Item 1. Business
Overview
We are an independent oil and gas exploration company with large prospects in offshore Republic of Guinea ("Guinea") in Northwest Africa pursuant to rights granted to us by Guinea (the "Concession") under a Hydrocarbon Production Sharing Contract, as amended ("PSC").
We sold a 23% gross interest in the Concession to Dana Petroleum, PLC ("Dana"), a subsidiary of the Korean National Oil Corporation, during the fourth quarter of fiscal 2010 and a 40% gross interest to Tullow Guinea Ltd. ("Tullow") during the second quarter of fiscal 2013. Tullow became the Operator of the Concession on April 1, 2013. Dana and Tullow transferred their interest back to us on August 15, 2016. On September 15, 2016, we signed a Second Amendment to the PSC with the Government of Guinea granting us 100% interest in the Concession and designating us as Operator upon receipt of a Presidential Decree. We refer to Tullow, Dana and us in the Concession as the "Consortium".
Pursuant to the terms Share Purchase Agreement ("Tullow SPA") between Tullow and us, Tullow paid us $26 million in cash and agreed to pay our entire participating interest share of expenditures associated with joint operations in the Concession up to a gross expenditure cap of $100 million incurred during the carry period that began on September 21, 2013. The Consortium planned to drill the exploration well in the ultra-deepwater area of the Concession the first half of calendar 2014, but Tullow called Force Majeure in March of 2014 based on the mere existence of Department of Justice ("DOJ") and Securities and Exchange Commission ("SEC") investigations pursuant to the Foreign Corrupt Practices Act of the United States ("FCPA Investigations"). Tullow withdrew its Force Majeure declaration in May of 2014, but did not resume petroleum operations citing the existence of the FCPA Investigations and the Ebola outbreak as the reason. The DOJ investigation ended in May 2015, the SEC investigation ended in September 2015, and the World Health Organization declared Guinea Ebola free on December 29, 2015. Notwithstanding the resolution of the FCPA Investigations, Dana insisted on further specific title assurances from the Government of Guinea. At a Petroleum Operations Management Committee meeting with the Government of Guinea in Conakry on December 16 and 17, 2015, Tullow and SCS obtained a PSC Amendment that we believed provided such further assurances. Instead of signing the PSC Amendment both Tullow and Dana refused to execute the agreement. Unable to see a path forward, we filed legal actions against Tullow and Dana under our Joint Operating Agreement. On August 15, 2016, we entered into a Settlement and Release
Agreement with Tullow and Dana ("Settlement Agreement"), as more fully described in Note 10 "Subsequent Events" in the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K, that gave us 100% of the interest under the PSC, property useful in the drilling of an exploratory well, and cash, in return for a mutual release of all claims. On August 19, 2016, we signed a non-binding Memorandum of Understanding with the Government of Guinea and executed a Second Amendment to the PSC ("2016 Amendment") on September 15, 2016. As more fully described below, upon receipt of a Presidential Decree, the 2016 Amendment will give us a one year extension to the second exploration period of the PSC to September 22, 2017 ("PSC Extension Period"). In addition to clarifying certain elements of the PSC, we agreed in the 2016 Amendment to drill one (1) exploratory well to a minimum depth of 2,500 meters below the seabed within the PSC Extension Period with a projected commencement date of April 2017 (the "Extension Well") with the option of drilling additional wells. If the Extension Well is not drilled within the PSC Extension Period, we will owe the Government of Guinea the difference between the actual expenditures in Guinea related to the well and $46,000,000. Fulfillment of the work obligation exempts us from the expenditure obligations during the PSC Extension Period.
In turn, we will retain an area equivalent to approximately 5,000 square kilometers in the Guinea offshore and will provide the Government of Guinea: (1) A parent company guarantee for the Extension Well, (2) monthly progress reports and a reconciliation of budget to actual expenditures, (failure to provide the reports and assurances on a timely basis may result in a notice of termination with a 30 day period to cure), and (3) guarantees to Guinea that (a) no later than January 21, 2017, we will provide a mutually acceptable security for $5,000,000 on terms customary in international petroleum operations, provided that this security is to be released at the time the drilling rig for the Extension Well is on location offshore Guinea, and (b) no later than April 12, 2017, we will deliver a mutually acceptable security for the difference between $46,000,000 and the amount spent to date on the Extension Well. For the purposes of calculation for this clause, however, only costs spent for services and goods provided in Guinea shall be taken into account until the drilling rig to be used in the drilling of the Extension Well is located in the territorial waters of the Republic of Guinea. If we do not provide either security by the specified dates, the Government of Guinea may terminate the PSC immediately and without prior notice to remedy such deficiency.
Additionally, we agreed to limit the cost recovery pool to date to our share of expenditures in the PSC since 2009 (estimated to be approximately $150,000,000) and move into the territory of Guinea the long lead items we received in the Settlement Agreement that are currently in Takoradi, Ghana for the drilling of the Extension Well by January 31, 2017. Finally, we agreed to allocate and administer a training budget during the PSC Extension Period for the benefit of the Guinea National Petroleum Office of $250,000 in addition to any unused portion of the training program under Article 10.3 of the PSC, estimated to be approximately $500,000.
Failure to comply with the drilling and other obligations of the PSC as amended subjects us to financial penalties and a risk of loss of the Concession. The continued delays have affected adversely the ability to explore the Concession and reduces the attractiveness of the Concession to prospective industry participants and financing sources. While we currently hold 100% of the Concession, it is unknown whether we will be able to raise the necessary funds to drill the Extension Well during the PSC Extension Period.
Since the grant of the Concession, we have conducted 2-dimensional ("2D") and 3-dimensional ("3D") seismic surveys over a portion of the Concession and drilled one non-commercial well completed in February of 2012. The most recent 3D seismic survey covering approximately 4,000 square kilometers in the deeper water portion of the Concession was completed and processed.
As of March 31, 2016, based on our impairment assessment, we fully impaired the $14,331,000 of unproved oil and gas properties. This impairment assessment was based on the inability to resume
petroleum operations and drill the next exploration obligation well as required by the PSC. Despite this impairment, we continued to pursue opportunities in order to begin drilling activities in our Concession. Our Settlement and Release with Tullow and Dana, coupled with the one (1) year extension to the PSC provided us the best chance to drill the Extension Well during the PSC Extension Period.
Our primary focus is the advancement of exploration work in Guinea. We have no source of operating revenue, and there is no assurance when we will, if ever. We have no operating cash flows, and we will require substantial additional funds, through additional participation arrangements, securities offerings, or through other means, to fulfill our business plans. If we farm-out additional interests in the Concession, our percentage will decrease. The terms of any such arrangements, if made, may not be advantageous. Our need for additional funding may also be affected by the uncertainties involved with resumption of petroleum operations and the planned exploratory well, and other risks discussed in Item 1A.
Item 1A. Risk Factors
An investment in our common stock involves significant risks. Prior to making a decision about investing in common stock, and in consultation with your own financial and legal advisors, you should carefully consider, among other matters, the following risk factors. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also inadvertently affect us. If any of the following risks occur, our business, financial condition or results of operations could be materially harmed.
Risks Relating to Our Business and the Industry in Which We Operate.
Our business is dependent on a single exploration asset.
The Concession is our single exploration asset. We have been conducting exploration work related to offshore Guinea since 2002, including significant seismic data surveys, processing, evaluations and studies, but we have no reserves and there is no assurance that our exploration work will result in any discoveries or in any commercial success. The PSC, as amended in September 15, 2016, requires the drilling of a minimum of one additional exploration well to a minimum depth of 2,500 meters below the seabed at a minimum cost of $46 million by September 21, 2017. The PSC has financial and other administrative additional obligations that need to be performed to maintain compliance with the PSC. Failure to comply could subject us to risk of loss of the Concession. In addition, oil and natural gas operations in Africa may be subject to higher political, health and security risks than operations in other areas of the world. Any adverse development affecting our operations such as, but not limited to, the drilling and operational hazards described below, could result in damage to, or destruction of, any wells and producing facilities constructed on the Concession as well as damage to life. As the Concession is our only exploration asset, any adverse development affecting it could have a material adverse effect on our financial position and results of operations.
We require additional financing to meet our obligations under the PSC and are unable to predict our ability to meet those obligations.
Our current capital resources are not sufficient to cover the required additional exploration activity in the Concession. We will require additional funding to pay for any exploration activity. We will seek such funding through additional sales of interest in the Concession, from equity or debt or other financial instruments. The Concession offshore Guinea is our principal asset and we do not have the funds necessary to fulfill our obligations under the PSC as amended.
In order to retain the Concession, we settled our disputes with Tullow and Dana with limited financial benefit to SCS and require additional financing. Our ability to obtain additional financing is likely dependent upon the valuation of this asset, prospects for exploration in the Concession area, the time left in the Concession, as well as market and other forces outside of our control. Continued delays to resume petroleum operations had a material adverse effect on our Concession and we are unable to predict if we will be able to obtain the necessary financing in time to cover the PSC and operational obligations for the PSC Extension Period. We do not have any firm commitments from external financing sources or third parties to allow us to fulfill our obligations under the PSC, and if obtained, the terms may not be advantageous to us. We may seek such funding through additional sales of interest in the Concession, from equity or debt financings, or through other means.
The absence of cash inflows into our company raises substantial doubts about our ability to continue as a going concern as reflected in the opinion of the auditors of our financial statements. If we are not successful in carrying out our plans, we may not be able to continue operations.
Our financial statements have been prepared assuming that we will continue as a going concern. As noted in Note 1 to our financial statements, the absence of cash inflows raises substantial doubt
about our ability to continue as a going concern. Our auditors have noted this concern in their opinion on our financial statements. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our plans to address this problem are discussed in Note 1. There can be no assurance that we will be successful in carrying out our plans to obtain additional cash resources. If we are unable to obtain additional cash resources, we may not be able to continue operations.
We have no proved reserves and our exploration program may not yield oil in commercial quantities or quality, or at all.
We have no proved reserves. We have drilled one exploratory well which had non-commercial results. We have identified prospects and leads based on seismic and geological information that we believe indicate the potential presence of hydrocarbons. However, we operated in a virgin basin without any hydrocarbon discoveries and the areas to be drilled may not yield oil in commercial quantities or quality, or at all. Even when properly used and interpreted, 2D and 3D seismic data and visualization techniques are only tools used to assist geoscientists in identifying subsurface structures and hydrocarbon indicators and do not enable the interpreter to know whether hydrocarbons are, in fact, present in those structures. Accordingly, we do not know if any of our prospects will contain oil in sufficient quantities, or at all, or quality to recover drilling and completion costs or to be economically viable. Even if oil is found in commercial quantities, construction costs of oil pipelines or floating production systems, as applicable, and transportation costs may prevent such leads from being economically viable. If these exploration efforts do not prove to be successful, our business, financial condition and results of operations will be materially adversely affected.
Efforts to attract commercial partners may not be successful and may not be on terms advantageous to us.
We have no source of operating revenue and will need to obtain additional resources through sales of additional interests in the Concession, equity or debt financings, or through other means. If we seek to sell additional interests in the Concession, we may not be successful in attracting a commercial partner, or the commercial partner may not have the capital resources or other attributes that are deemed desirable by us. If we enter into an arrangement, the terms may not be advantageous to us. Any such arrangement will likely involve the transfer of a negotiated interest in the Concession, which could reduce the potential profitability of our interest in the Concession.
An extended period of depressed oil and gas prices could adversely affect our financial condition, liquidity, ability to obtain financing and future operating results. Oil and gas prices are volatile, and we have no ability to control the price of oil and gas. A continued substantial or extended decline in prices could adversely affect our financial condition, liquidity, ability to obtain financing and future operating results.
We currently have no source of operating revenue and are no longer carried on our expenses in Guinea following the settlement with Tullow and Dana. Our financial condition is based solely on our ability to sell equity or debt securities to investors, enter into an additional joint operating or similar strategic relationship with an industry partner, sell interests related to the Concession or borrow funds. We expect that entering into these joint operating or similar relationships would entail transferring a portion of our interest in the Concession to such partner. Such investors would consider the price of oil and gas in making an investment decision. Prolonged periods of low oil and gas prices could adversely affect our financial condition, liquidity, ability to obtain financing, and operating results. Low oil and gas prices in the future will likely also reduce the amount of oil and gas that we could produce economically and could have a negative effect on our future financial results. Historically, oil and gas prices and markets have been volatile and they are likely to continue to be volatile, with prices
fluctuating widely in response to relatively minor changes in supply and demand, market uncertainty and a variety of additional factors that are beyond our control. These factors include:
• the level of domestic and foreign supplies of oil;
• the level of consumer product demand;
• weather conditions and natural disasters;
• political conditions in oil producing regions throughout the world;
• the ability of the members of the Organization of Petroleum Exporting Countries to agree to and maintain oil production;
• speculation as to the future price of oil and natural gas and the speculative trading of oil and natural gas futures contracts;
• price and production controls;
• political and economic conditions, including embargoes in oil-producing countries or affecting other oil-producing activities, particularly in the Middle East, Africa, Russia and South America;
• continued threat of terrorism and the impact of military and other action, including U.S. military operations in the Middle East;
• the level of global oil and natural gas exploration and production activity;
• the price of foreign oil imports;
• actions of governments;
• domestic and foreign governmental regulations;
• the price, availability and acceptance of alternative fuels;
• technological advances affecting energy consumption;
• global economic conditions; and
• the value of the U.S. dollar, the Euro and fluctuations in exchange rates generally.
These factors and the volatile nature of the energy markets make it impossible to predict oil and gas prices. Our inability to respond appropriately to changes in these factors could have a material adverse effect on our business plan, financial position, results of operations and future cash flows.
Legal fees and associated costs in connection with legal proceedings and the Tullow and Dana legal matters adversely affected our liquidity and financial condition and results of operations.
We are involved in legal proceedings and although we recently settled the arbitration against Tullow and Dana, we incurred significant legal fees in the arbitration proceedings.
The 2016 PSC Amendment significantly reduced our acreage in the Concession and we agreed to a very tight timeline to obtain financing and begin drilling the exploration well.
We received a one year extension and 100% of the Concession pursuant to rights granted to us under the 2016 PSC Amendment signed on September 15, 2016. Pursuant to the terms of the 2016 PSC Amendment, we agreed to relinquish an additional 77% of the remaining acreage, agreed to a timeline to drill a well planned for April 2017 and promised to provide security to the Government of Guinea and agreed to financial penalties for failure to drill the exploration well. Our reduced acreage, tight timeline, guarantees to the Government of Guinea, and financial penalties have reduced the value of the Concession and our ability to attract financing and third parties to join us in exploration
activities. There is no guarantee that we will be able to provide the promised security, raise the necessary funds or meet the drilling timeline..
The PSC is subject to renegotiation under certain conditions which may have an adverse impact upon our operations and profitability.
The PSC provides that should the Guinea government note material differences between provisions of the PSC and international standards or the Guinea Petroleum Code, the parties will renegotiate the relevant articles of the PSC. If the Guinea government identifies material differences between the PSC's provisions and international standards or the Guinea Petroleum Code, there is no assurance that we will be able to negotiate an acceptable modification to the PSC. If the parties are not successful in renegotiating the relevant articles of the PSC, the parties may be required to submit the matter to international arbitration. There is no assurance that any arbitration would be successful or otherwise lead to articles that are more favorable to us than the present articles. Therefore, the results of such negotiations or arbitration could be unfavorable to us and, as a result, could have a material adverse effect on our business, financial position, results of operation and future cash flows.
We may not be able to obtain the additional capital necessary to achieve our business plan.
Our business is capital intensive and we must invest a significant amount in our activities. We intend to make substantial capital expenditures to find, develop, and produce natural gas and oil reserves.
Additional capital could be obtained from a combination of funding sources. The current potential funding sources and the potential adverse effects attributable thereto, include:
• sales or assignments of interests in the Concession and exploration program, which would reduce any future revenues from that program while at the same time offsetting potential expenditures;
• offerings of equity, equity-linked and convertible debt securities, which would dilute the equity interests of our stockholders;
• debt and convertible debt offerings, which would increase our leverage and add to our need for cash to service such debt and which could result in assets being pledged as collateral; and
• borrowing from financial institutions, which may subject us to certain restrictive covenants, including covenants restricting our ability to raise additional capital or pay dividends.
It is difficult to quantify the amount of financing we may need to fund our business plan in the longer term. The amount of funding we may need in the future depends on various factors such as:
• our financial position;
• the cost of exploration and drilling;
• the prevailing market price of natural gas and oil; and
• the lead time required to bring any discoveries to production.
If we do not obtain capital resources in the future it is unlikely that we will be able to continue to pursue exploration offshore Guinea and our financial condition and operations will be adversely affected.
We are highly dependent on our management team and consultants, and any failure to retain the services of such parties could adversely affect our ability to effectively manage our operations or successfully execute our business plan.
Our business is dependent on retaining the services of a small number of key personnel of the appropriate caliber as the business develops. Our success is, and will continue to be to a significant extent, dependent upon the expertise and experience of the directors, senior management and certain key consultants, but the retention of their services cannot be guaranteed. The loss of key members of our management team or other highly qualified professionals has adversely affected our ability to effectively manage our overall operations or successfully execute current or future business strategies. If any further member of management, director, or other consultants were to leave our company, it may have a material adverse effect on our business, financial condition, results of operations and/or growth prospects.
We have claims and lawsuits against us that may result in adverse outcomes.
We are subject to a variety of claims and lawsuits concerning shareholder claims and other matters. Adverse outcomes in some or all of these claims may result in significant monetary damages or limit our ability to engage in our business activities. While we have director and officer insurance, it may not apply to or fully cover any liabilities we incur as a result of these lawsuits. Although management currently believes resolving all of these matters, individually or in the aggregate, will not have a material adverse impact on our financial statements, the litigation and other claims are subject to inherent uncertainties and management's view of these matters may change in the future. A material adverse impact on our financial statements also could occur for any period it was determined that an unfavorable final outcome is probable and reasonably estimable.
Drilling wells is speculative and potentially hazardous. Actual costs may be more than our estimates, and may not result in any discoveries. The cost of our recently drilled exploratory well was significantly higher than expected.
Exploring for and developing oil reserves involves a high degree of operational and financial risk, which precludes definitive statements as to the time required and costs involved in reaching certain objectives. The budgeted costs of drilling, completing, and operating wells are often exceeded. The cost of our exploratory well, the Sabu-1, was higher than we initially expected, primarily due to numerous delays and issues related to mechanical and operational matters on the rig, logistical delays resulting from limited port facilities in Guinea, and an expanded well logging program. In addition, oil was not discovered in commercial quantities. Unexpected delays and increases in costs associated with the upcoming well drilled in the future, could adversely affect our results of operation, financial position, liquidity and business plans.
Drilling may be unsuccessful for many reasons, including geological conditions, weather, cost overruns, equipment shortages and mechanical difficulties. Exploratory wells bear a much greater risk of loss than development wells. The successful drilling of an oil well may not be indicative of the potential for the development of a commercially viable field and will not necessarily result in a profit on investment. A variety of factors, both geological and market-related, can cause a well to become uneconomic or only marginally economic.
There are a variety of operating risks, including:
• blowouts, cratering and explosions;
• mechanical and equipment problems;
• uncontrolled flows of oil and gas or well fluids;
• fires;
• marine hazards with respect to offshore operations;
• formations with abnormal pressures;
• pollution and other environmental risks; and
• weather conditions and natural disasters.
Offshore operations are subject to a variety of operating risks particular to the marine environment, such as capsizing and collisions. Also, offshore operations are subject to damage or loss from adverse weather conditions. Any of these events could result in loss of human life, significant damage to property, environmental pollution, impairment of our operations and substantial losses.
The site for the next exploratory well we plan to drill will be in the ultra-deep water. Deepwater drilling generally requires more time and more advanced drilling technologies than exploration in shallower waters, involving a higher risk of equipment failure and higher drilling costs. In addition, even if there is a discovery, taking it to production presents risks that we may not be currently aware of. If we participate in the development of new subsea infrastructure and use floating production systems to transport oil from producing wells, these operations may require substantial time for installation or encounter mechanical difficulties and equipment failures that could result in significant liabilities, cost overruns, or delays. Furthermore, deepwater operations generally, and operations in West Africa in particular, lack the physical oilfield service infrastructure present in other regions. As a result, a significant amount of time may elapse between a deepwater discovery and the marketing of the associated oil and natural gas, increasing both the financial and operational risks involved with these operations. Because of the lack and high cost of this infrastructure, further discoveries we may make in Guinea may never be economically producible.
The cost of drilling rigs, equipment, supplies, personnel and oilfield services, as well as gathering systems and processing facilities, and our dependence on industry contractors generally, could adversely impact us.
We are dependent on industry contractors for the success of our oil and gas exploration projects. In particular, our drilling activity offshore of Guinea will require that we have access to offshore drilling rigs and contracts with experienced operators of such rigs. The availability and cost of drilling rigs and other equipment and services, and the skilled personnel required to operate those rigs and equipment is affected by the level and location of drilling activity around the world. An increase in drilling operations worldwide may reduce the availability and increase the cost to us of drilling rigs, other equipment and services, and appropriately experienced drilling contractors. The reduced availability of such equipment and services may delay our ability to discover reserves and higher costs for such equipment and services may increase our costs, both of which may have a material adverse effect on our business, results of operations and future cash flow. If we succeed in constructing oil wells, we may be required to shut them because access to pipelines, gathering systems or processing facilities may be limited or unavailable. If that were to occur, we would be unable to realize revenue from those wells until arrangements were made to deliver the production to market, which could cause a material adverse effect on our results of operations and financial condition.
We are exposed to the failure or non-performance of commercial counterparties.
Our operations will be dependent on certain third parties with whom we have commercial agreements (such as drilling contractors and the parties responsible for transporting and/or storing our production) for our future exploration, development, production, sales or other activities. The efficiency, timeliness and quality of contract performance by third party providers are largely beyond our direct control. If one or more of these third parties fails to meet its contractual obligations to us, or if such services are temporarily or permanently unavailable (for example, as a result of technical
problems or industrial action), or not available on commercially acceptable terms, we may experience a material adverse effect on our business, results of operations, financial condition and future cash flow. In addition, as a named party under the PSC, we could be held liable for the environmental, health and safety impacts arising out of the activities of our drilling project management contractor or any other third party service provider contracted by us or on our behalf, which could have a material adverse effect on our business, results of operations and future cash flow.
Participants in the oil and gas industry are subject to numerous laws that can affect the cost, manner or feasibility of doing business.
Exploration and production activities in the oil and gas industry are subject to local laws and regulations. We may be required to make large expenditures to comply with governmental laws and regulations, particularly in respect of the following matters:
• licenses for drilling operations;
• tax increases, including retroactive claims;
• unitization of oil accumulations;
• local content requirements (including the mandatory use of local partners and vendors); and
• environmental requirements and obligations, including investigation and/or remediation activities.
Under these and other laws and regulations, we could be liable for personal injuries, property damage and other types of damages. Failure to comply with these laws and regulations also may result in the suspension or termination of our operations and subject us to administrative, civil and criminal penalties. Moreover, new laws and regulations may be enacted and current laws and regulations could change or their interpretations could change, in ways that could substantially increase our costs. These risks may be higher in the developing countries in which we conduct our operations, where there could be a lack of clarity or lack of consistency in the application of these laws and regulations. Any resulting liabilities, penalties, suspensions or terminations could have a material adverse effect on our financial condition and results of operations.
Furthermore, the explosion and sinking in April 2010 of the Deepwater Horizon oil rig during operations on the Macondo exploration well in the Gulf of Mexico, and the resulting oil spill, may have increased certain of the risks faced by those drilling for oil in deepwater regions, including increased industry standards, governmental regulation and enforcement, and less favorable investor perception of the risk-adjusted benefits of deepwater offshore drilling.
The occurrence of any of these factors, or the continuation thereof, could have a material adverse effect on our business, financial position or future results of operations.
We may not be able to commercialize our interests in any oil and natural gas produced from our Guinea Concession.
Our Concession is in the deepwater area offshore Guinea. Even if we find accumulations of hydrocarbons, we may not be able to commercialize our interests due to the geology, water depth, distance to shore, or a ready market for the hydrocarbons. Further, the development of the market for natural gas in West Africa is in its early stages. Currently there is no infrastructure to transport and process natural gas on commercial terms in Guinea, and the expenses associated with constructing such infrastructure ourselves may not be commercially viable given local prices currently paid for natural gas. Accordingly, there may be limited or no value derived from any natural gas produced from our Guinea Concession.
Our insurance coverage may be insufficient to cover losses, or we could be subject to uninsured liabilities which could materially affect our business, results of operations or financial condition.
There are circumstances where insurance will not cover the consequences of an event, or where we may become liable for costs incurred in events or incidents against which we either cannot insure or may elect not to have insured (whether on account of prohibitive premium costs or for other commercial reasons). Further, insurance covering certain matters (such as sovereign risk, terrorism and many environmental risks) may not be available to us. Moreover, we may be subject to large excess payments in the event a third party has a valid claim against us, and therefore may not be entitled to recover the full extent of our loss, or may decide that it is not economical to seek to do so. The realization of any significant liabilities in connection with our future activities could have a material adverse effect on our business, results of operations, financial condition and future cash flow.
There are risks associated with the drilling of oil and natural gas wells which could significantly reduce our revenues or cause substantial losses, impairing our future operating results. We may become subject to liability for pollution, blow-outs or other hazards, including those arising out of the activities of our third-party contractors. We intend to obtain insurance with respect to certain of these hazards, but such insurance likely will have limitations that may prevent us from recovering the full extent of such liabilities. The payment by us of such liabilities could reduce the funds available to us or could, in an extreme case, result in a total loss of our properties and assets. Moreover, oil and natural gas production operations are also subject to all the risks typically associated with such operations, including premature decline of reservoirs and the invasion of water into producing formations.
We may incur a variety of costs to engage in business transactions, and the anticipated benefits of those transactions may never be realized.
As a part of our business strategy, we enter into business transactions, or significant investments in, other assets, particularly those that would allow us to produce oil and natural gas and generate revenue to fund our exploration activities. Any future acquisitions would be accompanied by risks such as:
• diversion of our management's attention from ongoing business concerns;
• our potential inability to maximize our financial and strategic position through the successful development of the asset or assets acquired;
• impairment of our relationship with our existing employees if we cannot hire employees to staff any new operations and our existing employees are required to staff both old and new operations; and
• maintenance of uniform standards, controls, procedures and policies.
We cannot guarantee that we will be able to successfully integrate any business, products, technologies or personnel that we might acquire in the future, and our failure to do so could harm our business.
We have competition from other companies that have larger financial and other resources than we do, which puts us at a competitive disadvantage.
A large number of companies and individuals engage in drilling for gas and oil, and there is competition for the most desirable prospects. We are likely to face competition from international oil and gas companies, which already may have significant operations in a region, together with potential new entrants into such markets, any of which may have greater financial, technological and other resources than us. There is a high degree of competition for the discovery and acquisition of properties considered to have a commercial potential. We compete with other companies for the acquisition of oil
and gas interests, as well as for the recruitment and retention of qualified employees and other personnel.
There can be no assurance that we will be able to continue to compete effectively with other existing oil and gas companies, or any new entrants to the industry. Any failure by us to compete effectively could have a material adverse effect on our business, results of operations, financial condition and future cash flow.
We do not have reserve reports for the Concession and our expectations as to oil and gas reserves are uncertain and may vary substantially from any actual production.
We do not have reserves nor do we have any reserve reports for the Concession. A reserve report is the estimated quantities of oil and gas based on reports prepared by third party reserve engineers. Reserve reporting is a subjective process of estimating underground accumulations of oil and natural gas that cannot be measured in an exact manner. Expectations as to oil and gas reserves are uncertain and may vary substantially from any actual production.
Risks Relating to Operating in Guinea
Geopolitical instability where we operate subjects us to political, economic and other uncertainties.
We conduct business in Guinea, which is in a region of the world where there have been prior civil wars, revolutions, coup d'états and internecine conflicts. There is the risk of political violence and increased social tension in Guinea as a result of the past political upheaval, and there is a risk of civil unrest, crime and labor unrest at times. Since 2010, democratic elections have been held, a president was democratically elected and re-elected. While these developments indicate that the political situation in Guinea is improving, external or internal political forces potentially could create a political or military climate that might cause a change in political leadership, the outbreak of hostilities, or civil unrest. Such uncertainties could result in our having to cease our Guinea operations and result in the loss or delay of our rights under the PSC.
Further, we face political and economic risks and other uncertainties with respect to our operations, which may include, among other things:
• loss of future revenue, property and equipment, as a result of hazards such as expropriation, war, acts of terrorism, insurrection and other political risks;
• increases in taxes and governmental royalties;
• unilateral renegotiation or cancellation of contracts by governmental entities;
• difficulties enforcing our rights against a governmental agency because of the doctrine of sovereign immunity and foreign sovereignty over international operations;
• changes in laws and policies governing operations of foreign-based companies; and
• currency restrictions and exchange rate fluctuations.
Realization of any of these factors could have a material adverse effect on our business, financial condition, results of operations and/or growth prospects. The Consortium's operations in Guinea also may be adversely affected by laws and policies of multiple jurisdictions.
An Epidemic of the Ebola virus disease in Guinea could adversely affect our business operations and financial condition.
There was an outbreak of the Ebola virus disease in Guinea. While the World Health Organization declared Guinea Ebola free on December 29, 2015, any future outbreak of the Ebola virus will adversely affect our business operations and financial condition.
Any drilling activities in Guinea will require safe access to the Conakry airport and port as well as other infrastructure in Guinea. If there is another Ebola virus outbreak, drilling plans will likely be delayed, could be compromised and costs of operations will be increased. Further, if contractors or subcontractors impose travel bans or personnel refuse to travel to Guinea, drilling plans will be further delayed or interrupted after commencement. It is likely that the cost of any services could be significantly higher than planned which in turn could have a material adverse effect on our liquidity, business, and results of operations.
We operate in Guinea, a country where corrupt behavior exists that could impair our ability to do business in the future or result in significant fines or penalties.
We operate in Guinea, a country where governmental corruption has been known to exist. There is a risk of violating either the US Foreign Corrupt Practices Act, laws or legislation promulgated pursuant to the 1997 OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions or other applicable anti-corruption regulations that generally prohibit the making of improper payments to foreign officials for the purpose of obtaining or keeping business. In addition, the future success of our Guinea operations may be adversely affected by risks associated with international activities, including economic and labor conditions, political instability, risk of war, expropriation, terrorism, renegotiation or modification of existing contracts, tax laws and changes in exchange rates.
We have been subject to a Department of Justice and Securities and Exchange Commission FCPA investigation into how we obtained or retained the Concession and spent approximately $12.8 million in legal fees in working with the US Government. Those matters were resolved in 2015, but should the DOJ, the SEC, or Guinea open additional investigations we currently do not have the financial ability to bear the cost of additional investigations and are unable to predict whether we will be able to raise the funds to properly defend the Company.
We are subject to governmental regulations, the cost of compliance with which may have an adverse effect on our financial condition, results of operations and future cash flow.
Oil and gas operations in Guinea will be subject to government regulation and to interruption or termination by governmental authorities on account of ecological and other considerations. It is impossible to predict future government proposals that might be enacted into law, future interpretation of existing laws or future amendments to the Guinea Petroleum Code or any other laws, or the effect those new or amended laws or changes in interpretation of existing laws might have on us. Restrictions on oil and gas activities, such as production restrictions, price controls, tax increases and pollution and environmental controls may have a material adverse effect on our financial condition, results of operations and future cash flows.
Social, economic and health conditions in Guinea may adversely affect our business, results of operation, financial condition and future cash flow.
As all of our potential revenue generating assets are currently located in Guinea, our operations are dependent on the economic and political conditions prevailing in Guinea. Accordingly, we are subject to the risks associated with conducting business in and with a foreign country, including the risks of changes in the country's laws and policies (including those relating to taxation, royalties,
acquisitions, disposals, imports and exports, currency, environmental protection, management of natural resources, exploration and development of mines, labor and safety standards, and historical and cultural preservation). The costs associated with compliance with these laws and regulations are substantial, and possible future laws and regulations as well as changes to existing laws and regulations could impose additional costs on us, require us to incur additional capital expenditures and/or impose restrictions on or suspensions of our operations and delays in the development of our assets.
Further, these laws and regulations may allow government authorities and private parties to bring legal claims based on damages to property and injury to persons resulting from the environmental, health and safety impacts of our past and current operations and could lead to the imposition of substantial fines, penalties or other civil or criminal sanctions. If material, these compliance costs, claims or fines could have a material adverse effect on our business, results of operations, financial condition and/or growth prospects. In addition, Guinea has high levels of poverty, crime, unemployment and an undeveloped health care system.
The legal and judicial system in Guinea is relatively undeveloped and subject to frequent changes, and we may be exposed to similar risks if we operate in certain other jurisdictions.
Guinea has a less developed legal and judicial system than more established economies which could result in risks such as: (i) effective legal redress in the courts of such jurisdictions, whether in respect of a breach of contract, law or regulation, or in an ownership dispute, being more difficult to obtain; (ii) a higher degree of discretion on the part of Governmental authorities who may be susceptible to corruption; (iii) the lack of judicial or administrative guidance on interpreting applicable rules and regulations; (iv) inconsistencies or conflicts between and within various laws, regulations, decrees, orders and resolutions; or (v) relative inexperience of the judiciary and courts in such matters. In Guinea and certain other jurisdictions, the commitment of local business people, government officials and agencies and the judicial system to abide by legal requirements and negotiated agreements may be more uncertain, creating particular concerns with respect to the Concession or other licenses, permits or approvals required by us for the operation of our business, which may be susceptible to revision or cancellation, and legal redress may be uncertain or delayed. There can be no assurance that joint ventures, licenses, license applications or other legal arrangements will not be adversely affected by the actions of government authorities or others, and the effectiveness of and enforcement of such arrangements in these jurisdictions cannot be assured.
Risks Relating to Our Common Stock
Uncertainties and our present capital resources, absent a cash inflow, create substantial doubt we can continue as a going concern. If we do not obtain additional financing, we could be forced to curtail operations.
Due to uncertainties related to the cost, pendency and ultimate outcome of legal proceedings and the costs and outcome of any ultra-deep water exploration well to be drilled, there is substantial doubt about our ability to continue as a going concern. If we are unable to obtain additional financing, we could be unable to continue exploration and execute our business plan, and we could be forced to curtail operations.
The price of our common stock historically has been volatile. This volatility may affect the price at which you could sell your common stock, and the sale of substantial amounts of our common stock could adversely affect the price of our common stock.
The closing price for our common stock has varied between a high of $1.98 on November 3, 2015 and a low of $0.36 on June 29, 2016 for the fiscal year ended June 30, 2016. On September 16, 2016, the closing price of our common stock was $1.14. This volatility may affect the price at which an investor could sell the common stock, and the sale of substantial amounts of our common stock could
adversely affect the price of our common stock. Our stock price is likely to continue to be volatile and subject to significant price and volume fluctuations in response to market and other factors, including the other factors discussed in "-Risks Relating to Our Business and the Industry in Which We Operate"; variations in our quarterly operating results from our expectations or those of securities analysts or investors; downward revisions in securities analysts' estimates; and announcement by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments.
Our common stock was delisted from the New York Stock Exchange ("NYSE") on March 10, 2015 and we began trading on the OTCQX market on March 11, 2015. Delisting from the NYSE has limited the liquidity of our common stock, and hinders our ability to raise additional capital as well as having other negative results.
Our common stock was delisted from the NYSE in March 2015 due to our failure to satisfy the NYSE's continued listing criteria. Our common stock is now traded on the OTCQX which is a less prestigious and less active marketplace. Accordingly, liquidity in the trading of our common stock is limited, which could limit the ability of shareholders to sell securities in the secondary market and limit our ability to raise funds.
Trading on an over-the-counter quotation system could adversely affect our ability to raise additional financing through public or private sales of equity securities and could also have other negative results, including the loss of institutional investor interest and fewer business development opportunities.
We may issue additional shares of common stock in the future, which could adversely affect the market price of our shares and cause dilution to existing stockholders.
We will seek to raise funds through a variety of means and plan to issue additional shares of our common stock in the future which could adversely affect the market price of our shares. Significant sales of shares of our common stock by major stockholders, or the public perception that an offering or sale may occur also could have an adverse effect on the market price of shares of our common stock. Issuance of additional shares of common stock will dilute the percentage ownership interest of the existing stockholders, and may dilute the book value per share of our shares of common stock held by existing stockholders.
Sales of substantial amounts of shares of our common stock in the public market could harm the market price of the shares of common stock.
The sale of substantial amounts of shares of our common stock (including shares issuable upon exercise of outstanding options and warrants to purchase shares) may cause substantial fluctuations in the price of shares of our common stock. Because investors may be more reluctant to purchase shares of our common stock following substantial sales or issuances, the sale of shares in an offering could impair our ability to raise capital in the near term.
Delaware law and our charter documents may impede or discourage a takeover, which could adversely impact the market price of our shares.
We are a Delaware corporation, and the anti-takeover provisions of Delaware law impose various impediments to the ability of a third party to acquire control of us, even if a change in control would be beneficial to our existing stockholders. Certain provisions of Delaware law and our certificate of incorporation and bylaws could impede a merger, takeover or other business combination involving us or discourage a potential acquirer from making a tender offer for our common stock, which, under certain circumstances, could reduce the market price of our common stock.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Information on Oil and Gas Properties is included in Item 1. Business above in this Annual Report on Form 10-K.
Our executive and administrative offices are located at 12012 Wickchester Lane, Suite 475, Houston, Texas 77079 where we lease 13,850 square feet of space pursuant to a lease agreement that expires in March 2020.
Item 3.
Item 3. Legal Proceedings
From time to time, we and our subsidiaries are involved in business disputes. We are unable to predict the outcome of such matters when they arise. Currently pending proceedings, in our opinion, will not have a material adverse effect upon our consolidated financial statements. The following is a description of certain disputes involving us.
Tullow and Dana Legal Actions
On January 11, 2016, we filed legal actions against members of the Consortium under the Joint Operating Agreement governing the oil and gas exploration rights offshore Guinea ("JOA") in the United States District Court for the Southern District of Texas and before the AAA against Tullow for their failure to meet their obligations under the JOAC. On January 28, 2016, the action in the Federal District Court was voluntarily dismissed by us and refiled in District Court in Harris County, Texas. On February 8, 2016 Tullow and Dana removed the case to Federal District Court.
On February 2, 2016, SCS filed an Application for Emergency Arbitrator and Interim Measures of Protection and requested the following relief: (a) expedite discovery prior to the constitution of the arbitral tribunal; (b) provide that the time period permitted by the parties' arbitration agreement for the selection of the arbitrators and the filing of any responsive pleadings or counterclaims be accelerated; (c) require Tullow, as the designated operator under the JOA, to maintain existing "well-planning activities"; (d) require Tullow to undertake and complete certain planning activities; and (e) require Tullow and Dana to join with SCS in completing the negotiation of an acceptable amendment to the PSC and to agree to a process that will result in the execution of the amendment. With the exception of limited relief regarding discovery and agreement by Tullow to maintain certain well plan readiness, the Emergency Arbitrator ruled on February 17, 2016, that SCS is not entitled to the emergency injunctive relief it requested. Further, the Emergency Arbitrator enjoined all parties to the dispute from pursuing parallel District Court proceedings. On February 12, 2016, the case was voluntarily stayed by us. SCS believes that it has exhausted all of its options for the pursuit of legal measures to require Tullow and Dana to drill the planned exploration well.
The AAA action seeks (1) a determination that Tullow and Dana are in breach of their contractual obligations and (2) the damages caused by the repeatedly delays in well drilling caused by the activities of Tullow and Dana. We determined to bring the legal actions only after it became apparent that Tullow and Dana would not move forward, despite many opportunities to do so, with petroleum operations. The action before the American Arbitration Association is ongoing, but neither the timing nor the outcome is known at this time. SCS expects that action will not conclude before 2017 at the earliest.
Subsequent Event-Settlement of Claims with Tullow and Dana
On August 15, 2016, we entered into a Settlement and Release Agreement ("Settlement and Release") with Tullow and Dana with respect to our dispute in arbitration (American Arbitration Association, Case No: 01-16-0000-0679, styled SCS Corporation Ltd v. Tullow Guinea Ltd. and Dana Petroleum (E&P) Ltd.). Under the Settlement and Release, we released all claims against Tullow and Dana and Tullow and Dana (i) issued to the Government of Guinea a notice of withdrawal from the Concession and PSC effective immediately, (ii) transferred their interest in the long lead items previously purchased by the Consortium in preparation for the drilling of the Fatala well, and agreed to pay net cash of $686,570 to us. We also agreed to pay Dana a success fee based upon the certified reserves of the Fatala well if it results in a discovery. We will record the long lead items and a gain once they have been inspected and appropriately valued.
Shareholder Lawsuits
Beginning on March 13, 2014, two lawsuits styled as class actions were filed in the U.S. District Court for the Southern District of Texas against us and several then-current officers of the Company alleging that we made false and misleading statements that artificially inflated our stock prices. The lawsuits allege, among other things, that we misrepresented our compliance with the Foreign Corrupt Practices Act and anti-money laundering statutes and that we lacked adequate internal controls. The lawsuits seek damages based on Sections 10(b) and 20 of the Securities Exchange Act of 1934, although the specific amount of damages is not specified. On May 12, 2014, a shareholder filed a motion for appointment as lead plaintiff, which remains pending. One of the March 2014 lawsuits has now been dismissed voluntarily, and the parties to the remaining suit await the issuance of a scheduling order in that matter. We have assessed the status of the remaining March 2014 lawsuit and have concluded that an adverse judgment remains reasonably possible, but not probable. As a result, no provision has been made in the consolidated financial statements. We are unable to estimate a range of possible loss; however, in our opinion, the outcome of this dispute will not have a material effect on our financial condition and results of operations.
In addition, we have received demands from shareholders to inspect our books and records.
Iroquois Lawsuit
On May 9, 2012, a lawsuit was filed in the Supreme Court of the State of New York against us and all of our directors. The plaintiffs, five hedge funds that invested in us in early 2012, allege that we breached an agreement with the plaintiffs, and that we and the directors made certain negligent misrepresentations relating to our drilling operations. Among other claims, the plaintiffs allege that we misrepresented the status of our drilling operations and the speed with which the drilling would be completed. The plaintiffs advance claims for breach of contract and negligent misrepresentation and seek damages in the amount of $18.5 million plus pre-judgment interest. On July 12, 2012, we and the directors moved to dismiss the suit for failure to state a claim as to all defendants and for lack of personal jurisdiction over the director defendants. On June 19, 2013, the court dismissed the negligent misrepresentation claim but declined to dismiss the breach of contract claim. The negligent misrepresentation claim was dismissed without prejudice, meaning plaintiffs could attempt to refile it. On August 12, 2013, the plaintiffs filed an amended complaint. That complaint names only us and seeks recovery for alleged breaches of contract. We filed an answer to the plaintiffs' amended complaint on September 9, 2013, and the court has entered a scheduling order governing pre-trial proceedings in the matter. The maximum possible loss is the full amount of $18.5 million plus interest accrued thereon until judgment. We, however, have assessed the status of this matter and have concluded that although an adverse judgment is reasonably possible, it is not probable. As a result, no provision has been made in the consolidated financial statements. In our opinion, the outcome of this dispute will not have a material effect on our financial condition and results of operations.
Item 4.
Item 4. Mine Safety Disclosures
Not Applicable.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Price Range of Common Stock
Shares of our common stock, for the periods presented below, were traded on the NYSE through March 10, 2015 and traded on the OTCQX since March 11, 2015. The following table sets forth the quarterly high and low sales prices per share for our common stock, as reported by the NYSE and the OTCQX exchanges for the respective periods.
On September 16, 2016, the last price for our common stock as reported by the OTCQX was $1.14 per share, and there were approximately 57 stockholders of record of the common stock.
Dividends
We have not paid, and we do not currently intend to pay in the foreseeable future, cash dividends on our common stock. The current policy of our Board of Directors is to retain all earnings, if any, to provide funds for operation and expansion of our business. The declaration of dividends, if any, will be subject to the discretion of the Board of Directors, which may consider such factors as our results of operations, financial condition, capital needs and acquisition strategy, among others.
Equity Compensation Plan Information
The following table gives aggregate information under all equity compensation plans of Hyperdynamics as of June 30, 2016.
Equity Compensation Plan Information
The Stock and Stock Option Plan (the "1997 Plan") of Hyperdynamics was adopted May 7, 1997 and amended on December 3, 2001, on January 21, 2005, and on February 20, 2008. The total number of shares authorized under the Plan, as amended, was 1,750,000. The Board terminated the 1997 Plan effective upon stockholder approval of the 2010 Equity Incentive Plan (the "2010 Plan").
Our 2008 Restricted Stock Award Plan (the "2008 Plan") was adopted on February 20, 2008. The total number of shares authorized under the 2008 Plan was 375,000. The Board terminated the 2008 Plan effective upon stockholder approval of the 2010 Plan.
On February 18, 2010, at our annual meeting of stockholders, the board of directors and stockholders approved the 2010 Plan. Subsequently, on February 17, 2012, the 2010 Plan was amended to increase the maximum shares issuable under the 2010 Plan from 625,000 shares to 1,250,000 shares and again on January 27, 2016, at our annual meeting of stockholders, the stockholders approved amending the 2010 Plan to increase the number of shares available for issuance by 750,000 shares to 2,000,000 shares.
The 2010 Plan provides for the grants of shares of common stock, restricted stock units or incentive stock options and/or nonqualified stock options to purchase our common stock to selected employees, directors, officers, agents, consultants, attorneys, vendors and advisors. Shares of common stock, options, or restricted stock can only be granted under the Plan within 10 years from the effective date of February 18, 2010.
The purpose of the Plan is to further our interest, and the interest of our subsidiaries and our stockholders by providing incentives in the form of stock or stock options to key employees, consultants, directors, and vendors who contribute materially to our success and profitability. We believe that our future success will depend in part on our continued ability to attract and retain highly qualified personnel as employees, independent consultants, and directors. The issuance of stock and grants of options will recognize and reward outstanding individual performances and contributions and will give such persons a proprietary interest in us, thus enhancing their personal interest in our continued success and progress. We pay wages, salaries, and consulting rates that we believe are competitive. We use the 2010 Plan to augment our compensation packages.
The following table provides a reconciliation of the securities remaining available for issuance as of June 30, 2016 under the 2010 Plan:
Item 6.
Item 6. Selected Financial Data
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
Our corporate mission is to provide energy for the future by exploring for, developing new, and re-establishing pre-existing sources of energy. Our primary focus is the advancement of exploration work in Guinea. We have no source of operating revenue, and there is no assurance when we will, if ever. We have no operating cash flows, and we will require substantial additional funds, through additional participants, securities offerings, or through other means, to fulfill our business plans.
Our operating plan within the next 12 months includes the following:
• Guinea and commence preparations for drilling of the exploration well.
• Consider financing alternatives and other measures to pursue our exploration objectives offshore Guinea.
Analysis of changes in financial position
Our current assets decreased by $7,998,000 from $19,625,000 on June 30, 2015 to $11,627,000 on June 30, 2016. The decrease in current assets is primarily due to cash used for general and administrative expenditures, including costs incurred on legal matters.
Our long-term assets decreased $14,420,000, from $14,471,000 on June 30, 2015, to $51,000 on June 30, 2016. This decrease was primarily due to our fully impairing the $14,331,000 of unproved oil and gas properties as of March 31, 2016 and also to the year over year depreciation of our fixed assets.
Our current liabilities increased $75,000, from $1,668,000 on June 30, 2015 to $1,743,000 on June 30, 2016.
We had no long-term liabilities at June 30, 2015 or at June 30, 2016.
Results of Operations
Based on the factors discussed below, the net loss attributable to common shareholders for the year ended June 30, 2016, increased $9,452,000, to a net loss of $22,846,000, or $1.09 per share in 2016 from a net loss of $13,392,000, or $0.64 per share in 2015.
Reportable segments
We have one reportable segment: our international oil and gas exploration activities in Guinea conducted through our subsidiary SCS.
Comparison for Fiscal Years 2016 and 2015
Revenues. There were no revenues for the years ended June 30, 2016 and 2015.
Depreciation. Depreciation decreased 54%, or $128,000, from fiscal 2015 to fiscal 2016. Depreciation expense was $109,000 and $237,000 in the years ended June 30, 2016 and 2015, respectively. The decrease is primarily attributed to no asset additions in the current year and a portion of assets used in the prior year being fully depreciated in the current year.
Full impairment of unproved oil and gas properties. At March 31, 2016, we fully impaired our unproved oil and gas properties as discussed in Note 3, Investment in Oil and Gas Properties, which totaled $14.3 million.
General, Administrative and Other Operating Expenses. Our general, administrative and other operating expenses were $8.4 million and $13.2 million for the years ended June 30, 2016 and 2015, respectively. This represents a decrease of 36% or, $4.8 million from fiscal 2015 to fiscal 2016. The $4.8 million decrease in expense was attributable to a decrease in legal and other professional fees of $3.4 million, which can be attributed primarily to a decrease in legal and other professional fees related to the FCPA investigations ($5.0 million) offset somewhat by increased legal and other professional fees related to our lawsuits against Tullow and Dana ($1.6 million). Additionally, we had a decrease in personnel related costs of approximately $1.8 million, which can be attributed to a decline in headcount as a result of fiscal 2015 and 2016 staff reductions. These factors resulting in decreased costs were partially offset by a partial year increase in our Director and Officer insurance costs of approximately $0.4 million.
Loss from Continuing Operations. Primarily as a result of the decrease in general and administrative expenses of $4,777,000, offset by the full impairment of unproved oil and gas properties of $14,331,000, our loss from continuing operations increased by $9,454,000, from $13,392,000 in the year ended June 30, 2015 to $22,846,000 for the year ended June 30, 2016.
Liquidity and Capital Resources
General
Operating Activities
Net cash used in operating activities for the year ended June 30, 2016 was $8.0 million compared to $16.8 million for the year ended June 30, 2015. The decrease in cash used in operating activities is primarily attributable to our $4.8 million decrease in General, administrative and other operating expenses and by changes in working capital during the periods, primarily a $4.1 million working capital change in accounts payable in the current year when compared to the previous year.
Investing Activities
Net cash used in investing activities for the year ended June 30, 2016 was $(20) thousand compared to $(63) thousand in the year ended June 30, 2015.
Financing Activities
There was no cash provided by financing activities during the years ended June 30, 2016 and 2015.
Liquidity
On June 30, 2016, we had $10.3 million in cash and $1.7 million in liabilities, all of which are current. We plan to use our existing cash to fund our general corporate needs and our expenditures associated with the Concession.
While the DOJ and SEC investigations are resolved, the investigations were costly and adversely affected our liquidity. We incurred approximately $7.5 million in legal and professional fees related to these investigations in the year ended June 30, 2014, approximately $5.2 million in the year ended June 30, 2015, and approximately $0.1 million in the year ended June 30, 2016 for a total of $12.8 million. The legal and professional fees related to legal actions taken against Tullow and Dana, as described in Note 8, could materially affect our liquidity.
The Consortium sent notice in July 2013 to the Government of Guinea of its intention to renew the second exploration period to September 2016 and the coordinates of the area to be relinquished as required under the PSC. A renewal of the second exploration period by the Minister of Mines and Geology occurs upon application when the work and expenditure obligations from the preceding period have been fulfilled. There has been no question raised by the Minister or others regarding satisfaction of these conditions.
The second and final exploration period may be extended with two months' notice prior to September 2016 to the Minister of Mines and Geology of Guinea for up to one additional year beyond September 2016 to allow the completion of a well in progress and for up to two additional years to allow the completion of the appraisal of any discovery made. Additionally, to satisfy the September 2013-2016 work requirement, one exploration well is required to be drilled, which is to be commenced by the end of September 2016, to a minimum depth of 2,500 meters below seabed.
On September 15, 2016, we executed a second amendment to our Production Sharing Contract where we received a one (1) year extension to September 22, 2017 and confirmed we are the holder of 100% and Operator of the Concession.
In turn, we agreed to drill one (1) exploratory well to a minimum depth of 2,500 meters below the seabed with a projected commencement of April 2017 and a budget of approximately $46,000,000.
Failure to comply with the drilling and other obligations of the PSC subjects us to risk of loss of the Concession. Continued delays have affected adversely the ability to explore the Concession and will diminish the attractiveness of the Concession to prospective industry participants and financing sources.
Our costs related to the items referred to above and any additional expenses, or any negative outcomes, could adversely affect our liquidity and financial condition and results of operations. Absent cash inflows, we could exhaust our current available liquidity within the next twelve months. The timing and amount of our cash outflows are dependent on a number of factors including: a negative outcome related to any of our legal proceedings, inability to resume petroleum operations or drilling delays, joint operations expenditures and well costs exceeding our carry, or if we have unfavorable well results. As a result, absent cash inflows, there is substantial doubt as to whether we will have adequate capital resources to meet our current obligations as they become due and therefore be able to continue as a going concern. Our ability to meet our current obligations as they become due over the next twelve months, and to be able to continue exploration, will depend on obtaining additional resources through sales of additional interests in the Concession, equity or debt financings, or through other means, and the resumption of petroleum operations although no assurance can be given that any of these actions can be completed.
Contractual Commitments and Obligations
Disclosure of Contractual Obligations as of June 30, 2016
(1)We are subject to certain commitments under the PSC as discussed in Item 1 above.
CRITICAL ACCOUNTING POLICIES
Our Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those estimates that may have a significant effect on our financial condition and results of operations. Our significant accounting policies are disclosed in Note 1 to our Consolidated Financial Statements. The following discussion of critical accounting policies addresses those policies that are both important to the portrayal of our financial condition and results of operations and require significant judgment and estimates. We base our estimates and judgment on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
Oil and Gas Properties
We account for oil and natural gas producing activities using the full-cost method of accounting as prescribed by the SEC. Accordingly, all costs incurred in the acquisition, exploration, and development of oil and natural gas properties, including the costs of abandoned properties, dry holes, geophysical costs, and annual lease rentals are capitalized. All selling, general and administrative corporate costs unrelated to drilling activities are expensed as incurred. 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, or to the extent that the sale proceeds exceed our capitalized costs. Depletion of evaluated oil and natural gas properties is computed on the units of production method based on proved reserves. The net capitalized costs of proved oil and natural gas properties are subject to a full cost ceiling limitation in which the costs are not allowed to exceed their related estimated future net revenues discounted at 10%, net of tax
considerations. In accordance with SEC release 33-8995, prices based on the preceding 12-months' average price based on closing prices on the first day of each month, or prices defined by existing contractual arrangements, are used in deriving future net revenues discounted at 10%, net of tax. The application of the full-cost method of accounting for oil and gas properties generally results in higher capitalized costs and higher depreciation, depletion and amortization rates compared to the successful efforts method of accounting for oil and gas properties.
Costs Excluded
Costs associated with unevaluated properties are excluded from amortization until evaluated. We review our unevaluated properties at the end of each quarter to determine whether the costs incurred should be transferred to the amortization base.
We assess unproved property on a quarterly basis for possible impairment or reduction in value. 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 under our concession; geological and geophysical evaluations; drilling results and activity; the assignment of proved reserves; and the economic viability of development if proved reserves are assigned. We assess our unproved properties on a country-by-country basis. During any period in which these factors indicate impairment, the adjustment is recorded through earnings of the period. As of March 31, 2016, based on our impairment assessment, we fully impaired the $14,331,000 of unproved oil and gas properties. At June 30, 2016, we had no capitalized costs associated with our Guinea operations.
Environmental Obligations and Other Contingencies
Management makes judgments and estimates in accordance with applicable accounting rules when it establishes reserves for environmental remediation, litigation and other contingent matters. Provisions for such matters are charged to expense when it is probable that a liability has been incurred and reasonable estimates of the liability can be made. Estimates of environmental liabilities are based on a variety of matters, including, but not limited to, the stage of investigation, the stage of the remedial design, evaluation of existing remediation technologies, and presently enacted laws and regulations. In future periods, a number of factors could significantly change our estimate of environmental remediation costs, such as changes in laws and regulations, or changes in their interpretation or administration, revisions to the remedial design, unanticipated construction problems, identification of additional areas or volumes of contaminated soil and groundwater, and changes in costs of labor, equipment and technology. Consequently, it is not possible for management to reliably estimate the amount and timing of all future expenditures related to environmental or other contingent matters and actual costs may vary significantly from our estimates.
Share-Based Compensation
We follow ASC 718 which 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). ASC 718 also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. We account for non-employee share-based awards based upon the provisions of ASC 505-50, "Equity-Based Payments to Non-Employees."
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our functional currency is the US dollar. We had, prior to their closures, some foreign currency exchange rate risk resulting from our in-country offices in Guinea and the United Kingdom and from
certain costs in our drilling program. US dollars are accepted in Guinea and many of our purchases and purchase obligations, such as our office lease in Guinea, were denominated in US dollars. However, our costs for labor, supplies, and fuel could have increased if the Guinea Franc, the Euro, or the Pound Sterling significantly appreciated against the US dollar. We did not hedge the exposure to currency rate changes. We do not believe our exposure to market risk to be material.
Item 8.
Item 8. Financial Statements and Supplementary Data
The Financial Statements and Supplementary Data information required hereunder is included in this report as set forth in the "Index to Financial Statements" on page.
HYPERDYNAMICS CORPORATION
Report of Management on Internal control Over Financial Reporting
Report of Independent Registered Public Accounting Firm-Hein & Associates LLP
Consolidated Balance Sheets as of June 30, 2016 and 2015
Consolidated Statements of Operations for the fiscal years ended June 30, 2016 and 2015
Consolidated Statements of Shareholders' Equity for the fiscal years ended June 30, 2016 and
Consolidated Statements of Cash Flows for the fiscal years ended June 30, 2016 and 2015
Notes to Consolidated Financial Statements
Quarterly Results (Unaudited)
Supplemental Oil and Gas Information (Unaudited)
REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Hyperdynamics Corporation (the "Company" or "our"), including the Company's Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting for the Company as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company's internal control system was designed to provide reasonable assurance to the Company's management and board of directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
Internal control over financial reporting includes the controls themselves, monitoring (including internal auditing practices), and actions taken to correct deficiencies as identified.
Internal control over financial reporting has inherent limitations and may not prevent or detect misstatements. The design of an internal control system is also based in part upon assumptions and judgments made by management about the likelihood of future events, and there can be no assurance that an internal control will be effective under all potential future conditions. Therefore, even those systems determined to be effective can provide only reasonable, not absolute, assurance with respect to the financial statement preparation and presentation. Further, because of changes in conditions, the effectiveness of internal control over financial reporting may vary over time.
Management assessed the effectiveness of the Company's internal control over financial reporting as of June 30, 2016. In making this assessment, management used the criteria for internal control over financial reporting described in Internal Control-Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Management's assessment included an evaluation of the design of the Company's internal control over financial reporting and testing of the operating effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of the Company's Board of Directors. Based on this assessment, management has concluded that, as of June 30, 2016, the Company's internal control over financial reporting was effective.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Hyperdynamics Corporation
Houston, Texas
We have audited the accompanying consolidated balance sheets of Hyperdynamics Corporation and subsidiaries (the "Company") as of June 30, 2016 and 2015, and the related consolidated statements of operations, shareholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting as of June 30, 2016. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting as of June 30, 2016. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hyperdynamics Corporation and subsidiaries as of June 30, 2016 and 2015, and the results of their consolidated operations and their consolidated cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the absence of cash inflows raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also discussed in Note 1 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Hein & Associates LLP
Houston, Texas
September 22, 2016
HYPERDYNAMICS CORPORATION
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Number of Shares and Per Share Amounts)
The accompanying notes are an integral part of these consolidated financial statements.
HYPERDYNAMICS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Number of Shares and Per Share Amounts)
The accompanying notes are an integral part of these consolidated financial statements.
HYPERDYNAMICS CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In Thousands, Except Number of Shares)
The accompanying notes are an integral part of these consolidated financial statements.
HYPERDYNAMICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
The accompanying notes are an integral part of these consolidated financial statements.
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Nature of business
Hyperdynamics Corporation ("Hyperdynamics," the "Company," "we," "us," and "our") is a Delaware corporation formed in March 1996. Hyperdynamics has two wholly-owned subsidiaries, SCS Corporation Ltd (SCS), a Cayman corporation, and HYD Resources Corporation (HYD), a Texas corporation. Through SCS and its wholly-owned subsidiary, SCS Guinea SARL (SCSG), which is a Guinea limited liability company formed under the laws of the Republic of Guinea ("Guinea") located in Conakry, Guinea, Hyperdynamics focuses on oil and gas exploration offshore the coast of West Africa. Our exploration efforts are pursuant to a Hydrocarbon Production Sharing Contract, as amended (the "PSC"). We refer to the rights granted under the PSC as the "Concession." We began operations in oil and gas exploration, seismic data acquisition, processing, and interpretation in late fiscal 2002.
As used herein, references to "Hyperdynamics," "Company," "we," "us," and "our" refer to Hyperdynamics Corporation and our subsidiaries, including SCS Corporation Ltd ("SCS"). The rights in the Concession offshore Guinea are held by SCS.
Status of our Business
We have no source of operating revenue and there is no assurance when we will, if ever. On June 30, 2016, we had $10.3 million in cash, and $1.7 million in liabilities, all of which are current liabilities. We plan to use our existing cash to fund our general corporate needs and our expenditures associated with the Concession.
On December 31, 2012, we closed a sale to Tullow, a subsidiary of Tullow Oil plc, of a 40% gross interest in the Concession. Through June 30, 2016, we held a 37% participating interest, with Dana Petroleum, PLC ("Dana"), which is a subsidiary of the Korean National Oil Corporation, holding the remaining 23% interest in the Concession. We refer to Tullow, Dana and us in the Concession as the "Consortium".
Pursuant to the Share Purchase Agreement ("Tullow SPA") between Tullow and us, Tullow agreed to pay our entire participating interest share of expenditures associated with joint operations in the Concession up to a gross expenditure cap of $100 million incurred during the carry period that began on September 21, 2013. Additionally, Tullow agreed to pay our participating interest share of future costs for the drilling of an appraisal of the initial exploration well, if drilled, up to a gross expenditure cap of $100 million.
We signed a non-binding Memorandum of Understanding with the Government of Guinea on August 19, 2016 and a second amendment to the PSC ("2016 Amendment") on September 15, 2016. As more fully described below, the 2016 Amendment gave us a one year extension to the PSC to September 22, 2017 ("PSC Extension Period"). During the PSC Extension Period, we agreed to drill an exploration well to a minimum depth of two thousand five hundred (2,500) meters below the seabed for an estimated amount of forty six million US Dollars ($46,000,000 USD). The projected commencement date of drilling of the exploration well is April 2017 with a currently estimated time to completion of 42 days. Additional exploration wells may be drilled during the PSC Extension Period. If the well is not drilled within the PSC Extension Period, we will owe the Government of Guinea the difference between the actual expenditures related to the well and U.S. $46,000,000. Failure to comply
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
with the drilling and other obligations of the PSC as amended subjects us to financial penalties and a risk of loss of the Concession.
The continued delays have affected adversely the ability to explore the Concession and reduces the attractiveness of the Concession to prospective industry participants and financing sources. While we currently hold 100% of the Concession, it is unknown whether we will be able to raise the necessary funds to drill the exploratory well during the PSC Extension Period.
As described in Note 8, SCS filed parallel actions on January 11, 2016, in the United States District Court for the Southern District of Texas and before the American Arbitration Association ("AAA") against Tullow and Dana. The legal actions sought (1) a determination that Tullow and Dana are in breach of their contractual obligations and (2) orders requiring Tullow and Dana to move forward with well drilling activities offshore Guinea. In addition, the arbitration action seeks the damages caused by the repeated delays in well drilling resulting from the activities of Tullow and Dana. On January 28, 2016, the action in the Federal District Court was voluntarily dismissed by us and refiled in District Court in Harris County, Texas (the "Texas District Court"). On February 8, 2016 Tullow and Dana removed the case to Federal District Court. On February 2, 2016, SCS filed an Application for Emergency Arbitrator and Interim Measures of Protection and requested the following relief: (a) expedite discovery prior to the constitution of the arbitral tribunal; (b) provide that the time period permitted by the parties' arbitration agreement for the selection of the arbitrators and the filing of any responsive pleadings or counterclaims be accelerated; (c) require Tullow, as the designated operator under the JOA, to maintain existing "well-planning activities"; (d) require Tullow to undertake and complete certain planning activities; and (e) require Tullow and Dana to join with SCS in completing the negotiation of an acceptable amendment to the PSC and to agree to a process that will result in the execution of the amendment. With the exception of limited relief regarding discovery and agreement by Tullow to maintain certain well plan readiness, the Emergency Arbitrator ruled on February 17, 2016 that SCS is not entitled to the emergency injunctive relief it requested. Further, the Emergency Arbitrator enjoined all parties to the dispute from pursuing parallel Federal District Court proceeding. The Federal District Court action was voluntarily stayed by us on February 12, 2016.
Subsequently, on August 15, 2016, we entered into a Settlement and Release Agreement with Tullow and Dana ("Settlement and Release") with respect to our dispute in arbitration (American Arbitration Association, Case No: 01-16-0000-0679, styled SCS Corporation Ltd v. Tullow Guinea Ltd. and Dana Petroleum (E&P) Ltd.). Under the Settlement and Release, we released all claims against Tullow and Dana and Tullow and Dana (i) issued to the Government of Guinea a notice of withdrawal from the Concession and PSC effective immediately, (ii) transferred their interest in the long lead items previously purchased by the Consortium in preparation for the drilling of the Fatala well, and agreed to pay net cash of $686,570 to us. We also agreed to pay Dana a success fee based upon the certified reserves of the Fatala well if it results in a discovery. We will record the long lead items and a gain once they have been inspected and appropriately valued.
The timing and amount of our cash outflows are dependent on a number of factors including: a negative outcome related to any of our legal proceedings, inability to resume petroleum operations or drilling delays, well costs exceeding our carry, or if we have unfavorable well results. As a result, absent cash inflows, there is substantial doubt as to whether we will have adequate capital resources to meet our current obligations as they become due and therefore be able to continue as a going concern. Our ability to meet our current obligations as they become due over the next twelve-months, and to be able
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
to continue exploration, will depend on obtaining additional resources through sales of additional interests in the Concession, equity or debt financings, or through other means, although no assurance can be given that any of these actions can be completed.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Hyperdynamics and its direct and indirect wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States and the rules of the Securities and Exchange Commission (SEC).
Use of Estimates
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and expenses at the balance sheet date and for the period then ended. We believe our estimates and assumptions are reasonable; however, such estimates and assumptions are subject to a number of risks and uncertainties that may cause actual results to differ materially from such estimates. Significant estimates and assumptions underlying these financial statements include:
• estimates in the calculation of share-based compensation expense,
• estimates made in our income tax calculations,
• estimates in the assessment of current litigation claims against the company, and
• estimates and assumptions involved in our assessment of unproved oil and gas properties for impairment.
We are subject to legal proceedings, claims, and liabilities that arise in the ordinary course of business. We accrue for losses when such losses are considered probable and the amounts can be reasonably estimated.
Cash and cash equivalents
Cash equivalents are highly liquid investments with an original maturity of three months or less. For the years presented, we maintained all of our cash in bank deposit accounts which, at times, exceed the federally insured limits.
Oil and Gas Properties
Full-Cost Method
We account for oil and natural gas producing activities using the full-cost method of accounting as prescribed by the SEC. Accordingly, all costs incurred in the acquisition, exploration, and development of oil and natural gas properties, including the costs of abandoned properties, dry holes, geophysical costs and annual lease rentals are capitalized. All selling, general and administrative corporate costs unrelated to drilling activities are expensed as incurred. Sales or other dispositions of oil and natural
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
gas properties are accounted for as adjustments to capitalized costs, with no gain or loss recorded unless the ratio of capitalized costs to proved reserves would significantly change, or to the extent that the sale proceeds exceed our capitalized costs. Depletion of evaluated oil and natural gas properties would be computed on the units of production method based on proved reserves. The net capitalized costs of proved oil and natural gas properties are subject to quarterly impairment tests.
Costs Excluded from Amortization
Costs associated with unproved properties are excluded from amortization until it is determined whether proved reserves can be assigned to the properties. We review our unproved properties at the end of each quarter to determine whether the costs incurred should be transferred to the amortization base.
We assess unproved property on a quarterly basis for possible impairment or reduction in value. 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 under our concession; geological and geophysical evaluations; drilling results and activity; the assignment of proved reserves; and the economic viability of development if proved reserves are assigned. We assess our unproved properties on a country-by-country basis. During any period in which these factors indicate an impairment, the adjustment is recorded through earnings of the period.
Full-Cost Ceiling Test
At the end of each quarterly reporting period, the capitalized costs less accumulated amortization and deferred income taxes shall not exceed an amount equal to the sum of the following items: (i) the present value of estimated future net revenues of oil and gas properties (including future development and abandonment costs of wells to be drilled) using prices based on the preceding 12-months' average price based on closing prices on the first day of each month, or prices defined by existing contractual arrangements, discounted at 10%, (ii) the cost of properties not being amortized, and (iii) the lower of cost or estimated fair value of unproved properties included in the costs being amortized, less related income tax effects ("Full-Cost Ceiling Test").
The calculation of the Full-Cost Ceiling Test is based on estimates of proved reserves. There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting the future rates of production, timing, and plan of development. The accuracy of any reserves estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of drilling, testing, and production subsequent to the date of the estimate may justify revision of such estimates. Accordingly, reserves estimates are often different from the quantities of oil and natural gas that are ultimately recovered. We have no proved reserves. We recognized a $14.3 million Full-Cost Ceiling test write-down in the year ended June 30, 2016. No Full-Cost Ceiling test write-down was recognized in the year ended June 30, 2015.
Property and Equipment, other than Oil and Gas
Property and equipment are stated on the basis of historical cost less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the assets, generally three to five years.
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes
We account for income taxes in accordance with FASB Accounting Standards Codification ("ASC") 740, "Income Taxes," which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the tax and financial reporting basis of assets and liabilities and for loss and credit carryforwards. Valuation allowances are provided when recovery of deferred tax assets is not considered likely.
Tax benefits are recognized only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon ultimate settlement. Unrecognized tax benefits are tax benefits claimed in our tax returns that do not meet these recognition and measurement standards. As of June 30, 2016 and 2015, the Company has unrecognized tax benefits totaling $5.5 million.
Our policy is to recognize potential accrued interest and penalties related to unrecognized tax benefits within income tax expense. For the years ended June 30, 2016 and 2015, we did not recognize any interest or penalties in our consolidated statements of operations, nor did we have any interest or penalties accrued on our consolidated balance sheets at June 30, 2016 and 2015 relating to unrecognized benefits.
The tax years 2011-2015 remain open to examination for federal income tax purposes and by the other major taxing jurisdictions to which we are subject.
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 account for non-employee share-based awards based upon ASC 505-50, "Equity-Based Payments to Non-Employees."
Earnings Per Share
Basic loss per common share has been computed by dividing net loss by the weighted average number of shares of common stock outstanding during each period. In a period of earnings, diluted earnings per common share are calculated by dividing net income available to common shareholders by weighted-average common shares outstanding during the period plus weighted-average dilutive potential common shares. Diluted earnings per share calculations assume, as of the beginning of the period, exercise of stock options and warrants using the treasury stock method.
All potential dilutive securities, including potentially dilutive options, warrants and convertible securities, if any, were excluded from the computation of dilutive net loss per common share for the years ended June 30, 2016, and 2015, respectively, as their effects are antidilutive due to our net loss for those periods.
Stock options to purchase approximately 1.0 million common shares at an average exercise price of $5.03 were outstanding at June 30, 2016. Using the treasury stock method, had we had net income,
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
approximately 25 thousand common shares attributable to our outstanding stock options would have been included in the fully diluted earnings per share for the year ended June 30, 2016.
Stock options to purchase approximately 1.2 million common shares at an average exercise price of $7.43 and warrants to purchase approximately 0.03 million shares of common stock at an average exercise price of $12.64 were outstanding at June 30, 2015. Using the treasury stock method, had we had net income, approximately four hundred common shares attributable to our outstanding stock options would have been included in the fully diluted earnings per share calculation for the year ended June 30, 2015. There would have been no dilution attributable to our outstanding warrants to purchase common shares. Had we had net income, approximately four thousand common shares attributable to restricted stock awards would have been included in the fully diluted earnings per share for the year ended June 30, 2015.
Contingencies
We are subject to legal proceedings, claims and liabilities. We accrue for losses associated with legal claims when such losses are probable and can be reasonably estimated. These accruals are adjusted as additional information becomes available or circumstances change. Legal fees are charged to expense as they are incurred. See Note 8 for more information on legal proceedings.
Foreign currency gains and losses from current operations
In accordance with ASC Topic 830, Foreign Currency Matters, the functional currency of our international subsidiaries is the U.S. Dollar. Gains and losses from foreign currency transactions arising from operating assets and liabilities are included in general, administrative and other operating expense, have not been significant. Net foreign currency transaction gains (losses) were ($3) thousand and ($0.1) million for the years ended June 30, 2016 and 2015, respectively.
Subsequent Events
The Company evaluated all subsequent events from June 30, 2016 through the date of issuance of these financial statements.
2. PROPERTY AND EQUIPMENT
A summary of property and equipment as of June 30, 2016 and 2015 is as follows:
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. PROPERTY AND EQUIPMENT (Continued)
We review assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. As of June 30, 2016 and 2015, there were no impairments of property and equipment.
3. INVESTMENT IN OIL AND GAS PROPERTIES
Investment in oil and gas properties consists entirely of our Guinea Concession in offshore West Africa. We owned a 77% participating interest in our Guinea Concession prior to the sale of a 40% gross interest to Tullow which closed on December 31, 2012. We now own a 37% interest in the Concession.
Guinea Concession
We have been conducting exploration work related to the area off the coast of Guinea since 2002. On September 22, 2006 we entered into the PSC with Guinea. Under that agreement, we were granted certain exclusive contractual rights by Guinea to explore and exploit offshore oil and gas reserves, if any, off the coast of Guinea. We are conducting our current work in Guinea under the PSC, as amended on March 25, 2010 (the "PSC Amendment").
The PSC Amendment clarified that we retained a Contract Area of approximately 25,000 square kilometers, which is approximately equivalent to 9,650 square miles or 30% of the original Contract Area under the PSC, following a December 31, 2009 relinquishment of approximately 70% of the original Contract Area. The PSC Amendment required that the Consortium relinquish an additional 25% of the retained Contract Area by September 30, 2013. The Contract Area is currently 18,750 square kilometers. Under the terms of the PSC Amendment, the first exploration period ended and the Consortium entered into the second exploration period on September 21, 2010. The second exploration period ran until September 2013, at which point it was renewed to September 2016 and may be extended for up to one (1) additional year to allow the completion of a well in process and for up to two (2) additional years to allow the completion of the appraisal of any discovery made.
The PSC Amendment required the drilling of an exploration well, which had to be commenced by the year-end 2011, to a minimum depth of 2,500 meters below seabed. This requirement was satisfied with the drilling of the Sabu-1 well which was commenced during October of 2011 and reached the minimum depth of 2,500 meters below the seabed in February of 2012. The Consortium is required to drill an additional exploration well, which is to be commenced by the end of September 2016, to a minimum depth of 2,500 meters below seabed. The PSC Amendment requires the expenditure of $15 million on each of the exploration wells ($30 million in the aggregate). The Consortium was also required to acquire a minimum of 2,000 square kilometers of 3D seismic by September 2013 with a minimum expenditure of $12 million. This requirement was satisfied with the first 3D seismic survey acquired in 2010. Fulfillment of work obligations exempts us from expenditure obligations and exploration work in excess of minimum work obligations for each exploration period may be carried forward to the following exploration period. If the Consortium does not fulfil the work requirement under the PSC, it is required to pay to Guinea the difference between the amounts actually spent on work realized in fulfillment of the obligations of the work program and the amounts estimated for the total work program.
Under the PSC Amendment, Guinea may participate in development of any discovery at a participating interest of up to 15% of costs being carried for its share. The cost of that carry is to be
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. INVESTMENT IN OIL AND GAS PROPERTIES (Continued)
recovered out of 62.5% of Guinea's share of cost and profit oil. The PSC Amendment clarified that only those eligible expenditures, which were made following the date the PSC was signed, on September 22, 2006, are eligible for cost recovery. We are required to establish an annual training budget of $200,000 for the benefit of Guinea's oil industry personnel, and we are also obligated to pay an annual surface tax of $2.00 per square kilometer on our retained Concession acreage. The PSC Amendment also provides that should the Guinea government note material differences between provisions of the PSC Amendment and international standards or the Petroleum Code, the parties will renegotiate the relevant articles.
Under the PSC and PSC Amendment our Guinea Concession is subject to a 10% royalty interest to Guinea. Of the remaining 90% of the first production, we will receive 75% of the revenue for recovery of the cost of operations, and Guinea will receive 25%.
After recovery cost of operations, revenue will be split as outlined in the table below:
The Guinea Government may elect to take a 15% working interest in any exploitation area.
On May 20, 2010, we completed a 23% assignment to Dana following the receipt of the final approvals from the Government of Guinea, which were in the form of a Presidential Decree approving the PSC and a document, referred to as an Arrêté, from the Guinea Ministry of Mines and Geology. On December 27, 2012, we received an Arrêté which formally authorized our 40% assignment of a participating interest to Tullow.
Sale of Interest to Tullow
On December 31, 2012, we closed a sale to Tullow of a 40% gross interest in the Concession. As consideration, we received $27 million from Tullow as reimbursement of our past costs in the Concession and, as additional consideration, Tullow agreed to: (i) pay our participating interest share of future costs associated with joint operations in the Concession, up to a gross expenditure cap of $100 million incurred during the carry period that began on September 21, 2013; and (ii) pay our participating interest share of costs associated with an appraisal well of the initial exploration well, if drilled, subject to a gross expenditure cap on the appraisal well of $100 million. Tullow will continue to pay our costs, subject to the gross expenditure cap of $100 million, until 90 days following the date on which the rig contracted to drill the exploration well moves off the well location. We are responsible for our share of any costs exceeding the gross expenditure cap of $100 million per well. The $27 million payment was received by us on December 31, 2012 and was recorded as a reduction in unproved oil and gas properties, net of transaction costs of approximately $3.3 million.
In connection with the transaction, SCS, Tullow and Dana entered into a Joint Operating Agreement Novation and Amendment Agreement reflecting that as a result of the sale to Tullow, the interest of the parties in the Concession are SCS 37%, Dana 23%, and Tullow 40%, and that Tullow agreed to be bound by the PSC and the JOA previously entered into between SCS and Dana. Tullow
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. INVESTMENT IN OIL AND GAS PROPERTIES (Continued)
assumed all the respective liabilities and obligations of SCS in respect of the assigned 40% interest. SCS and Tullow executed a Deed of Assignment. The Assignment was approved by Guinea's Ministry of Mines and Geology by issuing an Arrêté on December 27, 2012 which formally authorized our assignment of a participating interest to Tullow. SCS, Dana and Tullow have elected Tullow as the Operator of the Concession beginning April 1, 2013.
Accounting for oil and gas property and equipment costs
We follow the "Full-Cost" method of accounting for oil and natural gas property and equipment costs. Under this method, internal costs incurred that are directly identified with exploration, development, and acquisition activities undertaken by us for our own account, and which were not related to production, general corporate overhead, or similar activities, are capitalized. Capitalization of internal costs was discontinued April 1, 2013 when Tullow became the operator. Geological and geophysical costs incurred that are directly associated with specific unproved properties are capitalized in "Unproved properties excluded from amortization" and evaluated as part of the total capitalized costs associated with a prospect. The cost of unproved properties not being amortized is assessed to determine whether such properties have been impaired. In determining whether such costs should be impaired, we evaluate current drilling results and available geological and geophysical information. If petroleum operations are not commenced soon, our ability to obtain additional financing and our financial condition will be adversely affected, which will likely impact our ability to conduct exploration. No reserves have been attributed to the concession.
We exclude capitalized costs of unproved oil and gas properties from amortization until evaluated. Geological and geophysical information pertaining to the Guinea concession was collected and evaluated and no reserves have been attributed to the Concession. In February 2012, we completed the drilling of the Sabu-1 well, which was determined to be non-commercial. As a result, we evaluated certain geological and geophysical related costs in unproved properties along with the drilling costs of the Sabu-1 well totaling $116.8 million and determined that these properties were subject to the Full-Cost Ceiling Test. As we have no proved reserves to include in the Full-Cost Ceiling Test, the entire $116.8 million resulted in a Full-Cost Ceiling Test write-down of our unproved oil and gas properties. As of March 31, 2016, based on our impairment assessment, we fully impaired the $14,331,000 of unproved oil and gas properties. This impairment assessment was based on the continued impasse by our members of the Consortium to resume petroleum operations and drill the next exploration obligation well, which needs to be commenced by the end of September 2016, and our inability to get interim injunctive relief from the American Arbitration Association requiring Tullow and Dana to join with SCS in the negotiation of an acceptable amendment to the PSC and to agree to a process that would result in the execution of the amendment which we hoped would have led to the resumption of petroleum operations. Thus, we believe all legal measures to require Tullow and Dana to drill the planned exploration well have been exhausted. Despite this impairment, we continued to pursue any avenues in order to begin drilling activities in our Concession.
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. INVESTMENT IN OIL AND GAS PROPERTIES (Continued)
The following table provides detail of total capitalized costs for our Guinea Concession as of June 30, 2016 and 2015 (in thousands):
During the year ended June 30, 2016, our oil and gas property balance increased by $20 thousand to $14,331,000 as a result of additional geological and geophysical costs incurred.
Subsequently on August 19, 2016, we signed a non-binding Memorandum of Understanding with the Government of Guinea and executed a Second Amendment to the PSC ("2016 Amendment") on September 15, 2016. The 2016 Amendment, upon receipt of a Presidential Decree, will give us a one year extension to the second exploration period of the PSC to September 22, 2017 ("PSC Extension Period"). In addition to clarifying certain elements of the PSC, we agreed in the 2016 Amendment to drill one (1) exploratory well to a minimum depth of 2,500 meters below the seabed within the PSC Extension Period with a projected commencement date of April 2017 (the "Extension Well") with the option of drilling additional wells. If the Extension Well is not drilled within the PSC Extension Period, we will owe the Government of Guinea the difference between the actual expenditures in Guinea related to the well and $46,000,000. Fulfillment of the work obligations exempts us from the expenditure obligations during the PSC Extension Period.
In turn, we will retain only an area equivalent to approximately 5,000 square kilometers in the Guinea offshore and will provide the Government of Guinea: (1) A parent company guarantee for the well obligation, (2) monthly progress reports and a reconciliation of budget to actual expenditures, (failure to provide the reports and assurances on a timely basis in a notice of termination with a 30 day period to cure), and (3) guarantees to Guinea that (a) no later than January 21, 2017 we will provide a mutually acceptable security for $5,000,000 on terms customary in international petroleum operations, provided that this security is to be released at the time the drilling rig for the Extension Well is on location offshore Guinea, and (b) no later than April 12, 2017, we will deliver a mutually acceptable security for the difference between $46,000,000 and the amount spent to date on the Extension Well. For the purposes of calculation for this clause, however, only costs spent for services and goods provided in Guinea shall be taken into account until the drilling rig to be used in the drilling of the Extension Well is located in the territorial waters of the Republic of Guinea. If we do not provide either security by the specified dates, the Government of Guinea may terminate the PSC immediately and without prior notice to remedy such deficiency.
Additionally, we agreed to limit the cost recovery pool to date to our share of expenditures in the PSC since 2009 (estimated to be approximately $150,000,000) and move into the territory of Guinea the long lead items we received in the Settlement Agreement that are currently in Takoradi, Ghana for the drilling of the Extension Well by January 31, 2017. Finally, we agreed to allocate and administer a training budget during the PSC Extension Period for the benefit of the Guinea National Petroleum Office of $250,000 in addition to any unused portion of the training program under Article 10.3 of the PSC, estimated to be approximately $500,000.
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. INVESTMENT IN OIL AND GAS PROPERTIES (Continued)
Failure to comply with the drilling and other obligations of the PSC as amended subjects us to financial penalties and a risk of loss of the Concession. The continued delays have affected adversely the ability to explore the Concession and reduces the attractiveness of the Concession to prospective industry participants and financing sources. While we currently hold 100% of the Concession, it is unknown whether we will be able to raise the necessary funds to drill the exploratory well during the PSC Extension Period.
4. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses as of June 30, 2016 and 2015 include the following (in thousands):
The single largest payable in the Accounts payable trade balances is for the yearly Director & Officer Insurance renewal and was $1.3 million and $1.1 million for 2016 and 2015, respectively.
5. INCOME TAXES
Federal Income taxes are not currently due since Hyperdynamics has had losses since inception. Components of deferred tax assets as of June 30, 2016 and 2015 are as follows (in thousands):
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. INCOME TAXES (Continued)
Deferred tax assets have been fully reserved due to determination that it is more likely than not that the Company will not be able to realize the benefit from them. In accordance with generally accepted accounting principles, no deferred income tax asset has been recognized for the $118 million excess of the income tax basis in SCS, the Company's Cayman Island operating subsidiary, over the book basis of the subsidiary. This potential tax benefit will only be fully realized if the subsidiary or the Concession is sold at a taxable gain, subject to potential tax limitations.
Hyperdynamics has U.S. net operating loss carryforwards of approximately $115.8 million at June 30, 2016. The U.S. net operating losses contain excess tax benefits related to stock compensation in the amount of $2.2 million which have not been included in the financial statements.
Internal Revenue Code Section 382 restricts the ability to use these carryforwards whenever an ownership change, as defined, occurs. Hyperdynamics incurred such an ownership change on January 14, 1998 and again on June 30, 2001. As a result of the first ownership change, Hyperdynamics' use of net operating losses as of January 14, 1998, of $949,000, is restricted to $151,000 per year. The availability of losses from that date through June 30, 2001 of $3,313,000 is restricted to $784,000 per year.
The Company underwent a restructuring during fiscal 2012 that removed approximately $13.2 million of net operating losses from the U.S. consolidated tax return. It is unlikely that the entity where these net operating losses reside will ever generate U.S. taxable income sufficient to utilize any of these losses. Due to the existence of the valuation allowance, it is not expected that any possible limitation will have an impact on the results of operations or financial position of the Company. The U.S. net operating loss carryforwards expire from 2020 to 2035.
The difference between the statutory tax rates and our effective tax rate is primarily due to the valuation allowance applied against our deferred tax assets generated by net operating losses. A reconciliation of the actual taxes to the U.S. statutory tax rate for the years ended June 30, 2016 and 2015 is as follows (in thousands):
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. INCOME TAXES (Continued)
The following table summarizes the activity related to our gross unrecognized tax benefits from July 1, 2014 to June 30, 2016 (in thousands):
The total unrecognized tax benefits that, if recognized, would affect our effective tax rate was $5,485,000 for the years ended June 30, 2016 and June 30, 2015.
We file income tax returns, including tax returns for our subsidiaries, with federal, state, local, and foreign jurisdictions. Our tax returns are subject to routine compliance review by the taxing authorities in the jurisdictions in which we file tax returns in the ordinary course of business. We consider the United States to be our most significant tax jurisdiction; however, the taxing authorities in Guinea may audit various tax returns. We currently have no ongoing federal or state audits. The normal statute of limitations for tax returns being available for IRS audit is three years from the filing date of the return. However, net operating losses are subject to adjustment upon utilization of the loss to offset taxable income regardless of when the net operating loss was generated. Therefore, all of our historic losses are subject to adjustment until they are utilized or expire. We do not believe there will be any decreases to our unrecognized tax benefits within the next twelve months.
6. SHAREHOLDERS' EQUITY
Common Stock issuances
There were no stock options or warrants exercised during the years ended June 30, 2016 or 2015.
7. SHARE-BASED COMPENSATION
On February 18, 2010, at our annual meeting of stockholders, the board of directors and stockholders approved the 2010 Equity Incentive Plan (the "2010 Plan"). Prior to the 2010 stockholder meeting, we had two stock award plans: the Stock and Stock Option Plan, which was adopted in 1997 ("1997 Plan") and the 2008 Restricted Stock Award Plan ("2008 Plan"). In conjunction with the approval of the 2010 Plan at the annual meeting, the 1997 Plan and 2008 Plan were terminated as of February 18, 2010. Subsequently, on February 17, 2012, the 2010 Plan was amended to increase the maximum shares issuable under the 2010 Plan and again on January 27, 2016, at our annual meeting of
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. SHARE-BASED COMPENSATION (Continued)
stockholders, the stockholders approved amending the 2010 Plan to increase the number of shares available for issuance by 750,000 shares.
The 2010 Plan provides for the grants of shares of common stock, restricted stock or incentive stock options and/or nonqualified stock options to purchase our common stock to selected employees, directors, officers, agents, consultants, attorneys, vendors and advisors of ours' or of any parent or subsidiary thereof. Shares of common stock, options, or restricted stock can only be granted under this plan within 10 years from the effective date of February 18, 2010. A maximum of 2,000,000 shares are issuable under the 2010 Plan and at June 30, 2016, 945,710 shares remained available for issuance.
The 2010 Plan provides a means to attract and retain the services of participants and also to provide added incentive to such persons by encouraging stock ownership in the Company. Plan grants are administered by the Compensation, Nominating, and Corporate Governance Committee, who has substantial discretion to determine which persons, amounts, time, price, exercise terms, and restrictions, if any.
Additionally, from time to time, we issue non-compensatory warrants, such as warrants issued to investors.
Stock Options
The fair value of stock option awards is estimated using the Black-Scholes valuation model. For market based stock option awards, those options where vesting terms are dependent on achieving a specified stock price, the fair value was estimated using a Black-Scholes option pricing model with inputs adjusted for the probability of the vesting criteria being met and the median expected term for each grant as determined by utilizing a Monte Carlo simulation. Expected volatility is based solely on historical volatility of our common stock over the period commensurate with the expected term of the stock options. We rely solely on historical volatility as we do not have traded options. The expected term calculation for stock options is based on the simplified method as described in the Securities and Exchange Commission Staff Accounting Bulletin number 107. We use this method because we do not have sufficient historical information on exercise patterns to develop a model for expected term. The risk-free interest rate is based on the U. S. Treasury yield in effect at the time of grant for an instrument with a maturity that is commensurate with the expected term of the stock options. The dividend yield rate of zero is based on the fact that we have never paid cash dividends on our common stock and we do not expect to pay cash dividends on our common stock during the expected term of the options.
The following table provides information about options during the years ended June 30:
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. SHARE-BASED COMPENSATION (Continued)
The following table details the significant assumptions used to compute the fair market values of employee and director stock options granted during the years ended June 30:
Summary information regarding employee stock options issued and outstanding under all plans as of June 30, 2016 is as follows:
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. SHARE-BASED COMPENSATION (Continued)
Options outstanding and exercisable as of June 30, 2016
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. SHARE-BASED COMPENSATION (Continued)
Options outstanding and exercisable as of June 30, 2015
At June 30, 2016, there was $31 thousand of unrecognized compensation costs related to non-vested share based compensation arrangements granted to employees under the plans. During 2016, a total of 449,904 options, with a weighted average grant date fair value of $1.10 per share, vested in accordance with the underlying agreements. Unvested options at June 30, 2016 totaled 97,601 with a weighted average grant date fair value of $5.50, an amortization period of one to two years and a weighted average remaining life of 4.91 years. At June 30, 2015, there was $0.4 million of unrecognized compensation costs related to non-vested share based compensation arrangements granted to employees under the plans. During 2015, a total of 377,274 options, with a weighted average grant date fair value of $3.76 per share, vested in accordance with the underlying agreements. Unvested options at June 30, 2015 totaled 427,826 with a weighted average grant date fair value of $10.95, an amortization period of one to two years and a weighted average remaining life of 4.83 years.
Restricted Stock
The fair value of restricted stock awards classified as equity awards is based on the Company's stock price as of the date of grant. Such awards do not grant any rights as a shareholder of the company until a certificate for the vested shares of common stock has been issued. During the year ended June 30, 2015, all such awards were forfeited with compensation expense forfeiture credits of approximately $46 thousand recorded. No new grants have been issued, and none are outstanding at June 30, 2016.
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. SHARE-BASED COMPENSATION (Continued)
Warrants
The exercise price of the warrants may be adjusted in the case of stock splits, stock dividends or combinations of shares, or in the event the Company issues rights, options or warrants to all holders of the Company's common stock with an exercise or purchase price less than the volume weighted average price of the Company's shares on the record date. The warrants are considered indexed to our common stock and therefore are not considered a derivative. The fair value of the warrants was determined using the Black-Scholes option pricing model. The last of the previously granted outstanding warrants expired in October 2015, and there were no warrants granted or exercised in the years ended June 30, 2016 and 2015. Accordingly, there were no warrants outstanding at the year ended June 30, 2016
Summary information regarding common stock warrants issued and outstanding as of June 30, 2015 is as follows:
Warrants outstanding and exercisable as of June 30, 2015
8. COMMITMENTS AND CONTINGENCIES
LITIGATION AND OTHER LEGAL MATTERS
From time to time, we and our subsidiaries are involved in disputes. We are unable to predict the outcome of such matters when they arise. We review the status of on-going proceedings and other contingent matters with legal counsel. Liabilities for such items are recorded if and when it is probable that a liability has been incurred and when the amount of the liability can be reasonably estimated. If we are able to reasonably estimate a range of possible losses, an estimated range of possible loss is disclosed for such matters in excess of the accrued liability, if any. Liabilities are periodically reviewed for adjustments based on additional information.
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. COMMITMENTS AND CONTINGENCIES (Continued)
Tullow and Dana Legal Actions
On January 11, 2016, we filed legal actions against members of the Consortium under the Joint Operating Agreement governing the oil and gas exploration rights offshore Guinea ("JOA") in the United States District Court for the Southern District of Texas and before the AAA against Tullow for their failure to meet their obligations under the JOAC. On January 28, 2016, the action in the Federal District Court was voluntarily dismissed by us and refiled in District Court in Harris County, Texas. On February 8, 2016 Tullow and Dana removed the case to Federal District Court.
On February 2, 2016, SCS filed an Application for Emergency Arbitrator and Interim Measures of Protection and requested the following relief: (a) expedite discovery prior to the constitution of the arbitral tribunal; (b) provide that the time period permitted by the parties' arbitration agreement for the selection of the arbitrators and the filing of any responsive pleadings or counterclaims be accelerated; (c) require Tullow, as the designated operator under the JOA, to maintain existing "well-planning activities"; (d) require Tullow to undertake and complete certain planning activities; and (e) require Tullow and Dana to join with SCS in completing the negotiation of an acceptable amendment to the PSC and to agree to a process that will result in the execution of the amendment. With the exception of limited relief regarding discovery and agreement by Tullow to maintain certain well plan readiness, the Emergency Arbitrator ruled on February 17, 2016, that SCS is not entitled to the emergency injunctive relief it requested. Further, the Emergency Arbitrator enjoined all parties to the dispute from pursuing parallel District Court proceedings. On February 12, 2016, the case was voluntarily stayed by us.
The AAA action sought (1) a determination that Tullow and Dana are in breach of their contractual obligations and (2) the damages caused by the repeated delays in well drilling caused by the activities of Tullow and Dana. We determined to bring the legal actions only after it became apparent that Tullow and Dana would not move forward, despite many opportunities to do so, with petroleum operations.
Subsequently, on August 15, 2016, we entered into a Settlement and Release Agreement with Tullow and Dana ("Settlement and Release") with respect to our dispute in arbitration (American Arbitration Association, Case No: 01-16-0000-0679, styled SCS Corporation Ltd v. Tullow Guinea Ltd. and Dana Petroleum (E&P) Ltd.). Under the Settlement and Release, we released all claims against Tullow and Dana and Tullow and Dana (i) issued to the Government of Guinea a notice of withdrawal from the Concession and PSC effective immediately, (ii) transferred their interest in the long lead items previously purchased by the Consortium in preparation for the drilling of the Fatala well, and agreed to pay net cash of $686,570 to us. We also agreed to pay Dana a success fee based upon the certified reserves of the Fatala well if it results in a discovery. We will record the long lead items and a gain once they have been inspected and appropriately valued.
Shareholder Lawsuits
Beginning on March 13, 2014, two lawsuits styled as class actions were filed in the U.S. District Court for the Southern District of Texas against us and several then-current officers of the Company alleging that we made false and misleading statements that artificially inflated our stock prices. The lawsuits allege, among other things, that we misrepresented our compliance with the Foreign Corrupt Practices Act and anti-money laundering statutes and that we lacked adequate internal controls. The lawsuits seek damages based on Sections 10(b) and 20 of the Securities Exchange Act of 1934, although
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. COMMITMENTS AND CONTINGENCIES (Continued)
the specific amount of damages is not specified. On May 12, 2014, a shareholder filed a motion for appointment as lead plaintiff, which remains pending. One of the March 2014 lawsuits has now been dismissed voluntarily, and the parties to the remaining suit await the issuance of a scheduling order in that matter. We have assessed the status of the remaining March 2014 lawsuit and have concluded that an adverse judgment remains reasonably possible, but not probable. As a result, no provision has been made in the consolidated financial statements. We are unable to estimate a range of possible loss; however, in our opinion, the outcome of this dispute will not have a material effect on our financial condition and results of operations.
In addition, we have received demands from shareholders to inspect our books and records.
Iroquois Lawsuit
On May 9, 2012, a lawsuit was filed in the Supreme Court of the State of New York against us and all of our directors. The plaintiffs, five hedge funds that invested in us in early 2012, allege that we breached an agreement with the plaintiffs, and that we and the directors made certain negligent misrepresentations relating to our drilling operations. Among other claims, the plaintiffs allege that we misrepresented the status of our drilling operations and the speed with which the drilling would be completed. The plaintiffs advance claims for breach of contract and negligent misrepresentation and seek damages in the amount of $18.5 million plus pre-judgment interest. On July 12, 2012, we and the directors moved to dismiss the suit for failure to state a claim as to all defendants and for lack of personal jurisdiction over the director defendants. On June 19, 2013, the court dismissed the negligent misrepresentation claim but declined to dismiss the breach of contract claim. The negligent misrepresentation claim was dismissed without prejudice, meaning plaintiffs could attempt to refile it. On August 12, 2013, the plaintiffs filed an amended complaint. That complaint names only us and seeks recovery for alleged breaches of contract. We filed an answer to the plaintiffs' amended complaint on September 9, 2013, and the court has entered a scheduling order governing pre-trial proceedings in the matter. The maximum possible loss is the full amount of $18.5 million plus interest accrued thereon until judgment. We, however, have assessed the status of this matter and have concluded that although an adverse judgment is reasonably possible, it is not probable. As a result, no provision has been made in the consolidated financial statements. In our opinion, the outcome of this dispute will not have a material effect on our financial condition and results of operations.
COMMITMENTS AND CONTINGENCIES
Operating Leases
We lease office space under long-term operating leases with varying terms. Most of the operating leases contain renewal and purchase options. We expect that in the normal course of business, the majority of operating leases will be renewed or replaced by other leases.
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. COMMITMENTS AND CONTINGENCIES (Continued)
The following is a schedule by years of minimum future rental payments required under operating leases that have initial or remaining non-cancellable lease terms in excess of one year as of June 30, 2016 (in thousands):
Rent expense included in loss from operations for the years ended June 30, 2016 and 2015 was $0.4 million and $0.3 million, respectively in each year.
9. SUBSEQUENT EVENTS
On August 15, 2016, we entered into a Settlement and Release Agreement with Tullow and Dana ("Settlement Agreement") that gave us 100% of the interest under the PSC, property useful in the drilling of an exploratory well, and cash, in return for a mutual release of all claims. We will record the property received and a gain once they have been inspected and appropriately valued.
On August 19, 2016, we signed a non-binding Memorandum of Understanding with the Government of Guinea and executed a Second Amendment to the PSC ("2016 Amendment") on September 15, 2016. As more fully described below, upon receipt of a Presidential Decree, the 2016 Amendment will give us a one year extension to the second exploration period of the PSC to September 22, 2017 ("PSC Extension Period"). In addition to clarifying certain elements of the PSC, we agreed in the 2016 Amendment to drill one (1) exploratory well to a minimum depth of 2,500 meters below the seabed within the PSC Extension Period with a projected commencement date of April 2017 (the "Extension Well") with the option of drilling additional wells. If the Extension Well is not drilled within the PSC Extension Period, we will owe the Government of Guinea the difference between the actual expenditures in Guinea related to the well and $46,000,000. Fulfillment of the work obligations exempts us from the expenditure obligations during the PSC Extension Period.
In turn, we will retain only an area equivalent to approximately 5,000 square kilometers in the Guinea offshore and will provide the Government of Guinea: (1) A parent company guarantee for the well obligation, (2) monthly progress reports and a reconciliation of budget to actual expenditures, (failure to provide the reports and assurances on a timely basis in a notice of termination with a 30 day period to cure), and (3) guarantees to Guinea that (a) no later than January 21, 2017 we will provide a mutually acceptable security for $5,000,000 on terms customary in international petroleum operations, provided that this security is to be released at the time the drilling rig for the Extension Well is on location offshore Guinea, and (b) no later than April 12, 2017, we will deliver a mutually acceptable security for the difference between $46,000,000 and the amount spent to date on the Extension Well. For the purposes of calculation for this clause, however, only costs spent for services and goods provided in Guinea shall be taken into account until the drilling rig to be used in the drilling of the Extension Well is located in the territorial waters of the Republic of Guinea. If we do not provide
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. SUBSEQUENT EVENTS (Continued)
either security by the specified dates, the Government of Guinea may terminate the PSC immediately and without prior notice to remedy such deficiency.
Additionally, we agreed to limit the cost recovery pool to date to our share of expenditures in the PSC since 2009 (estimated to be approximately $150,000,000) and move into the territory of Guinea the long lead items we received in the Settlement Agreement that are currently in Takoradi, Ghana for the drilling of the Extension Well by January 31, 2017. Finally, we agreed to allocate and administer a training budget during the PSC Extension Period for the benefit of the Guinea National Petroleum Office of $250,000 in addition to any unused portion of the training program under Article 10.3 of the PSC, estimated to be approximately $500,000.
Failure to comply with the drilling and other obligations of the PSC as amended subjects us to financial penalties and a risk of loss of the Concession. The continued delays have affected adversely the ability to explore the Concession and reduces the attractiveness of the Concession to prospective industry participants and financing sources. While we currently hold 100% of the Concession, it is unknown whether we will be able to raise the necessary funds to drill the exploratory well during the PSC Extension Period.
10. QUARTERLY RESULTS (UNAUDITED)
Shown below are selected unaudited quarterly data for the years ended June 30, 2016 and 2015 (in thousands, except per share data):
The sum of the individual quarterly net loss per share amounts may not agree with year-to-date net loss per share as each quarterly computation is based on the weighted average number of common shares outstanding during that period. In addition, certain potentially dilutive securities were not included in any of the quarterly computations of diluted net loss per share because to do so would have been antidilutive.
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. SUPPLEMENTAL OIL AND GAS INFORMATION (UNAUDITED)
Estimates of reserve quantities and related standardized measure of discounted net cash flows are estimates only, and are not intended to reflect realizable values or fair market values of reserves. Reserve estimates are inherently imprecise and estimates of new discoveries are more imprecise than producing oil and gas properties. Additionally, the price of oil has been very volatile and downward changes in prices can significantly affect quantities that are economically recoverable. Accordingly, estimates are expected to change as future information becomes available and these changes may be significant.
Proved reserves are estimated reserves of crude oil and natural gas that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed reserves are those expected to be recovered through existing wells, equipment and operating methods.
The standardized measure of discounted future net cash flows are computed by applying average price for the year (with consideration of price changes only to the extent provided by contractual arrangements) to the estimated future production of proved oil and gas reserves, less estimated future expenditures (based on year-end costs) to be incurred in developing and producing the proved reserves, less estimated future income tax expenses. The estimated future net cash flows are then discounted using a rate of 10% per year to reflect the estimated timing of the future cash flows.
Capitalized Costs Related to Oil and Gas Activities
Aggregate capitalized costs relating to our crude oil and natural gas producing activities, including asset retirement costs and related accumulated depreciation, depletion & amortization are shown below (in thousands):
As of March 31, 2016, based on our impairment assessment, we fully impaired the $14,331,000 of unproved oil and gas properties. This impairment assessment was based on the continued impasse by our members of the Consortium to resume petroleum operations and drill the next exploration obligation well, which needs to be commenced by the end of September 2016, and our inability to get
HYPERDYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. SUPPLEMENTAL OIL AND GAS INFORMATION (UNAUDITED) (Continued)
interim injunctive relief from the American Arbitration Association requiring Tullow and Dana to join with SCS in the negotiation of an acceptable amendment to the PSC and to agree to a process that would result in the execution of the amendment which we hoped would have led to the resumption of petroleum operations. Despite this impairment, we continued to pursue any avenues in order to begin drilling activities in our Concession.
Costs Incurred in Oil and Gas Activities
Costs incurred in connection with our crude oil and natural gas acquisition, exploration and development activities are shown below (in thousands):
Proved Reserves
We do not hold any proved reserves as of June 30, 2016 and 2015.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
We conducted an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms. Disclosure controls and procedures also include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.
Our management is responsible for establishing and monitoring internal control over financial reporting. Management assessed the effectiveness of the Company's internal control over financial reporting as of June 30, 2016. In making this assessment, management used the criteria for internal control over financial reporting described in Internal Control-Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Management's assessment included an evaluation of the design of the Company's internal control over financial reporting and testing of the operating effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of the Company's Board of Directors. Based on this assessment, management has concluded that, as of June 30, 2016, the Company's internal control over financial reporting was effective.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this item will be included in our proxy statement for the 2016 Annual Meeting of Stockholders and is incorporated herein by reference thereto.
Item 11.
Item 11. Executive Compensation.
The information required by this item will be included in our proxy statement for the 2016 Annual Meeting of Stockholders and is incorporated herein by reference thereto.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this item will be included in our proxy statement for the 2016 Annual Meeting of Stockholders and is incorporated herein by reference thereto.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this item will be included in our proxy statement for the 2016 Annual Meeting of Stockholders and is incorporated herein by reference thereto.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this item will be included in our proxy statement for the 2016 Annual Meeting of Stockholders and is incorporated herein by reference thereto.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(A)
*Management contracts or compensatory plans or arrangements.
**Filed herewith.
(1)Incorporated by reference to Form 10-K filed September 11, 2013.
(2)Incorporated by reference to Schedule 14A filed January 11, 2011.
(3)Incorporated by reference to Form S-1 filed January 12, 2006, as amended.
(4)Incorporated by reference to Form 8-K filed June 15, 2001.
(5)Incorporated by reference to Form 8-K filed September 28, 2006.
(6)Incorporated by reference to Form 10-K filed on September 13, 2012.
(7)Incorporated by reference to Form S-8 filed June 14, 2010.
(8)Incorporated by reference to Form 8-K, dated March 31, 2010.
(9)Incorporated by reference to Form 8-K, filed December 7, 2009.
(10)Incorporated by reference to Form 8-K filed December 6, 2010.
(11)Incorporated by reference to Form 8-K filed November 21, 2012.
(12)Incorporated by reference to Form 8-K, dated January 29, 2010.
(13)Incorporated by reference to Form 8-K, dated January 7, 2013.
(14)Incorporated by reference to Form 8-K filed December 28, 2011.
(15)Incorporated by reference to Form 8-K filed on September 23, 2011.
(16)Incorporated by reference to Form 8-K filed on February 1, 2012.
(17)Incorporated by reference to Form 8-K filed on June 28, 2013.
(18)Incorporated by reference to Form 10-K filed on September 12, 2014.
(19)Incorporated by reference to Form 10-K filed on September 16, 2015.
(20)Incorporated by reference to Form 8-K dated on October 7, 2015.
(21)Incorporated by reference to Form 10-Q filed on February 11, 2016.
(B)
FINANCIAL STATEMENT SCHEDULES
The financial statement schedules required by this item are set forth in the notes to our financial statements set forth on page.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
HYPERDYNAMICS CORPORATION
September 22, 2016
/s/ RAY LEONARD
Ray Leonard
President, CEO and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
September 22, 2016
/s/ IAN NORBURY
Ian Norbury
Non-Executive Chairman and Director
September 22, 2016
/s/ RAY LEONARD
Ray Leonard
President, CEO and Director
September 22, 2016
/s/ WILLIAM STRANGE
William Strange
Director
September 22, 2016
/s/ FRED ZEIDMAN
Fred Zeidman
Director
September 22, 2016
/s/ GARY ELLISTON
Gary Elliston
Director
September 22, 2016
/s/ PATRICIA MOLLER
Patricia Moller
Director
September 22, 2016
/s/ DAVID WESSON
David Wesson
Chief Financial and Accounting Officer
Exhibit Index
*Management contracts or compensatory plans or arrangements.
**Filed herewith.
(1)Incorporated by reference to Form 10-K filed September 11, 2013.
(2)Incorporated by reference to Schedule 14A filed January 11, 2011.
(3)Incorporated by reference to Form S-1 filed January 12, 2006, as amended.
(4)Incorporated by reference to Form 8-K filed June 15, 2001.
(5)Incorporated by reference to Form 8-K filed September 28, 2006.
(6)Incorporated by reference to Form 10-K filed on September 13, 2012.
(7)Incorporated by reference to Form S-8 filed June 14, 2010.
(8)Incorporated by reference to Form 8-K, dated March 31, 2010.
(9)Incorporated by reference to Form 8-K, filed December 7, 2009.
(10)Incorporated by reference to Form 8-K filed December 6, 2010.
(11)Incorporated by reference to Form 8-K filed November 21, 2012.
(12)Incorporated by reference to Form 8-K, dated January 29, 2010.
(13)Incorporated by reference to Form 8-K, dated January 7, 2013.
(14)Incorporated by reference to Form 8-K filed December 28, 2011.
(15)Incorporated by reference to Form 8-K filed on September 23, 2011.
(16)Incorporated by reference to Form 8-K filed on February 1, 2012.
(17)Incorporated by reference to Form 8-K filed on June 28, 2013.
(18)Incorporated by reference to Form 10-K filed on September 12, 2014.
(19)Incorporated by reference to Form 10-K filed on September 16, 2015.
(20)Incorporated by reference to Form 8-K dated on October 7, 2015.
(21)Incorporated by reference to Form 10-Q filed on February 11, 2016.