825-10
also establishes presentation and disclosure requirements designed to facilitate
comparisons between entities that choose different measurement attributes for
similar types of assets and liabilities. ASC 825-10 is effective for financial
statements issued for fiscal years beginning after November 15, 2007 (January 1,
2008 for the Company) and interim periods within those fiscal years. At the
effective date, an entity may elect the fair value option for eligible items
that exist at that date. The entity shall report the effect of the first
remeasurement to fair value as a cumulative effect adjustment to the opening
balance of retained earnings. The Company has not elected to measure its
financial instruments and/or other eligible assets at their fair market
values.  Consequently, the adoption of ASC 825-10 has not had a
material impact on the Company’s financial position or reported results of
operations.
 
 ASC
808-10 requires certain income statement presentation of transactions with third
parties and of payments between parties to the collaborative arrangement, along
with disclosure about the nature and purpose of the arrangement.  ASC
808-10 is effective for the Company’s year beginning January 1, 2009.  The
adoption of ASC 808-10 has not had a material impact on the Company’s financial
statements.
 
 ASC 805
requires an acquiring company to recognize the assets acquired, the liabilities
assumed, and any non-controlling interest in the acquired entity at the
acquisition date, measured at their fair values as of that date, with limited
exceptions.  ASC 805 also requires the acquiring company in a business
combination achieved in stages to recognize the identifiable assets and
liabilities, as well as the noncontrolling interest in the acquired company, at
the full amounts of their fair values.  ASC 805 makes various other
amendments to authoritative literature intended to provide additional guidance
or to confirm the guidance in that literature to that provided in this
Statement.  ASC 805 is effective for the Company’s financial statements
beginning January 1, 2009.  The adoption of ASC 805 has not had a
material impact on the Company’s financial statements.
  F-12
 Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
 ASC
810-10-65 establishes accounting and reporting standards that require the
ownership interests in subsidiaries not held by the parent to be clearly
identified, labeled and presented in the consolidated statement of financial
position within equity, but separate from the parent's equity.  This
statement also requires the amount of consolidated net income attributable to
the parent and to the non-controlling interest to be clearly identified and
presented on the face of the consolidated statement of income.  Changes in
a parent's ownership interest while the parent retains its controlling financial
interest must be accounted for consistently, and when a subsidiary is
deconsolidated, any retained non-controlling equity investment in the former
subsidiary must be initially measured at fair value.  The gain or loss on
the deconsolidation of the subsidiary is measured using the fair value of any
non-controlling equity investment.  The Statement also requires entities to
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. This
Statement applies prospectively to all entities that prepare consolidated
financial statements and applies prospectively for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008
(January 1, 2009 for the Company).  The adoption of ASC 810-10-65 has not
had a material impact on the Company’s financial statements.
 
 Under ASC
855-10, as under previous practice, an entity must record the effects of
subsequent events that provide evidence about conditions that existed at the
balance sheet date and must disclose but not record the effects of subsequent
events which provide evidence about conditions that did not exist at the balance
sheet date. This standard added an additional required disclosure relative to
the date through which subsequent events have been evaluated and whether that is
the date on which the financial statements were issued. As it relates to the
Company, this standard was effective beginning April 1, 2009. The
additional disclosures required by this standard are included in Note
10.
 
 In
February 2010, the FASB issued Accounting Standards Update 2010-09, Amendments to Certain Recognition
and Disclosure Requirements, which amended ASC 855 and which requires
issuers of financial statements to evaluate subsequent events through the date
on which the financial statements are issued.  FASB 2010-09 defines
the term “SEC Filer” and eliminates the requirement that an SEC filer disclose
the date through which subsequent events have been evaluated.  This
change was made to alleviate potential conflicts between ASC 855-10 and the
reporting requirements of the SEC.  FASB 2010-09 is effective
immediately, but is not expected to have a material effect on the Company’s
financial statements.
 
 In
January 2010, the FASB issued Accounting Standards Update 2010-03, Oil and Gas Reserve Estimation and
Disclosures (“FASB 2010-03”), which amended Extractive Activities – Oil
and Gas (Topic 932).  Among other things, FASB 2010-03 expands the
definition of oil and gas producing activities and requires companies to use a
twelve-month average price, rather than a year-end price, when estimating
whether reserve quantities are economical to produce.    In
addition, FASB 2010-03 requires separate reserve disclosures for geographical
areas that contain more than fifteen percent of an entity's total reserves and
provides guidance with respect to the applicability of reporting requirements
for equity investments in oil and gas producing entities.  FASB
2010-03 is effective for annual reporting periods ending on or after December
31, 2009.  The adoption of FASB 2010-03 is not expected to have a
material effect on the Company’s financial statements.
  F-13
 Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
 In April
2010, the FASB issued Accounting Standards Update 2010-14, Amendments to Paragraph
932-10-S99-1 (FASB 2010-14), which amended ASC 932.  FASB
2010-14 revises the definitions of certain definitions contained in SEC
Regulation S-X.  FASB 2010-14 is effective for annual reporting
periods beginning after December 15, 2009.  The adoption of FASB
2010-14 is not expected to have a material effect on the Company’s financial
statements.
 
 3.
              Equipment and
      Leasehold Improvements
 
 The
following is a summary of equipment and improvements, at cost, as of March 31,
2010:
 Office
      equipment
              
              $
              102,907Leasehold
      improvements
              
              
              47,509Total
      equipment and improvements
              
              
              150,416Less:
      accumulated depreciation
              
              
              (111,987
              )Equipment
      and improvements, net
              
              $
              38,429
  Depreciation
expense for the three-month periods ended March 31, 2010 and 2009 was $11,779
and $9,233, respectively.
 
 The
Company purchased $19,000 of down-hole tools during the 2009 and $38,000 of
down-hole tools during, 2008.  Because the Company no longer possesses
exclusive rights to utilize the down-hole gas and water separation technology,
the Company has no plans to utilize the tools in the near future.  The
Company’s management does not believe that the value of the tools has been
impaired and is marketing the tools to other exploration and development
companies.  Accordingly, the down-hole tools have been classified as
Assets Held for Sale on the Company’s balance sheets as of March 31, 2010 and
December 31, 2009.
 
 4.
              Oil and Gas
      Properties
 
 As of
March 31, 2010 and December 31, 2009, the Company’s cost centers are as
follows:
 
 March
      31, 2010
              
              
              December
      31, 2009Amortizable
              
              
              Non-Amortizable
              
              
              Amortizable
              
              
              Non-AmortizableUnited
      States
              
              $
              -
              
              
              $
              405,927
              
              
              $
              -
              
              
              $
              411,751Canada
              
              
              -
              
              
              
              1,046
              
              
              
              -
              
              
              
              1,046Total
              
              $
              -
              
              
              $
              406,973
              
              
              $
              -
              
              
              $
              412,797
 
 F-14
 Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
 
 Producing
Properties
 
 Through
various transactions that occurred during 2007, the Company acquired a 75%
working interest in the South West Extension of the West Ranch Field (the “South
West Extension”), located in Jackson County, Texas.  In August 2009,
certain leases included in the West Ranch Field expired and, as a result, the
reserves associated with these leases contained in the Glasscock Reservoir are
no longer available to the Company.  These leases were pivotal to the
implementation of a waterflood program designed to stimulate production
throughout the South West Extension.  The Company has no immediate
plans to recomplete any of the remaining wells located in the South West
Extension.  Because there is no reasonable certainty that the Company
will seek to extract the underlying reserves associated with the remaining West
Ranch leases, the economic value of these reserves may not be used to evaluate
the recoverability of the Company’s investment in the West Ranch
property.  Accordingly, the Company fully impaired its full cost pool,
subject to amortization in August 2009.
 
 Because
the wells were shut-in, the Company recognized no depletion expense related to
the West Ranch property for the three-month periods ended March 31, 2010 and
2009.
 
 The net
capitalized cost of the West Ranch property is summarized below:
 
 December
      31,2009Acquisition
      costs
              
              $
              1,888,078Development
      costs
              
              
              846,9542,735,032Cumulative
      depletion
              
              
              (57,667
              )Impairment
              
              
              (2,677,365
              )Balance
      at December 31, 2009
              
              $
              -
  Exploratory
Prospects
 
 The
Company has entered into participation agreements in a number of exploratory oil
and gas properties. Unproven exploratory prospects are excluded from its
respective amortizable cost pool.  Each prospect’s costs are
transferred into the amortization base on an ongoing (well-by-well or
property-by-property) basis as the prospect is evaluated and proved reserves are
established or impairment is determined. Three of the five properties have been
abandoned as of March 31, 2010. The Company has a working interest and/or
overriding royalty interest in the wells on the remaining prospects, if they are
successful. The Company paid certain amounts upon execution of the agreements
and is obligated to share in the drilling costs of the exploratory wells. In
addition, the Company has agreed to issue shares of its common stock based upon
the proven reserves of the property.
  F-15
  Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
  United
States
 
 Steamroller
Prospect
 
 In
December 2007, the Company purchased a 50% interest in a 640-acre mineral lease
from the State of Utah. In the first quarter of 2008, the Company purchased a
50% interest in an additional 10,860 acre lease from the State of
Utah.
 
 In June
2008, the Company sold its 50% working interest in the Utah prospect. Under the
terms of the sale, the Company retained an overriding royalty interest on all
future production from the property sold, as well as an overriding royalty
interest on production from properties of mutual interest which the purchaser
may develop in the future.  The Company currently owns various
overriding royalty interests under approximately 20,172 net acres in Utah and
Colorado, located within the Steamroller Prospect.  In addition, the
Company is entitled to receive an overriding royalty interest on any additional
leasehold interest acquired by its working interest partners in an area of
mutual interest (“AMI”) between the parties.  The AMI covers
approximately 3,571,200 gross acres.
 
 Pebble Beach
Prospect
 
 In 2006,
the Company entered into a series of agreements that resulted in the acquisition
of five percent of the capital stock of Pebble Petroleum, Inc. (“Pebble”), as
well as the following rights and interest in the Pebble Beach
Prospect:
 
 ·
              A
      $250,000 spud fee for each of the first eight wells drilled by
      Pebble;
 
 ·
              A
      five percent (5%) gross overriding royalty from each well drilled on
      certain acreage that Pebble holds rights to in SE Saskatchewan, Canada (no
      capital outlay or other expenses to be required by the Company);
      and
 
 ·
              A
      ten percent (10%) working interest in a joint venture with Rover
      Resources, Inc., (“Rover”), a subsidiary of Pebble; the joint venture will
      explore and develop certain prospects principally located in Divide
      County, North Dakota (the Company will pay 10% of all costs
      incurred).
 
 The last
of the eight exploratory wells drilled by Pebble was completed in August
2008.  As of December 31, 2009, the Company had received all but
$20,000 of the spud fees related to the initial eight exploratory
wells.  The remaining $20,000 of spud fees was collected in March
2010.
 
 As of
March 31, 2010, Pebble owns approximately 324,590 gross and net acres in the
Pebble Beach Prospect in SE Saskatchewan, Canada in which the Company owns a
five percent gross overriding royalty.  In addition, Rover has
acquired approximately 61,572 gross and 35,264 net acres principally located in
Divide County, North Dakota, within the Pebble Peach Prospect.  The
Company owns a ten percent working interest in these properties. As of March 31,
2010, the Company’s working interest investment in the North Dakota property
totals $405,927.
  F-16
 Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
  This
property is evaluated for impairment annually.  There were no
impairments evident at March 31, 2010.  The property is currently in
an evaluation phase.  The Company does not expect that a determination
will be made on the ultimate viability of the property within the next twelve
months.  The Company sold its ten percent working interest in
approximately 700 net acres to Ryland Oil Corporation in March 2010 (Note
9).
 
 The North
Sea
 
 North Sea Quad 14 and Quad
41/42 Prospects
 
 In 2006,
the Company acquired a working interest in the Quad 41/42 Prospect with the
obligation to fund 15% of the drilling costs of an exploratory well. The Company
placed $1.5 million on deposit to cover its share of the drilling costs. The
exploratory well on the Quad 42/43 prospect was completed in 2007.  No
economically viable reserves were discovered.
 
 Because
the Company disputed its obligation to participate in the drilling of the Quad
41/42 exploratory well, no amounts held on deposit were released to the operator
for the Quad 41/42 Prospect.  The entire amount of funds held on
deposit, plus accrued interest ($1,604,101 in total), was returned to the
Company in November 2009.
 
 Canada
 
 In June
2008, the Company acquired a five percent overriding royalty position in
additional prospects located in Saskatchewan, Canada.
 
 5.
              Asset Retirement
      Obligation
 
 As of
March 31, 2010, the Company has recorded an aggregate asset retirement
obligation associated with its investment in the West Ranch Field in the amount
in the amount of $242,955.  The asset retirement obligation represents
estimated discounted future plugging and abandonment costs associated with each
of the thirty wells located within the Southwest Extension of the West Ranch
Field.  Unless the decision is made to recommence the production from
the West Ranch wells, the Company anticipates that the wells will be plugged and
abandoned over the next three year period.
  F-17
  Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
  The
following table summarizes the estimated plugging liability by year in which, in
the absence of production, the respective wells are projected to be plugged and
abandoned:
 Amount2010
              
              $
              65,2582011
              
              
              93,2252012
              
              
              121,193Gross
      amount of liability
              
              
              279,676Discount
      factor
              
              
              (32,241
              )Net
      present value of asset retirement obligation
              
              $
              247,435
  6.
              Commitments and
      Contingencies
 
 Financial
Results, Liquidity and Management's Plan
 
 The
Company has incurred net losses since inception and has an accumulated deficit
of $8,086,351 as of March 31, 2010.  These factors raise substantial
doubt about the Company's ability to continue as a going concern. The Company
has historically been successful in generating additional operating capital
through the disposition of oil and gas prospects.  However, the
disposition of properties is not a viable strategy for funding the Company’s
long-term operations.  Accordingly, the Company’s management is
developing and implementing plans to sustain the Company’s cash flow from
operating activities and/or acquire additional capital funding.
 
 No
assurances can be given that the Company will obtain sufficient working capital
through the sale of oil and gas properties, the issuance of common stock or by
leveraging the Company's current assets, or that the implementation of its
business plan will generate sufficient revenues in the future to sustain ongoing
operations. The financial statements do not include any adjustments that might
be necessary if the Company is unable to continue as a going
concern.
 
 Drilling
Obligations
 
 The
Company has an option to fund its share of future exploratory drilling costs
related to its 10% working interest in the Pebble Beach (North Dakota) prospect
should any exploratory wells be proposed by the other working interest
owner.
 
 Employment
Agreements
 
 In August
2009, the Company renewed its two-year employment agreement with its Vice
President of Engineering.  The financial terms of the renewed
employment agreement are substantially the same as the previous employment
agreements, which provide for annual compensation of $144,000.
 
 F-18
 Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
  In
October 2009, the Company amended its employment agreement with its Chief
Financial Officer to extend the contract through September 1,
2010.  The employment agreement provides for annual compensation in
the amount of $138,000.
 
 Effective
November 1, 2009, the Company renewed its two-year employment agreement with its
President and Chief Executive Officer.  The financial terms of the
renewed employment agreement are substantially the same as the previous
employment agreements, which provide for annual compensation of
$174,000.
 
 Lease
Obligation
 
 In June
2007, the Company executed an agreement to lease certain office equipment from
Banc of America leasing.  The lease agreement expires in June 2010 and
calls for monthly lease payments of $374.
 
 Effective
January 1, 2009, the Company entered into an agreement to lease its current
office space.  The new lease has a term of 36 months and expires in
December 31, 2011.
 
 Future
lease payments related to the Company’s office and equipment leases are as
follows:
 
 Amount2010
              
              $
              47,4642011
              
              
              64,1402012
              
              
              -2013
              
              
              -2014
              
              
              -Total
              
              $
              111,604
  Gross
office rent expense for each of the three-month periods ended March 31, 2010 and
2009 was $19,418.  Copier lease expense totaled $1,192 and $1,432 for
the three-month periods ended March 31, 2010 and 2009,
respectively.
 F-19
 Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
 7.
              Loss Per
      Share
  The
following is a reconciliation of the number of shares used in the calculation of
basic loss per share and diluted loss per share for the three-month periods
ended March 31, 2010 and 2009:
  2010
              
              
              2009Net
      loss
              
              $
              (331,735
              )
              
              $
              (497,486
              )Weighted
      average number of common shares outstanding (basic)
              
              
              44,548,141
              
              
              
              44,550,000Incremental
      shares from the assumed exercise of dilutive stock
      options
              
              
              -
              
              
              
              -Diluted
      common shares outstanding
              
              
              44,548,141
              
              
              
              44,550,000Net
      loss per share, basic and diluted
              
              $
              (0.01
              )
              
              $
              (0.01
              )
  The
following securities were not included in the computation of diluted net loss
per share as their effect would have been anti-dilutive:
 
 2010
              
              
              2009Stock
      Options
              
              
              6,000,000
              
              
              
              5,543,800
  8.
              Equity
      Transactions
 
 Stock
Repurchases
 
 In March
2010, the Company’s Board of Directors authorized implementation of a stock
repurchase program pursuant to which the Company may repurchase up to $500,000
of its then outstanding common shares at prevailing market
prices.  During the three-month period ended March 31, 2010, the
Company repurchased and retired 93,000 shares of its previously issued common
stock at an average price of $0.05 per share.  The aggregate cost
associated with the repurchase of these shares was $4,457.  As of
March 31, 2010, the Company has 44,457,000 shares of common stock
outstanding.  The Company has continued to repurchase shares
subsequent to March 31, 2010 (Note 10).
 
 Issuance
and Cancellation of Restricted Stock
 
 In
September 2009, the Company announced that it had granted 6,500,000 restricted
shares of common stock to its directors and officers in exchange for the return
and cancellation of 5,393,800 unexercised options to purchase shares of common
stock.  In October 2009, the Company’s board of directors rescinded
the grant of the restricted common shares, effective on the original grant
date.  Because the restricted stock certificates were never delivered
to the intended recipients, management has determined that the title to the
shares never transferred.  Accordingly, no stock-based compensation
has been recorded in connection with the issuance of the restricted
shares.  The stock options remained cancelled.
  F-20
  Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
  Issuance
and Cancellation of Stock Options
 
 As noted
above, the Company cancelled 5,393,000 stock options in connection with the
issuance of 6,500,000 shares of restricted stock in September
2009.  The shares of restricted stock were subsequently rescinded
prior to the delivery to the stock certificates to the Company’s directors and
officers.
 
 In
October 2009, the Company granted 6,000,000 options to purchase shares of the
Company’s common stock to its directors and officers.  The stock
options have a five-year life, vest immediately and have an exercise price of
$0.05, which exceeded the volume weighted average closing price of the Company’s
common stock for the five-day period preceding the grant.  The Company
accounted for the new stock option grant as a modification of the previously
outstanding stock options and immediately recognized stock-based compensation
expense of $145,190 associated with the new grant and the remaining $67,071 of
unamortized stock-based compensation associated with the original stock
options.  There were no additional stock options granted during the
three-month period ended March 31, 2010.  Accordingly, the Company did
not recognize any stock-based compensation expense for the three-month period
then ended.
 
 A summary
of stock option activity for the year ended December 31, 2009 and the
three-month period ended March 31, 2010 is presented below:
  Options
                
                
                Weighted
      Average Exercise Price
                
                
                Weighted
      Average Remaining Contract TermOutstanding
      at December 31, 2008
                
                
                5,543,800
                
                
                $
                0.46
                
                
                3.4
      yearsOptions
      granted
                
                
                6,000,000
                
                
                $
                0.05
                
                
                
                -Options
      forfeited
                
                
                (5,543,800
                )
                
                $
                0.46
                
                
                
                -Outstanding
      at December 31, 2009 and March 31, 2010
                
                
                6,000,000
                
                
                $
                0.05
                
                
                4.6
      yearsExercisable
      at March 31, 2010
                
                
                6,000,000
                
                
                $
                0.05
                
                
                4.6
      years
  The
assumptions used in the Black-Scholes option pricing model for the stock options
granted during the year ended December 31, 2009 were as follows:
 
 Risk-free
      interest rate
              
              
              2.37
              %Expected
      volatility of common stock
              
              
              101
              %Dividend
      yield
              
              $
              0.00Expected
      life of options
              
              5
      yearsWeighted
      average fair market value of options granted
              
              $
              0.03
 
 F-21
  Eternal
Energy Corp.
  Notes
to the Financial Statements (Unaudited)
  Shares
Reserved for Future Issuance
 
 As of
March 31, 2010, the Company has reserved 6,000,000 shares for future issuance
upon exercise of outstanding options.
  9.
              Proposed Acquisition
      by Ryland Oil Corporation
 
 In
November 2009, the Company entered into a letter agreement (the “Letter
Agreement”) with Ryland Oil Corporation (“Ryland”), a Canadian oil and gas
company whose shares are listed on the TSX Venture Exchange, whereby Ryland
proposed to acquire all of the then-outstanding shares of the Company’s common
stock in exchange for approximately 17,793,000 shares of Ryland’s common stock,
at a ratio of 0.352 shares of Ryland stock for every 1.000 share of the
Company’s stock.
 
 On March
26, 2010, the Company and Ryland mutually agreed to terminate the Letter
Agreement and, instead, entered into two new asset purchase agreements whereby
the Company agreed to sell to Ryland its interest in certain acreage located in
North Dakota, as well as our gross overriding royalty interest in certain lands
located in Saskatchewan.  The material terms of each agreement are as
follows:
 
 1.
              Purchase
      and Sale Agreement – Effective April 1, 2010, the Company will sell its
      ten percent working interest in approximately 700 net acres located in
      North Dakota to Rover for $1 million cash.  The closing of this
      transaction is contingent on the concurrent closing of the Purchase of
      Royalty Agreement, as outlined
below.
  2.
              Purchase
      of Royalty Agreement – Effective April 1, 2010 the Company will sell to
      Ryland all of its gross overriding royalty interest in approximately
      264,000 net acres within an area of mutual interest located in
      southeastern Saskatchewan for $2.9 million in cash, payable on June 1,
      2010, 2,145,883 shares of Ryland’s common stock, which were valued at
      approximately $772,500 as of March 26, 2010, and an assignment of Ryland’s
      100% working interest in approximately 4,480 net acres located in
      Saskatchewan (the “Hardy Prospect”).  Upon closing, 60% of the
      gross overriding royalty interest being sold will be placed in escrow
      pending receipt of the $2.9 million cash payment.  If that
      payment is not received by June 1, 2010, the escrowed gross overriding
      royalty interest will revert to the
Company.
  On April
30, 2010, the Company closed on the Ryland Purchase and Sale and the Purchase of
Royalty Agreements.  Upon closing, the Company received the $1 million
cash payment associated with the sale of the North Dakota acreage and 2,145,883
shares of Ryland’s common stock, valued at approximately $875,000 as of the date
of closing, and title to the Hardy Prospect.  The Company expects to
receive the remaining $2.9 million cash payment, as scheduled, on or before June
1, 2010.
 
 10.
              Subsequent
      Events
 
 During
the period from April 1 through May 14, 2010, the Company repurchased an
additional 951,000 shares of its previously outstanding common on the open
market pursuant to its stock repurchase program.  The aggregate
consideration paid for these shares totaled $52,510, resulting in an average
repurchase price of $0.05 per acquired share.
 
 F-22




ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.


THE
FOLLOWING PRESENTATION OF OUR MANAGEMENT'S DISCUSSION AND ANALYSIS SHOULD BE
READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND OTHER FINANCIAL
INFORMATION INCLUDED ELSEWHERE IN THIS REPORT.
 
 A
Note About Forward-Looking Statements
 
 This
Quarterly Report on Form 10-Q contains “forward-looking statements” within the
meaning of the Private Securities Litigation Reform Act of 1995 that are based
on current management's expectations. These statements may be identified by
their use of words like “plans,” “expect,” “aim,” “believe,” “projects,”
“anticipate,” “intend,” “estimate,” “will,” “should,” “could” and other
expressions that indicate future events and trends. All statements that address
expectations or projections about the future, including statements about our
business strategy, expenditures, and financial results are forward-looking
statements. We believe that the expectations reflected in such forward-looking
statements are accurate. However, we cannot assure you that such expectations
will occur.
  Actual
results could differ materially from those in the forward looking statements due
to a number of uncertainties including, but not limited to, those discussed in
this section. Factors that could cause future results to differ from these
expectations include general economic conditions, further changes in our
business direction or strategy, competitive factors, oil and gas exploration
uncertainties, and an inability to attract, develop, or retain technical,
consulting or managerial agents or independent contractors. As a result, the
identification and interpretation of data and other information and their use in
developing and selecting assumptions from and among reasonable alternatives
requires the exercise of judgment. To the extent that the assumed events do not
occur, the outcome may vary substantially from anticipated or projected results,
and accordingly, no opinion is expressed on the achievability of those
forward-looking statements. No assurance can be given that any of the
assumptions relating to the forward-looking statements specified in the
following information are accurate, and we assume no obligation to update any
such forward-looking statements. You should not unduly rely on these
forward-looking statements, which speak only as of the date of this Quarterly
Report, except as required by law; we are not obligated to release publicly any
revisions to these forward-looking statements to reflect events or circumstances
occurring after the date of this report or to reflect the occurrence of
unanticipated events.
 
 Industry
Outlook
 
 The
petroleum industry is highly competitive and subject to significant volatility
due to numerous market forces. Crude oil and natural gas prices are affected by
market fundamentals such as weather, inventory levels, competing fuel prices,
overall demand and the availability of supply.
  3
 
 Oil
prices cannot be predicted with any certainty and have significantly affected
profitability and returns for upstream producers. Historically, the WTI price
has averaged approximately $47 per barrel over the past ten years. However,
during that time, the industry has experienced wide fluctuations in prices.
While local supply/demand fundamentals are a decisive factor affecting domestic
natural gas prices over the long term, day-to-day prices may be more volatile in
the futures markets, such as on the NYMEX and other exchanges, making it
difficult to forecast prices with any degree of confidence. Over the last ten
years, the NYMEX gas price has averaged approximately $5.67 per
mcf.
 
 Results
of Operations for the Three-Month Period Ended March 31, 2010 vs.
2009
 
 We began
receiving royalty payments associated with our 5% gross overriding royalty
interest in certain properties located in Saskatchewan, Canada in April
2009.  We recognized $71,486 of oil and gas sales revenue associated
with these overriding interests during the three-month period ended March 31,
2010.  Revenues from our overriding royalty positions are expected to
continue or to grow as additional wells are drilled in the area or until we
dispose of our overriding royalty positions.
 
 The
Company acquired a 75% working interest in the West Ranch property through a
series of transactions occurring in 2007.  Falling oil prices and the
need to scale down our equipment to better suit our well compression needs led
us to temporarily shut-in the producing wells on the West Ranch property in June
2008.
 
 In August
of 2009, certain leases included in the West Ranch field expired.  In
our attempt to re-lease these properties, we were unable to reach mutually
acceptable terms with the mineral rights owners and, as a result, the proven oil
and gas reserves associated with these leases are no longer available to
us.  Because these leases were located near the crest of the Glasscock
reservoir structure and, thus, were essential to performing the planned
peripheral waterflood, we no longer plan to implement a waterflood program in
the Glasscock reservoir.
 
 As of
March 31, 2010, the remaining West Ranch wells continue to be shut
in.  Accordingly, we have not recognized any revenue from oil and gas
sales from the West Ranch property during the three-month periods ended March
31, 2010 and 2009.  During the three-month period ended March 31,
2009, we incurred oil and gas operating expenses of $30,009, which represented
costs necessary to maintain the wells during the shut-in period.  No
such operating expenses were incurred during the three-month period ended March
31, 2010.  As of March 31, 2010, we have fully impaired our investment
in the West Ranch property.
 
 General
and administrative expenses increased from $221,531 for the three-month period
ended March 31, 2009 to $233,412 for the three-month period ended March 31,
2010. Prior to October 2009, we provided shared CFO services to Roadrunner Oil
& Gas, Inc. (“Roadrunner”), for which Roadrunner paid us amounts ranging
from $3,000 to $4,000 per month.  Fees received from Roadrunner
reduced our gross salaries expense by $9,000 for the three-month period ended
March 31, 2009.  Because the shared CFO services arrangement
terminated in October 2009, we recognized no such savings for the three-month
period ended March 31, 2010.
  4
 
 Stock-based
compensation expense for the three-month period ended March 31, 2009 totaled
$110,250.  In September 2009, we cancelled all of our then outstanding
stock options in connection with the issuance of restricted shares to the option
holders.  In October 2009, we rescinded the issuance of the restricted
shares and granted new stock options to the previous option
holders.  Pursuant to accounting rules, the granting of the new
options was treated as a modification of the terms of the cancelled options and,
accordingly, all stock-based compensation attributable to the newly issued
options was fully recognized at the time of grant.  Further, all
remaining, unamortized stock-based compensation of the cancelled options was
also recognized.  As a result, no stock-based compensation expense was
recognized during the three-month period ended March 31, 2010 as all
compensation related to our outstanding stock options has already been
recognized.
 
 Professional
fees for the three-month period ended March 31, 2010 increased by $15,102 from
the same period in 2009, primarily as a result increased fees associated with
the sale of certain of our assets to Ryland Oil Corporation
(“Ryland”).  The Ryland transactions were completed in April
2010.  The increase in professional fees from 2009 to 2010 related to
the Ryland transactions was partially offset by a decrease in legal fees that
were incurred during the three-month period ended March 31, 2009 in connection
with our defense of the Zavanna litigation.  The Zavanna litigation
was favorably settled in July 2009.
 
 Depreciation,
depletion and amortization expense for the three-month period ended March, 31,
2010 increased by $7,026 from the same period in 2009 primarily due to
depreciation related to office equipment that was put into service in February
2009, as well as the normal accretion of the our asset retirement
obligations.
 
 Interest
income for the three-month period ended March 31, 2010 totaled $1,695, compared
to $10,291 for the three-month period ended March 31, 2009.  The
decrease is due to reduced interest rates available for the Company’s excess
cash, as well as the fact that the Company’s North Sea deposits were invested in
long-term investments during 2009, as required by law.  The Company
collected the deposits in November 2009.   Since that time, the
funds previously held on deposit were invested at normal money-market rates,
which are lower that the rates previously received when the funds were invested
in longer-term maturity instruments.
 
 Liquidity and Capital Resources
 
 As of
September 30, 2009, our assets totaled $1,939,077, which included cash balances
of $1,355,703 and investments in oil and gas properties of
$406,973.
 
 We began
receiving royalties in connection with our gross overriding royalty positions in
Saskatchewan in April 2009 and will continue to receive such royalties on the
sale of oil and gas produced through April 1, 2010, the effective date of the
sale of our overriding royalty interests to Ryland.
  5
 
 On March
26, 2010, we sold our five percent gross overriding royalty interest in certain
oil and gas properties located in southeastern Saskatchewan to Ryland Oil
Corporation (“Ryland”) in exchange for $2.9 million in cash, 2,145,883 shares of
Ryland’s common stock and Ryland’s 100% working interest in approximately 4,480
acres located in close southeastern Saskatchewan (the “Hardy
Prospect”).  The $2.9 million cash payment is due to us by June 1,
2010.  Upon closing, 60% of the overriding royalty interest sold was
placed into escrow pending the receipt of the remaining $2.9 million cash
payment.  In the event the $2.9 million payment is not received by
June 1, 2010, the escrowed overriding royalty interest will revert to
us.  The 2,145,883 shares of Ryland stock are restricted from trading
until August 30, 2010.
 
 In a
separate transaction, we sold approximately 700 acres of our North Dakota
property to Rover Resources, Inc. (“Rover”), a wholly-owned subsidiary of
Ryland, for $1 million in cash.
 
 The
transactions with Ryland and Rover closed on April 29, 2010, at which time we
received the $1 million cash payment, the assignment of the Hardy Prospect
leases and the 2,145,883 shares of Ryland stock.  The Ryland stock was
valued at approximately $880,000 ($CDN) as of the closing date.
 
 Off-Balance
Sheet Arrangements
 
 The
Company had no off-balance sheet arrangements at March31, 2010.


ITEM 4T. CONTROLS AND PROCEDURES.





The
Company, under the supervision and with the participation of its management,
including the Chief Executive Officer and the Chief Financial Officer, evaluated
the effectiveness of the design and operation of the Company’s "disclosure
controls and procedures" (as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934, as amended, as of the end of the period covered by this
report.  Based on that evaluation, the Chief Executive Officer and the
Chief Financial Officer concluded that the Company’s disclosure controls and
procedures were effective as of March 31, 2010.  There has been no
change in the Company’s internal control over financial reporting during the
quarter ended March 31, 2010, that has materially affected, or is reasonably
likely to materially affect, the Company’s internal control over financial
reporting.




6





Part II - OTHER INFORMATION





ITEM
6. EXHIBITS.





Exhibit
            
            Description
      of Exhibit




3(i).1
            Articles
      of Incorporation filed with the Nevada Secretary of State on July 25,
      2003. (Incorporated by reference to Exhibit 3.1 of our Form 10-SB filed
      August 18, 2004.)




3(i).2
            Certificate
      of Change filed with the Nevada Secretary of State effective November 7,
      2005. (Incorporated by reference to Exhibit 3(i).2 of our Current Report
      on Form 8-K filed November 9,
2005.)




3(i).3
            Articles
      of Merger filed with the Nevada Secretary of State effective November 7,
      2005. (Incorporated by reference to Exhibit 3(i).3 of our Current Report
      on Form 8-K filed November 9,
2005.)




3(ii).1
            Bylaws,
      adopted July 18, 2003. (Incorporated by reference to Exhibit 3.2 of our
      Form 10-SB filed August 18, 2004.)




3(ii).2
            Amendment
      No. 1 to Bylaws, adopted November 4, 2005. (Incorporated by reference to
      Exhibit 3(ii) of our Current Report on Form 8-K filed November 9,
      2005.)




10.1
            Agreement
      and Plan of Merger between Golden Hope Resources Corp. (renamed Eternal
      Energy Corp.) and Eternal Energy Corp., filed with the Nevada Secretary of
      State effective November 7, 2005. (Incorporated by reference to Exhibit
      10.1 of our Current Report on Form 8-K filed November 9,
      2005.)




10.2
            Reserved
      for future use.





10.3
            Reserved
      for future use.





10.4
            Reserved
      for future use.





10.5
            Reserved
      for future use.





10.6
            Letter
      Agreement by and between Eternal Energy Corp. and International Frontier
      Resources Corporation. (Incorporated by reference to Exhibit 10.1 of our
      Current Report on Form 8-K filed December 5,
  2005.)





10.7
            Reserved
      for future use.





10.8
            Reserved
      for future use.




10.9
            Letter
      Agreement by and between Eternal Energy Corp. and International Frontier
      Resources Corporation Relating to Quad 41 and Quad 42 dated January 30,
      2006. (Incorporated by reference to Exhibit 10.1 of our Current Report on
      Form 8-K filed February 3, 2006.)




10.10
            Amended
      and Restated Letter Agreement by and between Eternal Energy Corp. and
      International Frontier Resources Corporation Relating to Quad 14 dated
      January 30, 2006. (Incorporated by reference to Exhibit 10.2 of our
      Current Report on Form 8-K filed February 3,
  2006.)





10.11
            Reserved
      for future use.





10.12
            Reserved
      for future use.





10.13
            Reserved
      for future use.





10.14
            Reserved
      for future use.





10.15
            Reserved
      for future use.





10.16
            Letter
      Agreement effective as of May 19, 2006, by and among Eternal Energy Corp.,
      International Frontier Resources Corporation, Palace Exploration Company
      Limited, Oilexco Incorporated, and Challenger Minerals (North Sea) Limited
      (Incorporated by reference to Exhibit 10.1 of our Current Report on Form
      8-K filed May 23, 2006).




10.17**
            Letter
      Agreement dated October 15, 2006, by and among Eternal Energy Corp.,
      Fairway Exploration, LLC, Prospector Oil, Inc., and 0770890 B.C. Ltd.
      (Incorporated by reference to Exhibit 10.17 of our Registration Statement
      on Form 10-KSB filed April 16,
2007).




7




10.18**
            Letter
      Agreement dated October 26, 2006, by and among Eternal Energy Corp.,
      Fairway Exploration, LLC, Prospector Oil, Inc., 0770890 B.C. Ltd., and
      Rover Resources Inc. (Incorporated by reference to Exhibit 10.18 of our
      Registration Statement on Form 10-KSB filed April 16,
    2007).




10.19
            Letter
      Agreement dated February 28, 2007, by and among Eternal Energy Corp.,
      Pebble Petroleum Inc., Emerald Bay Holdings Ltd., and Heartland Resources
      Inc. (Incorporated by reference to Exhibit 10.19 of our Registration
      Statement on Form 10-KSB filed April 16, 2007).10.20
            Agreement
      To Terminate DGWS Option (Incorporated by reference to Exhibit 10.20 of
      our Quarterly Report on Form 10-Q filed May 15, 2009).10.21
            Amended
      and Restated Employment Agreement by and between Eternal Energy Corp. and
      Craig Phelps dated August 1, 2007 (Incorporated by reference to Exhibit
      10.21 of our Quarterly Report on Form 10-Q filed May 15,
      2009).10.22
            Employment
      Agreement by and between Eternal Energy Corp. and Kirk A. Stingley dated
      June 2, 2008 (Incorporated by reference to Exhibit 10.22 of our Quarterly
      Report on Form 10-Q filed May 15, 2009).10.23
            Amended
      and Restated Employment Agreement by and between Eternal Energy Corp. and
      Bradley M. Colbydated
      November 1, 2009 (Incorporated by reference to Exhibit 10.23 of
      our   ).10.24
            First
      Amendment to the Amended and Restated Employment Agreement by and between
      Eternal Energy Corp. and Craig H. Phelps dated August 1, 2009
      (Incorporated by reference to Exhibit 10.24 of our Quarterly Report on
      Form 10-Q filed November 23, 2009).10.25
            First
      Amendment to the Employment Agreement by and between Eternal Energy Corp.
      and Kirk. A. Stingley dated October 30, 2009 (Incorporated by reference to
      Exhibit 10.25 of our Form Quarterly Report on Form 10-Q filed November 23,
      2009).10.26
            Form
      Of Letter Agreement dated November 25, 2009, between the Registrant and
      Ryland Oil Corporation in respect of a potential acquisition of the
      registrant (Incorporated by reference to Exhibit 10.26 of our Current
      Report on Form 8-K filed March 10, 2010).10.27
            Lease
      Agreement dated January 2, 1009 by and between Eternal energy Corp. and
      Oakley Ventures, LLC (Incorporated by Reference to Exhibit 10.27 of our
      Annual Report on Form 10-K filed March 23, 2010).10.28
            Purchase
      and Sale Agreement by and between Eternal Energy Corp. and Ryland Oil
      Corporation dated March 26, 2010 (Incorporated by reference to Exhibit
      10.28 of our Current Report on Form 8-K filed March 29,
    2010).10.29
            Purchase
      of Royalty Agreement by and between Eternal Energy Corp. and Ryland Oil
      Corporation dated March 26, 2010 (Incorporated by reference to Exhibit
      10.29 of our Current Report on Form 8-K filed March 29,
    2010).10.29a
            Amending
      Agreement to the Ryland/Eternal Royalty Purchase Agreement by and between
      Eternal Energy Corp. and Ryland Oil Corporation dated April 20, 2010
      (Incorporated by reference to Exhibit 10.29a of our Current Report on Form
      8-K filed March 29, 2010).10.30*
            Termination
      Agreement (of the US Pebble Acquisition Agreement) by and between Eternal
      Energy Corp., FairwayExploration
      LLC, Prospector Oil, Inc., Pebble Petroleum Inc. and Rover Resources Inc.
      dated April 29, 2010.10.31*
            Termination
      Agreement (of the Canadian Pebble Acquisition Agreement) by and between
      Eternal Energy Corp., Fairway Exploration
      LLC, Prospector Oil, Inc. and Pebble Petroleum Inc. dated April 29,
      2010.10.32*
            Termination
      Agreement (of the US Prospect Acquisition Agreement) by and between
      Eternal Energy Corp., Fairway Exploration
      LLC, Prospector Oil, Inc., Pebble Petroleum Inc., Rover Resources Inc.,
      Steven Swanson, RichardL.
      Findley, Thomas G. Lantz and Ryland Oil Corporation dated May 11,
      2010.10.33*
            Termination
      Agreement (of the Canadian Prospect Acquisition Agreement) by and between
      Eternal Energy Corp., Fairway
      Exploration LLC, Prospector Oil, Inc., Pebble Petroleum Inc., Steven
      Swanson, Richard L. Findley, Thomas G. Lantzand
      Ryland Oil Corporation dated May 11, 2010.10.34*
            Termination
      of Management Services Agreement by and between Eternal Energy Corp.,
      Ryland Oil Corporation andBrad
      Colby dated December 1, 2009.10.35*
            Amendment
      to the Consulting Agreement by and between Eternal Energy Corp., Rover
      Resources Inc. and Brad Colby dated
      April 1, 2010.




31.1*
            Certification
      pursuant to Section 302 of the Sarbanes-Oxley
  Act




31.2*
            Certification
      pursuant to Section 302 of the Sarbanes-Oxley
  Act




32.1*
            Certification
      pursuant to Section 906 of the Sarbanes-Oxley
  Act




32.2*
            Certification
      pursuant to Section 906 of the Sarbanes-Oxley
  Act








*
            Filed
      herewith.




**
            Portions
      omitted pursuant to a request for confidential
  treatment.





8





SIGNATURES





In
accordance with the requirements of the Exchange Act, the registrant caused this
Report to be signed on its behalf by the undersigned, thereunto duly
authorized.





ETERNAL
      ENERGY CORP.(Registrant)May
      14, 2010
            /s/
      Bradley M. ColbyBradley
      M. ColbyPresident
      and Chief Executive Officer





9