Attached files
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended May 31, 2011
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____ to _______
Commission File Number: 333-146561
SYNERGY RESOURCES CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Colorado 20-2835920
--------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20203 Highway 60, Platteville, Colorado Code80651
---------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number including area code: (970) 737-1073
N/A
-----------------------------------------------------------
Former name, former address, and former fiscal year, if changed
since last report
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 [X] No [ ]
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
definition of "large accelerated filer", "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. Yes [ ] No [ ]
Larger accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
Indicate by check mark whether registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 35,568,117 shares outstanding
as of July 8, 2011.
1
SYNERGY RESOURCES CORPORATION
Index
Page
----
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets as of May 31, 2011 (unaudited)
and August 31, 2010 3
Statements of Operations for the three and nine months ended
May 31, 2011 and 2010 (unaudited) 4
Statements of Cash Flows for the nine months ended
May 31, 2011 and 2010 (unaudited) 5
Notes to Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 23
Item 4. Controls and Procedures 34
Part II - OTHER INFORMATION
Item 1. Legal Proceedings 34
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds 34
Item 3. Defaults Upon Senior Securities 34
Item 4. Removed and Reserved 34
Item 5. Other Information 35
Item 6. Exhibits 36
SIGNATURES 37
EXPLANATORY NOTE
This amendment to Form 10-Q was prepared to include the disclosures
required under Part I - Item 4, Controls and Procedures, that were inadvertently
omitted from the original filing on July 14, 2011.
2
SYNERGY RESOURCES CORPORATION
BALANCE SHEETS
As of As of
May 31, 2011 August 31, 2010
--------------- ---------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $11,096,665 $ 6,748,637
Accounts receivable:
Oil and gas sales 2,400,999 377,675
Joint interest billing 2,660,148 1,930,810
Related party receivable 30,391 867,835
Inventory 706,742 387,864
Other current assets 18,307 12,310
--------------- ---------------
Total current assets 16,913,252 10,325,131
--------------- ---------------
Property and equipment:
Oil and gas properties, full cost method, net 38,582,870 12,692,194
Other property and equipment, net 230,671 150,789
--------------- ---------------
Property and equipment, net 38,813,541 12,842,983
--------------- ---------------
Debt issuance costs, net of amortization - 1,587,799
Other assets 90,000 86,000
--------------- ---------------
Total assets $55,816,793 $24,841,913
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable:
Trade $ 3,641,713 $ 3,015,562
Related party payable - 554,669
Accrued expenses 1,334,560 517,921
Notes payable, related party 5,200,000 -
--------------- ---------------
Total current liabilities 10,176,273 4,088,152
Asset retirement obligations 521,081 254,648
Convertible promissory notes, net of debt
discount - 12,190,945
Derivative conversion liability - 9,325,117
--------------- ---------------
Total liabilities 10,697,354 25,858,862
--------------- ---------------
Commitments and contingencies (See Note 8)
Shareholders' equity (deficit):
Preferred stock - $0.01 par value,
10,000,000 shares authorized:
no shares issued and outstanding - -
Common stock - $0.001 par value,
100,000,000 shares authorized:
35,408,632 and 13,510,981 shares
issued and outstanding as of
May 31, 2011, and August 31, 2010,
respectively 35,409 13,511
Additional paid-in capital 81,613,428 22,308,963
Accumulated deficit (36,529,398) (23,339,423)
--------------- ---------------
Total shareholders' equity (deficit) 45,119,439 (1,016,949)
--------------- ---------------
Total liabilities and shareholders'
equity (deficit) $55,816,793 $24,841,913
=============== ===============
The accompanying notes are an integral part of these financial
statements.
3
SYNERGY RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended May 31, Nine Months Ended May 31,
2011 2010 2011 2010
------------- ------------- ----------- -----------
Revenues:
Oil and gas revenues $ 2,921,910 $ 607,253 $ 6,399,193 $ 995,764
Service revenues 184,426 - 211,715 -
------------- ------------- ----------- -----------
Total revenues 3,106,336 607,253 6,610,908 995,764
------------- ------------- ----------- -----------
Expenses:
Lease operating
expenses 668,683 106,503 1,131,837 161,545
Depreciation,
depletion,
and amortization 830,639 200,890 2,062,825 293,829
General and
administrative 1,059,742 350,954 2,171,721 986,364
------------- ------------- ----------- -----------
Total expenses 2,559,064 658,347 5,366,383 1,441,738
------------- ------------- ----------- -----------
Operating income (loss) 547,272 (51,094) 1,244,525 (445,974)
------------- ------------- ----------- -----------
Other income (expense):
Change in fair
value of
derivative
conversion liability 86,192 (2,764,888) (10,229,229)(2,764,888)
Interest expense, net (950,860) (834,381) (4,246,945)(1,248,517)
Interest income 25,784 551 41,675 4,237
------------- ------------- ----------- -----------
Total other
(expense) (838,884) (3,598,718) (14,434,499)(4,009,168)
------------- ------------- ----------- -----------
Loss before income taxes (291,612) (3,649,812) (13,189,974)(4,455,142)
Provision for income
taxes - - - -
------------- ------------- ----------- -----------
Net loss
$ (291,612) $(3,649,812) $(13,189,974)$(4,455,142)
============= ============= ============ ============
Net loss per common share:
Basic and Diluted (0.01) (0.30) (0.58) (0.37)
============= ============= ============ ============
Weighted average shares
outstanding:
Basic and Diluted 32,813,298 11,998,000 22,713,785 11,998,000
============= ============= ============ ============
The accompanying notes are an integral part of these financial
statements.
4
SYNERGY RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended May 31,
2011 2010
------------- -------------
Cash flows from operating activities:
Net loss $(13,189,974) $ (4,455,142)
------------- -------------
Adjustments to reconcile net loss to
net cash provided by (used in)
operating activities:
Depreciation, depletion, and
amortization 2,062,825 293,829
Amortization of debt issuance cost 1,587,799 283,535
Accretion of debt discount 2,664,138 622,214
Stock-based compensation 563,518 17,790
Change in fair value of derivative
liability 10,229,229 2,764,888
Changes in operating assets and
liabilities:
Accounts receivable (1,915,218) (681,923)
Inventory (318,878) (109,591)
Accounts payable 1,275,804 (64,008)
Accrued expenses 875,636 328,399
Other (9,997) 15,459
------------- -------------
Total adjustments
17,014,856 3,470,592
------------- -------------
Net cash provided by (used in)
operating activities 3,824,882 (984,550)
------------- -------------
Cash flows from investing activities:
Acquisition of property and equipment (21,163,392) (5,717,527)
Proceeds from sales of oil and gas
properties 4,995,817 -
------------- -------------
Net cash used in investing activities
(16,167,575) (5,717,527)
------------- -------------
Cash flows from financing activities:
Cash proceeds from sale of stock 18,000,000 -
Offering costs (1,309,279) -
Cash proceeds from convertible
promissory notes - 18,000,000
Debt issuance costs - (1,348,977)
Principal repayments - (1,161,811)
------------- -------------
Net cash provided by financing
activities 16,690,721 15,489,212
------------- -------------
Net increase in cash and equivalents 4,348,028 8,787,135
Cash and equivalents at beginning of
period 6,748,637 2,854,659
------------- -------------
Cash and equivalents at end of period $ 11,096,665 $ 11,641,794
============= =============
Supplemental Cash Flow Information (See
Note 11)
The accompanying notes are an integral part of these financial statements.
5
SYNERGY RESOURCES CORPORATION
NOTES TO FINANCIAL STATEMENTS
May 31, 2011
(unaudited)
1. Organization and Summary of Significant Accounting Policies
Organization: Synergy Resources Corporation (the "Company") is engaged in
oil and gas acquisitions, exploration, development and production activities,
primarily in the area known as the Denver-Julesburg ("D-J") Basin. The Company
has adopted August 31st as the end of its fiscal year.
Interim Financial Information: The interim financial statements included
herein have been prepared by the Company, without audit, pursuant to the rules
and regulations of the Securities and Exchange Commission ("SEC") as promulgated
in Item 210 of Regulation S-X. The Company prepares its financial statements in
accordance with accounting principles generally accepted in the
country-regionplaceUnited States of America ("US GAAP"). Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with US GAAP have been condensed or omitted pursuant to such SEC
rules and regulations. The Company believes that the disclosures included are
adequate to make the information presented not misleading and recommends that
these financial statements be read in conjunction with the audited financial
statements and notes thereto included in the Company's annual report on Form
10-K for the year ended August 31, 2010.
In management's opinion, the unaudited financial statements contained
herein reflect all adjustments, consisting solely of normal recurring items,
which are necessary for the fair presentation of the Company's financial
position, results of operations, and cash flows on a basis consistent with that
of its prior audited financial statements. However, the results of operations
for interim periods may not be indicative of results to be expected for the full
fiscal year.
Reclassifications: Certain amounts previously presented for prior periods
have been reclassified to conform to the current presentation. The
reclassifications had no net effect on net loss, shareholders' equity (deficit)
or cash flows.
Use of Estimates: The preparation of financial statements in conformity
with US GAAP requires management to make estimates and assumptions that affect
the reported amount of assets and liabilities, including, but not limited to,
oil and gas reserves, and disclosure of contingent assets and liabilities at the
date of the financial statements as well as the reported amounts of revenues and
expenses during the reporting period. Management routinely makes judgments and
estimates about the effects of matters that are inherently uncertain. Management
bases its estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Estimates and
assumptions are revised periodically and the effects of revisions are reflected
in the financial statements in the period it is determined to be necessary.
Actual results could differ from these estimates.
Cash and Cash Equivalents: The Company considers cash in banks, deposits in
transit, and highly liquid debt instruments purchased with original maturities
of three months or less to be cash and cash equivalents.
Inventory: Inventories consist primarily of tubular goods and well
equipment to be used in future drilling operations or repair operations and are
carried at the lower of cost or market.
Oil and Gas Properties: The Company uses the full cost method of accounting
for costs related to its oil and gas properties. Accordingly, all costs
associated with acquisition, exploration, and development of oil and gas
reserves (including the costs of unsuccessful efforts) are capitalized into a
6
single full cost pool. These costs include land acquisition costs, geological
and geophysical expense, carrying charges on non-producing properties, costs of
drilling and overhead charges directly related to acquisition and exploration
activities. Under the full cost method, no gain or loss is recognized upon the
sale or abandonment of oil and gas properties unless non-recognition of such
gain or loss would significantly alter the relationship between capitalized
costs and proved oil and gas reserves.
Capitalized costs of oil and gas properties are depleted using the
units-of-production method based upon estimates of proved reserves. For
depletion purposes, the volume of petroleum reserves and production is converted
into a common unit of measure at the energy equivalent conversion rate of six
thousand cubic feet of natural gas to one barrel of crude oil. Investments in
unevaluated properties and major development projects are not amortized until
proved reserves associated with the projects can be determined or until
impairment occurs. If the results of an assessment indicate that the properties
are impaired, the amount of the impairment is added to the capitalized costs to
be amortized.
Under the full cost method of accounting, a ceiling test is performed each
quarter. The full cost ceiling test is an impairment test prescribed by SEC
regulations. The ceiling test determines a limit on the book value of oil and
gas properties. The capitalized costs of oil and gas properties, adjusted for
accumulated depreciation, depletion, and amortization, and the related deferred
income taxes, may not exceed the estimated future net cash flows from proved oil
and gas reserves, plus the cost of unevaluated properties not being amortized,
plus the lower of cost or estimated fair value of unevaluated properties being
amortized. Prices are held constant for the productive life of each well. Net
cash flows are discounted at 10%. If net capitalized costs exceed this limit,
the excess is charged to expense and reflected as additional accumulated
depreciation, depletion and amortization. The calculation of future net cash
flows assumes continuation of current economic conditions. Once impairment
expense is recognized, it cannot be reversed in future periods, even if
increasing prices raise the ceiling amount. No provision for impairment was
required for either the nine months ended May 31, 2011 or 2010.
The oil and natural gas prices used to calculate the full cost ceiling
limitation are based upon a 12-month rolling average, calculated as the
unweighted arithmetic average of the first day of the month price for each month
within the 12-month period prior to the end of the reporting period, unless
prices are defined by contractual arrangements. Prices are adjusted for basis or
location differentials.
Oil and Gas Reserves: The determination of depreciation, depletion and
amortization expense, as well as the ceiling test calculation related to the
recorded value of the Company's oil and natural gas properties, will be highly
dependent on the estimates of the proved oil and natural gas reserves. Oil and
natural gas reserves include proved reserves that represent estimated quantities
of crude oil and natural gas which geological and engineering data demonstrate
with reasonable certainty to be recoverable in future years from known
reservoirs under existing economic and operating conditions. There are numerous
uncertainties inherent in estimating oil and natural gas reserves and their
values, including many factors beyond the Company's control. Accordingly,
reserve estimates are often different from the quantities of oil and natural gas
ultimately recovered and the corresponding lifting costs associated with the
recovery of these reserves.
Capitalized Overhead: A portion of the Company's overhead expenses are
directly attributable to acquisition and development activities. Under the full
cost method of accounting, these expenses, which totaled $46,673 and $154,621
for the three and the nine months ended May 31, 2011, respectively, were
capitalized into the full cost pool. No comparable costs were capitalized during
the three and nine month periods ended May 31, 2010.
7
Capitalized Interest: The Company capitalizes interest on expenditures made
in connection with exploration and development projects that are not subject to
current amortization. Interest is capitalized during the period that activities
are in progress to bring the projects to their intended use. Capitalized
interest totaled $253,887 and $84,154 for the three months ended May 31, 2011
and 2010, respectively, and $594,530 and $139,626 for the nine months ended May
31, 2011 and 2010, respectively.
Debt Issuance Costs: Debt issuance costs of $2,041,455 were incurred in
connection with the convertible promissory notes issued during the year ended
August 31, 2010 (see Note 6). Amortization expense is recognized over the
expected term of the debt and is adjusted for early conversion and redemption.
Amortization expense of $422,528 and $183,398 was recorded for the three months
ended May 31, 2011 and 2010, respectively, and $1,587,799 and $283,535 was
recorded for the nine months ended May 31, 2011 and 2010, respectively.
Fair Value Measurements: Fair value is the price that would be received to
sell an asset or be paid to transfer a liability in an orderly transaction
between market participants at the measurement date (exit price). The Company
uses market data or assumptions that market participants would use in pricing
the asset or liability, including assumptions about risk. These inputs can
either be readily observable, market corroborated or generally unobservable.
Fair value balances are classified based on the observability of the various
inputs (see Note 7).
Asset Retirement Obligations: The Company's activities are subject to
various laws and regulations, including legal and contractual obligations to
reclaim, remediate, or otherwise restore properties at the time the asset is
permanently removed from service. The fair value of a liability for the asset
retirement obligation ("ARO") is initially recorded when it is incurred if a
reasonable estimate of fair value can be made. This is typically when a well is
completed or an asset is placed in service. When the ARO is initially recorded,
the Company capitalizes the cost (asset retirement cost or "ARC") by increasing
the carrying value of the related asset. Over time, the liability increases for
the change in its present value (accretion of ARO), while the net capitalized
cost decreases over the useful life of the asset. The capitalized ARCs are
included in the full cost pool and subject to depletion, depreciation and
amortization. In addition, the ARCs are included in the ceiling test
calculation. Calculation of an ARO requires estimates about several future
events, including the life of the asset, the costs to remove the asset from
service, and inflation factors. The ARO is initially estimated based upon
discounted cash flows over the life of the asset and is accreted to full value
over time using the Company's credit adjusted risk free interest rate. Estimates
are periodically reviewed and adjusted to reflect changes.
Derivative Conversion Liability: The Company accounts for the embedded
conversion features in its convertible promissory notes in accordance with the
guidance for derivative instruments, which requires a periodic valuation of fair
value and a corresponding recognition of liabilities associated with such
derivatives. The recognition of derivative conversion liabilities related to the
issuance of convertible debt is applied first to the proceeds of such issuance
as a debt discount at the date of the issuance. Any subsequent increase or
decrease in the fair value of the derivative conversion liabilities is
recognized as a charge or credit to other income (expense) in the statements of
operations. As of May 31, 2011, all of the holders of convertible promissory
notes had elected to convert the notes into shares of common stock, thereby
eliminating the derivative conversion liability (see Note 6).
Revenue Recognition: Revenue is recognized for the sale of oil and natural
gas when production is sold to a purchaser and title has transferred. Revenues
from production on properties in which the Company shares an economic interest
with other owners are recognized on the basis of the Company's interest.
Provided that reasonable estimates can be made, revenue and receivables are
8
accrued and differences between the estimates and actual volumes and prices, if
any, are adjusted upon settlement, which typically occurs sixty to ninety days
after production.
Major Customers and Operating Region: The Company operates exclusively
within the country-regionplaceUnited States of America. Except for cash and
equivalent investments, all of the Company's assets are employed in and all of
its revenues are derived from the oil and gas industry.
The Company's oil and gas production is purchased by a few customers. The
table below presents the percentages of oil and gas revenue that was purchased
by major customers.
Three Months Ended May 31, Nine Months Ended May 31,
------------------------ ------------------------
Major Customers 2011 2010 2011 2010
--------------- ---- ---- ---- -----
Company A 77% 46% 77% 42%
Company B 21% 38% 20% 35%
Company C * 16% * 22%
* less than 10%
As there are other purchasers that are capable of and willing to purchase
the Company's oil and gas production and because the Company has the option to
change purchasers of its oil and gas if conditions so warrant, the Company
believes that its oil and gas production can be sold in the market in the event
that it is not sold to the Company's existing customers. However, in some
circumstances, a change in customers may entail significant transition costs
and/or shutting in or curtailing production for weeks or even months during the
transition to a new customer.
Stock Based Compensation: Stock based compensation is measured at the grant
date based upon the estimated fair value of the award and the expense is
recognized over the required employee service period, which generally equals the
vesting period of the grant. The fair value of stock options is estimated using
the Black-Scholes-Merton option pricing model. The fair value of restricted
stock grants is estimated on the grant date based upon the fair value of the
common stock.
Earnings Per Share Amounts: Basic earnings per share includes no dilution
and is computed by dividing net income (or loss) by the weighted-average number
of shares outstanding during the period. Diluted earnings per share reflect the
potential dilution of securities that could share in the earnings of the
Company. For the nine months ended May 31, 2010 and 2011, diluted earnings per
share is equivalent to basic earnings per share, as all potentially dilutive
securities have an anti-dilutive effect on earnings per share. The following
potentially dilutive securities could dilute future earnings per share:
Nine Months Ended May 31,
----------------------------
2011 2010
------------- -------------
Convertible promissory notes - 11,250,000
Warrants(1) 14,941,372 15,286,466
Employee stock options 4,470,000 4,100,000
------------- -------------
Total 19,411,372 30,646,466
============= =============
9
(1) Also, as of May 31, 2011 and 2010, the Company had a contingent
obligation to issue 63,466 potentially dilutive securities, all of which were
excluded from the calculation because the contingency conditions had not been
met.
Income Taxes: Deferred income taxes are recorded for timing differences
between items of income or expense reported in the financial statements and
those reported for income tax purposes using the asset/liability method of
accounting for income taxes. Deferred income taxes and tax benefits are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and for tax loss and credit carry-forwards. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The Company provides for deferred taxes for
the estimated future tax effects attributable to temporary differences and
carry-forwards when realization is more likely than not. If the Company
concludes that it is more likely than not that some portion or all of the
deferred tax asset will not be realized, the balance of deferred tax assets is
reduced by a valuation allowance. From inception through May 31, 2011, the
Company incurred substantial net operating losses, and provided a full valuation
allowance against deferred tax assets.
The Company follows the provisions of the ASC regarding uncertainty in
income taxes. No significant uncertain tax positions were identified as of any
date on or before May 31, 2011. Given the substantial net operating loss
carry-forwards at both the federal and state levels, neither significant
interest expense nor penalties charged for any examining agents' tax adjustments
of income tax returns are anticipated as any such adjustments would very likely
simply adjust the net operating loss carry-forwards.
Recent Accounting Pronouncements: The Company evaluates the pronouncements
of various authoritative accounting organizations, primarily the Financial
Accounting Standards Board ("FASB"), the Emerging Issues Task Force ("EITF"),
and the SEC to determine the impact of new pronouncements on US GAAP and the
impact on the Company.
In June 2011, the FASB issued ASU 2011-05 - Presentation of Comprehensive
Income ("ASU 2011-05"), which requires entities to present reclassification
adjustments included in other comprehensive income on the face of the financial
statements and allows entities to present the total of comprehensive income, the
components of net income and the components of other comprehensive income either
in a single continuous statement of comprehensive income or in two separate but
consecutive statements. It also eliminates the option for entities to present
the components of other comprehensive income as part of the statement of changes
in stockholders' equity. For public companies, ASU 2011-05 is effective for
fiscal years (and interim periods within those years) beginning after December
15, 2011, with earlier adoption permitted. Adoption of this ASU is not expected
to have a material affect on the Company's financial position, results of
operations, or cash flows.
Effective September 1, 2010, the Company adopted ASU No. 2010-11 -
Derivatives and Hedging, which was issued in March 2010 and clarifies that the
transfer of credit risk that is only in the form of subordination of one
financial instrument to another is an embedded derivative feature that should
not be subject to potential bifurcation and separate accounting. Adoption of
this ASU had no material affect on the Company's financial position, results of
operations, or cash flows.
There were various other accounting standards updates recently issued, most
of which represented technical corrections to the accounting literature or were
10
applicable to specific industries, and are not expected to a have a material
impact on the Company's financial position, results of operations or cash flows.
2. Accounts Receivable
Accounts receivable consist primarily of trade receivables from oil and gas
sales and amounts due from other working interest owners which have been billed
for their proportionate share of well costs. For receivables from joint interest
owners, the Company typically has the right to withhold future revenue
disbursements to recover outstanding joint interest billings. As of May 31, 2011
and August 31, 2010, major customers (i.e. those with balances greater than 10%
of total receivables) are shown in the following table:
Accounts Receivable As of May 31, As of August 31,
from Major Customers: 2011 2010
----------------------------- ---------------- ---------------
Company A 36% 27%
Company B 30% *
Company C 21% *
* less than 10%
11
3. Property and Equipment
Capitalized costs of property and equipment at May 31, 2011 and August 31,
2010, consisted of the following:
As of As of
May 31, 2011 August 31, 2010
------------------- -----------------
Oil and gas properties, full cost method:
Unevaluated costs, not subject to
amortization:
Lease acquisition and other costs $ 5,666,728 $ 848,696
Wells in progress 2,796,165 -
--------------- ---------------
Subtotal, unevaluated costs 8,462,893 848,696
--------------- ---------------
Evaluated costs:
Producing and non-producing 33,203,817 12,992,594
Less, accumulated depletion (3,083,840) (1,149,096)
--------------- ---------------
Subtotal, evaluated costs 30,119,977 11,843,498
--------------- ---------------
Oil and gas properties, net 38,582,870 12,692,194
--------------- ---------------
Other property and equipment:
Vehicles 163,904 89,527
Leasehold improvements 32,917 32,329
Office equipment 81,176 36,821
Less, accumulated depreciation (47,326) (7,888)
--------------- ---------------
Other property and 230,671 150,789
equipment, net
--------------- ---------------
Total property and equipment, net $ 38,813,541 $ 12,842,983
=============== ===============
The capitalized costs of evaluated oil and gas properties are depleted
using the unit-of-production method based on estimated reserves and the
calculation is performed quarterly. Production volumes for the quarter are
compared to beginning of quarter estimated total reserves to calculate a
depletion rate. Depletion of oil and gas properties was $803,756 and $198,474 or
$18.70 and $13.05 per barrel of oil equivalent, for the three months ended May
31, 2011 and 2010, respectively, and $1,999,311 and $291,191, or $18.59 and
$12.99 per barrel of oil equivalent, for the three months and the nine months
ended May 31, 2011 and 2010, respectively.
Periodically, the Company reviews its unevaluated properties and its
inventory to determine if the carrying value of either asset exceeds its
estimated fair value. The reviews for the three months ended May 31, 2011 and
2010, indicated that asset carrying values were less than estimated fair values
and no reclassification to the full cost pool was required.
On a quarterly basis, the Company performs the full cost ceiling test. The
ceiling tests performed for the three months and the nine months ended May 31,
2011 and 2010, did not reveal any impairment.
On March 21, 2011, the Company completed the sale of its interest in 3,502
unproved gross mineral acres (2,383 net acres) for net cash proceeds of
12
$4,995,817. No gain was recognized on the sale and all of the proceeds were
credited to the full cost pool. The sale reduced the amortization base of the
full cost pool by approximately 12%, which was determined to be less than the
"significant change" threshold required to recognize a gain on the sale.
On May 24, 2011, the Company acquired interests in various oil and gas
assets from a related party for $19,898,181 (see Note 8).
Depreciation of other property and equipment was $17,700 and $882 for the
three months ended May 31, 2011 and 2010, respectively and $39,438 and $1,104
for the nine months ended May 31, 2011 and 2010, respectively.
4. Interest Expense
The components of interest expense recorded for the three and nine months
ended May 31, 2011 and 2010, consisted of:
Three Months Ended May 31, Nine Months Ended May 31,
-------------------------- -----------------------------
2011 2010 2011 2010
------------ ------------ ------------ -------------
Interest cost, $ 20,083 $ 355,351 $ 589,539 $ 452,006
convertible
promissory notes
Interest cost,
bank loan - 2,915 - 30,388
Accretion of debt
discount (see
Note 6) 762,136 376,871 2,664,138 622,214
Amortization of
debt issuance
costs 422,528 183,398 1,587,799 283,535
Less, interest
capitalized (253,887) (84,154) (594,530) (139,626)
------------ ------------ ------------ -------------
Interest expense,
net $ 950,860 $ 834,381 $ 4,246,945 $ 1,248,517
============ ============ ============ =============
5. Asset Retirement Obligations
Upon completion or acquisition of wells, the Company recognizes obligations
for its oil and gas operations for anticipated costs to remove and dispose of
surface equipment, plug and abandon wells, and restore sites to their original
uses. The estimated present value of such obligations are determined using
several assumptions and judgments concerning the ultimate settlement amounts,
inflation factors, credit adjusted discount rates, timing of settlement and
changes in regulations. Changes in estimates are reflected in the obligations as
they occur.
On May 24, 2011, the Company acquired certain oil and gas properties from a
related party (see Note 8). The Company evaluated the wells and estimated the
present value of the future costs to plug and abandon the wells. Accordingly,
the Company recognized an additional asset retirement obligation of $165,694.
13
The following table summarizes the change in asset retirement obligations
for the nine months ended May 31, 2011:
Asset retirement obligations, August 31, 2010 $ 254,648
Liabilities incurred 76,663
Liabilities associated with acquired
properties 165,694
Liabilities settled -
Accretion 24,076
Revisions in estimated liabilities -
--------
Asset retirement obligations, May 31, 2011 $ 521,081
========
6. Convertible Promissory Notes and Derivative Conversion Liability
During the fiscal year ended August 31, 2010, the Company received gross
proceeds of $18,000,000 from the sale of 180 Units at $100,000 per Unit. Each
Unit consisted of one convertible promissory note ("Note") in the principal
amount of $100,000 and 50,000 Series C warrants (collectively referenced as a
("Unit"). The Notes bore interest at 8% per year, payable quarterly, and had a
stated maturity date of December 31, 2012. Each Series C warrant entitles the
holder to purchase one share of common stock at a price of $6.00 per share and
expires on December 31, 2014.
The Notes were considered hybrid debt instruments containing a detachable
warrant and a conversion feature under which the proceeds of the offering are
allocated to the detachable warrants and the conversion feature based on their
fair values. The Series C warrants were determined to be a component of equity,
and the fair value of the warrants was recorded as additional paid in capital.
Since the warrants were recorded as a component of equity, the fair value of
$1,760,048 was estimated at inception and was not re-measured in future periods.
The Notes contained a conversion feature, at an initial conversion price of
$1.60 that was subject to adjustment under certain circumstances, which allowed
the Note holders to convert the principal balance into a maximum of 11,250,000
common shares, plus conversion of accrued and unpaid interest into common
shares, also at $1.60 per share. The conversion feature was determined to be an
embedded derivative requiring the conversion option to be separated from the
host contract and measured at its fair value. At issuance, the estimated fair
value of the conversion feature was $3,455,809 and was recorded as derivative
conversion liability. The conversion option was re-measured and recorded at fair
value each reporting period, with changes in the fair value reflected in other
income (expense) in the statements of operations.
Allocation of value to the components created a debt discount of
$5,215,857, which was accreted over the life of the Notes using the effective
interest method. The effective interest rate on the Notes was 19%. The Company
recorded accretion expense of $762,136 and $2,664,138 during the three months
and nine months ended May 31, 2011, respectively. Accretion expense includes a
component for the conversion of Notes into common stock, which was $762,136 and
$2,391,245 for the three months and nine months ended May 31, 2011,
respectively.
In connection with the sale of the Units, the Company paid fees and
expenses of $1,348,977 and issued 1,125,000 Series D warrants to the placement
agent. The Series D warrants have an exercise price of $1.60 and an expiration
date of December 31, 2014. The warrants were valued at $692,478 using the
Black-Scholes-Merton option pricing model. The Company recorded $2,041,455 of
debt issuance costs, which is being amortized over the expected term of the
Notes. Amortization expense is adjusted to reflect early conversions.
Amortization expense of $422,528 and $1,587,799 was recorded during the three
months and nine months ended May 31, 2011, respectively. During the nine months
ended May 31, 2011, holders of 345,094 warrants exercised their warrants.
14
All of the noteholders elected to convert their Notes into common stock
prior to the Note maturity date. As of May 31, 2011, Notes with a face amount of
$18,000,000 had been converted into 11,250,000 shares of the Company's common
stock. At the time the Notes were converted, the estimated fair value of the
derivative conversion liability attributable to the converted notes totaled
$18,646,413, which was reclassified from derivative conversion liability to
additional paid in capital. Similarly, the unamortized debt discount
attributable to the converted notes totaled $3,120,293. The unamortized debt
discount of $2,067,376 applicable to the conversion option was charged to
accretion of debt discount and the unamortized debt discount of $1,052,917
applicable to the warrants was reclassified from debt discount to additional
paid-in capital.
The fair value of the derivative conversion liability was adjusted each
quarter to reflect the change in value. The estimated fair value of the
derivative conversion liability as of May 31, 2011, was nil, and the change in
fair value of derivative conversion liability was $10,229,229 during the nine
months ended May 31, 2011.
7. Fair Value Measurements
Assets and liabilities are measured at fair value on a recurring basis for
disclosure or. A fair value hierarchy was established that prioritizes the
inputs used to measure fair value. The hierarchy gives the highest priority to
unadjusted quoted prices in active markets for identical assets or liabilities
(Level 1 measurements) and the lowest priority to unobservable inputs (Level 3
measurements).
Level 1 - Quoted prices are available in active markets for identical
assets or liabilities as of the reporting date. Active markets are those in
which transactions for the asset or liability occur in sufficient frequency and
volume to provide pricing information on an ongoing basis. Level 1 primarily
consists of financial instruments such as exchange-traded derivatives, listed
securities and country-regionplaceUS government treasury securities.
Level 2 - Pricing inputs are other than quoted prices in active markets
included in Level 1, which are either directly or indirectly observable as of
the reporting date. Level 2 includes those financial instruments that are valued
using models or other valuation methodologies, where substantially all of these
assumptions are observable in the marketplace throughout the full term of the
instrument, which can be derived from observable data or are supported by
observable levels at which transactions are executed in the marketplace.
Level 3 - Pricing inputs include significant inputs that are generally less
observable than objective sources. These inputs may be used with internally
developed methodologies that result in management's best estimate of fair value.
Level 3 includes those financial instruments that are valued using models or
other valuation methodologies, where substantial assumptions are not observable
in the marketplace throughout the full term of the instrument, cannot be derived
from observable data or are not supported by observable levels at which
transactions are executed in the marketplace. At each balance sheet date, the
Company performs an analysis of all applicable instruments and includes in Level
3 all of those for which fair value is based on significant unobservable inputs.
A substantial portion of the Company's financial instruments consisted of
cash and equivalents, accounts receivable, accounts payable, and accrued
15
liabilities. Due to the short original maturities and high liquidity of cash and
equivalents, accounts receivable, accounts payable, and accrued liabilities,
carrying amounts approximated fair values.
As permitted under fair value accounting guidance, the outstanding
principal balance of the Company's convertible promissory notes were not
restated to fair value in the Company's financial statements for each reporting
period. It is estimated that the fair value of the convertible promissory notes
approximated face value because of the short term to maturity and the Company's
option to prepay the debt at any time after January 1, 2011.
During the fiscal year ended August 31, 2010, the Company issued Units that
included convertible promissory notes, as described in Note 6. These convertible
promissory notes contained an embedded conversion option which was required to
be separated and reported as a derivative conversion liability at fair value
The Company utilized the Monte Carlo Simulation ("MCS") model to value the
derivative conversion liability. Inputs to this valuation technique include the
Company's quoted stock price and published interest rates and credit spreads.
Assumptions used for valuations performed during the quarter ended May 31, 2011,
included: stock price ranging from $3.80 to $4.70 per share, an expected term of
1.8 years, volatility of 45.7%, which was derived from the expected volatility
of comparable companies, dividend yield of 0%, and a discount rate of 6.7%. All
of the significant inputs were observable, either directly or indirectly;
therefore, the Company's derivative conversion liability was included within the
Level 2 fair value hierarchy.
The following table sets forth, by level within the fair value hierarchy,
the Company's financial assets and financial liabilities as of May 31, 2011 and
August 31, 2010 that were measured at fair value on a recurring basis.
As of May 31, 2011 Total Level 1 Level 2 Level 3
----------------------- ------------ ------------ ------------ -----------
Derivative Conversion
Liability $ - $ - $ - $ -
As of August 31, 2010 Total Level 1 Level 2 Level 3
----------------------- ------------ ------------ ------------ -----------
Derivative Conversion
Liability $9,325,117 $ - $ 9,325,117 $ -
The Company also measures all nonfinancial assets and liabilities that are
not recognized or disclosed on a recurring basis. As discussed in Note 5, asset
retirement obligations and costs totaling $521,081 and $254,648 have been
accounted for as long-term liabilities and included in the oil and gas
properties, full cost pool at May 31, 2011, and August 31, 2010, respectively.
The Level 3 inputs used to measure the estimated fair value of the obligations
include assumptions and judgments about the ultimate settlement amounts,
inflation factors, credit adjusted discount rates, timing of settlement, and
changes in regulations.
8. Related Party Transactions and Commitments
Two of the Company's executive officers control three entities that have
entered into agreements to provide various goods, services, and facilities to
16
the Company. The entities are Petroleum Management, LLC ("PM"), Petroleum
Exploration and Management, LLC ("PEM"), and HS Land & Cattle, LLC ("HSLC").
Acquisition of Oil and Gas Assets from PEM: On May 24, 2011, the Company
acquired operating (working interest) oil and gas assets owned by PEM, including
interest in 88 oil and gas wells and mineral leases covering approximately 6,968
gross acres. All of the properties acquired from PEM are located in the
Wattenberg Field of the D-J Basin.
The nominal purchase price was $19,000,000, consisting of a cash payment of
$10,000,000, the issuance of 1,381,818 restricted shares of common stock valued
at $3,800,000, and a promissory note in the principal amount of $5,200,000. The
promissory note bears interest at an annual rate of 5.25%, is due on January 2,
2012, and is secured by the properties purchased by the Company. No liabilities
of PEM were assumed in the transaction. Prior to consummating the transaction,
the Company's acquisition committee, consisting of disinterested directors,
reviewed and approved the transaction, and the Company shareholders, not
including Mr. Holloway and Mr. Scaff, approved the transaction.
For accounting purposes, the value of the transaction was determined to be
$19,898,191, all of which were allocated to oil and gas properties. The
transaction is subject to customary post-closing adjustments for events
occurring between January 1, 2011 and May 24, 2011. No gain or loss was recorded
on the transaction. The Company incurred additional general and administrative
costs of approximately $150,000 related to the transaction, all of which were
charged to operating expenses during the nine months ended May 31, 2011.
The following unaudited pro forma financial information presents the
combined results of the Company and the properties acquired from PEM as though
the acquisition had been consummated as of September 1, 2009, the beginning of
the Company's fiscal year, for the two periods indicated below. Since the
Company and PEM do not share a common fiscal year, the pro-forma information
presents nine months of operating results which ended on May 31, 2011 and 2010
for the Company and on March 31, 2011 and 2010 for PEM.
2011 2010
---------------- ----------------
Operating revenues $ 9,345,171 $ 2,631,514
Net loss $ (12,022,017) $ (4,394,288)
Basic and Diluted loss per share $ (0.53) $ (0.37)
The pro forma information does not necessarily reflect the actual results
of operations had the acquisition been consummated at the beginning of the
period indicated nor is it necessarily indicative of future operating results.
The pro forma information does not give effect to any potential revenue
enhancements or operating efficiencies that could result from the acquisition.
Other Related Party Transactions: Effective June 11, 2008, the Company
entered into an Administrative Services Agreement with PM. The Company paid
$10,000 per month for leasing office space and an equipment yard located in
CityplacePlatteville, StateColorado, and paid $10,000 per month for office
support services including secretarial service, word processing, communication
services, office equipment and supplies. The Company paid $180,000 under this
agreement for the nine months ended May 31, 2010. Effective June 30, 2010, the
Company terminated the agreement.
17
Effective July 1, 2010, the Company entered into a lease with HSLC for
office space and an equipment yard located in Platteville, Colorado. The lease
requires monthly payments of $10,000 and terminates on June 30, 2011. The
Company paid $90,000 under this agreement for the nine months ended May 31,
2011.
On October 1, 2010, the Company acquired certain oil and gas properties
located in the Wattenberg field, part of the PlaceNameplaceD-J PlaceTypeBasin,
from PM and PEM for $1,017,435. The oil and gas properties consist of interest
in 6 producing oil and gas wells and 2 shut in oil wells as well as 15 drill
sites and miscellaneous equipment. The Company acquired a 100% working interest
and 80% net revenue interest in the properties.
In addition to the transactions described above, the Company undertook
various activities with PM and PEM that are related to the development and
operation of oil and gas properties. The Company occasionally purchases services
and certain oil and gas equipment, such as tubular goods and surface equipment,
from PM. The Company reimburses PM for the original cost of the services and
equipment. Prior to the asset acquisition transaction that closed on May 24,
2011, PEM was a joint working interest owner of certain wells operated by the
Company. PEM was charged for its pro-rata share of costs and expenses incurred
on its behalf by the Company, and similarly PEM was credited for its pro-rata
share of revenues collected on its behalf. The following table summarizes the
transactions with PM and PEM during the nine months ended May 31, 2011:
Balance due to PM, August 31, 2010 $ 538,698
Purchases from PM 2,290
Payments to PM (540,988)
-------------
Balance due to PM, May 31, 2011 $ -
=============
Joint interest billing balance due from PEM,
August 31, 2010 867,835
Joint interest costs billed to PEM 376,339
Amounts collected from PEM (1,213,783)
-------------
Joint interest billing due from PEM, May 31, 2011 $ 30,391
=============
Balance due to PEM for revenues, August 31, 2010 $ 15,971
Revenues collected on behalf of PEM 607,477
Payments to PEM for revenues (623,448)
-------------
Balance due to PEM for revenues, May 31, 2011 $ -
=============
9. Shareholders' Equity
Preferred Stock: The Company has authorized 10,000,000 shares of preferred
stock with a par value of $0.01 per share. These shares may be issued in series
with such rights and preferences as may be determined by the Board of Directors.
Since inception, the Company has not issued any preferred shares.
Common Stock: The Company has authorized 100,000,000 shares of common stock
with a par value of $0.001 per share.
Issued and Outstanding: The total issued and outstanding common stock at
May 31, 2011, is 35,408,632 common shares, representing an increase from August
31, 2010, of 21,897,651 shares, as follows:
18
On January 11, 2011, the Company completed the sale of 9,000,000 shares of
common stock to private investors. The shares were sold at a price of $2.00 per
share. Net proceeds to the Company from the sale of the shares were $16,690,721
after deductions for the placement agents' commissions and expenses of the
offering.
On May 24, 2011, the Company acquired certain assets from PEM (see Note 8).
As part of the consideration, the Company issued 1,381,818 shares of restricted
common stock valued at $4,698,181.
During the nine months ended May 31, 2011, the Company issued 1,125,699
shares of restricted common stock in consideration for the assignment of oil and
gas leases covering approximately 69,274 net mineral acres valued at $2,741,917,
based upon the fair value of stock at the time the lease was finalized.
During the nine months ended May 31, 2011, the Company issued 9,942,500
common shares pursuant to the conversion of notes in the principal amount of
$15,908,000 at the contractual conversion price of $1.60 per share. In addition,
the Company issued 36,876 common shares pursuant to the conversion of accrued
interest of $58,997.
During the nine months ended May 31, 2011, the Company issued 190,000
restricted common shares as compensation for services. The common shares were
valued at $593,600 based upon the quoted market price of the Company's common
stock on the effective dates of the grants. During the nine months ended May 31,
2011, compensation expense of $430,000 was recorded as general and
administrative expense and stock with a value of $163,600 was recorded as a
component of lease acquisition costs.
During the nine months ended May 31, 2011, the Company issued common shares
pursuant to the exercise of Series D warrants. As the Series D warrants contain
a cashless exercise provision, warrant holders exercised 345,094 warrants in
exchange for 220,758 shares of common stock, and the Company received no cash
proceeds in the transaction.
There are various warrants outstanding to purchase 14,941,372 shares of
common stock. The following table summarizes information about the Company's
issued and outstanding common stock warrants as of May 31, 2011:
Remaining
Contractual
Number of Life (in Expiration
Description Shares years) Date Strike Proceeds
------------------- --------------- ----------- --------- ----------------
Series A at $6.00 4,098,000 1.6 12/31/2012 $ 24,588,000
Series B at $10.00 1,000,000 1.6 12/31/2012 10,000,000
Series C at $6.00 9,000,000 3.6 12/31/2014 54,000,000
Series D at $1.60 779,906 3.6 12/31/2014 1,247,850
Placement Agent
Warrants at $1.80 63,466 1.6 12/31/2012 114,239
--------------- ----------------
14,941,372 2.9 $ 89,950,089
=============== ================
19
The following table summarizes activity for common stock warrants for the
nine month period ended May 31, 2011:
Number of Weighted Average
Warrants Exercise Price
------------- -----------------
Outstanding, August 31, 2010 15,286,466 $ 5.92
Granted - -
Exercised (345,094) 1.60
-------------
Outstanding, May 31, 2011 14,941,372 $ 6.02
=============
10. Stock-Based Compensation
The Company recognizes stock based compensation expenses for the grant of
stock options and for restricted stock awards based upon the estimated fair
value of the financial instruments at the date of the grant or award. The
expense is pro-rated over the term of service required under the terms of the
instrument. The following table summarizes the expense recorded during the
interim periods of 2011 and 2010:
Three Months Ended Nine Months Ended May
May 31, 31,
----------------------- ------------------------
2011 2010 2011 2010
----------- --------- ----------- ----------
Stock options $ 82,547 $ 6,962 $ 133,518 $ 17,790
Restricted stock grants 220,000 - 430,000 -
----------- --------- ----------- ----------
Total stock based
compensation $ 302,547 $ 6,962 $ 563,518 $ 17,790
=========== ========= =========== ==========
The estimated unrecognized compensation cost from unvested stock options as
of May 31, 2011, was approximately $764,000, and will be recognized as the
options vest. Substantially all of the options vest during 2011, 2010, and 2013;
and all options are fully vested by April 2016.
During the nine months ended May 31, 2011, the Company recognized
compensation expense for 150,000 restricted common shares issued in exchange for
services by advisors and employees. The common shares were valued at $430,000
based upon the quoted market price of the Company's common stock on the
effective dates of the grants. The entire value was recorded as general and
administrative expense during the nine months ended May 31, 2011.
During the nine months ended May 31, 2011, the Company granted
non-qualified options to purchase 250,000 shares of common stock to its
employees. All of the options have a contract term of ten years and an exercise
price equal to the closing price on the date of the grant. These options vest
over 3 to 5 years, pursuant to the terms of each grant. The options were
determined to have a fair value of $605,591 using the assumptions outlined in
the table below.
20
The assumptions used in valuing stock options issued during the nine months
ended May 31, 2011 were as follows:
Expected term (in years) 6.00 - 6.50
Stock fair value $2.40 - $4.40
Expected volatility 53.18-% - 66.026%
Risk-free rate 1.615% - 2.625%
Expected dividend yield 0.00%
The following table summarizes activity for stock options for the period
from August 31, 2010 to May 31, 2011:
Weighted
Average
Number of Exercise
Shares Price
----------- -------------
Outstanding, August 31, 2010 4,220,000 $ 5.36
Granted 250,000 $ 4.00
Exercised - -
-----------
Outstanding, May 31, 2011 4,470,000 $ 5.28
===========
The following table summarizes information about issued and outstanding
stock options as of May 31, 2011:
Remaining Weighted
Contractual Average Aggregate
Exercise Number Life Exercise Number Intrinsic
Price of Shares (in years) Price Exercisable Value
-------------- ---------- ----------- --------- ---------- ----------
$ 1.00 2,000,000 2.0 $ 1.00 2,000,000 $4,800,000
$2.40 to $4.40 470,000 9.1 $ 3.40 35,000 $ 198,000
$ 10.00 2,000,000 2.0 $ 10.00 2,000,000 -
---------- ---------- ----------
4,470,000 2.8 $ 5.28 4,035,000 $4,998,000
========== ========== ==========
21
11. Supplemental Schedule of Information to the Statements of Cash Flows
The following table supplements the cash flow information presented in the
financial statements for the nine months ended May 31, 2011 and 2010:
Nine Months Ended May 31,
------------------------------
2011 2010
------------- --------------
Supplemental cash flow information:
Interest paid $ 746,651 $ 255,936
Income taxes paid - -
Non-cash investing and financing
activities:
Conversion of promissory notes into
common stock $15,908,000 $ -
Reclassification of derivative
liability to additional paid in
capital 18,646,413 -
Properties acquired in exchange for
common stock 7,603,698 -
Properties acquired in exchange for
note payable 5,200,000 -
Accrued capital expenditures 2,242,117 1,526,113
Asset retirement costs and
obligations incurred 242,357 182,771
Placement agent warrants issued - 692,478
12. Subsequent Events
On June 8, 2011, the Company entered into a revolving line of credit with
Bank of Choice , which allows the Company to borrow up to $7 million. Amounts
borrowed under the line of credit are secured by the Company's accounts
receivable, equipment, inventory and fixtures, as well as 64 oil and gas wells.
Principal amounts outstanding under the Credit Facility bear interest, payable
monthly, at the Wall Street Journal Prime Rate plus 2%, subject to a minimum
interest rate of 5.5%. The entire unpaid outstanding balance of principal and
interest is due on June 3, 2012.
On June 23, 2011, the Company issued 159,485 shares of common stock for
mineral interests comprising 18,136 gross acres (15,862 net acres) in the D-J
Basin.
22
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operation
Introduction
The following discussion and analysis was prepared to supplement
information contained in the accompanying financial statements and is intended
to provide certain details regarding our financial condition as of May 31, 2011,
and the results of our operations for the three months and nine months ended May
31, 2011 and 2010. It should be read in conjunction with the unaudited financial
statements and notes thereto contained in this report as well as the audited
financial statements included in the Form 10-K for the fiscal year ended August
31, 2010.
Overview
We are an independent oil and gas operator in StateColorado and are focused
on the acquisition, development, exploitation, exploration and production of oil
and natural gas properties primarily located in the Wattenberg field in the
Denver-Julesburg ("D-J") Basin in northeast placeStateColorado. We commenced
active operations in September 2008 and have grown significantly during the last
two years. As of August 31, 2009, we had two productive wells (net wells of
0.6). As of August 31, 2010, we had twenty-four productive wells and fourteen
wells in the process of completion (net wells of 19). As of May 31, 2011, we had
124 gross wells, including 114 producing wells, 8 wells in progress, and 2 shut
in wells (net wells of 89).
As of May 31, 2011, we had estimated proved reserves of 1,721,647 Bbls of
oil and 13,586,923 Mcf of gas, including reserves acquired in the transaction
with PEM.
We currently have approximately 139,000 gross acres and 123,000 net acres
under lease, which include certain lease transactions which occurred subsequent
to May 31, 2011.
Our growth plans for 2011 and 2012 include additional drilling activities,
acquisition of existing wells, and recompletion of wells that provide good
prospects for improved hydraulic stimulation techniques. As cash flow from
operations is not sufficient to fund our growth plans, we are required to seek
additional financing. The completion of our recent financing for gross proceeds
of $18 million and the sale of mineral interests for $5.2 million will satisfy
most of our capital needs for fiscal year 2011. However, we expect that future
financing will be required, especially as we move forward into our 2012 drilling
program. Ultimately, implementation of our growth plans will be dependent upon
the amount of financing we are able to obtain.
Recent Developments
On May 24, 2011, we acquired interests in 88 oil and gas wells and oil and
gas leases covering approximately 6,968 gross acres from Petroleum Exploration
and Management, LLC ("PEM"), a company owned by Ed Holloway and William E.
Scaff, Jr., two of our officers. The total purchase price, which consisted of
$10 million in cash, 1,381,818 restricted shares of our common stock and a
promissory note in the principal amount of $5.2 million, totaled $19 million,
and is subject to customary post closing adjustments for transactions that
occurred between January 1, 2011 and May 24, 2011. All of the properties
acquired from PEM are located in the Wattenberg Field of the D-J Basin.
On March 21, 2011, we agreed to issue 1,125,699 shares of restricted common
stock for mineral interest comprising 78,805 gross acres (69,274 net acres) in
the D-J Basin.
23
On February 17, 2011, we acquired 5,724 acres in Larimer, Park, and Yuma
counties, Colorado for approximately $265,000.
In December 2010, we acquired four producing wells in an area that is
adjacent to one of our leases. We paid cash consideration of $400,000 and
assigned the lease rights on 340 net acres in northern PlaceNameplaceWeld
PlaceTypeCounty to the seller.
In a transaction which closed on March 21, 2011, we sold our mineral
interest in 3,502 gross acres (2,383 net acres) for cash proceeds of $5,244,517.
Effective March 31, 2011, all of the holders of Convertible Promissory
Notes not previously converted elected to convert the principal balance into
shares of common stock. As of March 31, 2011, the entire original principal
balance of $18 million has been converted into 11,250,000 shares of common
stock.
On January 11, 2011, we closed on the sale of 9 million shares of common
stock to private investors. The shares were sold at a price of $2.00 per share.
Net proceeds from the sale of the shares were approximately $16.7 million after
deductions for the sales commissions and expenses.
On June 8, 2011, we entered into a revolving line of credit with Bank of
Choice, which allows us to borrow up to $7 million. Amounts borrowed under the
line of credit are secured by certain of our assets as well as 64 oil and gas
wells in which we have a working interest. Principal amounts outstanding under
the Credit Facility bear interest, payable monthly, at the Wall Street Journal
Prime Rate plus 2%, subject to a minimum interest rate of 5.5%.
On June 23, 2011, we issued 159,485 shares of common stock in exchange for
mineral interest in 18,136 gross acres (15,862 net acres).
RESULTS OF OPERATIONS
For the three months ended May 31, 2011, compared to the three months ended May
31, 2010
Material changes of certain items in our statements of operations included
in our financial statements for the comparative periods are discussed below.
For the three months ended May 31, 2011, we reported a net loss of
$291,612, or $0.01 per share, compared to a net loss of $3,649,812, or $0.30 per
share, for the three months ended May 31, 2010. The comparison between the two
years was primarily influenced by increasing revenues and expenses associated
with the 36 wells completed during the 2010 drilling program which provided
operating income of $547,272 in 2011 compared to an operating loss of $51,094 in
2010. During both years, we incurred significant non-cash expenses for the
change in value of the derivative conversion liability and the amortization of
loan fee and debt discount.
24
Oil and Gas Production and Revenues - For the three months ended May 31,
2011, we recorded total oil and gas revenues of $2,921,910 compared to $607,253
for the three months ended May 31, 2010, as summarized in the following table:
Three Months Ended May 31,
-------------------------
2011 2010
----------- ---------
Production:
Oil (Bbls) 23,371 4,679
Gas (Mcf) 117,647 54,024
Total production in
BOE 42,979 13,683
Revenues:
Oil $ 2,293,945 $ 342,594
Gas 627,965 264,659
----------- ---------
Total $ 2,921,910 $ 607,253
=========== =========
Average sales price:
Oil (Bbls) $ 98.15 $ 73.22
Gas (Mcf) $ 5.34 $ 4.90
"Bbl" refers to one stock tank barrel, or 42 placecountry-regionU.S.
gallons liquid volume in reference to crude oil or other liquid hydrocarbons.
"Mcf" refers to one thousand cubic feet. A BOE (i.e. barrel of oil equivalent)
combines Bbls of oil and Mcf of gas by converting each six Mcf of gas to one Bbl
of oil.
Net oil and gas production for the three months ended May 31, 2011, was
42,979 BOE, or 467 BOE per day. The significant increase in production from the
comparable period in the prior year reflects the additional wells that began
production over the past twelve months. The change in average sales price is a
function of worldwide commodity prices, which have increased the realized sales
price of oil by 34% and increased the realized sales price of natural gas by 9%.
We do not currently engage in any commodity hedging activities, although we
may do so in the future.
Service Revenue- For the three months ended May 31, 2011, we recorded
revenue generated from the management of wells owned by third parties of
$184,426.
25
Lease Operating Expenses - As summarized in the following table, our lease
expenses include the direct operating costs of producing oil and natural gas and
taxes on production and properties:
Three Months Ended May 31,
----------------------------
2011 2010
------------- ------------
Production costs $ 86,521 $ 30,480
Severance and ad valorem taxes 290,663 76,023
Workover costs 291,499 -
------------- ------------
Total lease operating expenses $ 668,683 $ 106,503
============= ============
Per BOE:
Production costs $ 2.01 $ 2.23
Severance and ad valorem taxes 6.76 5.56
Workover costs 6.78 -
------------- ------------
Total per BOE $ 15.55 $ 7.79
============= ============
Production costs tend to increase or decrease primarily in relation to the
number of wells in production, and, to a lesser extent, on fluctuation in oil
field service costs and changes in the production mix of crude oil and natural
gas. Production costs may vary substantially among wells depending on the
methods of recovery employed and other factors, such as workover operations,
maintenance and repair, labor and utilities. Taxes tend to increase or decrease
primarily based on the value of oil and gas sold. As a percent of oil and gas
revenues, lease operating costs were 23% in the three months ended May 31, 2011,
and 18% in the respective period in 2010.
Depreciation, Depletion, and Amortization ("DDA") - DDA expense is
summarized in the following table:
Three Months Ended May 31,
--------------------------
2011 2010
------------- -----------
Depletion $ 803,756 $ 198,474
Depreciation and
amortization 17,700 882
Accretion of asset
retirement
obligations 9,183 1,534
------------- -----------
Total DDA $ 830,639 $ 200,890
============= ===========
Depletion per BOE $ 18.70 $ 14.51
The determination of depreciation, depletion and amortization expense is
highly dependent on the estimates of the proved oil and natural gas reserves.
The capitalized costs of evaluated oil and gas properties are depleted using the
units-of-production method based on estimated reserves. Production volumes for
the quarter are compared to beginning of quarter estimated total reserves to
calculate a depletion rate. For the three months ended May 31, 2011, production
volumes of 42,979 BOE and estimated net proved reserves of 1,366,340 BOE were
the basis of the depletion rate calculation. For the three months ended May 31,
2010, production volumes of 13,683 BOE and estimated net proved reserves of
261,342 BOE were the basis of the depletion rate calculation.
26
General and Administrative - The following table summarizes the components
of general and administration expenses:
Three Months Ended May 31,
------------------------------------
2011 2010
----------------- ----------------
Stock based compensation $ 292,547 $ 6,962
Other general and
administrative 813,869 343,992
Capitalized general and
administrative (46,674) -
----------------- ----------------
Totals $ 1,059,742 $ 350,954
================= ================
The stock-based compensation recorded in general and administrative
expenses related to the issuance of stock grants and stock options to officers,
directors, consultants, and employees. The expense recorded for stock grants is
based on the market value of the common stock on the date of grant. When stock
options are issued we estimate their fair value using the Black-Scholes-Merton
option-pricing model. The estimated fair value is recorded as a non-cash expense
on a pro-rata basis over the vesting period.
Other general and administrative expenses, which include salaries,
benefits, professional fees, and other corporate overhead, increased
approximately $460,000 during the current three-month period over the comparable
quarter in the prior year due to the growth in our business. The following items
contributed to the increase: salaries and benefits increased by $380,000 as we
increased the number of employees from seven to ten and we incurred additional
professional fees of approximately $150,000 related to the acquisition of assets
from PEM. The increased expenses in these areas were somewhat offset by a
$30,000 decrease in administrative services purchased from a related party.
Certain general and administrative expenses are directly related to the
acquisition and development of oil and gas properties. Those costs were
reclassified from general and administrative expense into capitalized costs in
the full cost pool.
Other Income (Expense) - During the three months ended May 31, 2011, we
recognized $838,884 in other expense compared to $3,598,718 during the
comparable period in 2010. The significant change between the periods was driven
by the change in fair value of a derivative conversion liability related to $18
million of convertible promissory notes.
The notes contained a conversion feature which was considered an embedded
derivative and recorded as a liability at its estimated fair value, when
marked-to-market, over time is reflected as a non-cash item in the statement of
operations. By May 31, 2011, all of the notes had been converted, thereby
eliminating the derivative conversion liability.
In addition, the line item of interest expense, net, contains several
components related to the 8% convertible promissory notes. In addition to the 8%
coupon rate, we recorded amortization of debt issue costs of $422,528 and
accretion of debt discount of $762,136 during the three months ended May 31,
2011. During the comparable period ended May 31, 2010, amortization of debt
issue costs was $183,398 and accretion of debt discount was $376,871.
Income Taxes - Our effective tax rate is currently zero. We have reported a
net loss every year since inception and, for tax purposes, have a net operating
loss carry forward ("NOL") of approximately $10 million. The NOL is available to
offset future taxable income, if any. At such time, if ever, that we are able to
demonstrate that it is more likely than not that we will be able to realize the
27
benefits of our tax assets, we will recognize the benefits in our financial
statements. If operational results for the remainder of the fiscal year continue
to improve, we may recognize the benefits of certain tax assets during the
latter periods of the year.
For the nine months ended May 31, 2011, compared to the nine months ended May
31, 2010
Material changes of certain items in our statements of operations included
in our financial statements for the comparative periods are discussed below.
For the nine months ended May 31, 2011, we reported a net loss of
$13,189,974, or $0.58 per share, compared to a net loss of $4,455,142, or $0.37
per share, for the nine months ended May 31, 2010. The comparison between the
two years was primarily influenced by increasing revenues and expenses
associated with the 36 wells completed during the 2010 drilling program which
provided operating income of $1,244,525 in 2011 compared to an operating loss of
$445,974 in 2010. During both years, we incurred significant non-cash expenses
for the change in value of the derivative conversion liability and the
amortization of loan fee and debt discount.
Oil and Gas Production and Revenues - For the nine months ended May 31,
2011, we recorded total oil and gas revenues of $6,399,193 compared to $995,764
for the nine months ended May 31, 2010, as summarized in the following table:
Nine Months Ended May 31,
-------------------------
2011 2010
----------- ----------
Production:
Oil (Bbls) 59,749 8,327
Gas (Mcf) 297,668 75,340
Total production in
BOE 109,360 20,884
Revenues:
Oil $ 5,079,629 $ 587,190
Gas 1,319,564 408,574
----------- ----------
Total $ 6,399,193 $ 995,764
=========== ==========
Average sales price:
Oil (Bbls) $ 85.02 $ 70.52
Gas (Mcf) $ 4.43 $ 5.42
"Bbl" refers to one stock tank barrel, or 42 placecountry-regionU.S.
gallons liquid volume in reference to crude oil or other liquid hydrocarbons.
"Mcf" refers to one thousand cubic feet. A BOE (i.e. barrel of oil equivalent)
combines Bbls of oil and Mcf of gas by converting each six Mcf of gas to one Bbl
of oil.
Net oil and gas production for the nine months ended May 31, 2011, was
109,360 BOE, or 401 BOE per day. The significant increase in production from the
comparable period in the prior year reflects the additional wells that began
production over the past twelve months. The change in average sales price is a
function of worldwide commodity prices, which have increased the realized sales
price of oil by 21% and decreased the realized sales price of natural gas by
18.%.
We do not currently engage in any commodity hedging activities, although we
may do so in the future.
28
Service Revenue- For the nine months ended May 31, 2011, we recorded
revenue generated from the management of wells owned by third parties of
$211,715.
Lease Operating Expenses - As summarized in the following table, our lease
expenses include the direct operating costs of producing oil and natural gas and
taxes on production and properties:
Nine Months ended May 31,
----------------------------
2011 2010
------------- ------------
Production costs $ 203,868 $ 46,399
Severance and ad valorem taxes 636,470 115,146
Workover costs 291,499 -
------------- ------------
Total lease operating expenses $ 1,131,837 $ 161,545
============= ============
Per BOE:
Production costs $ 1.86 $ 2.22
Severance and ad valorem taxes 5.82 5.51
Workover costs 2.67 -
------------- ------------
Total per BOE $ 10.35 $ 7.73
============= ============
Production costs tend to increase or decrease primarily in relation to the
number of wells in production, and, to a lesser extent, on fluctuation in oil
field service costs and changes in the production mix of crude oil and natural
gas. Production costs may vary substantially among wells depending on the
methods of recovery employed and other factors, such as workover operations,
maintenance and repair, labor and utilities. Taxes tend to increase or decrease
primarily based on the value of oil and gas sold. As a percent of revenues,
lease operating costs were 18% in the nine months ended May 31, 2011, and 16% in
the respective period in 2010.
Depreciation, Depletion, and Amortization ("DDA") - DDA expense is
summarized in the following table:
Nine Months ended May 31,
-----------------------------------
2011 2010
--------------- -----------------
Depletion $ 1,999,311 $ 291,191
Depreciation and
amortization 39,438 1,104
Accretion of asset
retirement obligations 24,076 1,534
--------------- -----------------
Total DDA $ 2,062,825 $ 293,829
=============== =================
Depletion per BOE $ 18.28 $ 13.94
The determination of depreciation, depletion and amortization expense is
highly dependent on the estimates of the proved oil and natural gas reserves.
The capitalized costs of evaluated oil and gas properties are depleted using the
units-of-production method based on estimated reserves. Production volumes for
the quarter are compared to beginning of quarter estimated total reserves to
calculate a depletion rate. For the nine months ended May 31, 2011, production
volumes of 109,360 BOE and estimated net proved reserves of 1,430,896 BOE were
29
the basis of the depletion rate calculation. For the nine months ended May 31,
2010, production volumes of 20,884 BOE and estimated net proved reserves of
268,544 BOE were the basis of the depletion rate calculation.
General and Administrative - The following table summarizes the components
of general and administration expenses:
Nine Months ended May 31,
------------------------------------
2011 2010
----------------- ----------------
Stock based compensation $ 553,518 $ 17,790
Other general and
administrative 1,772,824 968,574
Capitalized general and
administrative (154,621) -
----------------- ----------------
Totals $ 2,171,721 $ 986,364
================= ================
The stock-based compensation recorded in general and administrative
expenses related to the issuance of stock grants and stock options to officers,
directors, consultants, and employees. The expense recorded for stock grants is
based on the market value of the common stock on the date of grant. When stock
options are issued we estimate their fair value using the Black-Scholes-Merton
option-pricing model. The estimated fair value is recorded as a non-cash expense
on a pro-rata basis over the vesting period.
Other general and administrative expenses, which include salaries,
benefits, professional fees, and other corporate overhead, increased
approximately $794,000 during the current nine-month period over the comparable
period in the prior year due to the growth in our business. The following items
contributed to the increase: salaries and benefits increased by $630,000 as we
increased the number of employees from three to ten, reservoir engineering fees
increased by approximately $30,000, and we incurred additional professional fees
of approximately $150,000 related to the acquisition of assets from PEM. The
increased expenses in these areas were somewhat offset by a $90,000 decrease in
administrative services purchased from a related party.
Certain general and administrative expenses are directly related to the
acquisition and development of oil and gas properties. Those costs were
reclassified from general and administrative expense into capitalized costs in
the full cost pool.
Other Income (Expense) - During the nine months ended May 31, 2011, we
recognized $14,434,499 in other expenses compared to $4,009,168 during the
comparable period in 2010. The amounts included in other income (expense) are
primarily related to components of the 8% convertible promissory notes.. The
notes, contained a conversion feature which was considered an embedded
derivative and recorded as a liability at its estimated fair value, when
marked-to-market, over time is reflected as a non-cash item in the statement of
operations. The change in fair value increased by $7,464,341, from $2,764,888
during the nine months ended May 31, 2010, to $10,229,229 during the nine months
ended May 31, 2011
In addition, the line item of interest expense, net, contains several
components related to the 8% convertible promissory notes. In addition to the 8%
coupon rate, we recorded amortization of debt issue costs of $1,587,799 and
accretion of debt discount of $2,664,138 during the nine months ended May 31,
2011. During the comparable period ended May 31, 2010, amortization of debt
issue costs was $283,535 and accretion of debt discount was $622,214.
Income Taxes - Our effective tax rate is currently zero. We have reported a
net loss every year since inception and for tax purposes have a net operating
30
loss carry forward ("NOL") of approximately $10,000,000. The NOL is available to
offset future taxable income, if any. At such time, if ever, that we are able to
demonstrate that it is more likely than not that we will be able to realize the
benefits of our tax assets, we will recognize the benefits in our financial
statements. If operational results for the remainder of the fiscal year continue
to improve, we may recognize the benefits of certain tax assets during the
latter periods of the year.
LIQUIDITY AND CAPITAL RESOURCES
On January 11, 2011, we completed the sale of 9 million shares of our
common stock in a private offering. The shares were sold at a price of $2.00 per
share. Net proceeds to us from the sale of the shares were $16,690,721 after
deductions for sales commissions and expenses.
On March 21, 2011, we closed on a transaction to sell our mineral interest
in 3,502 gross acres (2,383 net acres) for cash proceeds of $5,244,517.
On March 31, 2011, holders of our 8% convertible promissory notes completed
the conversion of $18,000,000 in principal into 11,250,000 shares of common
stock at the conversion price of $1.60 per share.
On May 24, 2011, we acquired certain assets from PEM for a cash payment of
$10,000,000, issuance of 1,381,818 shares of restricted common stock, and a
$5,200,000 promissory note that matures on January 2, 2012.
Our sources and (uses) of funds for the nine months ended May 31, 2011 and
2010, are shown below:
Nine Months Ended May 31,
------------------------------
2011 2010
-------------- ------------
Cash provided by (or used in)
operations $ 3,824,882 $ (984,550)
Mineral property acquisitions (21,163,392) (5,717,527)
Mineral property sales 4,995,817 -
Cash proceeds from sale of stock or
units 16,690,721 16,651,023
Debt principal payments - (1,161,811)
-------------- -------------
Net increase in cash $ 4,348,028 $ 8,787,135
============== =============
Non-cash expenses had a $17,107,509 and $3,982,256 impact on net loss for
the nine months ended May 31, 2011 and 2010, respectively. Changes in working
capital items caused by the timing of payments and receipts of cash had an
impact of $92,656 and $511,664 for the nine months ended May 31, 2011 and 2010,
respectively.
Cash payments for the acquisition of oil and gas properties, drilling
costs, and other development activities for the nine months ended May 31, 2011
and 2010, were $21,163,392 and $5,717,527, respectively. These amounts differ
from the amounts reported as the increase in capitalized costs during the
period, which differences reflect non cash items plus the timing of when the
capital expenditure obligations are incurred and when the actual cash payment is
made. A reconciliation of the differences is summarized in the following table:
31
Nine Months Ended May 31,
-----------------------------
2011 2010
------------- -----------
Cash payments $ 21,163,392 $ 5,717,524
Accrued costs, beginning of
period (3,446,439) -
Accrued costs, end of period 2,242,117 1,526,113
Properties acquired in exchange
for common stock 7,603,698 -
Properties acquired in exchange
for note payable 5,200,000 -
Proceeds from sale of properties (4,995,817) -
Asset retirement obligation 242,357 184,305
Other (64,568) -
------------- -----------
Increase in capitalized costs $ 27,944,740 $ 7,427,942
============= ===========
Under full cost accounting requirements, the proceeds from the sale of
mineral interests are generally credited to the full cost pool and no gain or
loss in recognized, unless the transaction would have a significant impact on
proved reserves or the future rate of depreciation, depletion, and amortization
(DDA). The sale completed during the quarter ended May 31, 2011, was noteworthy,
but did not reach the level of significance required to recognize a gain. Our
accounting method reduced the amortization base used in the DDA calculation by
approximately 12% and it is estimated that future amortization expense will be
reduced by approximately $2.29 per BOE.
In addition to the transactions described in "Recent Developments", capital
expenditures for the nine months ended May 31, 2011, included the acquisition of
8 existing wells, 15 drill sites, and associated equipment for a purchase price
of $1,017,435, completion and rework activities on wells previously drilled, and
drilling additional 14 wells in Weld County, Colorado.
Our operating cash requirements are expected to approximate $250,000 per
month, which amount includes salaries and other corporate overhead of $150,000
and lease operating expenses of $100,000. During the current fiscal year, we
began to generate meaningful cash flow from operations, and we expect that the
revenue from wells recently placed into production will further improve our cash
flow.
Our primary need for cash in fiscal 2011 will be to fund our acquisition
and drilling program. Our capital expenditure estimate approximates $27 million
subject to significant adjustment for drilling success, acquisition
opportunities, operating cash flow, and available capital resources. Although
our recent sale of securities for gross proceeds of $18 million plus our recent
sale of mineral interests for cash proceeds of $5.2 million plus our recent
acquisition of mineral interests in exchange for shares of common stock will
provide substantially all of the capital resources required to fund our capital
expenditure plans, we may seek additional funding to expand our plans or to
provide resources for our 2012 drilling program. We have not completed our
capital budget for 2012. On a tentative basis, we expect to budget between $35
million and $50 million on the acquisition of mineral interests and drilling new
wells.
We plan to generate profits by drilling or acquiring productive oil or gas
wells. However, we may need to raise some of the funds required to drill new
wells through the sale of our securities, from loans from third parties or from
third parties willing to pay our share of drilling and completing the wells. We
32
may not be successful in raising the capital needed to drill or acquire oil or
gas wells. Any wells which may be drilled by us may not produce oil or gas in
commercial quantities.
TREND AND OUTLOOK
The factors that will most significantly affect our results of operations
include (i) activities on properties that we operate, (ii) the marketability of
our production, (iii) our ability to satisfy our substantial capital
requirements, (iv) completion of acquisitions of additional properties and
reserves, (v) competition from larger companies and (vi) prices for oil and gas.
Our revenues will also be significantly impacted by our ability to maintain or
increase oil or gas production through exploration and development activities.
It is expected that our principal source of cash flow will be from the
production and sale of oil and gas reserves which are depleting assets. Cash
flow from the sale of oil and gas production depends upon the quantity of
production and the price obtained for the production. An increase in prices will
permit us to finance our operations to a greater extent with internally
generated funds, may allow us to obtain equity financing more easily or on
better terms, and lessens the difficulty of obtaining financing. However, price
increases heighten the competition for oil and gas prospects, increase the costs
of exploration and development, and, because of potential price declines,
increase the risks associated with the purchase of producing properties during
times that prices are at higher levels.
A decline in oil and gas prices (i) will reduce our cash flow which in turn
will reduce the funds available for exploring for and replacing oil and gas
reserves, (ii) will increase the difficulty of obtaining equity and debt
financing and worsen the terms on which such financing may be obtained, (iii)
will reduce the number of oil and gas prospects which have reasonable economic
terms, (iv) may cause us to permit leases to expire based upon the value of
potential oil and gas reserves in relation to the costs of exploration, (v) may
result in marginally productive oil and gas wells being abandoned as
non-commercial, and (vi) may increase the difficulty of obtaining financing.
However, price declines reduce the competition for oil and gas properties and,
correspondingly, reduce the prices paid for leases and prospects.
Other than the foregoing, we do not know of any trends, events or
uncertainties that will have had or are reasonably expected to have a material
impact on our sales, revenues or expenses.
CRITICAL ACCOUNTING POLICIES
There have been no material changes in our critical accounting policies
since August 31, 2010, and a detailed discussion of the nature of our accounting
practices can be found in the section titled "Critical Accounting Policies" in
Part II, Item 7 of our Annual Report on Form 10-K for the year ended August 31,
2010.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This report contains "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. These statements are subject
to risks and uncertainties and are based on the beliefs and assumptions of
management and information currently available to management. The use of words
such as "believes", "expects", "anticipates", "intends", "plans", "estimates",
"should", "likely" or similar expressions, indicates a forward-looking
statement.
33
The identification in this report of factors that may affect our future
performance and the accuracy of forward-looking statements is meant to be
illustrative and by no means exhaustive. All forward-looking statements should
be evaluated with the understanding of their inherent uncertainty.
Factors that could cause our actual results to differ materially from those
expressed or implied by forward-looking statements include, but are not limited
to:
o The success of our exploration and development efforts;
o The price of oil and gas;
o The worldwide economic situation;
o Any change in interest rates or inflation;
o The willingness and ability of third parties to honor their
contractual commitments;
o Our ability to raise additional capital, as it may be affected by
current conditions in the stock market and competition in the oil
and gas industry for risk capital;
o Our capital costs, as they may be affected by delays or cost
overruns;
o Our costs of production;
o Environmental and other regulations, as the same presently exist
or may later be amended;
o Our ability to identify, finance and integrate any future
acquisitions; and
o The volatility of our stock price.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
An evaluation was carried out under the supervision and with the
participation of our management, including our Principal Financial Officer and
Principal Executive Officer, of the effectiveness of our disclosure controls and
procedures as of the end of the period covered by this report on Form 10-Q.
Disclosure controls and procedures are procedures designed with the objective of
ensuring that information required to be disclosed in our reports filed under
the Securities Exchange Act of 1934, such as this Form 10-Q, is recorded,
processed, summarized and reported, within the time period specified in the
Securities and Exchange Commission's rules and forms, and that such information
is accumulated and is communicated to our management, including our Principal
Executive Officer and Principal Financial Officer, or persons performing similar
functions, as appropriate, to allow timely decisions regarding required
disclosure. Based on that evaluation, our management concluded that, as of May
31, 2011, our disclosure controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting
during the quarter ended May 31, 2011, that materially affected or are
reasonably likely to materially affect our internal control over financial
reporting.
PART II
Item 1. Legal Proceedings.
None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
34
1. During the three months ended May 31, 2011, holders of convertible
promissory notes in the principal amount of $6,096,325, plus accrued
interest of $55,882, elected to convert their notes into 3,845,132 shares
of the Company's common stock. The Company relied upon the exemption
provided by Section 3(a)(9) of the Securities Act of 1933 in connection
with the issuance of these shares.
2. During the three months ended May 31, 2011, the Company agreed to issue
an aggregate of 1,125,699 shares of restricted common stock as
consideration for several mineral interests. These interests, which
include an aggregate of 78,815 gross acres (69,274 net acres), are
located in the D-J Basin and were acquired through leases with several
private parties. The Company relied upon the exemption provided by
Section 4(2) of the Securities Act of 1933 in connection with the
issuance of these shares.
3. On May 24, 2011, the Company issued 1,381,818 shares of common stock
pursuant to the purchase of certain oil and gas properties from Petroleum
Exploration and Management, LLC. These shares were valued at $3,800,000 in
accordance with the terms of the purchase and sale agreement and represent
partial consideration for the transaction The Company relied upon the
exemption provided by Section 4(2) of the Securities Act of 1933 in
connection with the issuance of these shares.
Item 3. Default Upon Senior Securities.
None.
Item 4. (Removed and Reserved)
Item 5. Other Information
On May 23, 2011, the Company held a Special Meeting of Shareholders in
CityplacePlatteville, StateColorado. Of the 33,495,519 shares of common stock
issued and outstanding as of the record date, 23,316,861 shares of common stock
(approximately 70%) were present or represented by proxy at the Special Meeting.
The Company's shareholders approved a proposal to acquire oil and gas properties
from Petroleum Exploration and Management LLC ("PEM"), the adoption of the
Company's 2011 Incentive Stock Option Plan, the adoption of the Company's 2011
Non-Qualified Stock Option Plan, the adoption of the Company's 2011 Stock Bonus
Plan and an amendment of the Company's Articles of Incorporation. The results of
voting on the aforementioned matters were as follows:
1. Approval of the acquisition of oil and gas properties from Petroleum
Exploration and Management, LLC:
FOR AGAINST ABSTAIN
------------------ ------------------- ------------------
18,730,523 154,947 4,315,260
2. Approval of the adoption of the Company's 2011 Incentive Stock Option
Plan, which provides that up to 2,000,000 shares of common stock may
be issued upon the exercise of options granted pursuant to the
Incentive Stock Option Plan:
FOR AGAINST ABSTAIN
------------------ ------------------- ------------------
18,020,015 4,070,711 1,110,004
3. Approval of the adoption of the Company's 2011 Non-Qualified Stock
Option Plan, which provides that up to 2,000,000 shares of common
stock may be issued upon the exercise of options granted pursuant to
the Non-Qualified Stock Option Plan:
35
FOR AGAINST ABSTAIN
------------------ ------------------- ------------------
16,902,243 5,197,404 1,101,083
4. Approval of the adoption of the Company's 2011 Stock Bonus Plan, which
provides that up to 2,000,000 shares of common stock may be issued to
persons granted Stock Bonuses pursuant to the Stock Bonus Plan:
FOR AGAINST ABSTAIN
------------------ ------------------- ------------------
16,615,144 5,405,140 1,180,446
5. Approval of the amendment of the Company's Articles of Incorporation
to allow shareholders owning less than all of the Company's common
stock to take action without meeting consistent with Colorado Revised
Statute 7-107-104.
FOR AGAINST ABSTAIN
------------------ ------------------- ------------------
21,915,238 684,122 601,370
36
Item 6. Exhibits
a. Exhibits
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 for Ed Holloway.
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 for Frank L. Jennings.
32 Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 for Ed Holloway and Frank L. Jennings.
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SYNERGY RESOURCES CORPORATION
Date: August 11, 2011
By: /s/ Ed Holloway
-----------------------------------
Ed Holloway, President and
Principal Executive Officer
Date: August 11, 2011
By: /s/ Frank L. Jennings
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Frank L. Jennings, Principal
Financial and Accounting Officer
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