---

­­UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

☒	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934: For the quarterly period ended January 31, 2015

or

☐	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934: For the transition period from _______ to _________

Commission file number: 000-53313

(Exact name of registrant as specified in its charter)

800 Gessner, Suite 375

(Address of principal executive offices, including zip code)

(Registrant’s principal executive office telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x     No o

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o   No x

As of March 17, 2015, 21,266,794 shares of common stock, $0.001 par value, were outstanding.

---

---

Table of Contents

Part I. Financial Information

 

 

---

Part I. Financial Information

 

 

---

HYDROCARB ENERGY CORP.

 Consolidated Balance Sheets

(Unaudited)

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

 

---

HYDROCARB ENERGY CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

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

 

---

HYDROCARB ENERGY CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

                                             

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

 

---

HYDROCARB ENERGY CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Description of Business and Summary of Significant Accounting Policies

Description of business and basis of presentation

The unaudited consolidated financial statements of Hydrocarb Energy Corp. (“Hydrocarb”, “HEC”, the “Company”, “we”, “us”, “our”) have been prepared in accordance with accounting principles generally accepted in the United States and the rules of the Securities and Exchange Commission (“SEC”), and should be read in conjunction with the audited financial statements and notes thereto contained in our Annual Report filed with the SEC on Form 10-K for the year ended July 31, 2014. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements which would substantially duplicate the disclosures contained in the audited financial statements for the most recent fiscal year ended July 31, 2014, as reported in the Form 10-K, have been omitted.

Reclassifications

Certain prior year amounts have been reclassified to conform with the current presentation.

Principles of consolidation

We own 100% of the issued and outstanding share capital of (i) Penasco Petroleum Inc. (“Penasco”), a Nevada corporation, (ii) Galveston Bay Energy, LLC (“GBE”), a Texas limited liability company, (iii) SPE Navigation I, LLC, a Nevada limited liability company (“SPE”), (iv) Namibia Exploration, Inc. (“NEI”), a Nevada corporation, (v) Hydrocarb Corporation, a Nevada corporation (“HCN”), (vi) Hydrocarb Texas Corporation, a Texas corporation, and (vii) Hydrocarb Namibia Energy (Pty) Limited (“Namibia”), a company chartered in the Republic of Namibia.  In addition, we own 95% of the issued and outstanding share capital of Otaiba Hydrocarb LLC (“Otaiba”), a UAE limited liability corporation. The accompanying consolidated financial statements include the accounts of the entities noted above.  All significant intercompany accounts and transactions have been eliminated in consolidation.

The acquisition of HCN, an entity under common control, on December 9, 2013 (See Note 2 – HCN Acquisition) has resulted in a change in the reporting entity. The consolidated financial statements presented for the periods subsequent to the acquisition include the accounts of HCN and its subsidiaries. As HEC and HCN are under the common control of same shareholder group, the acquired assets and liabilities were recorded at the historical carrying value and the consolidated financial statements were retroactively restated to reflect the Company as if HCN had been owned since the beginning of the earliest period presented.

Noncontrolling interests

Our consolidated financial statements include the accounts of all subsidiaries where we hold a controlling financial interest.  We have a controlling financial interest if we own a majority of the outstanding voting common stock and minority shareholders do not have substantive participating rights, we have significant control over an entity through contractual or economic interests in which we are the primary beneficiary or we have the power to direct the activities that most significantly impact the entity’s economic performance.  The ownership interest in subsidiaries held by third parties are presented in the consolidated balance sheet within equity, but separate from the parent’s equity, as noncontrolling interest.  All significant intercompany balances and transactions have been eliminated in consolidation.

Cash and cash equivalents

Cash and cash equivalents are all highly liquid investments with an original maturity of three months or less at the time of purchase and are recorded at cost, which approximates fair value.

Our functional currency is the United States dollars. Transactions denominated in foreign currencies are translated into their United States dollar equivalents using current exchange rates. Monetary assets and liabilities are translated using exchange rates that prevailed as of the balance sheet date. Non-monetary assets and liabilities are translated using exchange rates that prevailed as of the transaction date. Revenue, if applicable and expenses are translated using average exchange rates over the accounting period. We have had no revenue denominated in foreign currencies. Gains or losses resulting from foreign currency transactions are included in results of operations.

 

---

Stock Split

On May 8, 2014, we effected a 1:3 reverse split of our authorized common stock and a corresponding 3:1 reverse split of our outstanding common stock.  All share and per share amounts in this report have been retroactively restated to reflect the reverse split.  This presentation is consistent with the guidance in ASC 260-10-55-12, Earnings per Share, which requires retroactive restatement of earnings per share if a capital structure change due to a stock dividend, stock split or reverse split occurs after the date of the latest balance sheet, but before the release of the financial statements.

Recent accounting pronouncements

In August 2014, the FASB issued Accounting Standard Update No. 2014-15 (“ASU No. 2014-15”),  Presentation of Financial Statements Going Concern (Subtopic 205-40) which requires management to assess an entity's ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, ASU 2014-15 provides a definition of the term substantial doubt and requires an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). It also requires certain disclosures when substantial doubt is alleviated as a result of consideration of management's plans and requires an express statement and other disclosures when substantial doubt is not alleviated. ASU No. 2014-15 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, early application is permitted. We are currently evaluating the accounting implication and do not believe the adoption of ASU 2014-15 to have material impact on our consolidated financial statements, although there may be additional disclosures upon adoption.

Other recently issued or adopted accounting pronouncements are not expected to have, or did not have, a material impact on our financial position or results from operations.

Note 2 – HCN Acquisition

The acquisition Agreement provided that HEC would issue 7,470,000 shares of its common stock to the holders of certain rights to acquire HEC stock. These rights were previously issued by HEC as contingent consideration in connection with the acquisition of NEI. The rights had been convertible into HEC common stock based upon HEC market capitalization milestones. The rights were issued to entities deemed related parties to HEC.

 

---

HCN had 51% working-interest rights in and operated an unevaluated Namibian concession described in Note 3 – Oil and Gas Properties, below, and provided international oilfield consulting services.  Prior to this acquisition, HEC owned 39% working-interest right in this concession.  With the HCN acquisition, we now own 90% working interest (100% cost responsibility) in the concession.  This 5.3 million-acre concession is located in northern Namibia in Africa.  The concession specifies the following minimum cost responsibilities on an 8/8ths basis:

1)

Initial Exploration Period (expires September 2015): Perform a hydrocarbon potential study, gather and review existing technical data including reprocessing of available seismic lines, and acquire and process 750 kilometers of new 2D seismic data.  The minimum expenditure is $4,505,000.

2)

First Renewal Exploration Period (two years from end of the Initial Exploration Period):  Acquire 200 square kilometers of 3D seismic data, interpret and map the data, design a drilling program, drill one well, conduct an environmental study, and relinquish 25% of the exploration license area.  The minimum expenditure is $17,350,000.

3)

Second Renewal (Production License) Exploration Period (25 years):  Report on reserves and production and conduct an environmental study.  The minimum expenditure is $300,000.

In conjunction with the HCN acquisition, the HEC Board of Directors authorized the immediate issuance of 7,470,000 shares of our common stock to the former owners of NEI. We previously acquired NEI on August 7, 2012 and these 7,470,000 shares had been contingently-issuable consideration for the acquisition of NEI. We issued these shares on December 9, 2013. The original agreement contained market conditions for the issuance of this stock.

Note 3 – Supplemental Cash Flow Information

---

 Note 4 – Oil and Gas Properties

 

Evaluated properties

Additions to evaluated oil and gas properties during the six months ended January 31, 2015 consisted mainly of exploration costs, specifically, geological and geophysical costs of approximately $2,271,263.

 

Unevaluated Properties

Namibia, Africa

We own 90% (100% cost responsibility) of our Namibia concession, as described above in Note 2 –Acquisitions.

Additions to unevaluated properties of approximately $182,000 during the Six months ended January 31, 2015 primarily of:

·

Approximately $182,000 of leasehold costs, specifically payment of the annual concession fee to the Government of Namibia. As of January 31, 2015, approximately $2.2 million has been expended towards the initial exploration period.

Note 5 - Impairment

Oil and Gas Properties

We account for our oil and natural gas producing activities using the full cost method of accounting as prescribed by the United States Securities and Exchange Commission (“SEC”). Under this method, subject to a limitation based on estimated value, all costs incurred in the acquisition, exploration, and development of proved oil and natural gas properties, including internal costs directly associated with acquisition, exploration, and development activities, the costs of abandoned properties, dry holes, geophysical costs, and annual lease rentals are capitalized within a cost center.

We evaluated our capitalized costs using the full cost ceiling test as prescribed by the Securities and Exchange Commission at the end of each reporting period. As of January 31, 2015 and July 31, 2014, the net book value of oil and gas properties did not exceed the ceiling amount and thus, no impairment of the properties was required. Changes in production rates, levels of reserves, future development costs, and other factors will determine our actual ceiling test calculation and impairment analyses in future periods.

Note 6 – Asset Retirement Obligations

The following is a reconciliation of our asset retirement obligation liability as of January 31, 2015 and July 31, 2014:

 

---

Note 7 – Notes Payable

Installment Notes Payable

In May 2012, we entered into a note payable of $18,375 to purchase a vehicle. The note is collateralized by the vehicle. The note carries an interest rate of 6.93% and is payable beginning in June 2012, in 36 installments of $567 per month. The principal balance owed on the note payable was approximately $2,273 and $7,100 as of January 31, 2015 and July 31, 2014, respectively.

In February 2014, we financed our commercial insurance program using a note payable for $403,104. Under the note, we are obligated to make nine payments of $45,718 per month, which include principal and interest, beginning in March 2014. As of January 31, 2015, the note payable balance was approximately $45,000.

Related Party Installment Note Payable

In November 2013, we issued a promissory note for funds received from Mr. Kent P. Watts, Our Chairman, of $100,000. Under the terms of the note, principal on the note was due after one year and incurred interest at 5% per annum payable on a monthly basis. Accrued interest is payable monthly beginning in May 2014, and beginning in August 2014 the principal is due in 36 monthly payments through July 2017. The note is secured by the Company’s assets owned by GBE, subject to any other lien holder's superior rights, if any. In April 2014, the Company entered into a new debt agreement whereby Mr. Watts agreed to loan the Company up to $600,000 at an interest rate of 6.25%. The previous debt of $100,000 was rolled into this new note. Additionally, we borrowed $200,000 from Mr. Watts during April 2014 and $300,000 from Mr. Watts in May 2014. The total balance on the note was $600,000 as of January 31, 2015. As part of the financing agreement with Shadow Tree Capital Management, LLC (as discussed below), this note has been subordinated, and no payments will be made until the Shadow Tree debt has been repaid.

Credit Agreement

Effective August 15, 2014, we entered into a Credit Agreement (the “Credit Agreement”) as borrower, along with Shadow Tree Capital Management, LLC, as agent (the “Agent”), and certain lender parties thereto (the “Lenders”). Pursuant to the Credit Agreement, the Lenders loaned us $4.0 million, which was represented by Term Loan Notes in an aggregate amount of $4,545,454 (the “Notes”), representing an original issue discount of 12%. We also paid the Lenders a structuring fee of $90,909 equal to 2% of the principal amount of the Notes (the “Structuring Fee”) and agreed to reimburse the Lenders for all reasonable and documented fees, costs and expenses associated with the Credit Agreement, which totaled $172,824 in aggregate. Finally, we paid ROTH Capital Partners, LLC, a placement fee of 5% of the total value of the Loans ($227,273), as placement agent and Gary W. Vick, a consulting fee of 1% of the face value of the Loans ($45,455) for consulting services rendered. As a result of the payments above, the net amount of funding received from the Loans was $3,463,539.

 

---

The Credit Agreement contains customary representations, warranties, covenants and requirements for the Company to indemnify the Lenders, Agent and their affiliates. The Credit Agreement also includes various covenants (positive and negative) binding upon the Company (and its subsidiaries), including but not limited to, requiring that the Company comply with certain reporting requirements, and provide notices of material corporate events and forecasts to Agent, and prohibiting us from (i) incurring any additional debt; (ii) creating any liens; (iii) making any investments; (iv) materially changing our business; (v) repaying outstanding debt; (vi) affecting a business combination, sale or transfer; (vii) undertaking transactions with affiliates; (viii) amending our organizational documents; (ix) forming subsidiaries; or (x) taking any action not in the usual course of business, in each case except as set forth in the Credit Agreement.

Note 8 – Capital Stock

 

Common Stock Issuances

Pursuant our Credit Agreement, as noted in Note 6 – Notes Payable, during August 2014, we issued 60,000 shares of restricted common stock to the Lenders. The shares were issued pursuant to the terms and conditions of a Stock Grant Agreement, pursuant to which each of the Lenders made certain representations to the Company regarding their financial condition and other items in order for the Company to confirm that an exemption from registration existed and will exist for such issuances.

 

---

Receivables for Common Stock

On September 6, 2013, HCN sold 191,667 shares of HEC common stock to an employee of HCN (the nephew of our Chairman and Chief Executive Officer) in exchange for a note receivable in the amount of $1,000,000. HEC acquired this receivable upon its acquisition of HCN. The note is non-interest bearing and is payable only upon the sale of the common stock to a third party or HEC stock being listed on either the NASDAQ or NYSE stock exchanges. We will receive 95% of the proceeds up to $1,000,000 if the underlying stock is sold to a third party. Within 90 days of HEC stock being listed on a major stock exchange, we will receive up to $1,000,000, or the note can be paid earlier at the discretion of the other party. These shares of common stock are held in the name of the investors and are beneficially owned by the investors and the shares are not retrievable by the Company.

On December 4, 2013 HCN sold 619,960 shares of unregistered and restricted HEC common stock in return for a $1,859,879 non-interest bearing note receivable from an  entity in which Michael Watts has a minority interest. HEC acquired this receivable upon its acquisition of HCN. The 619,960 HEC common stock shares were previously issued by HEC to HCN to settle liabilities due by HEC related to the consulting services agreement described below in Note 6 – Notes Payable. The receivable from the individual is due to HEC upon the following conditions: 1) 100% of the proceeds payable from the sale of all or part of the shares by the owner of the shares to a third party; 2) within sixty days of the six month anniversary of the December 4, 2013 stock sale or within sixty days from the date that the shares become unrestricted (whichever is first); or 3) 100% of any remaining balance due within 90 days of HEC being listed on a major stock exchange and whereby the share price is above $6.00 per share. As with the above receivable for common stock, this receivable for the sale of HEC common stock is classified as a receivable for common stock within equity. These shares of common stock are held in the name of the investors and are beneficially owned by the investors and the shares are not retrievable by the Company.

Stock Options and Warrants

As of January 31, 2015, HEC could grant up to 737,706  shares of common stock under the 2013 Stock Incentive Plan (“2013 Plan”). The Plan is administered by the Compensation Committee of the Board of Directors, or in the absence of a Compensation Committee, the full Board of Directors, which has substantial discretion to determine persons, amounts, time, price, exercise terms, and restrictions of the grants, if any.

Options granted to non-employees

We account for options granted to non-employees under the provisions of ASC 505-50, Equity-Based Payments to Non-employees, and record the associated expense at fair value on the final measurement date. Because there is no disincentive for nonperformance for these awards, the final measurement date occurs when the services are complete, which is the vesting date. For the options granted to non-employees on a graded vesting schedule, we estimate the fair value of the award as of the end of each reporting period and recognize an appropriate portion of the cost based on the fair value on that date. When the award vests, we adjust the cost previously recognized so that the cost ultimately recognized is equivalent to the fair value on the date the performance is complete. There were 25,000 options granted to non-employees during the six months ended January 31, 2015. Compensation expense of $112,500 was recognized during the six months ended January 31, 2015. No options have been exercised, and 92,000 expired during the six months ended January 31, 2015.

Options granted to employees

The following table provides information about options granted to employees under our stock incentive plans during the six months ended January 31, 2015 and 2014:

 

		Options				Weighted Average Share Price				Aggregate intrinsic value				Weighted average remaining contractual life (years)
Outstanding at  July 31, 2014			265,333			$	6.81			$					7.95
Granted			25,000				4.50								5.00
Exercised			-				-
Expired			(92,000	)			6.85
Outstanding at January 31, 2015			198,333			$	6.52			$					7.51

---

Warrants

Summary information regarding common stock warrants issued and outstanding as of January 31, 2015, is as follows:

 

Warrants granted to related party

During the year ended July 31, 2011, we entered into a consulting agreement with Geoserve Marketing, LLC (“Geoserve”), a company controlled by Michael Watts, who is a related party. Under the terms of the agreement, we granted warrants to purchase 400,000 shares of common stock that have a market condition.  If our common stock attains a five day average closing price of $22.50 per share, 200,000 warrants with an exercise price of $7.50 and an expiration date of February 15, 2016 shall be exercisable (“Warrant B”). If our common stock attains a five day average closing price of $45.00 per share, 200,000 warrants with an exercise price of $7.50 and an expiration date of February 15, 2016 shall be exercisable (“Warrant C”). The fair value of warrants that vest upon the attainment of a market condition must be estimated and amortized over the lower of the implicit or derived service period of the warrants. Previously recognized expense is not reversed in the event of a subsequent decline in the fair value of market condition equity based compensation.  The fair value of the warrants and the derived service period were valued using a lattice model that values the liability of the warrants based on a probability weighted discounted cash flow model. This model is based on future projections of the various potential outcomes. Warrant B and Warrant C were amortized over the derived service periods of 2.08 years and 2.49 years, respectively.  No expense related to these warrants was recognized during the six months ended January 31, 2015, as the expense for the warrants was fully amortized in previously reported periods.

The following reflects the fair value at the end of the derived service for each of the warrants:

 

The following table reflects information regarding Warrant B and Warrant C during the six months ended January 31, 2015 and 2014:

 

Note 9 – Related Party Transactions

During the reporting period we have had transactions as described below with entities controlled by Michael Watts. Michael Watts is the father-in-law of Jeremy Driver, who served as a director and Chief Executive Officer through November, 2013. Additionally, Michael Watts is the brother of Kent Watts, who became the Company’s Chairman of Board of Directors in October 2013. Michael Watts is a related party to the Company by virtue of his relationships with Mr. Driver and with Mr. Watts. Further, two of Michael Watts’ adult children are significant shareholders of HEC’s common stock. Between them, they are beneficial owners of approximately 68% of the outstanding common stock.

A company controlled by Michael Watts purchased a 5% working interest in one of our wells in Galveston Bay.  As of January 31, 2015 and July 31, 2014, this company owed us $100 and $80,468, respectively, in joint interest billings.

During 2011, we entered into a consulting contract with a company controlled by Michael Watts, as detailed in Note 7 – Capital Stock - Warrants.  The contract permits us to terminate the agreement after the first year with thirty days’ notice.  We recognized expense of $0 and $6,754 from this contract during the six months ended January 31, 2015 and 2014, respectively.

 

---

During the three months ended October 31, 2013, a company controlled by one of our former officers, Carter E & P, LLC (“Carter”) operated several properties onshore in South Texas, including our producing properties located near the Victoria Barge Canal in Calhoun County, Texas. Although he was not a related party after September 1, 2013, he was a related party during the periods covered by this report. As of January 31, 2015 and July 31, 2014, there were no outstanding related party receivable from Carter.  Revenues generated, lease operating costs, and contractual overhead charges incurred during the time Carter was a related party were as follows:

 

In November 2013, we issued a promissory note for funds received from Mr. Kent Watts, Our Chairman, of $100,000. Under the terms of the note, principal on the note was due after one year and incurred interest at 5% per annum payable on a monthly basis. In April 2014, the Company entered into a new debt agreement whereby Mr. Watts agreed to loan the Company up to $600,000 at an interest rate of 6.25%. The previous debt of $100,000 was rolled into this new note. Additionally, we borrowed $200,000 from Mr. Watts during April 2014 and $300,000 from Mr. Watts in May 2014. The total balance on the note was $600,000 as of January 31, 2015. Accrued interest is payable monthly beginning in May 2014, and beginning in August 2014 the principal is due in 36 monthly payments through July 2017. The note is secured by the Company’s assets owned by GBE, subject to any other lien holder's superior rights, if any. As part of the financing agreement with Shadow Tree, this note has been subordinated, and no payments will be made until the Shadow Tree debt has been repaid.

Note 10 - Commitments and Contingencies

Legal

Environmental

We accrue for losses associated with environmental remediation obligations when such losses are probable and can be reasonably estimated. These accruals are adjusted as additional information becomes available or circumstances change. Costs of future expenditures for environmental remediation obligations are not discounted to their present value. Recoveries of environmental remediation costs from other parties are recorded at their undiscounted value as assets when their receipt is deemed probable.

Letters of Credit

Oil and gas operators in the State of Texas are required to obtain a letter of credit in favor of the Railroad Commission of Texas as security that they will meet their obligations to plug and abandon the wells they operate. We have two letters of credit in the amount of $6,610,000 and $120,000 issued by Green Bank. These letters of credit are collateralized by a certificate of deposit held with the bank for the same amount. We pay a 1.5% per annum fee in conjunction with these letters of credit.

In June 2014, when we renewed the letters of credit, we prepaid the entire years’ interest upfront. We amortize these fees on a straight-line basis. The following table reflects the prepaid balances as of:

 

 

Note 12 – Subsequent Events

Subsequent to January 31, 2015, we raised approximately $1 million through the sale of various convertible promissory notes as described below.

 

---

---

CAUTIONARY STATEMENT ON FORWARD-LOOKING INFORMATION

The Company is including the following cautionary statement for any forward-looking statements made by, or on behalf of, the Company. This quarterly report on Form 10-Q contains “forward looking statements” (as that term is defined in Section 27A(i)(1) of the Securities Act of 1933), including statements concerning plans, objectives, goals, strategies, expectations, future events or performance and underlying assumptions and other statements which are other than statements of historical facts.  Such forward looking statements involve risks and uncertainties which could cause actual results or outcomes to differ materially from those expressed in the forward looking statements.  Some of the factors that could cause actual results to differ materially from those expressed in such forward looking statements are set forth in the section entitled “Risk Factors” and elsewhere throughout this Form 10-Q.  Our expectations, beliefs and projections are expressed in good faith and are believed by us to have a reasonable basis, but there can be no assurance that our expectations, beliefs or projections will result or be achieved or accomplished.  We have no obligation to update or revise forward looking statements to reflect the occurrence of future events or circumstances.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

 

Results of Operations

The following table sets out consolidated data for the periods indicated:

Three months ended January 31, 2015 compared to the three months ended January 31, 2014:

 

Statements of operations:

 

		Three Months Ended January 31,								Increase/				%
		2015				2014				(Decrease)				Change
Revenues		$	646,348			$	989,732				(343,384	)			-35	%
Operating expenses
Lease operating expense			913,290				811,127				102,163				13	%
Depreciation, depletion, and amortization			162,166				191,764				(29,598	)			-15	%
Accretion			258,782				244,509				14,273				6	%
Consulting fees - related party			-				-				-
General and administrative expense			980,480				946,325				34,155				4	%
Total operating expenses			2,314,718				2,193,725				120,993				6	%
Loss from operations			(1,668,370	)			(1,203,993	)			(464,377	)			39	%
Consulting and other income (expense)			2,737				(4,940	)			7,677				-155	%
Interest income (expense), net			(279,727	)			(36,854	)			(242,873	)			659	%
Foreign currency transaction gain (loss)			(6,401	)			(28,971	)			22,570				-78	%
Net loss before income taxes			(1,951,761	)			(1,274,758	)			(677,003	)			53	%
Income tax provision			-				-				-
Net loss			(1,951,761	)			(1,274,758	)			(677,003	)			53	%
Less: Net loss attributable to noncontrolling interests			18				(1,888	)			1,906				-101	%
Net loss attributable to Hydrocarb Corporation			(1,951,779	)			(1,272,870	)			(678,909	)			53	%
Deemed dividend on preferred stock			-				(3,019	)			3,019				-100	%
Net loss attributable to Hydrocarb Energy Corp after dividends		$	(1,951,779	)			(1,275,889	)			(675,890	)			53	%

 

---

We recorded net loss of $1,951,779, or ($0.09)per basic and diluted common share, during the three months ended January 31, 2015, as compared to a net loss of $ 2,225,697, or ($0.05)per basic and diluted common share, during the three months ended Jaunary 31, 2014.

The changes in results were predominantly due to the factors below:

We continue to evaluate areas where we can reduce costs in lease operating expense and to increase production, which would increase revenues.

Six months ended January 31, 2015 compared to the six months ended January 31, 2014:

                                                            

		Six Months Ended January 31,								Increase/				%
		2015				2014				(Decrease)				Change
Revenues		$	1,851,777			$	2,829,943				(978,166	)			-35	%
Operating expenses
Lease operating expense			2,210,845				1,928,459				282,386				15	%
Depreciation, depletion, and amortization			386,422				493,679				(107,257	)			-22	%
Accretion			560,990				488,485				72,505				15	%
Consulting fees - related party			-				6,754				(6,754	)			-100	%
General and administrative expense			1,923,760				2,738,324				(814,564	)			-30	%
Total operating expenses			5,082,017				5,655,701				(573,684	)			-10	%
Loss from operations			(3,230,240	)			(2,825,758	)			(404,482	)			14	%
Consulting and other income (expense)			6,779				(30,266	)			37,045				-122	%
Interest income (expense), net			(507,504	)			21,338				(528,842	)			-2478	%
Foreign currency transaction gain (loss)			(1,642	)			(30,626	)			28,984				-95	%
Net loss before income taxes			(3,732,607	)			(2,865,312	)			(867,295	)			30	%
Income tax provision			-				(4,599	)			4,599				-100	%
Net loss			(3,732,607	)			(2,869,911	)			(862,696	)			30	%
Less: Net loss attributable to noncontrolling interests			(1,305	)			(3,360	)			2,055				-61	%
Net loss attributable to Hydrocarb Corporation			(3,731,302	)			(2,866,551	)			(864,751	)			30	%
Deemed dividend on preferred stock			-				(34,254	)			34,254				-100	%
Net loss attributable to Hydrocarb Energy Corp after dividends			(3,731,302	)		$	(2,900,805	)			(830,797	)			29	%

                                                         

We recorded net loss of $3,731,302, or ($0.18)per basic and diluted common share, during the six months ended January 31, 2015, as compared to a net loss of $ 2,866,551, or ($0.10)per basic and diluted common share, during the six months ended January 31, 2014.

The changes in results were predominantly due to the factors below:

 

---

Liquidity and Capital Resources

The following table sets forth our cash and working capital as of January 31, 2015 and July 31, 2014, respectively:

 

At January 31, 2015, we had $266,646 of cash on hand and a working capital of $(3,338,050).

 

Operation Plans and Focus

In Galveston Bay, Texas we plan to continue enhancing the production from our four productive fields. Our 2014 Production Enhancement Program has included primarily reworking, infrastructure improvements, and recompletions, as well as drilling, as to exploit the known reserves in at least 18 wells. Internal estimates show the projects are showing success, and as of February 2015 over production of February 2014, there has been an approximately 400% increase in production. Due to the fact that a large proportion of current operating costs in Galveston Bay are fixed it is expected that as production grows an increasing percentage of the revenue will contribute to positive cash flow. We plan to fund these projects as long as working capital and cash-flow permits and pending success of previous projects. If we are able to secure either bank or equity financing in the near future, this development plan can be accelerated.

 

---

Our plan of operations over the next nine months is to increase cash flow upon one or more of the following occurring:

Subsequent to January 31, 2015, we raised approximately $1 million through the sale of various convertible promissory notes as described below.

 

Critical Accounting Policies

The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission (“SEC”). The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.

We regularly evaluate the accounting policies and estimates that we use to prepare our consolidated financial statements. In general, our estimates are based on historical experience, on information from third party professionals, and on various other assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ from those estimates made by management.

We believe that our critical accounting policies and estimates include the accounting for oil and gas properties, long-lived assets reclamation costs, and accounting for stock-based compensation.

Oil and Natural Gas Properties

We account for our oil and natural gas producing activities using the full cost method of accounting as prescribed by the United States Securities and Exchange Commission (SEC). Under this method, subject to a limitation based on estimated value, all costs incurred in the acquisition, exploration, and development of proved oil and natural gas properties, including internal costs directly associated with acquisition, exploration, and development activities, the costs of abandoned properties, dry holes, geophysical costs, and annual lease rentals are capitalized within a cost center. Costs of production and general and administrative corporate costs unrelated to acquisition, exploration, and development activities are expensed as incurred.

 

---

Costs associated with unevaluated properties are capitalized as oil and natural gas properties but are excluded from the amortization base during the evaluation period. When we determine whether the property has proved recoverable reserves or not, or if there is an impairment, the costs are transferred into the amortization base and thereby become subject to amortization.

We assess all items classified as unevaluated property on at least an annual basis for inclusion in the amortization base. We assess properties on an individual basis or as a group if properties are individually insignificant. The assessment includes consideration of the following factors, among others: intent to drill; remaining lease term; geological and geophysical evaluations; drilling results and activity; the assignment of proved reserves; and the economic viability of development if proved reserves are assigned. During any period in which these factors indicate that there would be impairment, or if proved reserves are assigned to a property, the cumulative costs incurred to date for such property are transferred to the amortizable base and are then subject to amortization.

Capitalized costs included in the amortization base are depleted using the units of production method based on proved reserves. Depletion is calculated using the capitalized costs included in the amortization base, including estimated asset retirement costs, plus the estimated future expenditures to be incurred in developing proved reserves, net of estimated salvage values.

The net book value of all capitalized oil and natural gas properties within a cost center, less related deferred income taxes, is subject to a full cost ceiling limitation which is calculated quarterly. Under the ceiling limitation, costs may not exceed an aggregate of the present value of future net revenues attributable to prove oil and natural gas reserves discounted at 10 percent using current prices, plus the lower of cost or market value of unproved properties included in the amortization base, plus the cost of unevaluated properties, less any associated tax effects. Any excess of the net book value, less related deferred tax benefits, over the ceiling is written off as expense. Impairment expense recorded in one period may not be reversed in a subsequent period even though higher oil and gas prices may have increased the ceiling applicable to the subsequent period.

Sales or other dispositions of oil and natural gas properties are accounted for as adjustments to capitalized costs, with no gain or loss recorded unless the ratio of cost to proved reserves would significantly change.

Asset Retirement Obligations

We record the fair value of an asset retirement cost, and corresponding liability as part of the cost of the related long-lived asset and the cost is subsequently allocated to expense using a systematic and rational method. We record an asset retirement obligation to reflect our legal obligations related to future plugging and abandonment of our oil and natural gas wells and gas gathering systems. We estimate the expected cash flow associated with the obligation and discount the amount using a credit-adjusted, risk-free interest rate. At least annually, we reassess the obligation to determine whether a change in the estimated obligation is necessary. We evaluate whether there are indicators that suggest the estimated cash flows underlying the obligation have materially changed. Should those indicators suggest the estimated obligation may have materially changed on an interim basis (quarterly), we will accordingly update our assessment. Additional retirement obligations increase the liability associated with new oil and natural gas wells and gas gathering systems as these obligations are incurred.

Stock-Based Compensation

ASC 718, Compensation-Stock Compensation, requires recognition in the financial statements of the cost of employee services received in exchange for an award of equity instruments over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). We measure the cost of employee services received in exchange for an award based on the grant-date fair value of the award.

We recognize the cost associated with share-based awards that have a graded vesting schedule on a straight-line basis over the requisite service period of the entire award.

Off-Balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes of financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

---

Pursuant to Item 305(e) of Regulation S-K (§ 229.305(e)), the Company is not required to provide the information required by this Item as it is a “smaller reporting company,” as defined by Rule 229.10(f)(1).

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Principal Executive Officer has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, our Principal Executive Officer has concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were not effective, due to the deficiencies in our internal control over financial reporting as described in our Annual Report on Form 10-K for our fiscal year ended July 31, 2014, which deficiencies have not yet been remedied.

Internal Control over Financial Reporting

During the six months ended January 31, 2015, we continued to implement and document entity-level controls, formalize risk assessment processes and adopt additional policies and procedures to improve our internal control over financial reporting.

 

Part II Other Information

Item 1.

Legal Proceedings

 

As of anuary 31, 2015, we were a party to the following legal proceedings:

Item 1A.

Risk Factors

For information regarding our risk factors see the risk factors disclosed in Item 1A of our Annual Report on Form 10-K filed on November 13, 2014. There have been no material changes from the risk factors previously disclosed in such Annual Report as of the date of this report, other than the risk factors provided below:

In December 2013, the Board of Directors approved, and the Company filed a Certificate of Designation with the Secretary of State of Nevada to create a Series A 7% Convertible Voting Preferred Stock (“Series A Preferred”).  The designation authorized up to 10,000 shares of Series A Preferred. Pursuant to the designation, the Series A Preferred has a stated value of $400 per share, pays annual dividends at 7%, is convertible into the Company’s common stock, at the holder’s option, at a conversion rate of $6.00 per share, and is neither redeemable nor callable. The designation provides that the Series A Preferred shareholders may vote their common stock equivalent voting power (i.e., the number of shares of common stock which the Series A Preferred stock shares convert into). A total of 8,188 shares of Series A Preferred Stock were issuable to Kent Watts, our Chief Executive Officer, in connection with the acquisition of HCN on December 9, 2013.

In connection with certain recent due diligence undertaken by the Company, it has come to the attention of management, that although the Company previously believed, on advice of prior counsel, that the Board of Directors of the Company had the authority under the Company’s Articles of Incorporation, to unilaterally authorize preferred stock, that under applicable Nevada law, unless such preferred stock is specifically authorized in a Nevada corporation’s articles no preferred stock can be designated or issued.  As such, our Board of Directors did not have authority under the Articles of Incorporation, as amended, and applicable Nevada law to designate the Series A Preferred or to file such designation with the Secretary of State of Nevada. Consequently, we now believe that the Series A Preferred is not validly issued or outstanding and the filing of the Series A Preferred designation was invalid and had no legal effect.

Notwithstanding the above, the documentation relating to the designation of the Series A Preferred was filed with and accepted by the Secretary of State of Nevada and the Company has previously been treating the Series A Preferred as validly issued and outstanding. For example, during the year ended July 31, 2014, the holder of the Series A Preferred Stock purportedly earned dividends of $150,548 on such securities.  As of July 31, 2014, these dividends have not been accrued as liabilities since they were not declared by the Company.

Although the Company took action in good faith, based on the advice of prior counsel, in connection with the designation of the Series A Preferred, following the date of this filing, the Company plans to promptly take steps to hold a shareholders meeting to seek shareholder approval to amend the Articles of Incorporation to properly authorize preferred stock and provide the Board of Directors the ability in their discretion to designate such preferred stock, and may further request shareholder approval and ratification of the specific terms of the terms of the prior Series A Preferred. Assuming shareholder approval of the authorization of preferred stock, and the Board of Director’s ability to designate such preferred stock, and/or the actual terms of the Series A Preferred, the Company will re-file the Series A Preferred designation with the Secretary of State of Nevada. The Company plans to provide the Series A Preferred holder (Mr. Watts), upon amendment of the Articles of Incorporation to authorize preferred stock and the designation of the Series A Preferred, the equivalent rights as he would have held and be due (including accrued and unpaid dividends) had the Series A Preferred been validly designated and issued to Mr. Watts in December 2013. Due to the fact that the prior filing of the Series A Preferred Stock and actions taken in connection therewith were on advice of prior counsel and made in good faith and our current Chief Executive Officer, Mr. Watts, was to be the sole recipient of the Series A Preferred, we believe that our liability to Mr. Watts for our failure to properly designate and issue such Series A Preferred stock is minimal; however, we may in the future, enter into amendments or addendums to the December 2013 closing documents with Mr. Watts to clarify the current status of the Series A Preferred as well as certain other matters.

 

---

We have various outstanding convertible notes which are convertible into shares of our common stock at a discount to market.

As described above under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Recent Funding Transactions”, we sold various convertible promissory notes in February and March 2015. Specifically, we sold an 8% Convertible Redeemable Note to LG Capital Funding, LLC in the amount of $105,000; an 8% Convertible Redeemable Note to Adar Bays, LLC in the amount of $105,000; a Convertible Promissory Note in the principal amount of $350,000 to KBM Worldwide, Inc.; a 10% Convertible Note to JSJ Investments Inc. in the amount of $137,000; and a Secured Convertible Promissory Note to Typenex Co-Investment, LLC in the amount of $350,000 (collectively, the “Convertible Notes”). The conversion prices of the Convertible Notes vary from between 50% to 80% of the market value of our common stock, subject in many cases to antidilution and other rights. As a result, any conversion of the Convertible Notes and sale of shares of common stock issuable in connection with the conversion thereof will likely cause the value of our common stock, if any, to decline in value, as described in greater detail under the Risk Factors below. Notwithstanding the above, we plan to repay the Convertible Notes in full before any conversions take place.

The issuance and sale of common stock upon conversion of the Convertible Notes may depress the market price of our common stock.

If sequential conversions of the Convertible Notes and sales of such converted shares take place, the price of our common stock may decline, and as a result, the holders of the Convertible Notes will be entitled to receive an increasing number of shares in connection with conversions, which shares could then be sold in the market, triggering further price declines and conversions for even larger numbers of shares, to the detriment of our investors. The shares of common stock which the Convertible Notes are convertible into may be sold without restriction pursuant to Rule 144. As a result, the sale of these shares may adversely affect the market price, if any, of our common stock.

In addition, the common stock issuable upon conversion of the Convertible Notes may represent overhang that may also adversely affect the market price of our common stock. Overhang occurs when there is a greater supply of a company’s stock in the market than there is demand for that stock. When this happens the price of the company’s stock will decrease, and any additional shares which shareholders attempt to sell in the market will only further decrease the share price. The Convertible Notes will be convertible into shares of our common stock at a discount to market as described above, and such discount to market provides the holders with the ability to sell their common stock at or below market and still make a profit. In the event of such overhang, the note holders will have an incentive to sell their common stock as quickly as possible. If the share volume of our common stock cannot absorb the discounted shares, then the value of our common stock will likely decrease. Notwithstanding the above, we plan to repay the Convertible Notes in full before any conversions take place.

The issuance of common stock upon conversion of the Convertible Notes will cause immediate and substantial dilution.

The issuance of common stock upon conversion of the Convertible Notes will result in immediate and substantial dilution to the interests of other stockholders since the holders of the Convertible Notes may ultimately receive and sell the full amount of shares issuable in with the conversion of such Convertible Notes. Although certain of the Convertible Notes may not be converted if such conversion would cause the holders thereof to own more than 4.99% or 9.99% of our outstanding common stock, this restriction does not prevent the holders of the Convertible Notes subject to such restrictions from converting some of their holdings, selling those shares, and then converting the rest of its holdings, while still staying below the 4.99% limit. In this way, the holders of the Convertible Notes could sell more than any applicable ownership limit while never actually holding more shares than the applicable limits allow. If the holders of the Convertible Notes choose to do this, it will cause substantial dilution to the then holders of our common stock. Notwithstanding the above, we plan to repay the Convertible Notes in full before any conversions take place.

 

 

---

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

During the six months ended January 31, 2015, we issued an aggregate of 100,000 shares of common stock to consultants for services rendered. We valued these transactions at approximately $266,722.

 

Item 3.

Defaults Upon Senior Securities

None.

Item 4.

Mine Safety Disclosures

Not applicable.

Item 5.

Other Information

In September 2014 our Chief Executive Officer, Kent P. Watts, traveled to Abu Dhabi and met with the Board of Directors of Otaiba Hydrocarb LLC, of which we own 95%. His goal was to proceed with oil company registration work that would allow Otaiba to receive bids on oilfield services work with the hopes of developing profitable business, which has been the plan since the subsidiary was established. Instead of being able to proceed with the business plan, the Company’s partner in Otaiba made it clear that they wanted more control over management of the subsidiary while still requiring the Company to fund ongoing expenses. As such, an impasse was created between the Company and its partners in Otaiba. Together with consideration for the severe drop in oil prices, the Board of Directors made the decision to cease operations in Otaiba in favor of our focus in oilfield services to be developed domestically. Thus, during the quarter ended January 31, 2015, the decision was made to close the office in the U.A.E. and not to continue its operations thereby reducing cash expense obligations that we have had in the past but no longer have. The accounting effect of this shutdown is minimal.

---

Item 6.

Exhibits

See the Exhibit Index following the signature page to this Quarterly Report on Form 10-Q for a list of exhibits filed or furnished with this report, which Exhibit Index is incorporated herein by reference.

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.

HYDROCARB ENERGY CORP.

 

---

EXHIBIT INDEX

*	Filed herewith.

**	Furnished herewith.

 

# XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

 

---