ITEM 1A. RISK FACTORS RELATED TO THE COMPANY'S BUSINESS
JayHawk is subject to various risks and uncertainties in the course of its business. The following summarizes some, but not all, of the risks and uncertainties that may adversely affect its business, financial condition or results of operations.
Going Concern - As shown in the accompanying consolidated financial statements, the Company has incurred operating losses since inception. As of September 30, 2014, JayHawk Energy has limited financial resources with which to achieve its objectives and obtain profitability and positive cash flows. Achievement of the Company's objectives will be dependent upon its ability to obtain additional financing, to locate profitable oil and gas properties and generate revenue from the current and planned business operations, and control costs. The Company plans to fund future operations by joint venturing, obtaining additional financing from investors, and attaining additional commercial production. However, there is no assurance that JayHawk Energy will be able to achieve these objectives.
Commodity Price Risk: The Company's estimated proved reserves, revenue, operating cash flows, and operating margins are highly dependent on the prices of crude oil and natural gas. A substantial or extended decline in oil or natural gas prices would reduce its operating results and cash flows and could impact the rate of growth and carrying value of the Company's assets. Prices for liquid hydrocarbons and natural gas are very volatile. JayHawk Energy's revenues, operating results and ability to grow in the future are highly dependent on the prices it receives for its oil and natural gas. Many factors beyond the Company's control influence the price it receives for production. These include, but are not limited to, general economic conditions worldwide, political instability in other parts of the world, changes in weather patterns, price and availability of alternative sources of energy, and government regulation.
Technical Risk: The Company's exploration and development operations are subject to many risks which may affect its ability to profitably extract oil and natural gas reserves or achieve targeted returns. In addition, continued growth requires that the Company acquire and successfully develop additional oil and natural gas reserves.
JayHawk Energy's exploration and development activities will depend in part on the evaluation of data obtained through geophysical testing and geological analysis, as well as test drilling activity. The results of such studies and tests are subjective, and no assurances can be given that exploration and development activities based on positive analysis will produce oil or natural gas in commercial quantities or costs. As developmental and exploratory activities are performed, further data required for evaluation of its oil and natural gas interests will become available. The exploration and development activities that will be undertaken by the Company are subject to greater risks than those associated with the acquisition and ownership of producing properties. The drilling of development wells, although generally consisting of drilling to reservoirs believed to be productive, may result in dry holes or a failure to produce oil and natural gas in commercial quantities. Moreover, any drilling of exploratory wells is subject to significant risk of dry holes.
The Company's commercial success depends on its ability to find, acquire, develop and commercially produce oil and natural gas reserves. Without the continual addition of new reserves, any existing reserves and the production thereof will decline over time as such existing reserves are depleted. A future increase in the Company's reserves will depend not only on its ability to explore and develop any properties the Company may have from time to time, but also on its ability to select and acquire suitable producing properties or prospects. No assurance can be given that JayHawk Energy will be able to continue to locate satisfactory properties for acquisition or participation. Moreover, if such acquisitions or participations are identified, the Company may determine that current markets, terms of acquisition and participation or pricing conditions make such acquisitions or participations economically disadvantageous. There is no assurance that commercial quantities of oil and natural gas will be discovered or acquired by the Company.
Catastrophic Risk: The Company's oil and natural gas operations are subject to unforeseen operating hazards which may damage or destroy assets. Although the Company maintains a level of insurance coverage consistent with industry practices against property or casualty losses, unique circumstances to any particular event may make the coverage inadequate. Oil and natural gas exploration, development and production operations are subject to all the risks and hazards typically associated with such operations, including hazards such as fire, explosion, blowouts, sour gas releases and spills, each of which could result in substantial damage to oil and natural gas wells, production facilities, other property and the environment or in personal injury.
Competitive Risk: The petroleum industry is highly competitive and very capital intensive. If the Company is unable to successfully compete with the large number of oil and natural gas producers in its industry, it may not be able to achieve profitable operations. The Company encounters competition from numerous companies in each of its activities, including acquiring rights to explore for crude oil and natural gas. The Company's competitors include oil and natural gas companies that have substantially greater financial resources, staff and facilities than JayHawk Energy. JayHawk's ability to increase reserves in the future will depend not only on its ability to explore and develop its existing properties, but also on the ability to select and acquire suitable producing properties or prospects for
exploratory drilling. Competitive factors in the distribution and marketing of oil and natural gas include price and methods and reliability of delivery. Competition may also be presented by alternate fuel sources.
Regulatory and Environment Risk: The Company is subject to various regulatory requirements, including environmental regulations, and may incur substantial costs to comply and remain in compliance with those requirements. Oil and gas operations are subject to environmental hazards such as oil spills, produced water spills, gas leaks and ruptures and discharges of substances or gases that could expose the Company to substantial liability. The Company's operations are also subject to numerous laws and regulations at the federal, state and local levels, including regulation relating to matters such as the exploration for and the development, production, marketing, pricing, transmission and storage of oil and natural gas, as well as environmental and safety matters. Failure to comply with applicable regulations could result in fines or penalties being owed to third parties or governmental entities, the payment of which could have a material adverse effect on the Company's financial condition or results of operations. The Company's operations are subject to significant laws and regulations, which may adversely affect its ability to conduct business or increase its costs.
Environmental legislation provides for, among other things, restrictions and prohibitions on spills, releases or emissions of various substances produced in association with oil and natural gas operations. The legislation also requires that wells and facility sites be operated, maintained, abandoned and reclaimed to the satisfaction of the applicable regulatory authorities. Compliance with such legislation can require significant expenditures and a breach may result in the imposition of fines and penalties.
The discharge of oil, natural gas or other pollutants into the air, soil or water may give rise to liabilities to governments and third parties and may require the Company to incur costs to remedy such discharge. No assurance can be given that environmental laws will not result in a curtailment of production or a material increase in the costs of production, development or exploration activities or otherwise adversely affect the Company's financial condition, results of operations or prospects. The Company could incur significant liability for damages, clean-up costs and/or penalties in the event of discharges into the environment, environmental damage caused by the Company or previous owners of the Company's property or non-compliance with environmental laws or regulations. In addition to actions brought by governmental agencies, the Company could face actions brought by private parties or citizens groups. Any of the foregoing could have a material adverse effect on the Company's financial results.
Market Risk: The marketability and price of oil and natural gas that may be acquired or discovered by the Company will be affected by numerous factors beyond JayHawk Energy's control. The Company's ability to market its natural gas may depend upon the ability to acquire space on pipelines that deliver natural gas to commercial markets. The Company may also be affected by deliverability uncertainties related to the proximity of its reserves to pipelines and processing facilities, by operational problems with such pipelines and facilities, and by government regulation relating to price, taxes, royalties, land tenure, allowable production, the export of oil and natural gas and by many other aspects of the oil and natural gas business.
Financial Risks: JayHawk Energy's business may be harmed if the Company is unable to retain interests in existing leases. All of the Company's properties are held under licenses, working interests in operating agreements and interests in oil and gas mineral leases, some of which expire within the next twelve months. If the Company fails to meet the specific requirements of a particular lease, especially any future drilling and production requirements, the lease may be terminated or otherwise expire. The Company cannot be assured that it will be able to meet its obligations under each lease. The termination or expiration of its working interest relating to any lease would harm the Company's business, financial condition and results of operations.
Estimation Risks: Reserve estimates, like all estimates, are subject to numerous uncertainties and may be inaccurate. There are numerous uncertainties inherent in estimating quantities of oil or natural gas reserves and cash flows to be derived therefrom, including many factors beyond the Company's control. The reserve and associated cash flow information set forth herein represent estimates only. In general, estimates of economically recoverable oil and natural gas reserves and the future net cash flows therefrom are based upon a number of variable factors and assumptions, such as historical production from the properties, production rates, ultimate reserve recovery, timing and amount of capital expenditures, marketability of oil and natural gas, royalty rates, the assumed effects of regulation by governmental agencies and future operating costs, all of which may vary from actual results. All such estimates are to some degree speculative, and classifications of reserves are only attempts to define the degree of speculation involved. For those reasons, estimates of the economically recoverable oil and natural gas reserves attributable to any particular group of properties, classification of such reserves based on risk of recovery and estimates of future net revenues expected therefrom prepared by different engineers, or by the same engineers at different times, may vary. Actual production, revenues, taxes and development and operating expenditures with respect to the Company's reserves will vary from estimates thereof and such variations could be material.
Estimates of proved or unproved reserves that may be developed and produced in the future are often based upon volumetric calculations and upon analogy to similar types of reserves rather than actual production history. Estimates based on these methods are generally less reliable than those based on actual production history. Subsequent evaluation of the same reserves based upon production history and production practices will result in variations in the estimated reserves and such variations could be material.
Default Risks: Properties are held in the form of licenses, leases and working interests in operating agreements and leases. If the Company and/or a lease holder fail to meet the specific requirements of the lease, license or operating agreement the specific instrument may terminate or expire. There can be no assurance that any of the obligations required to maintain each license or lease will be met, although the Company exercises commercially reasonable efforts to do so. The termination or expiration of licenses or leases or the working interests relating to a license or lease may have a material adverse effect on the Company's results of operations and business.
Risk of Loss of Key Personnel: The Company's success depends in large measure on certain key personnel, including its President and Chief Executive Officer, and Chief Financial Officer. The loss of the services of such key personnel could have a material adverse effect on the Company. Although the Company is considering acquiring key person insurance, the Company does not currently have such insurance in effect for these key individuals. In addition, the competition for qualified personnel in the oil and natural gas industry is intense and there can be no assurance that the Company will be able to continue to attract and retain all personnel necessary for the development and operation of its business.
Title Deficiencies Risk: The existence of a material title deficiency can render a lease worthless and can result in a large expense to the Company's business. It is the Company's practice in acquiring oil and gas leases or undivided interests in oil and gas leases to forego the expense of retaining lawyers to examine the title to the oil or gas interest to be placed under lease or already placed under lease. Instead, we rely upon the judgment of oil and gas landmen who perform the field work in examining records in the appropriate governmental office before attempting to place under lease a specific oil or gas interest. This is customary practice in the oil and gas industry. However, we do not anticipate that we, or the person or company acting as operator of the wells located on the properties that we currently lease or may lease in the future, will obtain counsel to examine title to the lease until the well is about to be drilled. As a result, we may be unaware of deficiencies in the marketability of the title to the lease. Such deficiencies may render the lease worthless and impede upon the Company's ability to develop the property subject to the lease.
Risk Related to Debentures: The Company currently is indebted to four institutional investors in the form of convertible debentures the repayment of which are secured by liens against the Company’s North Dakota properties. The Company is currently in default of provisions in the debenture agreements as discussed in Note 7 of the consolidated financial statements. Should the debenture holders choose to exercise their rights to foreclose on the North Dakota properties, the Company's cash flow from operations could be reduced significantly to only those revenues derived from the Kansas natural gas operations.
Risk related to disclosure controls: As a result of ineffective disclosure controls and procedures and ineffective internal control over financial reporting causing unreliable financial reporting, the Company has, in the past, disseminated incorrect financial information to the public. The Company's management evaluated its disclosure controls and procedures as of September 30, 2014 and concluded that as of that date, the Company's disclosure controls and procedures were not effective. In addition, management evaluated the Company's internal control over financial reporting as of September 30, 2014 and concluded that that there were material weaknesses in the Company's internal control over financial reporting as of that date and that its internal control over financial reporting was not effective as of that date. A material weakness is a control deficiency, or combination of control deficiencies, such that there is a reasonable possibility that a material misstatement of the financial statements will not be prevented or detected on a timely basis.
Communication failures between individuals executing transactions and individuals accounting for transactions has, in the past, led to the identification of certain required disclosures to the financial statements that had not been timely disclosed. Additionally, due to insufficient staffing, it has not been possible to ensure appropriate segregation of duties between incompatible functions, and formalized monitoring procedures have not been established or implemented. The Company has not yet remediated this material weakness and management believes that the Company's disclosure controls and procedures and internal control over financial reporting continue to be ineffective. Until these issues are corrected, the Company's ability to report financial results or other information required to be disclosed on a timely and accurate basis may be adversely affected and the Company's financial reporting may continue to be unreliable, which could result in additional incorrect financial information being disseminated to the public. Investors relying upon this incorrect information may make a misinformed investment decision.
Risks Related to the Company's Common Stock: Shares of the Company's common stock may continue to be subject to price volatility and illiquidity because the shares are thinly traded and may never become eligible for trading on a national securities exchange. While the Company may at some point be able to meet the requirements necessary for its common stock to be listed on a national securities exchange, the Company cannot assure investors or potential investors that it will ever achieve a listing of its common stock. Initial listing is subject to a variety of requirements, including minimum asset values, minimum revenue, minimum trading price and minimum public “float” requirements. There are also continuing eligibility requirements for companies listed on public trading markets. If the Company is unable to satisfy the initial or continuing eligibility requirements of any such market, then its stock may not be listed or could be delisted. This could result in a lower trading price for the Company's common stock and may limit investors ability to sell their shares, any of which could result in losing some or all of their investment.
The Company's common stock is subject to the “penny stock” rules of the Securities and Exchange Commission and the trading market in the Company's securities is limited, which makes transactions in JayHawk Energy's stock cumbersome and may reduce the value of an investment in its stock. The Securities and Exchange Commission (the “SEC”) has adopted Rule 3a51-1 which establishes the definition of a “penny stock,” for the purposes relevant to the Company, as any equity security that (i) has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, or (ii) is not registered on a national securities exchange or listed on an automated quotation system sponsored by a national securities exchange. For any transaction involving a penny stock, unless exempt, Rule 15g-9 of the Securities and Exchange Act of 1934, as amended, requires:
•
that a broker or dealer approve a person’s account for transactions in penny stocks; and
•
the broker or dealer receives from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased.
In order to approve a person’s account for transactions in penny stocks, the broker or dealer must:
•
obtain financial information and investment experience objectives of the person; and
•
make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the SEC relating to the penny stock market, which, in highlight form:
•
sets forth the basis on which the broker or dealer made the suitability determination; and
•
attests that the broker or dealer received a signed, written agreement from the investor prior to the transaction.
Disclosure also has to be made about the risks of investing in penny stocks in both public offerings and in secondary trading, and about the commissions payable to the broker-dealer and the registered representatives, as well as current quotations for the securities, and the rights and remedies available to an investor in cases of fraud in penny stock transactions. Finally, monthly statements have to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Generally, brokers may be less willing to execute transactions in securities subject to the “penny stock” rules. This may make it more difficult for investors to dispose of the Company's common stock and cause a decline in the market value of its stock.
The market valuation of energy companies, such as JayHawk Energy, Inc., frequently fluctuate due to factors unrelated to the past or present operating performance of such companies. The Company's market valuation may fluctuate significantly in response to a number of factors, many of which are beyond its control, including:
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changes in securities analysts’ estimates of the Company's financial performance, although there are currently no analysts covering its stock;
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fluctuations in stock market prices and volumes, particularly among securities of energy companies;
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changes in market valuations of similar companies;
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announcements by the Company or its competitors of significant contracts, new technologies, acquisitions, commercial relationships, joint ventures or capital commitments;
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variations in the Company's quarterly or annual operating results;
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fluctuations in oil and natural gas prices; and
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additions or departures of key personnel.
Dividends: Investors should not look to dividends as a source of income. In the interest of reinvesting initial profits back into its business, the Company does not intend to pay cash dividends in the foreseeable future. Consequently, any economic return will initially be derived, if at all, from appreciation in the fair market value of the Company's stock, and not as a result of dividend payments.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2.
ITEM 2.
PROPERTIES
S.E. Kansas - Girard Properties -The Girard Project is in Crawford County Kansas which the Company acquired on March 31, 2008. With this transaction JayHawk acquired 34 wells, of which 7 were tied into a pipeline also acquired at this time (more fully described immediately following). This acquisition provided JayHawk infrastructure necessary for future development of existing and acquired leased acreage, and during July and August of 2008, the Company completed drilling and casing an additional 21 gas wells. JayHawk Energy's acreage position in both Bourbon and Crawford counties Kansas was enhanced again with the acquisition from Missouri Gas Partners of certain oil, gas and mineral rights to 11,462 leased acres in June of 2008. As of September 30, 2014, the Company has 21 producing gas wells tied into the pipeline. Since June of 2008 through September of 2014, the Company's gas production and sales has contributed $306,153 in net revenues. At this time, The Company produces only natural gas at its Girard, Kansas well sites. This is more fully discussed in Note 5 to the Consolidated Financial Statements of this Form 10-K.
JayHawk Gas Transportation Company - Associated with the acquisition of the Girard properties in March of 2008, the Company acquired a 16 mile pipeline. In May of 2008, the Company established a 100% owned and controlled subsidiary, "JayHawk Gas Transportation Corporation" to hold and manage the assets associated with the pipeline. This pipeline is tied into a 2 million cubic foot sales pipeline and allows for substantial growth.
North Dakota - Crosby (formerly Candak) Project - On January 16, 2008, the Company acquired a 65% working interest in five producing oil wells, historically referred to as the Candak properties but currently referred to as the Crosby properties more properly reflecting the pool designation of the properties, located in the Williston Basin area of North Dakota. In addition to the five producing wells, the Company acquired certain oil, gas, and mineral rights in a 15,500-acre land position, of which the land position leases have subsequently lapsed The Crosby properties provide production of approximately 40 barrels ("Bbls") of light to medium crude oil daily from the five existing wells. Since their acquisition and through September 30, 2014 these five wells have produced and sold in excess of 102,000 Bbls. and generated net revenues to JayHawk of $3,966,866.
During the year ending September 30, 2010, JayHawk drilled two vertical wells on the Crosby property in order to develop the Mississippian reservoir further within the pool. The wells exhibited marginal production potential after attempts to stimulate flow and are currently shut-in. The Company plugged one of the shut in wells (Knudsen) and completed substantially all reclamation efforts of the adjacent pits during the first seven months of calendar year 2014. The remaining Jenks well has been plugged and is currently under consideration for conversion to a water disposal well in order to reduce operating expense.
JayHawk, in its acquisition of leases during 2010, acquired Bakken rights along with the Mississippian rights in section 28-164N-97W at the Crosby property. The Company divested its Bakken leases during the fiscal year ended September 30, 2013.
The Company is also looking at strategies to redeploy redundant production equipment on the property in order to streamline the production system and to increase overall efficiency.
Disclosure of Reserves - The Company holds proved oil reserves in North Dakota. For the North Dakota properties, the independent petroleum engineering firm of Cedar Technical Services (“Cedar”) of Baldwin City, Kansas, prepared the estimates of the Company's proved developed and proved undeveloped reserves as of September 30, 2014. The independent petroleum engineering firm of McDaniel & Associates Consultants, Ltd. (“McDaniel”) of Calgary, Alberta Canada, prepared the estimates of the Company's proved developed and proved undeveloped reserves as of September 30, 2013.
The future net cash flows (and related present value) attributable to proved and probable reserves were calculated for each well and the properties in total as of these respective dates. Proved developed reserves are defined as estimated quantities of oil, natural gas and natural gas liquids which upon analysis of geological and engineering data, appear with reasonable certainty to be recoverable in the future from known oil and gas reservoirs under existing economic and operating conditions. Proved undeveloped reserves are those reserves which can be expected to be recovered from new wells with existing equipment and operating methods.
The reserve data set forth in the reports and in this Report represents only estimates, and should not be construed as being exact quantities. The reserves may or may not be actually recovered, and if recovered, the actual revenues and costs could be more or less than the estimated amounts. Moreover, estimates of reserves may increase or decrease as a result of future operations.
Cedar’s Report of Third Party for the Evaluation of Oil Reserves attributed to Jayhawk Energy, Inc’s. interest in the Crosby property in the United States and related consent for use is filed as an Exhibit with this 10-K.
McDaniel’s Report of Third Party for the Evaluation of Oil Reserves attributed to Jayhawk Energy, Inc.’s interests in the Crosby in the United States and related consent for use is filed as an Exhibit with this 10-K.
The independent expert engineering, geological, and technical advisory background of both Cedar and McDaniel are disclosed in the associated Exhibits to this 10-K.
Both Cedar and McDaniels & Associates used all assumptions, data, methods and procedures they considered necessary and appropriate under the circumstances to prepare their estimates. The reserves set forth in their reports for the properties are estimated by performance methods or analogy. In general, reserves attributable to producing wells and reservoirs are estimated by performance methods such as decline curve analysis which utilizes extrapolations of historical production data. Reserves attributable to non-producing and undeveloped reserves included in the reports are estimated by analogy. The estimates of the reserves, future production, and income attributable to properties are based on the reserve definitions set out in Rule 4-10(a) in SEC Regulation S-X.
Both the Cedar and McDaniel & Associate reports summarize conclusions made by them with respect to the reserve estimates. To estimate economically recoverable crude oil, many factors and assumptions were considered, including the use of reservoir parameters derived from geological, geophysical and engineering data which cannot be measured directly, economic criteria based on current costs and SEC pricing requirements, and forecasts of future production rates. Under applicable SEC regulations, proved reserves must be demonstrated to be economically producible based on the existing economic conditions including the prices and costs at which economic production from a reservoir is determined as of the effective date of the report. With respect to the property interests the Company owns, production and well tests from examines wells, normal direct costs of operating the wells or leases, other costs such as transportation and processing fees, production taxes, recompletion and development costs and product prices are based on SEC regulations, geological maps, well logs, core analyses, and pressure measurements.
Reservoir engineering is a subjective process of estimating underground accumulations of crude oil that cannot be measured in an exact manner. There are numerous uncertainties inherent in estimating crude oil reserves and their estimated values, including many factors beyond the Company’s control. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geologic interpretation and judgment. As a result, estimates of different engineers, including those used by the Company, may vary. In addition estimates of reserves are subject to revision based upon actual production, result of future developments and exploration activities, prevailing crude oil prices, operating costs and other factors. The revisions may be material. Accordingly, reserve estimates are often different from the quantities of crude oil that are ultimately recovered and are highly dependent upon the accuracy of the assumptions upon which they are based. The Company’s estimate net proved reserves, included in the Company’s SEC filings, have not been filed with or included in reports to any other federal agency. See Item 1A of this Report entitled “RISK FACTORS - Estimation Risks: Reserve estimates, like all estimates, are subject to numerous uncertainties and may be inaccurate.”
Federal and state regulations governing protection of the environment may prevent the Company from recovering the estimated reserves disclosed in this section of the Report. For a discussion of the main federal laws and regulations in the United States in place to protect the environment, see the subsection of this Annual Report above entitled “DESCRIPTION OF BUSINESS - Governmental Regulations,” which disclosure is incorporated herein by reference.
A summary of the Company’s net proved oil reserves for the North Dakota, Crosby properties for the years end September 30, 2014, 2013 and 2012 are presented below:
The Company has no reserve estimates for synthetic oil, synthetic gas or sales of other non-renewable natural resources that are intended to be upgraded into synthetic oil and gas.
The Kansas properties identified above as the Girard project has not been evaluated and no independent estimates of proved reserves have yet been made. Consequently, management has determined the producing natural gas properties in Girard, Kansas be classified as unproven for purposes of financial statement disclosure. Additional information about the Company’s proved oil reserves are presented under Note 18 - Supplemental Oil and Gas Information in the accompanying Consolidated Financial Statements.
Controls over Reserve Estimates
Compliance as it relates to reporting the Company’s reserves is the responsibility of Lindsay Gorrill, Chairman of the Board of
Directors, who has over 20 years’ experience in resource-based companies. Mr. Gorrill has a strong background in asset evaluation and management.
With respect to the Company’s properties, the control over reserve estimates included retaining Cedar and McDaniel as our independent and geological auditing firms for the periods indicated in their respective reports. Jayhawk provided both Cedar and McDaniel with information about its oil properties, including production profiles, prices and costs, and both Cedar and McDaniel reviewed the estimates of the reserves attributable to oil properties. Both Cedar Technical Services and McDaniel & Associates Consulting LTD are independent expert engineering, geological, technical and advisory company providing services to the oil and gas industry.
All of the information on the North Dakota oil reserves for the years ended September 30, 2013 and 2012 in this Report is derived from McDaniel & Associates’ report. All of the information on the North Dakota oil reserves for the year ended September 30, 2014 in this Report is derived from the Cedar Technical Services report
Proved undeveloped reserves
At September 30, 2014, management estimated the Company had proved undeveloped reserves (PUDs) of 27,009 Bbls for its North Dakota properties which accounted for 22.6% of its total estimated North Dakota proved oil reserves. The table following table discloses the Company's PUDs during 2014, 2013 and 2012:
Production volumes
The following table set forth certain information regarding the production volumes of oil and natural gas for the periods indicated for the Company for the period indicated. The Company's oil wells are located in North Dakota. The Company's natural gas wells are located in Kansas:
The oil and gas sales revenue shown in the table below is the Company’s net share of annual revenue in each project for the past three fiscal years:
The table below shows the average sales price per unit and average cost of goods sold per unit the Company received for oil and
natural gas for the past three fiscal years:
Drilling and Development Activity
The following table sets forth wells drilled and completed during the periods indicated on the Company's oil and gas properties:
No wells were drilled and completed in the years ended September 30, 2014 and 2013. The Company experienced no dry wells in the years ended September 30, 2014 and 2013.
The following table summarizes the Company's total oil wells by type as of September 30, 2014. A net well represents the Company's percentage ownership of a gross well. The following table does not include wells which were awaiting completion, in the process of completion or awaiting flowback subsequent to fracture stimulation. All oil wells are located in North Dakota; all natural gas wells are located in Kansas.
Title to Properties
Management believes the Company has satisfactory title to all of its U.S. properties in accordance with standards generally accepted in the oil and gas industry. The properties are subject to customary royalty interests, liens for current taxes and other burdens, which management believes does not materially interfere with the use of or affect the value of such properties. Prior to acquiring undeveloped properties, the Company performs a title investigation that is thorough but less vigorous than that conducted prior to drilling, which is consistent with standard practice in the oil and gas industry. Before the Company commences drilling operations, it conducts a thorough title examination and performs curative work with respect to significant defects before proceeding with operations. The Company has performed a thorough title examination with respect to substantially all of its active properties.
Delivery Commitments
The Company currently has no delivery commitments for product obtained from its wells.
Dry Holes
The Company did not experience any dry holes in fiscal years ending September 30, 2014, 2013 or 2012.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
On March 7, 2012, Gross Capital, Inc. (“Gross”) filed suit against the Company (Civil Action No. 4:12-cv-00714) in the United States District Court for the Southern District of Texas, Houston Division (the “Gross Lawsuit”) alleging breach of provisions of two contracts entered into between the Company and Gross. The Gross Lawsuit requested monetary relief in excess of $132,000 plus attorneys, fees, interest and costs. Prior to the filing of the Gross Lawsuit the Company had offered to settle the dispute for $42,000.
On July 16, 2013, the Company and Gross entered into a Mediated Settlement Agreement (the “Agreement”). Under the terms of the Agreement, the Company agreed to pay Gross a total of $60,000 (the “Settlement Amount”) in four monthly installments of $15,000 each. The first payment of the Settlement Amount was paid on July 19, 2013 with each additional payment made on the 19th day of
each successive month and the final payment being made on October 19, 2013. Following the final payment being made on October 19, 2013 the Gross Lawsuit was dismissed with prejudice.
On August 1, 2013, the North Dakota Industrial Commission (“NDIC”) submitted an administrative complaint to the State of North Dakota related to plugging and remediation of the Company’s Jenks 1 and Knudsen 1 wells in Crosby, ND. The administrative complaint alleged the Company violated certain portions of the North Dakota Century Code and requested administrative relief against Jayhawk Energy, Inc. for violation of sections of the North Dakota Administrative Code governing the oil and gas industry.
On or about August 12, 2013, the Company responded to the administrative complaint and entered into settlement negotiations with the NDIC. As a good faith effort, the Company began plugging the Knudsen 1 well on or about December 20, 2013. The work required to plug the Knudsen 1 well was completed on or about January 1, 2014. The range of associated penalties as proposed by the NDIC was $100,000 to $525,000 for failure to comply.
On February 18, 2014, the Company entered into a Consent Agreement with the State of North Dakota whereby the Company is required to finish reclamation work, by June 30, 2014, on the two waste water storage pits adjacent to the Jenks 1 and Knudsen 1 wells respectively. Further, the Consent Agreement allows that the Company must plug the “production zone” of the Jenks 1 well and then may apply for a permit to convert the Jenks 1 well to a salt water disposal well. As a part of the Consent Agreement the Company agreed to pay a civil penalty of no less than $105,000, consisting of $25,000 due and payable upon execution of the Consent Agreement and a $16,000 installment per month for five successive months thereafter. Should the Company fail to comply with the terms of the Consent Agreement, the Company is subject to penalties of up to an additional $420,000 (over and above the $105,000 penalty agreed to in the Consent Agreement).
The Company made the initial $25,000 payment and subsequently made each monthly payment with the final installment of $16,000 paid to the State of North Dakota on June 26, 2014.
Although reclamation work was to have been completed by June 30, 2014, unseasonably heavy rains which saturated the soil and limited safe access to the site by heavy equipment delayed scheduled reclamation until such time as ground conditions improved. On July 12, 2014, the Company completed reclamation work on both the Jenks 1 and Knudsen 1 waste water storage pits. The Company also completed plugging of the ‘production zone’ on the Jenks 1 well and set a balance plug on the Knudsen 1 well bore. The Company has submitted an application for conversion of the Jenks 1 well to a saltwater disposal well which is currently under consideration by the North Dakota Industrial Commission. The Company is performing additional engineering surveys and cost estimates related to construction of the salt water disposal well to address considerations requested by the North Dakota Industrial Commission.
With respect to the Knudsen 1 site reclamation, under North Dakota statute, the Company is required to revegetate the disturbed area with native species or with crops according to reasonable specifications of the surface owner. The Company intends to plant native grass in the Spring of 2015 and believes it has substantially complied with the standards set for reclamation of the site. Management does not believe the cost of replanting to be material at this time and, therefore, accrues no additional contingent liability.
No director, officer or affiliate of Jayhawk Energy, Inc. and no owner of record or beneficial owner of more than 5% of the Company’s securities or any associate of any such director, officer or security holder is a party adverse to JayHawk Energy, Inc. or has a material interest adverse to JayHawk Energy, Inc. in reference to pending litigation.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report Form 10-K
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Market Information
The bid and ask prices for the Company's common stock are reported on the OTC Bulletin Board under the symbol "JYHW.OB". For the periods indicated, the following table sets forth the high and low bid prices per share of JayHawk’s common stock since inception of trading. These prices represent inter-dealer quotations without retail markup, markdown, or commission and may not necessarily represent actual transactions.
Holders
As of September 30, 2014, there were 91 stockholders of record who owned 80,375,841 shares of common stock. The number of record holders was determined from the records of the Company's transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various security brokers, dealers, and registered clearing agencies. The transfer agent of the Company's common stock is Corporate Stock Transfer Company at 3200 Cherry Creek Drive South, Suite #340, Denver, Colorado, 80209.
Description of Securities
The authorized capital stock of the Company consists of 200,000,000 of the common stock, at $0.001 par value, and 10,000,000 shares of preferred stock, at $0.001 par value. The shares of preferred stock may be issued in one or more series. The designations, powers, rights, preferences, qualifications, restrictions, and limitations of each series of preferred stock shall be established from time to time by the Board of Directors in accordance with Colorado law.
Dividends
Holders of common and preferred stock are entitled to receive dividends as may be declared by the Board of Directors. The Board of Directors is not restricted from paying any dividends but is not obligated to declare a dividend. No dividends have ever been declared and it is not anticipated that dividends will ever be paid, but will be dependent upon the Company's financial condition, results of operations, capital requirements, and such other factors as the Board of Directors deem relevant.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The Registrant is a “smaller reporting company” as defined Rule 10(f)(1) of Regulation S-K, and as such is not required to present the information required under this Item.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS
The following information should be read in conjunction with the consolidated financial statements and the notes thereto contained elsewhere in this report. All notes referred to in this Management Discussion and Analysis refer to the notes to the Consolidated Financial Statements presented in Item 8. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Information in this Item 7, "Management's Discussion and Analysis or Plan of Operation," and elsewhere in this 10-K that does not consist of historical facts, are "forward-looking statements."
Statements accompanied or qualified by, or containing words such as "may," "will," "should," "believes," "expects," "intends," "plans," "projects," "estimates," "predicts," "potential," "outlook," "forecast," "anticipates," "presume," and "assume" constitute
forward-looking statements, and as such, are not a guarantee of future performance. The statements involve factors, risks and uncertainties including those discussed in the “Risk Factors” section contained elsewhere in this report, the impact or occurrence of which can cause actual results to differ materially from the expected results described in such statements.
Investors should not place undue reliance on forward-looking statements as predictive of future results. The Company disclaims any obligation to update the forward-looking statements in this report.
Overview
This overview is presented in chronological order as to dates the respective transactions were completed. It should be read in conjunction with the "Notes to the Consolidated Financial Statements" presented in Item 8, specifically Note 10 relative to Common Stock, and Note 4 and Note 5 relative to Asset Impairments.
On June 21, 2007, the Company changed its name from Bella Trading Company, Inc. to JayHawk Energy, Inc. and shifted focus from the retail jewelry industry to the oil and gas business. The Company's new business plan was to acquire oil and gas properties for exploration and development with the intent to bring the projects to feasibility at which time it would either contract out the operations or joint venture the project to qualified interested parties. The Company implemented this plan on July 25, 2007 with the acquisition of certain oil, gas, and mineral leases to approximately 35,000 gross acres located in Bourbon County, Kansas (the “Uniontown project”). The assets were purchased for a total purchase price of $2.2 million.
On January 16, 2008, JayHawk purchased a 65% working interest in 5 producing oil wells located in the Williston Basin of North Dakota, along with the right to develop the oil, gas and mineral resources on 15,500 acres of leases in this same area. In consideration for these properties JayHawk paid JED Oil $3.5 million in cash. The cash used to complete this transaction was raised in a private placement offering of the Company's common stock.
On March 31, 2008, JayHawk closed a transaction, initiated with an agreement dated February 18, 2008, whereby JayHawk acquired a 16 mile pipeline, associated easements, oil, gas and mineral leases to approximately 6,500 gross acres, 34 gas wells, compressor, and other field equipment. In consideration for these assets JayHawk exchanged $1 million in cash and 1 million shares of its common stock.
On April 18, 2008, JayHawk entered into an agreement to acquire oil and natural gas rights to 1,336 gross acres and 14 completed but non-producing gas wells, in exchange for $300,000 in cash and 50,000 shares of the Company's common stock.
On June 30, 2008, the Company agreed to purchase oil, gas and mineral leases on 11,462 gross acres and 5 completed and cased gas wells, located in Crawford and Bourbon counties in Kansas. In consideration for these assets JayHawk paid $140,000 in cash and was obligated to issue 286,550 shares of its common stock as the leases were assigned at the rate of 25 shares per acre.
On July 22, 2008, the former purchaser of the Company's North Dakota crude oil production, SemCrude, L.P, filed a Chapter 11 bankruptcy proceeding in the United States Bankruptcy Court, District of Delaware. At the time of the SemCrude filing JayHawk Energy, Inc., had not been paid for the crude oil SemCrude had taken from the Company's properties for the months of June and July 2008. As a consequence, the Company had an outstanding receivable exceeding $283,000 and offsetting allowance for doubtful accounts of $119,763 at September 30, 2009. The amount was subsequently paid.
During the 4th quarter of the year ending September 30, 2009 the Company completed a signed letter agreement with DK True Energy Development Limited ("DKTED”) which allowed DKTED to earn up to an 85% working interest in JayHawk's Coal Bed Methane ("CBM") project in southeast Kansas (the Girard project). This interest could have been earned by DKTED after paying the Company $500,000 and spending a minimum of $1,300,000 over a three year period. DKTED had the option to cap its participation and working interest at 42.5% after paying the Company $250,000 and spending $300,000 on workovers of existing wells during the first year, in what is described as the “Primary Program”. DKTED subsequently assigned its interests in the Girard project to WHL Energy Midcon, LLC. ("WHL"), in December 2009 who provided operational expertise and personnel on the Girard project.
In 2010, after WHL had fulfilled the $250,000 cash payment obligation and spent the $300,000 on workovers of the Girard project, the Company issued WHL an option to earn an additional 42.5 percent (total 85 percent) participation and working interest upon remitting to the Company an additional $250,000 within nine months of the granting of the option. During the year ended September 30, 2011, the option period expired unexercised and, per the terms of the agreement, WHL's total working interest earned was set at 35 percent. As such, the Company has reduced the cost basis of the Girard by $250,000 to offset the elimination of the corresponding investment from WHL that had previously been carried as "Investment by Joint Venture Partner" on JayHawk Energy's balance sheet.
In 2012, the Company acquired WHL's remaining 35% working interest in the Girard project in exchange for equipment with a net book value of $16,595. The Company now controls a 100% working interest in the Girard project.
In September 2009, the Company completed a full analysis of the Crosby North Dakota property in which JayHawk is the operator. At that time, there were five producing Ratcliffe formation oil wells with gross production of approximately 60 barrels of oil produced per day. Considering that large mineral interests held in the area by JayHawk and its joint venture partners, the area was considered a prime opportunity for exploitation of the reserves attributable to the reservoir as determined by management’s analysis of the Crosby pool and other analogue oil pools within the same depositional fairway of the Crosby pool. Many of these analogue pools had been successfully developed by other operators and had returned significant additional production and reserves associated with that drilling exploitation. Corroboration for the development of the pool was also given by the independent engineering assessment performed by McDaniel Associates of Calgary, Alberta, Canada who had been commissioned by JayHawk to perform an independent third party report for the Company’s year-end in both 2013 and 2012.
In March 2010, JayHawk commenced the drilling of the first of two vertical wells on the Crosby property located on the western side of the acreage position. These wells were inferred to be in the thick part of the reservoir and were offsetting some of the better producing wells in the pool. Both wells were ultimately drilled and tested oil in the Ratcliffe target formation and despite early encouraging results, both wells produced oil at marginal rates over a longer production period and were eventually shut in during September of 2010. Both wells are currently being remediated and plugged.
While the management and third party engineering assessments were both favorable in terms of the development potential of the Crosby pool, risk factors associated with any drilling of oil and gas resources are common. These risk factors are associated with changing parameters within the reservoir and include, but are not limited to; non-deposition of reservoir, reduced porosity and permeability of reservoir rock when present, structural changes to the reservoir which may preclude the trapping of hydrocarbons, drainage of existing reserves by other wells, mechanical problems while drilling which may prevent production, rising costs due to unforeseen circumstances which may result in wells becoming non-commercial, lower than anticipated production rates due to changes in reservoir quality which were un-anticipated, well bore damage by drilling which may prevent commercial production of hydrocarbons, catastrophic failure during drilling which may prevent the well from reaching its intended target or other unforeseen events which may mitigate the economic success of a drilling operation.
The Company has not entered into commodity swap arrangements or hedging transactions, and although it has no current plans to do so, it may enter into commodity swap and/or hedging transactions in the future in conjunction with oil and gas production. The Company has no off-balance sheet arrangements.
The forecast for the period for which the Company's financial resources will be adequate to support its operations involves risks and uncertainties and actual results could fail as a result of a number of factors. The Company's future financial results continue to depend primarily on (1) the Company's ability to discover commercial quantities of oil and gas; (2) the market price for oil and gas; (3) the ability to continue to source and screen potential projects; and (4) the Company's ability to fully implement its exploration and development program with respect to these and other matters. The Company cannot assure that it will be successful in any of these activities or that the prices of oil and gas prevailing at the time of production will be at a level allowing for profitable production.
Results of Operations
For the years ending September 30, 2014 and 2013 the Company reports net revenues of $394,925 and $411,756, respectively, from the sales of oil and natural gas. Details of these two revenue components follow:
Oil Revenues: As commented on in Note 2 to the Consolidated Financial Statements for the period ended September 30, 2014, the Company recognizes revenues only to the extent of its net working interest, which is the remainder after deduction of the outside working and royalty interests and the deduction of severance and production taxes.
For the years ended September 30, 2014 and 2013, JayHawk sold a gross 10,066 Bbls and 9,848 Bbls respectively. Jayhawk’s Gross working interest in the revenues generated from the five North Dakota oil wells were $394,925 and $411,756 respectively. Gross receipts reconciled to JayHawk net working interest, or revenue recognized is reflected in the following table:
The decrease in gross revenues evidenced here is attributable to the Company's ongoing constraints of working capital. Regular and necessary maintenance is often delayed due to lack of sufficient cash resources. Consequently, wells remain non-producing while cash reserves are built up from the remaining producing wells to address ongoing maintenance issues. Management believes a work-over program including electrification and conversion of the abandoned Jenks well to a salt water disposal will dramatically increase cash flows from oil production. Management is seeking joint venture partners and other sources of capital to initiate said program.
For the year ending September 30, 2014 the average price net of taxes and transportation costs the Company received for a barrel of oil was $75.24. During the comparable period ending September 30, 2013 the average price received per barrel was $78.37.
Gas Revenues: Revenues derived from gas sales for the years ending September 30, 2014 and 2013 were $Nil and $Nil, respectively. The Company suspended production in 2013 with the intent of re-starting operations in Kansas in anticipation of increased natural gas prices at some point in the future. The Company did not produce natural gas during the fiscal year ended September 30, 2014, due to flat natural gas prices and significant costs associated with upgrading the meters at its Bourbon County tap head. The average price received for the 12 month period ending September 31, 2014 was $0.00 per mcf. The average price received for the 12 month period ending September 30, 2013 was $0.00 per mcf.
Exploration Expenses: There were no exploration expenses incurred during the years ending September 30, 2014 or 2013.
Production Expenses: Production expenses are comprised of field labor, maintenance, chemicals, fuel, and salt water disposal, less amounts charged other working interests in the particular wells. These expenses associated with the Company’s North Dakota oil operations increased from $195,513 for the year ending September 30, 2013 to $230,238 for the year ending September 30, 2014. The primary factor in the increase was reworking the Kearney well and improving pad sites for all five producing wells to ensure more consistent access to the property.
Management does not anticipate significant increases in production expenses in the forthcoming year other than those related to increased production and oil sales.
Depreciation, depletion, amortization, abandonment and asset impairment expense: The aggregate of these expenses for the years ending September 30, 2014 and 2013 are detailed below.
As discussed in Note 4 of "Notes to the Consolidated Financial Statements," management made a review of its Kansas Girard project. Management's outlook for the U.S. natural gas prices indicated it is unlikely that sufficient U.S. demand for natural gas would materialize in the foreseeable future. Using a historical income approach based upon internal estimates of natural gas prices and future deliveries, management determined that the unproved and developed properties in Girard, Kansas should be impaired to the extent of the salvage value of field equipment and pipeline.
General and Administrative Expenses: General and administrative expenses increased 8.6% or $33,535 to $424,752 for the year ending September 2013 from $391,217 for the comparable period ended September 30, 2013.
Directors’ fees were accrued but not paid in the years ended September 30, 2014 and 2013, respectively.
Included in General and Administrative Expense is the recognition of a non-cash Stock Option expense in the amount of $24,803 for the year ended September 30, 2014 awarded to certain directors, officers and employees of the Company as part of the 2009 Stock Option Incentive Plan compared to $12,584 recognized in the year ended September 30, 2013.
Audit fees and public company expense increased for the year ended September 30, 2014 by $13,202 over the comparable year ended September 30, 2013. Management expects audit fees and public company expense to decrease in the forthcoming fiscal year. Legal, professional and consulting fees decreased $231 for the year ended September 30, 2014.
Management expects General and Administrative Expense to remain relatively constant in the forthcoming fiscal year. In the event of a merger or acquisition, management expects compensation expense to increase proportionally with available capital resources.
Other Income (Expense): Detail of the aggregate of this classification is disclosed in the following table:
Interest expense decreased $42,777 during the year ended September 30, 2014 compared to the year ended September 30, 2013. As described in Note 12 of the financial statements, the Company incurred $59,200 in financing costs resulting from the issuance of broker warrants during the fiscal year ended September 30, 2013, an expense that was not replicated in the year ended September 30, 2014. . The Company incurred interest expense of $121,080 exclusive of the broker warrants for the year ended September 30, 2013 compared to interest expense of $137,503 for the year ended September 30, 2014. The increase was a result of additional debt incurred related to the reclamation of the Company’s North Dakota property. Additionally, interest expense is reported net of interest income, of which there was a minimal amount reported in the current year as a result of limited excess cash availability for investment.
The Company will continue to recognize gains (losses) on the fair value of derivative based on quarterly revaluation of the warrant and conversion option derivatives. The extent of these gain (losses) is unpredictable due to the volatility of the Company's share price, the unknown future value of the Company's shares and the length of term still remaining on the warrants and debentures at any particular revaluation event (end of quarter, conversion of debenture, etc.). The change in value will be charged to operations.
Change in fair value of the conversion option derivatives increased as the fair value price of the instruments was above their conversion and exercise price for the year. To that extent, the Company recognized additional loss on fair value of conversion option derivative of $115,029 for the year ended September 30, 2014, a change of $1,139,693 over the prior comparable year ended
September 30, 2013.
As the modification of terms related to the debentures resulted in extinguishment of debt under ASC 470-50-40-2, the Company charged $399,287 to operations. The Company also recognize a gain of $15,336 related to a conversion of debt for the Company’s common stock of $35,000.
Liquidity and Capital Resources: At September 30, 2014 and 2013, the Company's cash balances were $177,260 and $96,833, respectively. The Company's accounts receivable totaled $55,528 and $68,497, respectively. Subsequent to year-end, in October 2014, the Company received $55,528 from the current purchasers of its crude oil and gas production, representing proceeds of September sales, included in accounts receivable at September 30, 2014.
The Company's working capital deficit (current liabilities less current assets) was $2,635,213 at September 30, 2014 of which $1,038,687 is in the form of convertible debentures which are currently due. At September 30, 2013, the Company's working capital deficit was $2,603,133, of which $1,073,687 of convertible debentures were due in the current year and in default. The Company is seeking sources of capital to refinance the debenture and other accrued liabilities.
The increase in liabilities at September 30, 2014 is attributable to unanticipated costs associated with returning the Company's North Dakota oil wells to productivity and accrued contingencies related to plugging and reclamation work on the Jenks 1 and Knudsen 1 wells. The Company accrued $330,000 at September 30, 2013 in anticipation of reclamation and remediation claims on its Jenks and Knudsen wells. The Company incurred an additional $291,765 for the year ended September 30, 2014 related to reclamation of the Jenks and Knudsen wells. As work was completed the associated vendor accounts payables increased. At September 30, 2014, management believes there will be no additional material cost related to reclaiming the pits and surface area surrounding the Jenks and Knudsen wells.
To fully carry out the Company's business plans the Company needs to raise a substantial amount of additional capital, or obtain industry joint venture financing, which it is currently seeking. The Company is also contemplating a merger or consolidation with other business entities. The Company can give no assurance that it will be able to raise such capital or enter into any other beneficial business arrangements. The Company has limited financial resources until such time that it is able to generate such additional financing or cash flow from operations. The Company's ability to establish profitability and positive cash flow is dependent upon its ability to exploit its mineral holdings, generate revenue from its planned business operations and control exploration cost. Should the Company be unable to raise adequate capital or to meet the other above objectives, it is likely that the Company would have to substantially curtail its business activity, and that the Company's investors would incur substantial losses of their investment.
The accompanying Consolidated Financial Statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As reflected in the accompanying Consolidated Financial Statements JayHawk Energy is an independent oil and gas company with a limited operating history and losses since inception. These factors, among others, may indicate that the Company will be unable to continue as a going concern for reasonable period of time.
The Consolidated Financial Statements do not include any adjustments relating to the recoverability and classification of assets and liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to obtain additional operating capital, and ultimately, to attain profitability. The Company intends to acquire additional operating capital through debt or equity offerings, or through joint ventures or other business arrangements, to fund its business plan. There is no assurance that the Company will be successful in raising additional funds.
Cash Flows: Net cash provided by operations decreased primarily due to less cash being received for the Company’s crude oil sales associated with improved ability to deliver oil to market. In the year ending at September 30, 2014, cash used by operating activities exceeded cash provided by operating activities by $503,045, the primary use of cash being reclamation and plugging of the Jenks and Knudsen wells and surrounding surface area. Exclusive of the accrued reclamation expense and additional costs of reclamation in the current year, cash provided by operations for the year ended September 30, 2014 was $102,316. In the year ending at September 30, 2013, cash used by operating activities exceeded cash provided by operating activities by $116,426.
During the year ending September 30, 2014, investment activities used cash of $11,528 as compared to $138,763 of cash provided during the comparable period ending September 30, 2013. The Company sold certain equipment in Kansas and undeveloped leases in North Dakota as a source of working capital during the year ended September 30, 2013.
The Cash flows provided from financing activities were $600,000 and $Nil for the years ended September 30, 2014 and 2013, respectively.
Commitments: As noted in Item 3 of this report, on or about August 1, 2013, the North Dakota Industrial Commission (“NDIC”) submitted an administrative complaint to the State of North Dakota related to plugging and remediation of the Company’s Jenks 1 and Knudsen 1 wells in Crosby, ND. The administrative complaint alleges the Company violated certain portions of the North Dakota Century Code and request administrative relief against Jayhawk for violation of sections of the North Dakota Administrative Code governing the oil and gas industry.
On February 18, 2014, the Company entered into a Consent Agreement with the State of North Dakota whereby the Company was required to finish reclamation work on the two waste water storage pits adjacent to the Jenks 1 and Knudsen 1 wells respectively. Further, the Consent Agreement allows that the Company must plug the “production zone” of the Jenks 1 well and then may apply for a permit to convert the Jenks 1 well to a salt water disposal well. As a part of the Consent Agreement the Company agreed to pay a civil penalty of no less than $105,000, consisting of $25,000 due and payable upon execution of the Consent Agreement and a $16,000 installment per month for four successive months thereafter.
The Company made the final installment payment of $16,000 to the State of North Dakota on June 26, 2014. As of September 30, 2014 the Company has completed substantially all reclamation work and has paid all fines assessed.
On July 12, 2014, the Company completed reclamation work on both the Jenks 1 and Knudsen 1 waste water storage pits. Unseasonably heavy rains which saturated the soil and limited safe access to the site by heavy equipment delayed scheduled reclamation until such time as ground conditions improved. The Company also completed plugging of the ‘production zone’ on the Jenks 1 well and set a balance plug on the Knudsen 1 well bore.
With respect to the Knudsen 1 site reclamation, under North Dakota statute, the Company is required to revegetate the disturbed area with native species or with crops according to reasonable specifications of the surface owner. The Company intends to plant native grass in the Spring of 2015 and believes it has substantially complied with the standards set for reclamation of the site. Management does not believe the cost of replanting to be material at this time and, therefore, accrues no additional contingent liability.
The Company was obligated under its original office lease agreement, which expired July 1, 2011, to make payments of $1,500 per month. Management was successful in extending this agreement through December 1, 2011 whereby the Company entered into a new lease agreement in Coeur d'Alene, Idaho for $2,500 per month. The term of the lease is four years and contains no escalation clauses.
At September 30, 2013 the Company has no commitments to make any capital expenditures. Any potential future capital expenditures will be dependent on concluding adequate and successful financing arrangements.
ITEM 7A.
ITEM 7A. QUANTITATIVE and QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Registrant has no investments in any market risk sensitive instruments either held for trading purposes or entered into for other than trading purposes.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS.
JAYHAWK ENERGY, INC. AND SUBSIDIARY
Consolidated Financial Statements
September 30, 2014 and 2013
JAYHAWK ENERGY, INC. AND SUBSIDIARY
Contents
Page
FINANCIAL STATEMENTS:
Report of Independent Registered Public Accounting Firm
Consolidated balance sheets
Consolidated statements of operations
Consolidated statement of changes in stockholders' equity (deficit)
Consolidated statements of cash flows
Notes to consolidated financial statements
29-46
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
JayHawk Energy, Inc.
We have audited the accompanying consolidated balance sheets of JayHawk Energy, Inc. (“the Company”) as of September 30, 2014 and 2013, and the related consolidated statements of operations, change in stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of JayHawk Energy, Inc. as of September 30, 2014 and 2013, and the results of its consolidated operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has incurred substantial losses, has negative working capital and has an accumulated deficit. These factors raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
DeCoria, Maichel & Teague, PS
Spokane, Washington
January 7, 2015
JAYHAWK ENERGY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these financial statements.
JAYHAWK ENERGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
JAYHAWK ENERGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)
The accompanying notes are an integral part of these financial statements.
JAYHAWK ENERGY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
JAYHAWK ENERGY, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
NOTE 1 - ORGANIZATION AND DESCRIPTION OF BUSINESS
JayHawk Energy, Inc. (the Company or JayHawk) and its wholly owned subsidiary, Jayhawk Gas Transportation Company, are engaged in the acquisition, exploration, development, production and sale of natural gas, crude oil and natural gas liquids primarily from conventional reservoirs within North America. The Company incorporated in Colorado on April 5, 2004 as Bella Trading Company, Inc. During the third quarter ending June 30, 2007, the Company changed management and entered the oil and gas business, and ceased all activity in retail jewelry. On June 21, 2007, the Company changed its name to JayHawk Energy, Inc. Since then, the Company has devoted its efforts principally to the raising of capital, organizational infrastructure development, the acquisition of oil and gas properties and exploration activities. To date, the Company has acquired three properties, the Uniontown in Kansas, the Crosby in North Dakota, and Girard in Kansas. The Company also formed a wholly owned subsidiary to transport natural gas in Kansas called JayHawk Gas Transportation Corporation.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
This summary of significant accounting policies is presented to assist in understanding the financial statements. These consolidated financial statements as of and for the years ended September 30, 2014 and 2013 are prepared using the accrual basis of accounting in accordance with generally accepted accounting principles in the United States of America ("US GAAP") and have been consistently applied in the preparation of the Consolidated Financial Statements.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary JayHawk Gas Transportation Company after elimination of the intercompany accounts and transactions.
Going Concern
As shown in the accompanying consolidated financial statements, the Company has incurred operating losses since inception. As of September 30, 2014, the Company has limited financial resources with which to achieve the objectives and obtain profitability and positive cash flows. As shown in the accompanying balance sheets and statements of operations, the Company has an accumulated deficit of $25,506,889 and a net loss of $1,479,897 for the year ended September 30, 2014, and as of that date the Company's current liabilities exceeded its current assets by $2,635,213. Achievement of the Company's objectives will be dependent upon the ability to obtain additional financing, to locate profitable energy properties and generate revenue from current and planned business operations, and control costs. The Company plans to fund its future operations by joint venturing, obtaining additional financing from investors, and/or lenders, and attaining additional commercial production. However, there is no assurance that the Company will be able to achieve these objectives, therefore substantial doubt about its ability to continue as a going concern exists. The financial statements do not include adjustments relating to the recoverability of recorded assets nor the implications of associated bankruptcy costs should the Company be unable to continue as a going concern.
Use of Estimates
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the respective reporting periods. Significant areas requiring the use of management assumptions and estimates relate to asset impairments, asset retirement obligations, stock-based compensation, income taxes and derivatives. Actual results may differ from these estimates and assumptions which could have a material effect on the Company's reported financial position and results of operations.
Income or Loss Per Common Share
Basic earnings per share ("EPS") is computed as net income (loss) available to common stockholders divided by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options, warrants, and other convertible securities.
JAYHAWK ENERGY, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
The dilutive effect of convertible and outstanding securities as of September 30, 2014 and 2013, would be as follows:
At September 30, 2014 and 2013, the effect of the Company's outstanding options and common stock equivalents would have been anti-dilutive.
Revenue and Cost Recognition
The Company uses the sales method of accounting for oil and gas revenues. Under this method, revenues are recognized based on the actual volumes of gas and oil sold to purchasers. The volume sold may differ from the volumes the Company may be entitled to, based on the Company's individual interest in the property. Periodically, imbalances between production and nomination volumes can occur for various reasons. In cases where imbalances have occurred, a production imbalance receivable or liability will be recorded when determined. Costs associated with production are expensed in the period in which they are incurred.
Cash Equivalents
The Company considers all highly liquid instruments purchased with maturity of three months or less when acquired to be cash equivalents.
Trade Accounts Receivable
Trade accounts receivable are carried at original invoice amount less an estimate for doubtful accounts. The was no allowance for doubtful accounts at September 30, 2014 and 2013. Management determines the allowance by regularly evaluating individual customer receivables and considering a customer's financial condition, credit history and current economic conditions. Trade receivables are written off when deemed uncollectible. Recoveries of receivables previously written off are recorded as income when received.
Concentrations
All of the Company’s direct operating revenues originate from oil production from its property in Crosby, North Dakota. Each revenue stream is sold to a single customer through month to month contracts. While this creates a customer concentration, there are alternate buyers of the production in the event the sole customer is unable or unwilling to purchase.
Property, Plant and Equipment
Acquisition costs associated with the acquisition of leases are capitalized when incurred. These consist of costs incurred in obtaining a mineral interest or right in the property, such as a lease, concession, license, production sharing agreement, or other type of agreement granting such rights. In addition, options to lease, brokers' fees, recording fees, legal costs, and other similar costs related to activities in acquiring property interests are capitalized.
The Company follows the successful effort method of accounting for oil and gas property as promulgated in Accounting Standards Codification (ASC) Topic 932, "Extractive Activities - Oil and Gas". Under this method of accounting, acquisition costs for proved and unproved properties are capitalized when incurred. Exploration costs, including geological and geophysical costs, the costs of carrying and retaining unproved properties and exploratory dry hole drilling costs, are expensed. Development costs, including the costs to drill and equip development wells, and successful exploratory drilling costs to locate proved reserves are capitalized. Exploratory drilling costs are capitalized when incurred pending the determination of whether a well has found proved reserves. A determination of whether a well has found proved reserves is made shortly after drilling is completed. The determination is based on a process that relies on interpretations of available geologic, geophysics and engineering data. If a well is determined to be successful, the capitalized drilling costs will be reclassified as part of the cost of the well. If a well is determined to be unsuccessful, the capitalized drilling costs will be charged to expense in the period the determination is made. If an exploratory well requires a major capital expenditure before production can begin, the cost of drilling the exploratory well will continue to be carried as an asset pending determination of whether proved reserves have been
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September 30, 2014
found only as long as: i) the well has found a sufficient quantity of reserves to justify its completion as a producing well if the required capital expenditure is made and ii) drilling of the additional exploratory wells is under way or firmly planned for the near future. If drilling in the area is not under way or firmly planned, or if the well has not found a commercially producible quantity of reserves, the exploratory well is assumed to be impaired and its costs are charged to expense.
In the absence of a determination as to whether the reserves that have been found can be classified as proved, the costs of drilling such an exploratory well is not carried as an asset for more than one year following completion of drilling. If, after that year has passed, a determination that proved reserves exist cannot be made, the well is assumed to be impaired, and its capitalized costs, net of salvage value are charged to expense. Its costs can, however, continue to be capitalized if sufficient quantities of reserves are discovered in the well to justify its completion as a producing well and sufficient progress is made in assessing the reserves and the well's economic and operating feasibility.
The Company calculates depletion, depreciation and amortization (DD&A) of capitalized cost of proved oil properties on a field-by-field basis using the units-of-production method based upon proved reserves. In computing DD&A the Company will take into consideration restoration, dismantlement and abandonment cost and the anticipated proceeds from equipment salvage. When applicable, the Company will apply the provisions of ASC Topic 410, "Accounting for Asset Retirement Obligations", ("ASC 410") which provides guidance on accounting for dismantlement and abandonment cost (see Note 9).
Support equipment and other property, plant and equipment related to oil and gas production are depreciated on a straight-line basis over their estimated useful lives which range from 5 to 35 years. Property, plant and equipment unrelated to oil and gas producing activities is recorded at cost and depreciated on a straight-line basis over the estimated useful lives of the assets, which range from 3 to 25 years.
The Company recognizes a gain or loss on sales or retirement of property, plant and equipment and includes the gain or loss in the results of operations.
Impairment of Long-Lived Assets
The Company performs separate impairment tests for proved and unproved properties.
Proved properties - The Company evaluates its proved properties for impairment when circumstances or events occur that may impact the fair value of the assets. The fair value of property is primarily evaluated based upon the present value of expected revenues directly associated with those assets. An impairment loss would be recognized if the carrying amount of a capitalized asset is not recoverable and exceeds its fair value.
Unproved properties - Unproved properties are assessed periodically to determine whether they have been impaired. An undeveloped property may be considered impaired as the expiration of a lease term approaches and the Company has not begun drilling on the property or nearby properties and the possibility of partial or total impairment of the property increases. If the property is found to be impaired, an impairment allowance is provided and a loss is charged to operations. However, if the property is surrendered or the lease expires without identifying proved reserves, the cost of the property is charged against the impairment allowance already to the extent impairment has been recognized. Any remaining cost is charged to operations.
In the case of unproved developed properties, the fair value of property is primarily evaluated based upon the present value of expected revenues directly associated with those assets. An impairment loss would be recognized if the carrying amount of a capitalized asset is not recoverable and exceeds its fair value.
Fair Value Measures
ASC Topic 820 "Fair Value Measurements and Disclosures" ("ASC 820") requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 establishes a fair value hierarchy based on the level of independent, objective evidence surrounding the inputs used to measure fair value. A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. ASC 820 prioritizes the inputs into three levels that may be used to measure fair value:
Level 1: Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.
Level 2: Level 2 applies to assets or liabilities for which there are inputs other than quoted prices that are observable for the asset or liability such as quote prices for similar assets or liabilities in active markets; quoted prices for identical assets in markets with
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September 30, 2014
insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3: Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.
Derivative Instruments
The Company has financing arrangements that contain freestanding derivative instruments or hybrid instruments that contained embedded derivative features. In accordance with U.S. GAAP, derivative instruments and hybrid instruments are recognized as either assets or liabilities in the Company’s balance sheet and are measured at fair value with gains or losses recognized in earnings depending on the nature of the derivative or hybrid instruments. Embedded derivatives that are not clearly and closely related to the host contract are bifurcated and recognized at fair value with changes in fair value recognized as either a gain or loss in earnings if they can be reliably measured. When the fair value of embedded derivative features cannot be reliably measured, the Company measures and reports the entire hybrid instrument at fair value with changes in fair value recognized as either a gain or loss in earnings. The Company determines the fair value of derivative instruments and hybrid instruments based on available market data using a Black Scholes model, giving consideration to all of the rights and obligations of each instrument and precluding the use of “blockage” discounts or premiums in determining the fair value of a large block of financial instruments. Fair value under these conditions does not necessarily represent fair value determined using valuation standards that give consideration to blockage discounts and other factors that may be considered by market participants in establishing fair value.
Income Tax and Accounting for Uncertainty
Income taxes are determined using the liability method in accordance with ASC Topic 740 "Income Taxes" ("ASC 740"). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. In addition, a valuation allowance is established to reduce any deferred tax asset for which it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.
ASC 740 recognizes that the ultimate deductibility of positions taken or expected to be taken on tax returns is often uncertain. It provides guidance on when tax positions claimed by an entity can be recognized and guidance on the dollar amount at which those positions are recorded. In order to recognize the benefits associated with a tax position taken the entity must conclude that the ultimate allowability of the deduction is more likely than not. If the ultimate allowability of the tax position exceeds 50% (more likely than not), the benefit associated with the position is recognized at the largest dollar amount that has more than a 50% likelihood of being realized upon ultimate settlement. Differences between tax positions taken in a tax return and recognized in accordance with the guidance will generally result in (1) an increase in income taxes currently payable or a reduction in an income tax refund receivable or (2) an increase in a deferred tax liability or a decrease in a deferred tax asset, or both (1) and (2).
Stock Options Granted to Employees and Non-Employees
The Company follows financial accounting standards that require the measurement of the value of employee services received in exchange for an award of an equity instrument based on the grant-date fair value of the award. Non-employee stock-based compensation is granted at the Board of Director’s discretion to award select consultants for exceptional performance. Prior to issuance of the awards, the Company is not under any obligation to issue the stock options. Subsequent to the award, the recipient is not obligated to perform any services. Therefore, the fair value of these options is expensed on the grant date, which is also the measurement date.
The Company estimates the fair value of employee stock option awards on the date of grant using a Black-Scholes valuation model which requires management to make certain assumptions regarding: (i) the expected volatility in the market price of the Company's common stock; (ii) dividend yield; (iii) risk-free interest rates; and (iv) the period of time employees are expected to hold the award prior to exercised (referred to as the expected holding period). The expected volatility under this valuation model is based on the current and historical implied volatilities of the Company's common stock. The dividend yield is based on the approved annual dividend rate in effect and current market price of the underlying common stock at the time of grant. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for bonds with maturities ranging from one month to five years. The expected holding period of the awards granted is estimated using the historical exercise behavior of employees. In addition, the Company estimates the expected impact of forfeited awards and recognize stock-based compensation cost only for those awards expected to vest. The Company utilizes
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September 30, 2014
historical experience to estimate projected forfeitures. If actual forfeitures are materially different from estimates, stock-based compensation expense could be significantly different from what we have recorded in the current period. The cumulative effect on current and prior periods of a change in the estimated forfeiture rate is recognized as compensation cost in the period of the revision.
Stock Granted to Employees and Non-Employees in Lieu of Cash Payments
The Company periodically issues shares of its common stock in lieu of cash payments to certain consultants, vendors and employees. The Company follows financial accounting standards that require the measurement of the value of services received in exchange for an award of an equity instrument based on the grant-date fair value of the award.
Reclassifications
Certain reclassifications have been made to the 2013 financial statements in order to conform to the 2014 presentation. These reclassifications have no effect on net loss, total assets or accumulated deficit as previously reported.
New Accounting Pronouncements
From time to time, new accounting guidance is issued by the FASB that the Company adopts as of the specified effective date. If not discussed, management believe that the impact of recently issued standards, which are not yet effective, will not have a material impact on its financial statements upon adoption.
NOTE 3 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values of cash and cash equivalents, reclamation bonds and promissory note payable approximate fair value due to their limited time to maturity or ability to immediately convert them to cash in the normal course. The carrying values of convertible debentures is net of a discount and does not reflect fair value of similar instruments. The approximate fair value of the convertible debentures based upon the number of shares into which the debentures are convertible is $2,222,579 using the current market price per share of stock at September 30, 2014.
The table below sets forth the Company's financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2014 and September 30, 2013, respectively, and the fair value calculation input hierarchy that the Company has determined has applied to each asset and liability category.
NOTE 4 - UNPROVED PROPERTIES AND IMPAIRMENT
The total of the Company's investment in unproved properties and equipment at September 30, 2014 and 2013, consists of the following capitalized costs respectively:
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September 30, 2014
NOTE 5 - PROVED PROPERTIES AND IMPAIRMENT
For the years ended September 30, 2014 and 2013, respectively, the Company performed an analysis to determine whether the carrying amounts in its financial statements exceeded the present value of the expected revenues directly associated with the Crosby, North Dakota property. Management determined that the net value reflected in the financial statements did not exceed the present value of such revenues.
The total of the Company's investment in proved properties and equipment at September 30, 2014 and 2013, consists of the following capitalized costs respectively:
NOTE 6 - RECLAMATION BONDS AND OTHER LONG-TERM ASSETS
Reclamation bonds and other long-term assets consists of various deposits and reclamation bonds. Detail is disclosed in the following table:
NOTE 7 - CONVERTIBLE DEBENTURES
During the years ended September 30, 2011 and 2010, the Company issued 10% convertible debentures with an aggregate face value of
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September 30, 2014
$2,000,000. All of the debentures had a two year maturity from their respective issuance date and were issued with attached common stock purchase warrants. The effective interest rate on the debentures was, and is, 10% per annum. The debentures were secured by all assets of the Company except those specifically excluded in the agreement which include all Kansas properties and related assets.
The debentures are convertible at any time after the original issue date into a number of shares of the registrant’s common stock, determined by dividing the amount to be converted by an initial conversion price of $0.18 per share. In addition to the debentures the purchasers were issued an aggregate of 2,833,113 common share purchase warrants, each having a term of 42 months, which expired April 2014, and gave the purchasers the right to purchase the Company’s common shares at an initial exercise price of $0.18 per share. Subsequent to the initial issue date, the initial conversion price of $0.18 per share was amended to $0.12 per share based on provisions in the agreements related to equity issuances and issuance of additional convertible debentures during the year ended September 30, 2011.
The modified conversion price of $0.12 per share was amended on or about January 9, 2012, to $0.05 per share based on provisions in the agreements related to equity issuances of additional convertible shares.
The debentures all contain anti-dilution provisions which call for the debt conversion and warrant exercise prices be reduced based on future issues of debt or equity with more favorable provisions. Management has determined that these provisions cause the conversion options and warrants to require derivative liability accounting. See Note 8.
The entire proceeds of the debt issued was allocated to warrants and conversion option, resulting in a discount, and was amortized over the respective term of the debt.
Modification of debt
On April 23, 2013, the Company entered into a Partial Reset of Conversion Price agreement (the “Partial Reset”) with certain institutional investors (the “Investors”) who are holders of convertible debentures of the Company.
The change in terms of the debentures and share purchase warrants created a substantial modification of terms of the notes resulting in a loss on extinguishment of $1,492,912 which was charged to Loss on extinguishment on the Consolidated Statements of Operations for the year ended September 30, 2013.
On or about May 3, 2013, investors converted $90,313 in convertible debentures at $0.01 per share. Pursuant to these conversions, the Company issued 9,031,400 shares of its common stock. The Company also issued 7,085,263 shares of stock at $0.01 per share in payment of interest owed pursuant to the debentures.
On November 5, 2013, an investor converted $35,000 in convertible debentures at $0.01 per share. Pursuant to this conversion, the Company issued 3,500,000 shares of common stock.
On June 3, 2014, the Company entered into a Partial Reset of Conversion Price for the 10% Senior Secured Convertible Debentures agreement (the “2014 Partial Reset”) with one of the Investors. Under the terms of the 2014 Partial Reset, the Investor and the Company agreed to the following terms:
The Investor has the right to convert, into common stock of the Company, up to two hundred thousand dollars ($200,000) (in addition to the principal amount of the Debentures rest in the 2013 Partial Reset) of the principal amount of the Debentures outstanding at a Conversion Price equal to $0.01.
The Company considered the impact of ASC 470-50 “Debt Modifications and Extinguishments” of the 2014 Partial Reset and concluded it constituted a substantial modification and therefore should be accounted for as an extinguishment of debt. During the year ended September 30, 2014, the Company recognized a loss on extinguishment of $399,287 representing the change in fair value of the embedded conversion option because of the modification.
Fiscal year ended September 30, 2014
On or about June 3, 2014, the Company entered into Securities Purchase Agreements with an institutional investor, and accredited investor and the Chairman of the Board of Directors of the Company (each an “Investor” and together the “Investors”), wherein the Company agreed to sell and the Investors agreed to purchase $600,000 (total) of Secured Convertible Debentures. The Debentures are due sixty (60) months from the date of closing. The Debentures are secured by a security agreement granting the Investors a security interest in and to all of the Company’s assets located in the State of Kansas. At closing, the Company also entered into a Stock Pledge Agreement pledging to
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September 30, 2014
each Investor, as additional security, all of the Company’s right, title and interest in and to the capital stock of JayHawk Gas Transportation Corporation (a wholly owned subsidiary of the Company and the owner of the Company’s gas transmission pipeline in Kansas).
The Debentures are convertible at any time after the original issue date into a number of shares of the Company’s common stock, determined by dividing the amount to be converted by a conversion price of $0.01 per share, or an aggregate of 60,000,000 shares.
Additionally, each Investor will receive: 1) a Wastewater Disposal Fee; and 2) a Royalty Interest.
Wastewater Disposal Fee: the Company agrees to pay each Investor a per barrel fee (the "Disposal Fee") for each barrel of wastewater, which emanates from the Company's five currently producing, as of the original issue date of the Debentures, oil wells located in North Dakota, which is disposed of in the Company's proposed wastewater disposal well to be located in North Dakota (the "Disposal Well"). For a period commencing on the original issue date of the Debentures and continuing for five years or until the Debenture is repaid by the Company, whichever is sooner, the Disposal Fee will be equal to one and no/I 00 dollars ($1.00) per barrel of wastewater disposed of in the Disposal Well. After year five and continuing until each respective Debenture repaid by the Company the Disposal Fee shall be equal to fifty cents ($.50) per barrel of wastewater, emanating from the Company's five currently producing, as of the date the Debenture is issued, oil wells located in North Dakota, disposed of in the Disposal Well.
Royalty Interest: beginning on the original issue date of the Debentures and continuing thereafter so long as the Company owns the subject wells, the Company agrees to pay each Investor a one percent (1 %) overriding royalty interest, calculated monthly, on all proceeds received by the Company from sales of crude oil produced from the Company's five (5) then producing, as of the date the Debentures were issued, oil wells located in North Dakota
On June 3, 2014, the price for the Company’s common stock exceeded the $0.01 conversion price stated in the debentures. Management determined that the favorable exercise price represented a beneficial conversion feature. Using the intrinsic value method at the debenture date, a total discount of $600,000 was recognized on the debentures. The discount is being amortized over the term of the debentures using the straight-line method, which approximated the effective interest method. The Company recorded $40,000 in interest expense related to the amortization of the discount for the year ended September 30, 2014. The remaining discount balance was $560,000 at September 30, 2014.
At September 30, 2014, principal payments on debt are due as follows:
NOTE 8 - DERIVATIVE LIABILITIES
As discussed in Note 7, the Company entered into three separate issuances of convertible debentures, dated December 14, 2009, April 23, 2010, and October 20, 2010, which contained provisions allowing holders of the debentures to convert outstanding debt to shares of the Company's common stock. The debentures contain anti-dilution provisions which call for the debt conversion and warrant exercise prices to be reduced based on future issues of debt or equity with more favorable provisions. Management has determined that these provisions cause the conversion options and warrants to require derivative liability accounting. As such, management has valued them at fair value at the date of issuance.
Conversion option derivative
For the years ended September 30, 2014 and 2013, the fair value of conversion options was estimated at the period’s end using the Black-Scholes option pricing model using the following weighted average assumptions.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
Below is detail of the change in conversion option liability balance for the years ended September 30, 2014 and 2013, respectively.
Warrant derivative
At September 30, 2014 and 2013, respectively, the fair value of warrant derivative liability was estimated using the Black-Scholes option pricing model using the following weighted average assumptions:
As discussed in Note 12, during the first quarter of 2013, 1,000,000 warrants were issued to an investment banking advisor for services rendered. The warrants contained anti-dilution provisions which call for the warrant exercise price to be reduced based on future issues of debt or equity with more favorable provisions. Therefore, based on current guidance, the warrants were treated as derivatives. The warrants were valued at $58,257 using the Black-Scholes option pricing model with the following assumptions: risk free interest rate of 0.81%, volatility of 158.4%, exercise price of $0.06, current market price of $0.06 per share and an expected life of 5 years. The warrants expire February 15, 2017.
Below is detail of the change in warrant derivative liability balance for years ended September 30, 2014 and 2013, respectively.
NOTE 9 - ASSET RETIREMENT OBLIGATIONS
The Company has identified asset retirement obligations at the Girard, Kansas and Crosby, North Dakota operating sites. These retirement obligations are determined based on the estimated cost to comply with abandonment regulations established by the Kansas Corporation Commission and the State of North Dakota. The Company's engineers have estimated the cost, in today's dollars, to comply with these regulations. These estimates have been projected out to the anticipated retirement date 7 to 15 years in the future, at an assumed inflation rate of 1.5 percent. These amounts were discounted back at an assumed interest rate of 10 percent, to arrive at a net present value of the obligation. The amount of the annual increase in the obligation is charged to accretion expense and for the years ended September 30, 2014 and 2013, was computed to be $14,603 and $18,746, respectively.
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September 30, 2014
The following table summarizes the change in the asset retirement obligation since the beginning of the fiscal year ending September 30, 2014 and September 30, 2013, respectively:
On or about August 12, 2013, the Company responded to the administrative complaint and entered into settlement negotiations with the NDIC. As a good faith effort, the Company began plugging the Knudsen 1 well on or about December 20, 2013 (Note 16). The work required to plug the Knudsen 1 well was completed on or about January 1, 2014 and the work to plug the production zone of the Jenks well was completed on or about July 6, 2014. As September 30, 2013, the Company accrued $330,000 as an estimate of total liability related to the Jenks and Knudsen reclamation. For the year ended September 30, 2014, the Company revised the estimate related to the Jenks and Knudsen reclamation and accrued an additional $190,947 for completion of remaining remediation.
With respect to the Knudsen 1 site reclamation, under North Dakota statute, the Company is required to revegetate the disturbed area with native species or with crops according to reasonable specifications of the surface owner. The Company intends to plant native grass in the Spring of 2015 and believes it has substantially complied with the standards set for reclamation of the site. Management does not believe the cost of replanting to be material at this time and, therefore, accrues no additional contingent liability or revision to the asset retirement obligation liability.
NOTE 10 - COMMON STOCK
Fiscal Year End September 30, 2014
On November 11, 2013, the Company issued 3,500,000 shares of common stock to a holder of 10% convertible debentures within the terms thereof referenced in Note 7 who elected to convert the principal amount of $35,000.
Fiscal Year End September 30, 2013
On May 3, 2013, the Company issued 7,085,263 shares of common stock in lieu of paying interest with cash, to holders of convertible debentures described in Note 7.
On May 3, 2013, the Company issued 9,031,400 shares of common stock to holders of 10% convertible debentures within the terms thereof referenced in Note 7 who elected to convert the principal amount of $90,313.
NOTE 11 - STOCK BASED COMPENSATION
The Company’s board of directors approved a stock and option plan on August 11, 2009 (the “Plan”). The purpose of the Plan is to provide employees and consultants of the Corporation and its Subsidiaries with an increased incentive to make significant and extraordinary contributions to the long-term performance and growth of the Corporation and its Subsidiaries, to join the interests of employees and consultants with the interests of the shareholders of the Corporation, and to facilitate attracting and retaining employees and consultants of exceptional ability. The total number of shares available for grant under the terms of the Plan is 4,000,000. The number of shares subject to the Plan and any outstanding awards will be adjusted appropriately by the Board of Directors if the Company’s common stock is affected through a reorganization, merger, consolidation, recapitalization, restructuring, reclassification dividend (other than quarterly cash dividends) or other distribution, stock split, spin-off or sale of substantially all of the Company’s assets.
On October 10, 2013, the Board of Directors rescinded, from various officers and directors, 2,040,000 options to purchase shares of the Company’s common stock. The rescinded options had a strike price of $0.20 based on the closing price of the Company’s common stock on the date of grant. Also on October 10, 2013, the Board of Directors authorized the grant, to various officers and directors, of 4,000,000 options to purchase shares of the Company’s common stock. The options have a strike price of $0.01 based on the closing price of the Company’s common stock on the date of grant and vest over 9 months. The concurrent grant of a replacement award was accounted for as a modification of terms and resulted in an offset to compensation expense of $20,151.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
The Company recognizes compensation expense straight-line over the vesting term. Historically, the Company has issued new shares to satisfy exercises of stock options and the Company expects to issue new shares to satisfy any future exercises of stock options.
At September 30, 2014, the Company had 4,000,000 options granted and outstanding. The outstanding options have a weighted average remaining term of 2 years.
The following table reflects the summary of changes during the years ended September 30, 2014 and 2013:
A summary of the status of the Company’s nonvested stock options outstanding at September 30, 2014 is presented as follows:
As of September 30, 2014, there was no unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. The Company recognized $24,803 and $12,584 of compensation cost related to options vested during the year ended September 30, 2014 and 2013, respectively.
NOTE 12 - BROKER AND SHARE PURCHASE WARRANTS
A summary of activity of the Company's share purchase and broker warrants outstanding at September 30, 2014 is presented as follows:
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September 30, 2014
The exercise price and expiration dates of the broker and share purchase warrants as revised by the Partial Reset (Note 7) is presented as follows:
NOTE 13 - RELATED PARTY TRANSACTIONS
On or about December 1, 2011, the Company entered into a four year lease with Marlin Property Management, LLC, an entity owned by the spouse of the Company's former President/CEO and current chairman of the board of directors. Under the terms of the lease the Company is required to pay $2,500 per month for office space in Coeur d'Alene, Idaho. For the year ended September 30, 2014 and 2013, $30,000 and $30,000, respectively, were due under the terms of the lease. The balance due to the related party including common area expenses as of September 30, 2014 was $2,826
On or about June 3, 2014, the Company entered into a Securities Purchase Agreement with the chairman of the board of directors of the Company to sell $200,000 of Secured Convertible Debentures (Note 7). For the year ended September 30, 2014, the Company paid $3,382 pursuant to the terms of the agreement. The balance due to the related party as of September 30, 2014 was $555 which was subsequently paid in October 2014.
The balance attributable to the related party as of September 30, 2014 is $200,000 which is convertible at any time after the original issue date into a number of shares of the Company’s common stock, determined by dividing the amount to be converted by a conversion price of $0.01 per share, or an aggregate of 20,000,000 shares.
NOTE 14 - SUPPLEMENTAL CASH FLOW AND OTHER DISCLOSURES
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September 30, 2014
NOTE 15- INCOME TAX
The Company did not recognize an income tax benefit or expense for the fiscal years ended September 30, 2014 and 2013.
The deferred tax assets were calculated based on an expected future combined tax rate of 40% consisting of maximum statutory federal tax rate of 35% and state taxes calculated at the rate of 5%, which is net of the expected federal income tax benefit.
The components of the Company’s net deferred tax assets are as follows:
As management of the Company cannot determine that it is more likely than not the Company will realize the benefit of the estimated net deferred tax asset, a valuation allowance equal to 100% of the net deferred tax asset has been recorded at September 30, 2014 and 2013.
The Company has approximately $12 million of federal and state net operating loss carryforwards that expire through 2025 and 2034 that may be used to offset future taxable income.
Based on the net loss for the year ended September 30, 2014 and 2013, of $1,479,897 and $1,263,950, respectively, the income tax benefit shown in the financial statements for the years ended September 30, 2014 and 2013 differs from the projected statutory rate as follows:
The Company has concluded that the guidance regarding accounting for uncertainty in income taxes had no significant impact on the results of operations or financial position as of September 30, 2014 or 2013. Therefore, the Company does not have an accrual for uncertain tax positions as of September 30, 2014 or 2013. As a result, tabular reconciliation of beginning and ending balances would not be meaningful. If interest and penalties were to be assessed, the Company would charge interest expense and penalties to other operating expense. It is not anticipated that unrecognized tax benefits would significantly increase or decrease within 12 months of the reporting date. The Company is currently delinquent in their federal and state tax filings. Fiscal years 2009 through 2014 remain subject to examination by state and federal tax authorities.
NOTE 16 - COMMITMENTS AND CONTINGENCIES
On December 1, 2011, the Company entered into an office space lease with a related party for a term of four years, at the fixed monthly rental amount of $2,500. Accordingly, the Company's commitment to make these lease payments for each successive year is $30,000.
The Company is obligated to pay royalties to holders of oil and natural gas interests in both North Dakota and Kansas operations. The Company also is obligated to pay working interest holders a pro-rata portion of revenue in oil operations net of shared operating expenses.
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September 30, 2014
The amounts are based on monthly oil and natural gas sales and are charged monthly net of oil and gas revenue and recognized as "Due to royalty and working interest holders" on the Company's balance sheet.
On or about July 12, 2014, the Company entered into a promissory note for $46,642 with a working interest partner. The Company will make seven monthly payments in the amount of $2,500 and subsequently make ten monthly payments in the amount of $2,914. At September 30, 2014, the balance due on the note was $36,642, of which $30,814 is due in the subsequent twelve months of the balance sheet date.
On August 1, 2013, the North Dakota Industrial Commission (“NDIC”) submitted an administrative complaint to the State of North Dakota related to plugging and remediation of the Company’s Jenks 1 and Knudsen 1 wells in Crosby, ND. The administrative complaint alleged the Company violated certain portions of the North Dakota Century Code and requested administrative relief against Jayhawk Energy, Inc. for violation of sections of the North Dakota Administrative Code governing the oil and gas industry.
On or about August 12, 2013, the Company responded to the administrative complaint and entered into settlement negotiations with the NDIC. As a good faith effort, the Company began plugging the Knudsen 1 well on or about December 20, 2013. The work required to plug the Knudsen 1 well was completed in January 2014. The range of associated penalties as proposed by the NDIC was $100,000 to $525,000 for failure to comply.
As September 30, 2013, the Company accrued $330,000 as an estimate of total liability related to the Jenks and Knudsen reclamation. For the year ended September 30, 2014, the Company revised the estimate related to the Jenks and Knudsen reclamation and paid an additional $190,947 for completion of remaining remediation.
On February 18, 2014, the Company entered into a Consent Agreement with the State of North Dakota whereby the Company was required to finish reclamation work on the two waste water storage pits adjacent to the Jenks 1 and Knudsen 1 wells respectively. Further, the Consent Agreement allows that the Company must plug the “production zone” of the Jenks 1 well and then may apply for a permit to convert the Jenks 1 well to a salt water disposal well. As a part of the Consent Agreement the Company agreed to pay a civil penalty of no less than $105,000, consisting of $25,000 due and payable upon execution of the Consent Agreement and a $16,000 installment per month for five successive months thereafter.
The Company made the initial $25,000 payment and each subsequent monthly installment payment of $16,000 with the final installment paid to the State of North Dakota on June 26, 2014. As of September 30, 2014 the Company has completed substantially all reclamation work and has paid all fines assessed.
On July 12, 2014, the Company completed reclamation work on both the Jenks 1 and Knudsen 1 waste water storage pits. Unseasonably heavy rains which saturated the soil and limited safe access to the site by heavy equipment delayed scheduled reclamation until such time as ground conditions improved. The Company also completed plugging of the ‘production zone’ on the Jenks 1 well and set a balance plug on the Knudsen 1 well bore.
With respect to the Knudsen 1 site reclamation, under North Dakota statute, the Company is required to re-vegetate the disturbed area with native species or with crops according to reasonable specifications of the surface owner. The Company intends to plant native grass in the Spring of 2015 and believes it has substantially complied with the standards set for reclamation of the site. Management does not believe the cost of replanting to be material at this time and, therefore, accrues no additional contingent liability.
NOTE 17 - SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (Unaudited)
In January 2010, the FASB issued an ASU to amend existing oil and gas reserve accounting and disclosure guidance to align its requirements with the SEC's revised rules discussed in Note 1. The significant revisions involved revised definitions of oil and gas producing activities, changing the pricing used to estimate reserves the period end to a twelve month arithmetic average of the first day of the month prices and additional disclosure requirements. In contrast to the SEC rule, the FASB does not permit the disclosure of probable and possible reserves in the supplemental oil and gas information in the notes to the financial statements. The amendments are effective for annual reporting periods ending on or after December 31, 2009. Application of the revised rules is prospective and companies are not required to change prior period presentation to conform to the amendments. Application of the amended guidance has only resulted in changes to the prices used to determine proved reserves at December 31, 2009. The new guidelines have expanded the definition of proved undeveloped reserves that can be recorded from an economic producer did not impact or prove undeveloped reserves.
The Company follows the guidelines prescribed in ASC 932 for computing a standardized measure of future cash net cash flows and changes therein relating to estimated proved reserves. Future cash inflows and future production and development costs are determined by
JAYHAWK ENERGY, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
applying prices and costs, including transportation, quality and basis differentials to the year-end estimated quantities of oil and gas to be produced in the future. The resulting net cash flows are reduced to present value amounts by applying a ten percent annual discount factor. Future operating costs are determined based on estimates of expenditures to be incurred in producing the proved oil and gas reserves in place at the end of the period using year-end costs and assuming continuation of existing conditions, plus Company overhead incurred. Future development costs are determined based on estimates of capital expenditures to be incurred in developing proved oil and gas reserves.
The assumptions used to compute the standardized measure are those prescribed by the FASB and the SEC. The assumptions do not necessarily reflect the Company's expectations of actual revenues to be derived from these reserves, no their present value. The limitations inherent in the reserve quantity estimation process, as discussed previously, are equally applicable to the standardized measure computations since these reserve quantity estimates are the basis for the valuation process. The Company emphasizes that reserve estimates are inherently imprecise and that estimate of new discoveries and undeveloped locations are more imprecise than estimates of establishing proved producing oil properties. Users of this information should be aware that the process of estimating quantities of “proved” and “proved-developed” oil reserves is very complex, requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may also change substantially over time as a result of numerous factors including, but not limited to, additional development activity, evolving production history and continual reassessment of the viability of production under varying economic conditions. As a result, revisions to existing reserve estimates may occur from time to time. Although every reasonable effort is made to ensure reserve estimates reported represent the most accurate assessments possible, the subjective decisions and variances in available data for various reservoirs make these estimates generally less precise than other estimates included in the financial statements disclosures.
Proved oil reserve quantities at September 30, 2014 and 2013, and the related future net cash flows are based on the estimates prepared by independent petroleum engineers.
The following reserve quantity and future net cash flow information for 2013 was prepared by McDaniel & Associates Consultants, Ltd and are consistent with internal estimates. The Company provided McDaniel & Associates with engineering, geological and geophysical data, actual production histories and other information necessary for the reserve determination. The reserve estimates were prepared based on economic and operating conditions existing at September 30, 2013.
The following reserve quantity and future net cash flow information for 2014 was prepared by Cedar Technical Associates and are consistent with internal estimates. The Company provided Cedar Technical Associates with engineering, geological and geophysical data, actual production histories and other information necessary for the reserve determination. The reserve estimates were prepared based on economic and operating conditions existing at September 30, 2014.
All of the Company's oil reserves are within the continental United States in the states of North Dakota. Based on the evaluation described in the preceding paragraph, presented below (in barrels) is a summary of changes to the Company's net interest in proved developed and proved undeveloped reserves for the years ending September 30, 2014 and 2013:
September 30, 2012
65,700
Revisions of previous estimates
1,800
Purchase of minerals in place
-
Production
(6,600)
September 30, 2013
60,900
Revisions of previous estimates
65,772
Purchase of minerals in place
-
Production
(6,906)
September 30, 2014
119,766
Oil reserves
JAYHAWK ENERGY, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
Based on the evaluation described in the preceding paragraph, presented below (in barrels) is a summary of changes to the Company’s net interest in proved undeveloped and proved developed producing and non-producing reserves for the years ending September 30, 2014 and 2013:
The reserves in this report have been estimated using deterministic methods. For wells classified as proved developed producing where sufficient production history existed, reserves were based on individual well performance evaluation and production decline curve extrapolation techniques. For undeveloped locations and wells that lacked sufficient production history, reserves were based on analogy to producing wells within the same area exhibiting similar geologic and reservoir characteristics, combined with volumetric methods. The volumetric estimates were based on geologic maps and rock and fluid properties derived from well logs, core data, pressure measurements, and fluid samples. Well spacing was determined from drainage patterns derived from a combination of performance-based recoveries and volumetric estimates for each area or field. Proved undeveloped locations were limited to areas of uniformly high quality reservoir properties, between existing commercial producers.
Capitalized Costs Relating to Oil and Gas Producing Activities
Evaluated and unevaluated capitalized costs related to the Company's oil and natural gas producing activities are summarized as follow in $ thousands:
The Company will continue to evaluate its unevaluated properties; however, the timing of the ultimate evaluation and disposition of the properties has not been determined.
Costs Incurred in Oil and Gas Producing Activities (in $ thousands)
Costs incurred in oil and natural gas property acquisitions, exploration and development are summarized as follows, in $ thousands:
JAYHAWK ENERGY, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
Standardized Measure of Discounted Future Net Cash Flow
The following Standardized Measure of Discounted Future Net Cash Flow information has been developed utilizing ASC 932, Extractive Activities - Oil and Gas (ASC 932) procedures and based on estimated oil reserve and production volumes. It can be used for some comparisons, but should not be the only method used to evaluate the Company or the Company performance. Further, the information in the following table may not represent realistic assessments of future cash flows, nor should the Standardized Measure of Discounted Future Net Cash Flows be viewed as representative of the Company’s current value.
The Company believes that the following factors should be taken into account when reviewing the following information:
·
future costs and selling prices will probably differ from those required to be used in these calculations;
·
due to future market conditions and governmental regulations, actual rates of production in future years may vary significantly from the rate of production assumed in the calculations;
·
a 10% discount rate may not be reasonable as a measure of the relative risk in realizing future net oil reserves; and
·
future net revenues may be subject to different rates of income taxation.
The Standardized Measure of discounted future net cash flows relating to the Company's ownership interests in proved developed oil reserves for the years ended September 30, 2014 and 2013 are as follows:
Changes in Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil Reserves
The following is a summary of the changes in Standardized Measure of discounted future net cash flows for the Company’s proved oil reserves during each of the years in the two year period ended September 30, 2014:
Results of Operations for Oil and Gas Producing Activities
The results of operations shown below exclude non-oil and gas producing activities, corporate overhead items, interest expense and other incomes expense, gains and losses. Therefore, these results are on a different basis than results of operations reported upon in the consolidated statement of operations.
JAYHAWK ENERGY, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2014
All operations were conducted in the United States. The Company produces crude oil in North Dakota and natural gas in southeast Kansas. The Company produces no natural gas in North Dakota and no oil in Kansas at this time. Because of limited funding, exploration activities were not conducted in the years ended September 30, 2014 and 2013.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
In connection with the preparation of this annual report on Form 10-K, an evaluation was carried out by JayHawk’s management, with the participation of the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)) as of September 30, 2014. Disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures.
Based on that evaluation, JayHawk’s management concluded, as of the end of the period covered by this report, that the Company’s disclosure controls and procedures were not effective in recording, processing, summarizing, and reporting information required to be disclosed, within the time periods specified in the Securities and Exchange Commission’s rules and forms.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of JayHawk Energy, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process, under the supervision of the Chief Executive Officer and the Chief Financial Officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with United States generally accepted accounting principles (GAAP). Internal control over financial reporting includes those policies and procedures that:
·
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the Company’s assets;
·
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and the Board of Directors; and
·
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of September 30, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). As a result of this assessment, management identified a material weakness in internal control over financial reporting.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
The material weakness identified is described below:
Due to insufficient staffing, it was not possible to ensure appropriate segregation of duties between incompatible functions, and formalized monitoring procedures have not been established or implemented.
As a result of the material weakness in internal control over financial reporting described above, the Company’s management has concluded that, as of September 30, 2014, the Company’s internal control over financial reporting was not effective based on the criteria in Internal Control - Integrated Framework (2013) issued by COSO.
This annual report does not include an attestation report of the Company's independent registered public accounting firm regarding internal control over financial reporting. The Company was not required to have, nor has it, engaged its independent registered public accounting firm to perform an audit of internal control over financial reporting pursuant to the rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There have been no changes in internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) during the year ended September 30, 2014, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B
ITEM 9B - OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS.
DIRECTORS AND EXECUTIVE OFFICERS
Name
Age
Position
Kelly J. Stopher
Interim President/Chief Executive Officer, and Chief Financial Officer
Lindsay E. Gorrill
Chairman of the Board
Matthew J. Wayrynen
Director, Chairman of the Compensation Committee
Jeffrey W. Bright
Director, Chairman of Nominating Committee
Tyrone Docherty
Director, Chairman of Audit Committee
Directors are elected to serve until the next annual meeting of stockholders and until their successors are elected and qualified. Directors are compensated at the rates of $8,000 per year. The Chairmen of the Audit Committee is compensated an additional $4,000 per year. Each other committee chairman is compensated an additional $2,000 per year. Officers are elected by the Board of Directors and serve until their successors are appointed by the Board of Directors. Biographical resumes of each officer and director are set forth below.
Lindsay E. Gorrill - Chairman
Mr. Lindsay Gorrill is a C.A. and has university degrees in Finance and Marketing. Mr. Gorrill has a background in acquisitions, company building, financial markets and world exposure. Mr. Gorrill has served as a member of the Company's Board of Directors since July 2007. Mr. Gorrill was appointed Chairman of JayHawk Energy, Inc. on April 9, 2013. Mr. Gorrill has also, in the past, served as the Company's Chief Financial Officer, Chief Executive Officer and also President. He has also served as President and Treasurer of Star Gold Corp., a company quoted on the OTC Bulletin Board, from February 2008 until April 2012. Mr. Gorrill had, in the past, served as Star Gold’s Treasurer. Mr. Gorrill currently serves as the Chairman of the Board of Directors for Star Gold Corp. Mr. Gorrill has also served as a member of the board of directors of Yaterra Ventures Corp, a company quoted on the OTC Bulletin Board previously. He has served as President, Chief Operating Officer and as a member of the board of directors of Berkley Resources Inc., a company listed on the TSX Venture Exchange, since July 2004. Since April 2009, Mr. Gorrill has served as Chief Executive Officer and Chief Financial Officer of Canada Fluorspar Inc., a now privately held company formerly listed on the TSX Venture Exchange. Mr. Gorrill also served as President and Chief Financial Officer of Canada Fluorspar, Inc. He has also been a member of the board of directors of Deer Horn Metals, Inc., a TSX Venture Exchange listed company since September 2009.
Kelly J. Stopher - President, CEO and CFO
Mr. Kelly Stopher was appointed Chief Financial Officer of the Company on September 28, 2010. Mr. Stopher was appointed interim President and Chief Executive Officer on April 9, 2013. Mr. Stopher has developed strategies to implement financial management systems, internal control policies and procedures, and financial reporting and modeling for small-cap companies. From March, 2010 through September, 2010, Mr. Stopher worked for Allied Security. Mr. Stopher worked as business relationship manager for Wells Fargo Bank, Spokane, WA, from April 2006 through August 2009. From September 2004 through January 2006, he acted as CFO for Weldon
Barber, Spokane, WA. From October 2003 through September 2004, he was a sales associate for Kiemle & Hagood Company, in Spokane, WA. And from January 2001 through March 2003 he worked as an account executive for Aston Business Solutions in Boise, ID specializing in enterprise accounting software systems. Prior that Mr. Stopher worked as CFO for Lee Read Jewelers in Boise, ID and spent 5 years in public accounting with Langlow Tolles & Company in Tacoma, WA. Mr. Stopher also serves as Chief Financial Officer for Star Gold Corp., a company quoted on the OTC Bulletin Board, and was appointed to that position in October 2010. Mr. Stopher holds a bachelor’s degree from Washington State University in Business Administration - Accounting.
Matthew J. Wayrynen - Director
Mr. Wayrynen was appointed to the Board of Directors on April 30, 2008. Mr. Wayrynen has also, in the past, served as the Company's Chairman of the Board of Directors. Mr. Wayrynen is a citizen of Canada. He also serves as a director of Deer Horn Metals, Inc. (since 2009), as a Director of Discovery Ventures Inc. (since August 2012) as a director of Avino Silver & Gold Mines, Ltd. (since 2004), as a director and President of American Uranium Corporation (since 2010) and as a director, President and CEO of Berkley Resources, Inc. (since 2003). Mr. Wayrynen is an original co-founder and former President and Chief Executive Officer of TrichoScience Innovations Inc., which was acquired by Replicel Life Sciences Inc. Mr. Wayrynen also serves as Director, President and CEO of WestKam Gold Corp. Prior to these positions Mr. Wayrynen was a broker with Golden Capital Securities, located in Vancouver, British Columbia. Mr. Wayrynen is not an officer or director of any other U.S. reporting company.
Tyrone Docherty - Director
Mr. Docherty was appointed to the Board of Directors on July 10, 2008. Mr. Docherty is a citizen of Canada and is presently the CEO and a director of Deer Horn Metals, Inc. Prior to this position he was president and CEO of Quinto Mining Corporation from June 1997 to June 2008. Mr. Docherty is not an officer or director of any other U.S. reporting company.
Jeffrey W. Bright - Director
Mr. Bright was appointed to the Board of Directors on April 30, 2008. Mr. Bright is a citizen of Canada. Mr. Bright has worked as an attorney since 2003, currently employed with Miller Thomson LLP of Calgary, Alberta, Canada. Mr. Bright was previously legal counsel for Agrium Inc., located in Calgary Alberta, Canada. He is a member of the Association of International Petroleum Negotiators, and the Canadian and American Bar Associations. Mr. Bright is not an officer or director of any other U.S. reporting entity.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) requires the Company's directors and executive officers, and persons who own more than ten percent of a registered class of the Company's equity securities, to file with the Commission initial reports of ownership and reports of changes in ownership of the Company's Common Stock and other equity securities of the Company. Officers, directors and greater than ten percent shareholders are required by the Commission's regulations to furnish the Company with copies of all Section 16(a) forms they filed.
The Company have been provided with copies of all forms (3, 4 and 5) filed by officers, directors, or ten percent shareholders within three days of such filings. Based on the review of such forms that the Company received, or written representations from reporting persons that no Forms 5s were required for such persons, the Company believe that, during all prior fiscal periods, all Section 16(a) filing requirements have been satisfied on a timely basis for members of the Board of Directors and Executive Officers.
Code of Ethics
The Company's Board of Directors has adopted a Code of Business Conduct and Ethics Compliance Program and an Insider Trading Policy providing guidelines with respect to transactions in Company securities and is applicable to all directors, officers, employees and consultants who receive or have accesses to material non-public Company information.
Corporate Governance
Audit Committee
On June 30, 2008 JayHawk established an audit committee of its Board of Directors and adopted a "Code of Ethics" to promote honest and ethical conduct, proper disclosure of financial information and compliance with applicable laws, rules and regulations by all of the Company's employees and members of the board of directors. Mr. Tyrone Docherty has served as Chairman of the Audit Committee since June 15, 2009. Jeff W. Bright also serves on the Audit Committee.
Compensation Committee
Mathew J. Wayrynen has served as Chairman of the Compensation Committee since August 27, 2008. Lindsay Gorrill and Tyrone Docherty also serve on the Compensation Committee.
Nominating Committee
Jeff W. Bright was appointed Chairman of the Nominating Committee on August 27, 2008, Lindsay Gorrill and Matthew Wayrynen also serve as members of the Nominating Committee.
Reserves Committee
Lindsay Gorrill has served as the Chairman of the Reserves Committee since April 29, 2011. Jeff W. Bright also serves on the Reserves Committee.
Compensation Committee Interlocks and Insider Participation
Mathew J. Wayrynen has served as the Chairman of the Compensation Committee since August 27, 2008. Lindsay Gorrill and Tyrone Docherty also serve as members of the compensation committee.
None of the Company's directors or executive officers serves as a member of the board of directors or compensation committee of any other entity that has one or more of its executive officers serving as a member of JayHawk Energy Inc.'s board of directors.
Director Compensation
The table below sets forth, for the last fiscal year, the compensation earned by the Company's non-employee directors:
Name
Fees earned or paid in cash
Stock Awards
Non-Equity Incentive Plan Compensation
Non-qualified deferred Compensation Earnings
All Other Compensation
Total
Lindsay Gorrill, Chairman
$ 13,750
$ -
$ 21,915
$ -
$ -
$35,665
Matthew Wayrynen
12,750
-
3,372
-
-
16,122
Tyrone Docherty
14,750
-
3,372
-
-
18,122
Jeffrey Bright
11,750
-
3,372
-
-
15,122
TOTAL
$ 53,000
$ -
$ 32,031
$ -
$ -
$ 85,031
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Each individual's total compensation consisted of cash paid as salary and recognition of options vested during the years ended September 30, 2014 and 2013. The following amounts were paid to the respective individuals:
The amounts in the Option Awards column reflect the dollar amount recognized and expensed for financial statement reporting purposes for the years ended September 30, 2013, in accordance with ASC Topic 718 of awards of stock options and thus do not represent aggregate fair value of grants. The Company used the Black-Scholes option price calculation to value the options granted in 2010 and using the following assumptions: risk-free rate of 0.06% and 5.35%; volatility of 0.99; actual term and exercise price of options granted. See Note 11 - Stock Based Compensation in the Notes to the Consolidated Financial Statements for additional details on option issuances.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The following table sets forth certain information regarding beneficial ownership of the Company's common stock as of September 30, 2014:
· by each person who is known by us to beneficially own more than 5% of the Company's common stock;
· by each of the Company's officers and directors; and
· by all of the Company's officers and directors as a group.
NAME AND ADDRESS OF OWNER
TITLE OF CLASS
NUMBER OF SHARES OWNED (1)
PERCENTAGE OF CLASS
Lindsay Gorrill, Chairman
611 E. Sherman Ave., Coeur d'Alene ID 83814
Common stock
5,076,112
6.32%
Kelly Stopher, CEO and CFO
611 E. Sherman Ave., Coeur d'Alene ID 83814
Common stock
1,000
0.00%
Matthew Wayrynen
570 Granville, Suite 900 Vancouver, BC V6C 3P1
Common stock
166,583
0.21%
Tyrone Docherty
4672 Kensington Pl., Delta, BC V4K 4W5
Common stock
48,169
0.06%
Jeffrey Bright, Director
111 Edenstone View NW, Calgary, AB T3A 3Z2
Common stock
40,141
0.05%
All Officers and Directors
Common stock
5,332,005
6.64%
(1) Beneficial Ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Shares of common stock subject to options or warrants currently exercisable or convertible, or exercisable or convertible within 60 days of September 30, 2014 are deemed outstanding for computing the percentage of the person holding such option or warrant but are not deemed outstanding for computing the percentage of any other person.
(2) Percentage based on 80,375,841 shares of common stock outstanding as of September 30, 2014
Outstanding Equity awards at fiscal year ended September 30, 2014
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As discussed in Note 13 - Related Party Transactions in the Notes to the Consolidated Financial Statements, on December 1, 2011, the Company entered into a four year lease with Marlin Property Management, LLC, an entity owned by the spouse of the Company's former President/CEO and current chairman of the board of directors. Under the terms of the lease the Company is required to pay $2,500 per month for office space in Coeur d'Alene, Idaho. For the year ended September 30, 2014 and 2013, $30,000 and $30,000, respectively, were due under the terms of the lease. The balance due to the related party including common area expenses as of September 30, 2014 was $2,826
On June 3, 2014, the Company entered into Securities Purchase Agreements with an institutional investor and the chairman of the board of directors of the Company (Note 13), wherein the Company agreed to sell and the Investors agreed to purchase $400,000 (total) of Secured Convertible Debentures. The Debentures are due sixty (60) months from the date of closing. The Debentures are secured by a security agreement granting the Investors a security interest in and to all of the Company’s assets located in the State of Kansas. At closing, the Company also entered into a Stock Pledge Agreement pledging to each Investor, as additional security, all of the Company’s right, title and interest in and to the capital stock of JayHawk Gas Transportation Corporation (a wholly owned subsidiary of the Company and the owner of the Company’s gas transmission pipeline in Kansas).
Additionally, each Investor will receive: 1) a Wastewater Disposal Fee; and 2) a Royalty Interest.
Wastewater Disposal Fee: the Company agrees to pay each Investor a per barrel fee (the "Disposal Fee") for each barrel of wastewater, which emanates from the Company's five (5) currently producing, as of the original issue date of the Debentures, oil wells located in North Dakota, which is disposed of in the Company's proposed wastewater disposal well to be located in North Dakota (the "Disposal Well"). For a period commencing on the original issue date of the Debentures and continuing for five (5) years or until the Debenture is repaid by the Company, whichever is sooner, the Disposal Fee will be equal to one and no/I 00 dollars ($1.00) per barrel of wastewater disposed of in the Disposal Well. After year five and continuing until each respective Debenture repaid by the Company the Disposal Fee shall be equal to fifty cents ($.50) per barrel of wastewater, emanating from the Company's 5 currently producing, as of the date the Debenture is issued, oil wells located in North Dakota, disposed of in the Disposal Well.
Royalty Interest: beginning on the original issue date of the Debentures and continuing thereafter so long as the Company owns the subject wells, the Company agrees to pay each Investor a one percent (1 %) overriding royalty interest, calculated monthly, on all proceeds received by the Company from sales of crude oil produced from the Company's five (5) currently, as of the date the Debentures are issued, producing oil wells located in North Dakota
The balance attributable to the related party as of September 30, 2014 is $200,000 which is convertible at any time after the original issue date into a number of shares of the Company’s common stock, determined by dividing the amount to be converted by a conversion price of $0.01 per share, or an aggregate of 20,000,000 shares.
The Company has no policy regarding entering into transactions with affiliated parties.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Audit Fees
The aggregate fees billed by the Company's auditors, for professional services rendered for the audit of the Company's annual financial statements for the years ended September 30, 2014 and 2013 and for the reviews of the financial statements included in the Company's Quarterly Reports on Form 10-Q during the fiscal years were $58,696 and $65,167, respectively.
All Other Fees
No other fees have been billed in the last two years for products and services provided by the principal accountant other than the services reported pursuant to the above portions of this Item 14.
The Company's board of directors acts as the audit committee and had no “pre-approval policies and procedures” in effect for the auditors’ engagement for the audit years 2014 and 2013.
PART IV
ITEM 15.
ITEM 15. EXHIBITS.
*XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
JAYHAWK ENERGY, INC.
Date: January 14, 2014
By: /s/ KELLY J. STOPHER
Kelly J. Stopher
President and Chief Executive Officer
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.
Name
Position
Date
By: /s/ KELLY J. STOPHER
Kelly J. Stopher
President, Chief Executive Officer, Chief Financial Officer
January 9, 2015