Notes to Condensed Financial Statements
June 30, 2014
(Unaudited)
NOTE 1 – ORGANIZATION AND NATURE OF BUSINESS
GulfSlope Energy, Inc. (the “Company,” “GulfSlope,” “our” and words of similar import), a Delaware corporation, is an independent energy company engaged in the acquisition, exploration, exploitation, development and production of crude oil and natural gas properties. To this end, the Company entered the exploration stage on March 22, 2013 when it executed a master license agreement with a geophysical company to license certain seismic data for the purposes of engaging in the exploration of oil and natural gas.
NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES
The condensed financial statements included herein are unaudited. However, these condensed financial statements include all adjustments (consisting of normal recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of financial position, results of operations and cash flows for the interim periods. The results of operations for interim periods are not necessarily indicative of the results to be expected for an entire year. The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the Company’s condensed financial statements and accompanying notes. Actual results could differ materially from those estimates.
Certain information, accounting policies, and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted in this Form 10-Q pursuant to certain rules and regulations of the Securities and Exchange Commission (“SEC”). The condensed financial statements should be read in conjunction with the audited financial statements for the year ended September 30, 2013, which were included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2013.
Cash and Cash Equivalents
GulfSlope considers highly liquid investments with insignificant interest rate risk and original maturities to the Company of three months or less to be cash equivalents. Cash equivalents consist primarily of interest-bearing bank accounts and money market funds. The Company’s cash positions represent assets held in checking and money market accounts. These assets are generally available on a daily or weekly basis and are highly liquid in nature.
Liquidity/Going Concern
We have incurred accumulated losses for the period from inception to June 30, 2014 of $23,852,547. Further losses are anticipated in developing our business.
As a result, our auditors have expressed substantial doubt about our ability to continue as a going concern.
As of June 30, 2014, we had $160,650 of unrestricted cash on hand. The Company raised gross proceeds of $8.03 million in a private equity offering in July 2014. We believe that under the current spending plan this capital should fund operations through March 2015. Our policy has been to periodically raise funds through sale of equity on a limited basis, to avoid undue dilution while at the early stages of execution of our business plan. Short term needs have been historically funded through loans from executive management.
Full Cost Method
The Company uses the full cost method of accounting for oil and gas exploration and development activities. Under the full cost method of accounting, all costs associated with the exploration for and development of oil and gas reserves are capitalized on a country-by-country basis into a single cost center (“full cost pool”). Such costs include land acquisition costs, geological and geophysical (“G&G”) expenses, carrying charges on non-producing properties, costs of drilling both productive and non-productive wells and overhead charges directly related to acquisition, exploration and development activities. All of the Company’s oil and gas properties are located within the United States, its sole cost center.
The costs of unproved properties and related capitalized costs are withheld from the depletion base until such time as they are either developed or abandoned. When proved reserves are assigned or the property is considered to be impaired, the cost of the property or the amount of the impairment is added to costs subject to depletion and full cost ceiling calculations. Capitalized costs that are directly associated with unproved properties acquired by the Company during the current quarter are included in the full cost pool. As of June 30, 2014, the Company had no proved reserves.
Companies that use the full cost method of accounting for oil and natural gas exploration and development activities are required to perform a ceiling test calculation each quarter. The full cost ceiling test is an impairment test prescribed by SEC Regulation S-X Rule 4-10. The ceiling test is performed quarterly, on a country-by-country basis, utilizing the average of prices in effect on the first day of the month for the preceding twelve month period. The ceiling limits such pooled costs to the aggregate of the present value of future net revenues attributable to proved crude oil and natural gas reserves discounted at 10% plus the lower of cost or market value of unproved properties less any associated tax effects. If such capitalized costs exceed the ceiling, the Company will record a write-down to the extent of such excess as a non-cash charge to earnings. Any such write-down will reduce earnings in the period of occurrence and results in a lower depreciation, depletion and amortization rate in future periods. A write-down may not be reversed in future periods even though higher oil and natural gas prices may subsequently increase the ceiling.
Proceeds from property sales will generally be credited to the full cost pool, with no gain or loss recognized, unless such a sale would significantly alter the relationship between capitalized costs and the proved reserves attributable to these costs. A significant alteration would typically involve a sale of 25% or more of the proved reserves related to a single full cost pool.
Net Loss Per Share
Basic earnings per share (“EPS”) is computed by dividing net income (loss) (the numerator) by the weighted average number of common shares outstanding for the period (denominator). Diluted EPS is computed by dividing net income (loss) by the weighted average number of common shares and potential common shares outstanding (if dilutive) during each period. Potential common shares include stock options, warrants, and restricted stock. The number of potential common shares outstanding relating to stock options, warrants, and restricted stock is computed using the treasury stock method.
As the Company has incurred losses for the nine months ended June 30, 2014 and 2013, the potentially dilutive shares are anti-dilutive and are thus not added into the loss per share calculations. As of June 30, 2014 and 2013, there were 51,701,528 and 43,803,125 potentially dilutive shares.
Recent Accounting Pronouncements
In June 2014, the FASB issued Accounting Standards Update No. 2014-10 (“ASU No. 2014-10”), which eliminated the definition of a Development Stage Entity and the related reporting requirements. ASU No. 2014-10 is effective for annual reporting periods beginning after December 15, 2014, with early adoption allowed. The Company intends to adopt ASU No. 2014-10 on or before its interim reporting period ending December 31, 2014. The Company has evaluated all other recent accounting pronouncements and believes that none of them will have a significant effect on the Company’s financial statements.
NOTE 3 – EXPLORATION COSTS
On March 20, 2013, the Company entered into an assignment and assumption agreement (the “Assignment Agreement”) with third parties pursuant to which the Company was assigned the exclusive right to license certain seismic data. On March 22, 2013, the Company executed a master license agreement with this seismic company. In consideration for the assignment and other transactions contemplated by the Assignment Agreement, the Company agreed to issue to the assignor parties an aggregate of 243,516,666 shares of the Company’s common stock. The common stock was valued at $2,435,167 and the shares were subsequently issued in April 2013. In March 2013, the Company licensed certain seismic data from a geophysical company. The seismic data license fee totaled $6,135,500. Also in March 2013, the Company licensed certain seismic data from a second seismic company pursuant to another ordinary business course agreement. The seismic data purchase totaled $4,012,260. These expenses were included in accrued expenses as of March 31, 2013 and also capitalized as oil and gas exploration costs. The Company properly capitalized these G&G costs and included them in the depletion base. During April through September of 2013, the Company incurred $1,674,376 of costs associated with technological infrastructure and third party hosting services, $773,271 in consulting fees and salaries and benefits associated with full time geoscientists, and $90,000 in costs to participate in a geophysical research program with a public institution. These expenses were also capitalized as oil and gas exploration costs. The Company properly capitalized these G&G costs and included them in the depletion base because the Company did not yet own the specific unevaluated properties these costs related to. These costs were subject to the ceiling limitation test, resulting in immediate impairment for accounting purposes for the year ended September 30, 2013.
During October through December 2013, the Company incurred $808,613 in consulting fees, salaries and benefits associated with consultants and full-time geoscientists, $787,935 associated with technological infrastructure and third party hosting services and seismic data, and $80,000 for an independent reserve study. During January through March 2014, the Company incurred $618,173 in consulting fees, salaries and benefits associated with consultants and full-time geoscientists, and $431,382 associated with technological infrastructure and third party hosting services and seismic data. The Company properly capitalized these G&G costs and included them in the depletion base because the Company did not yet own the specific unevaluated properties these costs related to. Therefore, these G&G costs were subject to the ceiling limitation test, resulting in immediate impairment for accounting purposes for the six months ended March 31, 2014.
NOTE 4 – OIL AND NATURAL GAS PROPERTIES
During March 2014, the Company bid on 23 blocks in the Central Gulf of Mexico Lease Sale 231, conducted by the Bureau of Ocean Energy Management (“BOEM”). Of those 23 bids, we were the high bidder on 22 of 23 blocks. During May and June of 2014, the Company was awarded 21 of the 22 blocks and paid the remaining 80% lease bid amount and the first year lease rentals on all of the awarded blocks. The total amount paid was $8,126,972, which includes the lease deposit amount, the remaining 80% and the first year lease rental payment. During April through June 2014, the Company
incurred
$639,970 in consulting fees and salaries and benefits associated with full-time geoscientists, and $580,998 associated with technological infrastructure, third party hosting services and seismic data. The Company properly capitalized these G&G costs because the Company acquired specific unevaluated properties during the quarter which these costs relate to. The capitalized exploration costs of $1,220,968 and the $8,126,972 paid for the awarded leases are netted with the $8,200,000 received for the sale of a
working interest in five of our prospects resulting in the amount of our unproved oil and gas properties of $1,147,940 reflected on our balance sheet.
In March 2014, the Company entered into a farm out letter agreement with Texas South Energy, Inc. (“Texas South”) relating to five prospects located within the blocks the Company bid on at the Central Gulf of Mexico Lease Sale 231. Under the terms of the farm-out letter agreement, Texas South may acquire up to a 20% working interest in 5 prospects for up to $10 million. As of June 30, 2014, the Company had received $8.2 million of the proceeds from the agreement. In accordance with full cost requirements, the Company recorded the proceeds from the transaction as an adjustment to capitalized costs with no gain recognition.
As of
June 30, 2014, the Company was owed $104,885 by the BOEM for the lease deposit on the lease which was not awarded. This amount was received in July of 2014.
NOTE 5 – RELATED PARTY TRANSACTIONS
In May 2013, James Askew resigned as the Company’s chief executive officer. Simultaneously, John Seitz was appointed chief executive officer and chairman of the board of directors.
In May 2013, Ronald A. Bain was appointed as the president and chief operating officer, and Dwight "Clint" M. Moore was appointed as the vice president and secretary.
During April through September 2013, the Company entered into convertible promissory notes whereby it borrowed a total of $6,500,000 from John Seitz, its current chief executive officer. The notes are due on demand, bear interest at the rate of 5% per annum, and are convertible into shares of common stock at a conversion price equal to $0.12 per share of common stock (the then offering price of shares of common stock to unaffiliated investors). In May 2013, John Seitz converted $1,200,000 of the aforementioned debt into 10,000,000 shares of common stock, which shares were issued in July 2013. As of June 30, 2014, there was a total of $298,183 accrued interest associated with these loans and the Company has recorded $94,319 in interest expense for the year ended September 30, 2013 and $69,892 and $203,864 in interest expense for the three and nine months ended June 30, 2014.
During September 2013, the Company entered into convertible promissory notes whereby it borrowed a total of $200,000 from Dr. Ronald Bain, its current president and chief operating officer, and his affiliate ConRon. The notes are due on demand, bear interest at the rate of 5% per annum, and are convertible into shares of common stock at a conversion price equal to $0.12 per share of common stock (the then offering price of shares of common stock to unaffiliated investors). As of September 30, 2013, there was a total of $667 accrued interest associated with these loans and the Company has recorded interest expense for the same amount. In October 2013, Dr. Bain converted principal and accrued interest in the amount of $180,408 into 1,503,403 shares of common stock (a conversion rate of $0.12 per share). In November 2013, the Company repaid in full the $20,000 remaining principal balance (plus accrued interest) of the convertible promissory note.
In October 2013, the Company issued 937,500 shares of common stock to Brady Rodgers, the Company’s vice president Engineering and Business Development, to settle $112,500 of fees due to Mr. Rodgers for services rendered.
In October 2013, the Company issued to Brady Rodgers, the Company’s vice president Engineering and Business Development, a ten-year option to purchase 2,000,000 shares of the Company’s common stock at an exercise price of $0.12 per share. A fair value of $177,298 was computed using the Black-Scholes option-pricing model, of which $24,562 has been expensed during the three months ended June 30, 2014, and $81,246 for the nine months ended June 30, 2014. The options vest 50% in October 2014 and 50% in October 2015.
As of June 30, 2014, executive officers paid $56,480 to trade vendors on behalf of the Company in the ordinary course of business.
Domenica Seitz, CPA, has provided accounting consulting services to the Company. During the fiscal year ended September 30, 2013, the amount of services rendered was nominal and was donated. During the nine month period ended June 30, 2014, the level of services provided increased and was valued at $44,630 based on market-competitive salaries, time devoted and professional rates. The Company has accrued this amount, and it has been reflected in the June 30, 2014 condensed financial statements. The Company has also engaged a third party professional services firm to assist with accounting and internal controls and maintains the proper segregation of duties.
James M. Askew is the sole officer, director and greater than 10% shareholder of Texas South Energy, Inc. (“Texas South”), the entity with which the Company entered into the March 2014 farm-out letter agreement pursuant to which the Company agreed to convey certain working interests in potential prospects. Subsequent to the execution of the March 2014 Texas South farm-out agreement, Mr. Askew resigned as a director of the Company.
Mr. Seitz has not received a salary since May 31, 2013, the date he commenced serving as our chief executive officer and accordingly, no amount has been accrued on our financial statements. Prior to serving as an executive officer, Mr. Seitz served as a Company consultant and the Company has accrued $120,000 of consulting compensation owed to Mr. Seitz. As of June 30, 2014, Mr. Seitz beneficially owns 244,212,223 shares of the Company’s common stock (including shares issuable upon conversion of the principal amount of convertible notes held by Mr. Seitz). The Company recognizes that his level of stock ownership significantly aligns his interests with shareholders’ interests. From time to time, the compensation committee may consider compensation arrangements for Mr. Seitz given his continuing contributions and leadership.
In connection with the Company’s 2013 private placement of common stock at a purchase price of $0.12 per share, Mr. John Malanga, our CFO, purchased 166,667 shares, Mr. Brady Rodgers, our V.P. Engineering and Business Development purchased 256,106 shares of common stock, Mr. Paul Morris, a director, purchased 1,666,667 shares of common stock, and Mr. Richard Langdon, a director, purchased 416,667 shares of common stock.
In June 2014, the Company entered into a promissory note whereby it borrowed a total of $1,160,000 from John Seitz, its current chief executive officer. The note is due on demand, not convertible and bears interest at the rate of 5% per annum.
NOTE 6 – COMMON STOCK/PAID IN CAPITAL
Effective April 2012, the Company completed a reincorporation in the State of Delaware from the State of Utah.
During February through March of 2013 the Company sold 47,000,000 shares of common stock for cash proceeds of $470,000, agreed to issue 6,000,000 shares of common stock to two third parties for services valued at $60,000, and agreed to issue 10,000,000 shares of common stock, valued at $100,000, to John B. Connally III as consideration for termination of a consulting agreement. During this period, the Company also entered into an Assignment Agreement (see Note 3 above) in exchange for the issuance of 243,516,666 shares of common stock valued at $2,435,167. All of these shares were issued in April of 2013.
During April through October of 2013 the Company sold 68,496,107 shares of common stock for proceeds of $8,219,533 or $.12 per share. The Company issued 10,000,000 shares of common stock to Mr. Seitz, its chief executive officer, to settle $1,200,000 in convertible debt (see Note 5, above) and 1,503,403 shares of common stock to Dr. Ron Bain, its chief operating officer, for the conversion of $180,408 of convertible debt and accrued interest (see Note 5 above). The Company also issued 937,500 shares of common stock to Mr. Rodgers, the Company’s vice president engineering, to settle $112,500 of fees due to Mr. Rodgers for services rendered.
In October 2013, the Company issued 1,620,000 shares of common stock, with a fair value of $194,400, to three employees pursuant to employment arrangements. The Company also made gross-up payments to cover the three employees’ personal income tax obligations in connection with these grants.
In October 2013, the Company issued to Brady Rodgers, the Company’s vice president Engineering and Business Development, a ten-year option to purchase 2,000,000 shares of the Company’s common stock at an exercise price of $0.12 per share. A fair value of $177,298 was computed using the Black-Scholes option-pricing model, of which $24,562 has been expensed during the three months ended June 30, 2014 and $81,246 for the nine months ended June 30, 2014. The options vest 50% in October 2014 and 50% in October 2015.
In March 2014, the Company awarded 500,000 shares of restricted stock to an employee, of which one-half vests in April 2015 and the remaining half vests in April 2016.
In March 2014, the Company issued an aggregate of 1,000,000 shares of restricted stock to two non-employee directors. The restricted stock is subject to vesting pursuant to which one-half will vest on March 27, 2015 and the remaining one-half will vest on March 27, 2016.
In May 2014, the Company awarded 550,000 shares of restricted stock to an employee, one-half of which vests in May 2015 and the remaining half vests in May 2016.
At our annual meeting in May of 2014 our shareholders approved increasing the number of authorized shares of common stock from 750,000,000 to 975,000,000. The number of authorized shares of preferred stock was not changed and is 50,000,000.
NOTE 7– STOCK-BASED COMPENSATION
Stock-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized over the required vesting period. The Company recognized $52,563 and $109,247 in stock-based compensation expense during the three and nine months ended June 30, 2014, and $0 during the three and nine months ended June 30, 2013. A portion of these costs were capitalized to unproved properties and the remainder were recorded as general and administrative expenses.
The following table summarizes the Company’s stock option activity during the nine-month period ended June 30, 2014.
|
Number of Options
|
Weighted Average Exercise Price
|
Outstanding at beginning of period
|
-
|
-
|
Granted
|
2,000,000
|
$0.12
|
Exercised
|
-
|
-
|
Cancelled
|
-
|
-
|
Outstanding at end of period
|
2,000,000
|
$0.12
|
|
|
|
Exercisable at end of period
|
-
|
-
|
The Black-Scholes option-pricing model is used to estimate the fair value of options granted. The weighted-average fair values of stock options granted for the nine months ended June 30, 2014 were based on the following assumptions at the date of grant as follows:
Expected dividend yield
|
0%
|
Expected stock price volatility
|
91.42%
|
Risk-free interest rate
|
1.53%
|
Expected life of options
|
5.75 years
|
Weighted-average grant date fair value, per option
|
$0.09
|
The Company used a variety of comparable and peer companies to determine the expected volatility. The Company has no historical data regarding the expected life of the options and therefore used the simplified method of calculating the expected life. The risk free rate was calculated using the U.S. Treasury constant maturity rates similar to the expected life of the options, as published by the Federal Reserve. The Company has no plans to declare any future dividends.
As of June 30, 2014 there was $96,052 of unrecognized stock-based compensation cost related to the stock option grant that is expected to be expensed over a weighted-average period of one and one-half years. There was $820,000 of intrinsic value for options outstanding as of June 30, 2014.
NOTE 8– COMMITMENTS AND CONTINGENCIES
In March 2013, the Company licensed certain seismic data pursuant to two agreements. With respect to the first agreement, as of June 30, 2014, the Company has paid $2,135,500 in cash, and in April 2014 paid an additional $2,500,000 in cash by releasing the funds being held in the escrow account. The Company is obligated to provide an additional $1,500,000 in an escrow account upon the delivery of certain seismic data by the vendor to the Company, which occurred in July 2014. This amount will be paid to the seismic company in March of 2015. With respect to the second agreement, as of June 30, 2014, the Company has paid $3,009,195 in cash, and is obligated to pay $1,003,065 during April 2015.
In July 2013, the Company entered into a two-year office lease agreement. The agreement calls for monthly payments of approximately $20,200 for the first twelve months and $20,500 for the second twelve months. In addition, the Company paid a security deposit of $18,760 in July 2013.
In October 2013, the Company purchased an insurance policy and financed the premium by executing a note payable in the amount of $114,748. The balance of the note payable at June 30, 2014 is $31,361.
In May 2014, the Company purchased liability insurance policies and financed the premium by executing a note payable in the amount of $6,878. The balance of the note payable at June 30, 2014 is $6,271.
On May 13, 2014, the Company entered into an agreement with a seismic data reprocessing company in which the Company agreed to purchase an aggregate of $3 million of reprocessing services prior to May 2015, of which $1.5 million will be paid in cash and the remaining by the issuance of 2 million shares of our common stock using the valuation of $0.75 per share. As of June 30, 2014, no services have been provided by the seismic data reprocessing company and the Company has not paid for any services or issued any shares under this contract.
NOTE 9 – SUBSEQUENT EVENTS
In July 2014, the Company sold to 43 accredited investors an aggregate of 33,448,335 shares of common stock at a purchase price of $0.24 per share for gross proceeds of $8,027,600. Ron Bain, chief operating officer, purchased 750,000 shares, and Paul Morris, director, purchased 416,667 shares.
In July 2014, the Company deposited $1,500,000 into the escrow account to be paid out in the first quarter of 2015 according to the terms of the contract with a seismic company dated March 22, 2013 and amended March 12, 2014.
On July 28, 2014, the Company appointed John H. Malanga its new chief financial officer and chief accounting officer. John Seitz relinquished his title as chief financial officer and chief accounting officer on such date, but will continue to serve as the Company’s chief executive officer and Chairman of the Board of Directors.
In July 2014, John H. Malanga, chief financial officer and chief accounting officer, was awarded 2,500,000 shares of restricted stock with a fair value of $600,000, one-half of which vests in July 2015 and the remaining half vests in July 2016.