UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

ý Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934: For the quarterly period ended April 30, 2015

or

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

Commission file number: 000-53313

HYDROCARB ENERGY CORP.
(Exact name of registrant as specified in its charter)
NEVADA
 
30-0420930
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)

800 Gessner, Suite 375
Houston, Texas  77024
(Address of principal executive offices, including zip code)

(713) 970-1590
(Registrant’s principal executive office telephone number)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer     o
 
Accelerated filer                       o
     
Non-accelerated filer        o
 
Smaller reporting company      ý
(Do not check if a smaller reporting company)

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

As of June 15, 2015, 21,289,089 shares of common stock, $0.001 par value, of the registrant were outstanding.
 


Table of Contents

Part I. Financial Information
Item 1.
3
     
Item 2.
26
     
Item 3.
32
     
Item 4.
32
     
Part II. Other Information
     
Item 1.
32
     
Item 1A.
32
     
Item 2.
34
     
Item 3.
35
     
Item 4.
35
     
Item 5.
35
     
Item 6.
35
 
2

Part I. Financial Information

Item 1. Financial Statements

1.
4
     
2..
5
     
3.
6
     
4.
7
 
HYDROCARB ENERGY CORP.
 Consolidated Balance Sheets
(Unaudited)
 
   
April 30, 2015
   
July 31, 2014
 
ASSETS
       
Current assets:
       
Cash and cash equivalents
 
$
90,261
   
$
144,258
 
Oil and gas revenues receivable
   
323,839
     
372,120
 
Accounts receivable - related party
   
2,722
     
58,014
 
Other current assets
   
639,005
     
446,320
 
Other receivables, net
   
139,542
     
38,455
 
Total current assets
   
1,195,369
     
1,059,167
 
                 
Oil and gas properties, accounted for using the full cost method of accounting
               
Evaluated property, net of accumulated depletion of $4,221,633 and $3,491,420, respectively; and accumulated impairment of $373,335 and $373,335, respectively
   
16,765,761
     
15,288,370
 
Unevaluated property
   
2,260,912
     
2,119,769
 
Restricted cash
   
6,857,002
     
6,877,944
 
Other assets
   
404,264
     
219,942
 
Property and equipment, net of accumulated depreciation of $175,620 and $135,590, respectively
   
126,060
     
166,963
 
TOTAL ASSETS
 
$
27,609,368
   
$
25,732,155
 
                 
LIABILITIES AND EQUITY
               
Current liabilities:
               
Accounts payable and accrued expenses
 
$
3,631,169
   
$
2,795,675
 
Short term notes payable, net of discount $280,210 and $0
   
1,228,305
     
334,688
 
Derivative Liability
   
1,940,460
     
-
 
Asset retirement obligation – short term
   
60,000
     
1,133,690
 
Advances
   
195,904
     
195,904
 
Due to related parties
   
78,585
     
165,542
 
Total current liabilities
   
7,134,423
     
4,625,499
 
                 
Notes payable, net of discount of $491,374 and $0
   
4,054,080
     
-
 
Notes payable - related party
   
600,000
     
600,000
 
Asset retirement obligation – long term
   
12,394,349
     
10,582,540
 
Total liabilities
   
24,182,852
     
15,808,039
 
                 
Stockholders' Deficit:
               
 
   
-
     
-
 
Common stock: $001 par value; 333,333,333 shares authorized; 21,272,785 and 21,081,602 shares issued and outstanding as of April 30, 2015 and July 31, 2014, respectively
   
21,273
     
21,082
 
Receivable for common stock
   
(2,184,879
)
   
(2,184,879
)
Additional paid-in capital
   
82,920,196
     
82,228,799
 
Accumulated deficit
   
(77,294,234
)
   
(70,106,351
)
Total stockholders' equity
   
3,462,356
     
9,958,651
 
Noncontrolling interests
   
(35,840
)
   
(34,535
)
Total equity
   
3,426,516
     
9,924,116
 
                 
TOTAL LIABILITIES AND EQUITY
 
$
27,609,368
   
$
25,732,155
 

The accompanying notes are an integral part of these unaudited consolidated financial statements
 
HYDROCARB ENERGY CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Unaudited)

   
Three Months Ended April 30,
   
Nine Months End April 30,
 
   
2015
   
2014
   
2015
   
2014
 
                 
Revenues
 
$
1,139,278
   
$
1,057,550
   
$
2,991,055
   
$
3,887,493
 
                                 
Operating expenses
                               
Lease operating expense
   
1,043,956
     
1,559,339
     
3,254,801
     
3,487,798
 
Depreciation, depletion, and amortization
   
385,058
     
179,678
     
771,480
     
673,357
 
Accretion
   
229,560
     
242,608
     
790,550
     
731,093
 
Consulting fees - related party
   
-
     
-
     
-
     
6,754
 
General and administrative expense
   
749,154
     
645,496
     
2,672,914
     
3,383,820
 
Total operating expenses
   
2,407,728
     
2,627,121
     
7,489,745
     
8,282,822
 
                                 
Loss from operations
   
(1,268,450
)
   
(1,569,571
)
   
(4,498,690
)
   
(4,395,329
)
                                 
Consulting and other income (expense)
   
14,126
     
712
     
20,906
     
68,912
 
Gain or Loss on derivatives
   
(1,468,016
)
   
-
     
(1,468,016
)
   
-
 
Interest income (expense), net
   
(697,291
)
   
(20,905
)
   
(1,204,795
)
   
(98,033
)
Foreign currency transaction gain (loss)
   
(36,951
)
   
(3,380
)
   
(38,593
)
   
(34,006
)
                                 
Net loss before income taxes
   
(3,456,582
)
   
(1,593,144
)
   
(7,189,188
)
   
(4,458,456
)
                                 
Income tax provision
   
-
     
-
     
-
     
(4,599
)
                                 
Net loss
   
(3,456,582
)
   
(1,593,144
)
   
(7,189,188
)
   
(4,463,055
)
                                 
Less:  Net loss attributable to noncontrolling interests
   
-
     
(1,602
)
   
(1,305
)
   
(4,962
)
                                 
Net loss attributable to Hydrocarb Corporation
   
(3,456,582
)
   
(1,591,542
)
   
(7,187,883
)
   
(4,458,093
)
                                 
Basic and diluted loss per common share:
 
$
(0.16
)
 
$
(0.08
)
 
$
(0.34
)
 
$
(0.34
)
                                 
Weighted average shares  outstanding  (basic and diluted)
   
21,270,879
     
20,963,759
     
21,184,600
     
13,111,626
 
 
The accompanying notes are an integral part of these unaudited consolidated financial statements
 
HYDROCARB ENERGY CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

   
Nine Months Ended April 31,
 
         
   
2015
   
2014
 
CASH FLOWS FROM OPERATING ACTIVITIES
       
Net income (loss)
 
$
(7,189,188
)
 
$
(4,463,055
)
Adjustments to reconcile net income loss to net cash used in operating activities:
               
Depreciation, depletion and amortization
   
771,480
     
673,357
 
Accretion
   
790,550
     
731,093
 
Amortization of debt discount
   
820,448
     
-
 
Amortization of debt issuance cost
   
205,131
         
Change in Derivative Liabilities
   
1,468,016
     
-
 
Loss on settlement shares
   
65,000
     
-
 
Warrants granted to related party
   
-
     
6,754
 
Share based compensation
   
396,475
     
1,251,212
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
48,281
     
366,220
 
Other receivables
   
(101,087
)
   
-
 
Accounts receivable - related party
   
55,292
     
120,816
 
Payments on borrowings from related parties
   
(86,957
)
   
-
 
Other assets
   
77,862
 
   
428,971
 
Accounts payable and accrued expenses
   
790,702
     
128,352
 
Advances
   
-
     
15,100
 
Settlement of asset retirement obligation
   
-
     
(84,618
)
NET CASH USED IN OPERATIONS
   
(1,887,995
)
   
(825,798
)
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchases of oil and gas properties
   
(2,401,177
)
   
(1,031,171
)
Purchases of property and equipment
   
-
     
(156,560
)
Proceeds from sale of property and equipment
   
2,366
     
-
 
Proceeds from sale of oil and gas properties
   
-
     
625,000
 
Change in restricted cash
   
20,942
     
40,000
 
CASH USED IN INVESTING ACTIVITIES
   
(2,377,869
)
   
(522,731
)
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Payments on notes payable
   
(596,672
)
   
(311,995
)
Proceeds from note payable to related party
   
-
     
300,000
 
Proceeds from collections on receivable for stock sale
   
-
     
675,000
 
Dividend on HCN preferred stock
   
-
     
(34,254
)
Payments on borrowings from Related Parties
   
-
     
(610,514
)
Proceeds from borrowings
   
4,808,539
     
1,736,437
 
Proceeds from subsidiary sale of its common stock
   
-
     
31,071
 
CASH PROVIDED BY FINANCING ACTIVITIES
   
4,211,867
     
1,785,745
 
                 
NET CHANGE IN CASH AND CASH EQUIVALENTS
   
(53,997
)
   
437,216
 
                 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
   
144,258
     
354,829
 
                 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
90,261
   
$
792,045
 
                 
SUPPLEMENTAL CASH FLOW INFORMATION
               
Cash paid during the period for:
               
Income taxes
 
$
-
   
$
10,000
 
Interest
 
$
8,331
   
$
15,271
 
                 
NONCASH INVESTING AND FINANCING ACTIVITIES
               
Asset retirement obligation sold
 
$
-
   
$
33,195
 
Asset retirement obligations incurred
   
-
     
100,932
 
Asset retirement obligations - change in estimate
   
(52,431
)
   
-
 
Discount from derivatives
   
454,903
     
-
 
Note payable for prepaid insurance
   
309,212
     
403,104
 
Settlement of HCN debt with HCN preferred stock
   
-
     
1,585,200
 
Tainted warrant liability
   
17,541
     
-
 
Common stock exchanged for HCN common stock for acquisition of HCN
   
-
     
8,397
 
Receivable for common stock - related party
           
1,000,000
 
Receivable for common stock - related party
   
-
     
1,859,879
 
Common stock issued to satisfy contingently issuable shares from 2012 acquisition of Namibia Exploration , Inc.
   
-
   
$
7,410
 
Value of shares issued to lenders as part of debt financing
 
$
247,655
   
$
-
 
Debt issue costs $ 308,729 -

The accompanying notes are an integral part of these unaudited consolidated financial statements
 
HYDROCARB ENERGY CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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

Description of business and basis of presentation

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

While working towards plans and expectations of being listed on a major stock exchange, we currently trade on the OTCQB under the stock symbol “HECC”.

We are a natural resource exploration and production company engaged in the exploration, acquisition, development, and production of oil and gas properties in the United States and onshore in Namibia, Africa. We maintain developed acreage offshore in Texas. As part of our ongoing business strategy, we continue to review and evaluate acquisition opportunities in the continental United States and internationally.

Reclassifications

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

Principles of consolidation

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

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

Noncontrolling interests

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

Recent accounting pronouncements

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

Note 2 – HCN Acquisition

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

In anticipation of the HCN acquisition, HEC issued 619,960 shares of its common stock to HCN as full payment for HEC’s indebtedness to HCN in the amount of $3,589,567. A condition to the Agreement closing was that HCN will sell the 619,960 shares before closing of the acquisition, which it did (see Note 7 – Capital Stock – Receivables for Common Stock).

With HCN, we acquired its 100% owned subsidiaries: Hydrocarb Namibia Energy (Pty) Limited, a Namibia Company and Hydrocarb Texas Corporation, a Texas Corporation; and its 95% owned subsidiary Otaiba Hydrocarb LLC, a UAE Limited Liability Company.

Prior to the acquisition, HCN was directly and indirectly majority-owned and controlled by HEC’s Chairman of the Board and entities related to him and his family. Since HCN and HEC were under common control of a controlling party both before and after the completion of the share exchange, the transaction was accounted for as a business acquired from an entity under common control and the assets and liabilities acquired were recorded at HCN’s historical cost at Acquisition Date following ASC 805-50-30, Business Combinations. Under this accounting treatment, the results of operations for the three months and nine months ended April 30, 2015 and assets and liabilities of HCN as of April 30, 2015 are included in these financial statements as if the transaction had occurred at the beginning of the period. Prior reporting periods in these financial statements have been retroactively adjusted to include HCN and its subsidiaries.

According to ASC 805-50-30, the net assets of HCN are to be recorded at historical cost, therefore, the value of the 8,396,667 common shares with excess of $3,874,609 recorded as additional paid in capital by HEC.

Summary of the accounting entry to record this acquisition in December 2013 is as follows.

Assets acquired
 
$
1,529,246
 
Liabilities assumed
   
(161,599
)
Noncontrolling interest in 95% owned HCN subsidiary
   
30,480
 
   
$
1,398,127
 
Common stock, at par
   
8,397
 
Receivable for common stock
   
(2,484,879
)
Additional paid-in capital
   
3,874,609
 
   
$
1,398,127
 

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

1) Initial Exploration Period (expires September 2015): Perform a hydrocarbon potential study, gather and review existing technical data including reprocessing of available seismic lines, and acquire and process 750 kilometers of new 2D seismic data.  The minimum expenditure is $4,505,000.
2) First Renewal Exploration Period (two years from end of the Initial Exploration Period):  Acquire 200 square kilometers of 3D seismic data, interpret and map the data, design a drilling program, drill one well, conduct an environmental study, and relinquish 25% of the exploration license area.  The minimum expenditure is $17,350,000.
3) Second Renewal (Production License) Exploration Period (25 years):  Report on reserves and production and conduct an environmental study.  The minimum expenditure is $300,000.

In conjunction with the HCN acquisition, the HEC Board of Directors authorized the immediate issuance of 7,470,000 shares of our common stock to the former owners of NEI. We previously acquired NEI on August 7, 2012 and these 7,470,000 shares had been contingently-issuable consideration for the acquisition of NEI. We issued these shares on December 9, 2013. The original agreement contained market conditions for the issuance of this stock.
 
In connection with certain recent due diligence undertaken by the Company, it has come to the attention of management, that although the Company previously believed, on advice of prior counsel, that the Board of Directors of the Company had the authority under the Company’s Articles of Incorporation, as amended, to unilaterally authorize preferred stock, including the designation of the Series A Preferred, under applicable Nevada law, unless such preferred stock is specifically authorized in a Nevada corporation’s articles no preferred stock can be designated or issued. As such, our Board of Directors did not have authority under the Articles of Incorporation, as amended and applicable Nevada law to designate the Series A Preferred or to file such certificate of designations with the Secretary of State of Nevada. Consequently, we now believe that the Series A Preferred is not validly issued or outstanding and the filing of the Series A Preferred designation with the consent of the Board of Directors and without shareholder approval, was invalid and had no legal effect. We are in the process of seeking shareholder approval, at our 2015 Annual Meeting of stockholders, to ratify and approve the designation of the Series A Preferred Stock.  As a result, we removed Series A 7% Convertible Voting Preferred Stock (“Series A Preferred”) from the accompanying financial statements for current and prior periods.

Hydrocarb Energy Corp.
Consolidated Balance Sheets
As of July 31, 2014

   
As Previously
Reported
   
Adjustment
   
July 31, 2014
 
ASSETS
           
             
Stockholders' Deficit:
           
Series A 7% Convertible Preferred Stock, 10,000 shares authorized $400 par, 8,188 shares issued and outstanding as of July 31, 2014
   
3,275,200
     
(3,275,200
)
   
-
 
Additional paid-in capital
   
78,953,599
     
3,275,200
     
82,228,799
 
Total stockholders' equity
   
9,958,651
             
9,958,651
 
Noncontrolling interests
   
(34,535
)
           
(34,535
)
Total equity
   
9,924,116
             
9,924,116
 
                         
TOTAL LIABILITIES AND EQUITY
 
$
25,732,155
           
$
25,732,155
 

Hydrocarb Energy Corp.
Consolidated Statements of Operations and Comprehensive Loss
As of July 31, 2014

   
As Previously
Reported
   
Adjustment
   
July 31, 2014
 
Net loss attributable to Hydrocarb Corporation
   
(6,549,322
)
       
(6,549,322
)
Dividend on preferred stock
                   
Deemed dividend on preferred stock
   
(34,254
)
   
34,254
     
-
 
Accretion dividend-Beneficial Cash Feature on preferred stock
   
(150,548
)
   
150,548
     
-
 
Net loss attributable to Hydrocarb Energy Corp after dividends
   
(949,808
)
   
949,808
     
-
 
   
$
(7,683,932
)
 
$
1,134,610
   
$
(6,549,322
)
 
Hydrocarb Energy Corp.
Consolidated Statements of Operations and Comprehensive Loss
For the Three Months Ended April 30, 2014

   
As Previously Reported
   
Adjustment
   
April 30, 2014
 
Net loss attributable to Hydrocarb Corporation
   
(1,591,542
)
       
(1,591,542
)
Dividend on preferred stock
                   
Deemed dividend on preferred stock
   
(57,609
)
   
57,609
     
-
 
   
$
(1,649,151
)
 
$
57,609
   
$
(1,591,542
)
 
Note 3 – Oil and Gas Properties

Oil and natural gas properties as of April 30, 2015 and July 31, 2014 consisted of the following:

   
April 30,
2015
   
July 31,
2014
 
Evaluated Properties
       
Costs subject to depletion
 
$
21,360,727
   
$
19,153,125
 
Accumulated impairment
   
(373,335
)
   
(373,335
)
Accumulated depletion
   
(4,221,631
)
   
(3,491,420
)
Total evaluated properties
   
16,765,761
     
15,288,370
 
                 
Unevaluated properties
   
2,260,912
     
2,119,769
 
Net oil and gas properties
 
$
19,026,673
   
$
17,408,139
 

Evaluated properties

Additions to evaluated oil and gas properties during the nine months ended April 30, 2015 totaled $2,207,602 which consisted mainly of recompletion expenses.

Unevaluated Properties

Namibia, Africa

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

Additions to unevaluated properties of approximately $182,000 during the nine months ended April 30, 2015 consisted primarily of:

· Approximately $182,000 of leasehold costs, specifically payment of the annual concession fee to the Government of Namibia. As of April 30, 2015, approximately $2.2 million has been expended towards the initial exploration period.

Note 4 - Impairment

Oil and Gas Properties

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

We evaluated our capitalized costs using the full cost ceiling test as prescribed by the Securities and Exchange Commission at the end of each reporting period. As of April 30, 2015 and July 31, 2014, the net book value of oil and gas properties did not exceed the ceiling amount and thus, no impairment of the properties was required. Changes in production rates, levels of reserves, future development costs, and other factors will determine our actual ceiling test calculation and impairment analyses in future periods.
 
Note 5 – Asset Retirement Obligations

The following is a reconciliation of our asset retirement obligation liability as of April 30, 2015 and July 31, 2014

   
April 30,
2015
   
July 31,
2014
 
Liability for asset retirement obligation, beginning of period
 
$
11,716,230
   
$
10,933,398
 
Asset retirement obligations sold
   
-
     
(33,195
)
Asset retirement obligations incurred on properties drilled
   
-
     
-
 
Accretion
   
790,550
     
1,043,928
 
Revisions in estimated cash flows
   
(52,431
)
   
(104,237
)
Costs incurred
   
-
     
(123,664
)
Liability for asset retirement obligation, end of period
 
$
12,454,349
   
$
11,716,230
 
                 
Current portion of asset retirement obligation
 
$
60,000
   
$
1,133,690
 
Noncurrent portion of asset retirement obligation
   
12,394,349
     
10,582,540
 
Total liability for asset retirement obligation
 
$
12,454,349
   
$
11,716,230
 

Note 6 – Notes Payable

Installment Notes Payable

In May 2012, we entered into a note payable of $18,375 to purchase a vehicle. The note is collateralized by the vehicle. The note carries an interest rate of 6.93% and is payable beginning in June 2012, in 36 installments of $567 per month. The principal balance owed on the note payable was approximately $602 and $7,100 as of April 30, 2015 and July 31, 2014, respectively.

In February 2014, we financed our commercial insurance program using a note payable for $403,104. Under the note, we are obligated to make nine payments of $45,718 per month, which include principal and interest, beginning in March 2014. As of April 30, 2015, the note payable balance was approximately $256,625.
 
In February 2015, we financed our commercial insurance program using a note payable for $420,690. Under the note, we are obligated to make eight payments of $52,586 per month, which include principal and interest, beginning in March 2014. As of April 30, 2015, the note payable balance was approximately $309,212.
 
Related Party Installment Note Payable

In November 2013, we issued a promissory note for funds received from Mr. Kent P. Watts, Our Chairman, of $100,000. Under the terms of the note, principal on the note was due after one year and incurred interest at 5% per annum payable on a monthly basis. Accrued interest is payable monthly beginning in May 2014, and beginning in August 2014 the principal is due in 36 monthly payments through July 2017. The note is secured by the Company’s assets owned by GBE, subject to any other lien holder's superior rights, if any. In April 2014, the Company entered into a new debt agreement whereby Mr. Watts agreed to loan the Company up to $600,000 at an interest rate of 6.25%. The previous debt of $100,000 was rolled into this new note. Additionally, we borrowed $200,000 from Mr. Watts during April 2014 and $300,000 from Mr. Watts in May 2014. The total balance on the note was $600,000 as of April 30, 2015. As part of the financing agreement with Shadow Tree Capital Management, LLC (as discussed below), this note has been subordinated, and no payments will be made until the Shadow Tree debt has been repaid.

Convertible Notes Payable

LG Capital Funding, LLC Convertible Note

On February 17, 2015, we sold an 8% Convertible Redeemable Note to LG Capital Funding, LLC (“LG Capital” and the “LG Capital Convertible Note”) in the amount of $105,000 pursuant to a Securities Purchase Agreement. Amounts owed under the LG Capital Convertible Note accrue interest at the rate of 8% per annum (24% upon the occurrence of an event of default). The LG Capital Convertible Note is due and payable on February 17, 2016. The principal amount of the LG Capital Convertible Note and all accrued interest thereon is convertible at the option of the holder into our common stock at any time. The conversion price of the LG Capital Convertible Note is 65% of the average of the two lowest closing bid prices of our common stock for the 12 trading days prior to the date a notice of conversion is received by us from LG Capital. In the event we experience a “DTC chill” at any time, the conversion price percentage above decreases to 55%. At no time may the LG Capital Convertible Note be converted into shares of our common stock if such conversion would result in LG Capital and its affiliates owning an aggregate of in excess of 9.9% of the then outstanding shares of our common stock.
 
The LG Capital Convertible Note provides for customary events of default such as failing to timely make payments under the note when due. Additionally, in the event we fail to timely deliver shares due in connection with a conversion, we are required to pay the holder $250 per day beginning on the 4th day after the conversion notice was delivered to us, increasing to $500 per day on the 10th day after the conversion notice was delivered. In the event we have no “bid” price for our common stock at any time while the note is outstanding, the outstanding principal due under the terms of the note increases by 20%. In the event our common stock is delisted from an exchange (including the OTCQB), the outstanding principal amount of the note increases by 50%. If not paid at maturity, the outstanding principal amount of the note increases by 10%.

We may prepay in full the unpaid principal and interest on the LG Capital Convertible Note, upon notice, any time prior to the 180th day after the issuance date. Any prepayment is subject to payment of a prepayment amount ranging from 115% to 135% of the then outstanding balance on the LG Capital Convertible Note (inclusive of accrued and unpaid interest and any default amounts then owing), depending on when such prepayment is made. Additionally, upon the occurrence of certain fundamental events as described in the note, we are required to repay the note at the request of the holder in an amount equal to 150% of the then balance of the note.
 
We agreed to pay $5,000 of LG Capital’s legal fees in connection with the sale of the LG Capital Convertible Note and as such, the net amount received in connection with the sale of the LG Capital Convertible Note, before our expenses, was $100,000. We hope to repay the LG Capital Convertible Note prior to any conversion.

As of April 30, 2015, we have repaid this note and all accrued interest.

Adar Bays, LLC Convertible Note

On February 17, 2015, we sold an 8% Convertible Redeemable Note to Adar Bays, LLC (“Adar Bays” and the “Adar Bays Convertible Note”) in the amount of $105,000 pursuant to a Securities Purchase Agreement. Amounts owed under the Adar Bays Convertible Note accrue interest at the rate of 8% per annum (24% upon the occurrence of an event of default). The Adar Bays Convertible Note is due and payable on February 17, 2016. The principal amount of the Adar Bays Convertible Note and all accrued interest is convertible at the option of the holder thereof into the Company’s common stock at any time. The conversion price of the Adar Bays Convertible Note is 65% of the average of the two lowest closing bid prices of our common stock for the 12 trading days prior to the date a notice of conversion is received by us from Adar Bays. In the event we experience a “DTC chill” at any time, the conversion price percentage above decreases to 55%. At no time may the Adar Bays Convertible Note be converted into shares of our common stock if such conversion would result in Adar Bays and its affiliates owning an aggregate of in excess of 9.9% of the then outstanding shares of our common stock.

The Adar Bays Convertible Note provides for customary events of default such as failing to timely make payments under the note when due. Additionally, in the event we fail to timely deliver shares due in connection with a conversion, we are required to pay the holder $250 per day beginning on the 4th day after the conversion notice was delivered to us, increasing to $500 per day on the 10th day after the conversion notice was delivered. In the event we have no “bid” price for our common stock at any time the note is outstanding, the outstanding principal due under the terms of the note increases by 20%. In the event our common stock is delisted from an exchange (including the OTCQB), the outstanding principal amount of the note increases by 50%. If not paid at maturity, the outstanding principal amount of the note increases by 10%.

We may prepay in full the unpaid principal and interest on the Adar Bays Convertible Note, upon notice, any time prior to the 180th day after the issuance date. Any prepayment is subject to payment of a prepayment amount ranging from 115% to 135% of the then outstanding balance on the Adar Bays Convertible Note (inclusive of accrued and unpaid interest and any default amounts then owing), depending on when such prepayment is made, provided that upon the occurrence of certain fundamental events, we are required to repay the note at the request of the holder for 150% of the then balance of the note.

We agreed to pay $5,000 of Adar Bays’ legal fees in connection with the sale of the Adar Bays Convertible Note and as such, the net amount received in connection with the sale of the Adar Bays Convertible Note, before our expenses, was $100,000.

As of April 30, 2015, we have repaid this note and all accrued interest.

KBM Worldwide, Inc. Convertible Note

On February 19, 2015, we sold KBM Worldwide, Inc. (“KBM”) a Convertible Promissory Note in the principal amount of $350,000 (the “KBM Convertible Note”), pursuant to a Securities Purchase Agreement, dated and entered into on February 17, 2015. The KBM Convertible Note bears interest at the rate of 8% per annum (22% upon an event of default) and is due and payable on February 19, 2016. The KBM Convertible Note provides for customary events of default such as failing to timely make payments under the KBM Convertible Note when due. Additionally, upon the occurrence of certain fundamental defaults, as described in the KBM Convertible Note, we are required to repay KBM liquidated damages in addition to the amount owed under the KBM Convertible Note.

The principal amount of the KBM Convertible Note and all accrued interest is convertible at the option of the holder thereof into our common stock at any time following the 180th day after the KBM Convertible Note was issued. The conversion price of the KBM Convertible Note is equal to 50% multiplied by the average of the lowest five closing bid prices of our common stock during the fifteen trading days immediately prior to the date of any conversion.
 
The KBM Convertible Note included a $26,000 original issue discount and we paid $4,000 of KBM’s attorney’s fees in connection with the sale of the KBM Convertible Note and as such, the net amount, before our expenses, that we received upon sale of the KBM Convertible Note was $320,000.

We are required to keep reserved from our authorized but unissued shares of common stock eight times the number of shares of common stock issuable upon conversion of the KBM Convertible Note at all times and if we fail to keep such amount reserved it is considered an event of default under the KBM Convertible Note.

At no time may the KBM Convertible Note be converted into shares of our common stock if such conversion would result in KBM and its affiliates owning an aggregate of in excess of 9.99% of the then outstanding shares of our common stock.

We may prepay in full the unpaid principal and interest on the KBM Convertible Note, upon notice, any time prior to the 180th day after the issuance date. Any prepayment is subject to payment of a prepayment amount ranging from 110% to 135% of the then outstanding balance on the KBM Convertible Note (inclusive of accrued and unpaid interest and any default amounts then owing), depending on when such prepayment is made.

We also deposited 750,000 shares of our common stock into escrow with KBM’s counsel to secure the repayment of the KBM Convertible Note, which shares are to be held in escrow and released to KBM only upon the occurrence of an event of default under the KBM Convertible Note.

As of April 30, 2015, the outstanding balance if ths note is $350,000.

JSJ Investments Inc. Convertible Note

On February 23, 2015 we sold a 10% Convertible Note to JSJ Investments Inc. (“JSJ” and the “JSJ Convertible Note”) in the amount of $137,000. Amounts owed under the JSJ Convertible Note accrue interest at the rate of 10% per annum. The JSJ Convertible Note is payable by us on demand by JSJ at any time after August 23, 2015. We have the right to prepay the JSJ Convertible Note (a) for an amount equal to 135% of the then balance of such note until the 90th day following the date of the note, (b) for an amount equal to 140% of the balance of such note from the 91st day following the date of the note until the maturity date of the note, and (c) for an amount equal to 150% of the balance of such note subsequent to the maturity date (provided the holder consents to such payment after maturity).

The JSJ Convertible Note and all accrued interest are convertible at the option of the holder thereof into the Company’s common stock at any time. The conversion price of the JSJ Convertible Note is the lower of (a) 58% of the lowest trading price of our common stock during the prior 20 trading days prior to any conversion; or (b) 58% of the lowest trading price of our common stock during the 20 trading days prior to the date of the note. In the event we do not issue the holder any shares due in connection with a conversion within three business days, we are required to issue the holder additional shares equal to 25% of the conversion amount, and an additional 25% of such shares for each additional five business days beyond such fourth business day that such failure continues.

We agreed to pay $2,000 of JSJ’s legal fees and $10,000 of due diligence fees in connection with the sale of the JSJ Convertible Note and as such, the net amount received in connection with the sale of the JSJ Convertible Note, before our expenses, was $125,000.

Pursuant to the terms of the JSJ Convertible Note, we are not allowed to borrow any additional money or incur any liability for borrowed money, except borrowings in place as of the date of the note or indebtedness to trade creditors or financial institutions in the ordinary course of business, or sell, lease or dispose of a significant portion of our assets outside the usual course of business, without the written consent of JSJ.

The JSJ Convertible Note also includes anti-dilution rights in the event we sell or issue any securities with a price less than the then applicable conversion price, subject to certain exceptions.

As of April 30, 2015, the outstanding balance of this note is $137,000.

Typenex Co-Investment, LLC Convertible Note

On March 5, 2015, we sold a Secured Convertible Promissory Note (the “Typenex Convertible Note”) to Typenex Co-Investment, LLC (“Typenex”) in the amount of $350,000. The Typenex Convertible Note was issued pursuant to the terms of a Securities Purchase Agreement dated as of the same date. The Typenex Convertible Note bears interest at the rate of 10% per annum (22% upon the occurrence of an event of default) and is due and payable in full on January 5, 2016. The Typenex Convertible Note provides for customary events of default such as failing to timely make payments under the Typenex Convertible Note when due. Additionally, upon the occurrence of certain fundamental defaults, as described in the Typenex Convertible Note, we are required to repay Typenex liquidated damages in addition to the amount owed under the Typenex Convertible Note.
 
We have the right to prepay the Typenex Convertible Note, pursuant to the terms thereof, at any time, provided we pay a prepayment amount of 125% of the then outstanding balance. The principal amount of the Typenex Convertible Note and all accrued interest is convertible at the option of the holder thereof into our common stock at any time. The conversion price of the Typenex Convertible Note is initially $2.25 per share, provided that if our market capitalization falls below $20 million (provided further that our current market capitalization is below $20 million), the conversion price becomes the lower of $2.25 per share and the average of the five lowest closing bid prices of our common stock on the twenty trading days immediately prior to such conversion date (the “Market Price”) multiplied by 80% (provided such percentage is subject to automatic reduction upon the occurrence of certain events, including among other things described in the Convertible Secured Note, a reduction by 5% in the event the Market Price is less than $0.75).

The Typenex Convertible Note included a $45,000 original issuance discount and we agreed to pay $5,000 of Typenex’s legal fees in connection with the transaction. As a result, the net amount received in connection with the sale of the Typenex Convertible Note, before our expenses, was $300,000.

The Typenex Convertible Note also includes anti-dilution rights in the event we sell or issue any securities with a price less than the applicable conversion price, subject to certain exceptions. The Typenex Convertible Note also includes various restrictions on our ability to enter into subsequent variable rate security transactions following the date thereof.

Beginning on the date that is six months after March 5, 2015, and continuing each month thereafter until maturity, we are required to prepay the Convertible Secured Note in cash or shares of our common stock (provided that upon the occurrence of certain defaults described in the Typenex Convertible Note we are only able to pay this amount in cash), an amount equal to the greater of (i) $70,000 and (ii) the outstanding balance of the Convertible Secured Note divided by the number of such required installment payments prior to the maturity date. Additionally, on the twentieth trading day following the date each tranche of installment shares becomes free trading we are required to issue Typenex additional shares of common stock if the applicable conversion price calculated on the true-up date is less than the original conversion price.

We are subject to various fees and penalties under the Typenex Convertible Note for our failure to timely deliver shares due upon any conversion or installment payment.

At no time may the Typenex Convertible Note be converted into shares of our common stock if such conversion would result in Typenex and its affiliates owning an aggregate of in excess of 4.99% of the then outstanding shares of our common stock, provided such percentage increases to 9.99% if our market capitalization is less than $10 million, and provided further that Typenex may change such percentage from time to time upon not less than 61 days prior written notice to us.

As additional consideration for the loan evidenced by the Typenex Convertible Note, the Company granted Typenex a five year warrant to purchase 38,889 shares of our common stock at an exercise price of $2.25 per share (the “Warrant”) which number of shares at exercise price are subject to adjustment. The Warrant includes the same ownership limitation described above in connection with the Typenex Convertible Note. The Warrant includes cashless exercise rights.

The Warrant contains anti-dilution rights such that if we issue or sell or are deemed to issue or sell securities for less than the then applicable exercise price of the Warrant, subject to certain exceptions, the exercise price of the Warrant is reduced to such lower price and the number of shares of common stock issuable upon exercise of the Warrant increases, such that the aggregate exercise price payable upon exercise of the Warrant remains the same upon such anti-dilutive adjustment, up to a maximum of three times the current number of shares issuable upon exercise of the Warrant, subject to certain exceptions upon which there is no cap on the number of shares issuable upon exercise of the Warrant.

The amounts owed under the Typenex Convertible Note were secured by a Stock Pledge Agreement (the “Pledge Agreement”) whereby CW Navigation, Inc., a Texas corporation, a significant shareholder of the Company, which is beneficially owned by Christopher Watts, the nephew of Kent P. Watts, our Chief Executive Officer and Chairman (“CW Navigation”), pledged one million one hundred thousand (1,100,000) shares of our common stock held by CW Navigation as security for our obligations under the Typenex Convertible Note and related documents. Pursuant to the Stock Pledge Agreement, in the event the value (determined based on the average closing trade price for our common stock) of the pledged shares, for the immediately preceding three trading days as of any applicable date of determination, declines below $900,000 it constitutes a default of the Typenex Convertible Note and CW Navigation is required to pledge additional shares to bring the total value of such pledged shares (as calculated above) to $900,000. Typenex also entered into a subordination agreement in favor our senior lender, Shadow Tree Capital Management, LLC (“Shadow Tree”), to subordinate the repayment of the Typenex Convertible Note to amounts owed by us to Shadow Tree.

As of April 30, 2015, the outstanding balance of ths note is $350,000.
 
Vis Vires Group Convertible Promissory Note

On March 31, 2015, we sold Vis Vires Group, Inc. (“Vis Vires”) a Convertible Promissory Note in the principal amount of $414,500 (the “Vis Vires Convertible Note”), pursuant to a Securities Purchase Agreement, dated and entered into on March 31, 2015. The Vis Vires Convertible Note bears interest at the rate of 8% per annum (22% upon an event of default) and is due and payable on April 2, 2016. The Vis Vires Convertible Note provides for customary events of default such as failing to timely make payments under the Vis Vires Convertible Note when due. Additionally, upon the occurrence of certain fundamental defaults, as described in the Vis Vires Convertible Note, we are required to repay Vis Vires liquidated damages in addition to the amount owed under the Vis Vires Convertible Note.
 
The principal amount of the Vis Vires Convertible Note and all accrued interest is convertible at the option of the holder thereof into our common stock at any time following the 180th day after the Vis Vires Convertible Note was issued. The conversion price of the Vis Vires Convertible Note is equal to the greater of (a) 50% multiplied by the average of the lowest five closing bid prices of our common stock during the fifteen trading days immediately prior to the date of any conversion; and (b) $0.00005.

The Vis Vires Convertible Note included a $9,500 original issue discount and we paid $5,000 of Vis Vires’s attorney’s fees in connection with the sale of the Vis Vires Convertible Note and as such, the net amount, before our expenses, that we received upon sale of the Vis Vires Convertible Note was $400,000.

We are required to keep reserved from our authorized but unissued shares of common stock 8 million shares of common stock issuable upon conversion of the Vis Vires Convertible Note at all times and if we fail to keep such amount reserved it is considered an event of default under the Vis Vires Convertible Note.

At no time may the Vis Vires Convertible Note be converted into shares of our common stock if such conversion would result in Vis Vires and its affiliates owning an aggregate of in excess of 9.99% of the then outstanding shares of our common stock.

We may prepay in full the unpaid principal and interest on the Vis Vires Convertible Note, upon notice, any time prior to the 180th day after the issuance date. Any prepayment is subject to payment of a prepayment amount ranging from 110% to 135% of the then outstanding balance on the Vis Vires Convertible Note (inclusive of accrued and unpaid interest and any default amounts then owing), depending on when such prepayment is made.

We also deposited 750,000 shares of our common stock into escrow with Vis Vires’ counsel to secure the repayment of the Vis Vires Convertible Note, which shares are to be held in escrow and released to Vis Vires only upon the occurrence of an event of default under the Vis Vires Convertible Note.

We hope to repay the Vis Vires Convertible Note prior to any conversion.

As of April 30, 2015, the outstanding balance on this note is $414,500.

Credit Agreement

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

Pursuant to the Credit Agreement, we have the right, at any time prior to the one year anniversary of the Credit Agreement, to borrow up to an additional $1,000,000 under the Credit Agreement (the “Additional Loan”), subject to certain pre-requisites and requirements as set forth in the Credit Agreement, including, but not limited to us raising $750,000 through the sale of equity subsequent to the closing of the transactions contemplated by the Credit Agreement (which we agreed to obtain within 150 days of the date of the Credit Agreement). We also agreed to pay a 2% Structuring Fee on the Additional Loan. The proceeds of the Additional Loan may only be used for the Oil and Gas Activities.

The amount owed pursuant to the Notes (and any amount borrowed pursuant to the Additional Loan) is guaranteed by our wholly-owned subsidiary, Hydrocarb Corporation (“HC”) and its subsidiaries, and our other wholly-owned subsidiaries and is secured by a first priority security interest in substantially all of our assets (including, but not limited to the securities of our subsidiaries and HC and its subsidiaries) evidenced by a Guarantee and Collateral Agreement, various pledge agreements and a deed of trust providing the Agent, as agent for the Lenders, a security interest over our oil and gas assets and rights.
 
The Notes do not accrue any interest for the first nine months after their issuance date (August 15, 2014), provided thereafter they accrue interest at the rate of (a) 16% per annum where the average net monthly oil and gas production revenues of Galveston Bay Energy LLC, our wholly-owned subsidiary, for the trailing three month period (the “Trailing Three Month Revenues”) is less than $900,000; or (b) 14% per annum, where the Trailing Three Month Revenues are equal to or greater than $900,000, payable monthly in arrears through the maturity date of such Notes, August 15, 2016. The Additional Loan, if any, will bear interest at the rate of 14% per annum, payable monthly in arrears, and will have the same maturity date as the Notes. Upon the occurrence of an event of default, the Notes (and any amount outstanding under the Additional Loan) will bear interest at the rate of 24% per annum until paid in full.

Pursuant to the Credit Agreement, we agreed to issue the Lenders their pro rata share of (a) 60,000 restricted shares of common stock on the effective date of the Credit Agreement, August 15, 2014 (the “Effective Date”); (b) 32,500 restricted shares in the event any amount of the Loans (or other obligations outstanding under agreements entered into in connection with the Loans, the “Loan Documents”) are outstanding on the 12 month anniversary of the Effective Date; (c) 32,500 restricted shares in the event any amount is outstanding under the Loan Documents on the 18 month anniversary of the Effective Date; and (d) 25,000 restricted shares in the event any amount is outstanding under the Loan Documents on the 21 month anniversary of the Effective Date. The shares are to be issued pursuant to the terms and conditions of a Stock Grant Agreement, pursuant to which each of the Lenders made certain representations to the Company regarding their financial condition and other items in order for the Company to confirm that an exemption from registration existed and will exist for such issuances.

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

The Credit Agreement includes customary events of default for facilities of a similar nature and size as the Credit Agreement, including, but not limited to, if any breach or default occurs under the Loan Documents, the failure of the Company to pay any amount when due under the Loan Documents, if the Company (or its subsidiaries) is subject to any judgment in excess of $250,000 which is not discharged or stayed within 30 days, or if a change in control of the Company, any subsidiary or any guarantor should occur, defined for purposes of the Credit Agreement as any transfer of 25% or more of the voting stock of such entity.

For the nine months ended April 30, 2015, the Company has recognized $565,467 of amortization expense of the original issuance discount, with a net payable balance of $3,922,289 and unamortized original issuance discount of $491,374 as of April 30, 2015. In addition, we have recognized $283,455 of debt issuance cost related to professional fees and expenses, which we have classified within other non-current assets, related to the issuance of this debt. We are amortizing these costs over the term of the loan of two years. During the nine months ended April 30, 2015, we recognized $151,664 of amortization expense and have $131,791 in unamortized debt issuance cost as of April 30, 2015.

Note 7 – Capital Stock

Common Stock Issuances

 
Pursuant our Credit Agreement, as noted in Note 6  - Notes Payable, during August  2014, we issued 60,000 shares of restricted common stock to the Lenders.  The company recorded these shares as a debt discount with a fair value of $247,655.  The shares were issued pursuant to the terms and conditions of a Stock Grant Agreement, pursuant to which each of the Lenders made certain representations to the Company regarding their financial condition and other items in order for the Company to confirm that an exemption from registration existed and will exist for such issuances.

During the nine months ended April 30, 2015, 10,008 shares of restricted common stock valued at $20,012 to directors of the Company. Additionally, during the nine months ended April 30, 2015, 122,000 shares of restricted common stock to certain vendors for services rendered during the period for legal and professional services.  The relative fair value of the 100,000 shares issued for services is $266,700.  The remaining 22,000 shares were issued to settle the litigation with ERG. The value of this settlement is $65,000.
 
Receivables for Common Stock

On September 6, 2013, HCN sold 191,667 shares of HEC common stock to an employee of HCN (the nephew of our Chairman and Chief Executive Officer) in exchange for a note receivable in the amount of $1,000,000. HEC acquired this receivable upon its acquisition of HCN. The note is non-interest bearing and is payable only upon the sale of the common stock to a third party or HEC stock being listed on either the NASDAQ or NYSE stock exchanges. We will receive 95% of the proceeds up to $1,000,000 if the underlying stock is sold to a third party. Within 90 days of HEC stock being listed on a major stock exchange, we will receive up to $1,000,000, or the note can be paid earlier at the discretion of the other party. These shares of common stock are held in the name of the investors and are beneficially owned by the investors and the shares are not retrievable by the Company.
 
On December 4, 2013 HCN sold 619,960 shares of unregistered and restricted HEC common stock in return for a $1,859,879 non-interest bearing note receivable from an entity in which Michael Watts, the father-in-law of our former CEO Jeremy Driver and the brother of our current CEO, has a minority interest. HEC acquired this receivable upon its acquisition of HCN. The 619,960 HEC common stock shares were previously issued by HEC to HCN to settle liabilities due by HEC related to the consulting services agreement described below in Note 6 – Notes Payable. The receivable from the individual was due to HEC upon the following conditions: 1) 100% of the proceeds payable from the sale of all or part of the shares by the owner of the shares to a third party; 2) within sixty days of the six month anniversary of the December 4, 2013 stock sale or within sixty days from the date that the shares become unrestricted (whichever is first); or 3) 100% of any remaining balance due within 90 days of HEC being listed on a major stock exchange and whereby the share price is above $6.00 per share. As with the above receivable for common stock, this receivable for the sale of HEC common stock is classified as a receivable for common stock within equity. These shares of common stock are held in the name of the investors and are beneficially owned by the investors and the shares are not retrievable by the Company.

This note receivable was extended on August 4, 2014, for an extension fee of $50,000, payable in the future, with $750,000 due to be repaid by December 31, 2014, with the remaining balance to be repaid by March 31, 2015. These repayment terms may be changed if the Company is successful in being up-listed to either the NYSE or NASDAQ. If this occurs, the entire balance is due within 60 days after an up-listing occurs.  The Company is currently negotiating an extension of this note.

Stock Options and Warrants

As of April 30, 2015, HEC could grant up to 737,706 shares of common stock under the 2013 Stock Incentive Plan (“2013 Plan”). The Plan is administered by the Compensation Committee of the Board of Directors, or in the absence of a Compensation Committee, the full Board of Directors, which has substantial discretion to determine persons, amounts, time, price, exercise terms, and restrictions of the grants, if any.

Options granted to non-employees

We account for options granted to non-employees under the provisions of ASC 505-50, Equity-Based Payments to Non-employees, and record the associated expense at fair value on the final measurement date. Because there is no disincentive for nonperformance for these awards, the final measurement date occurs when the services are complete, which is the vesting date. For the options granted to non-employees on a graded vesting schedule, we estimate the fair value of the award as of the end of each reporting period and recognize an appropriate portion of the cost based on the fair value on that date. When the award vests, we adjust the cost previously recognized so that the cost ultimately recognized is equivalent to the fair value on the date the performance is complete. There were options granted to purchase 25,000 shares to non-employees during the nine months ended April 30, 2015. Compensation expense of $112,500 was recognized during the nine months ended April 30, 2015. No options have been exercised, and options to purchase 92,000 shares expired during the nine months ended April 30, 2015.

Options granted to employees

The following table provides information about options granted to employees under our stock incentive plans during the nine months ended April 30, 2015 and 2014:

   
2015
   
2014
 
Number of options granted
   
25,000
     
-
 
Compensation expense recognized
 
$
112,500
   
$
56,208
 
Weighted average exercise price of options  granted
 
$
4.50
   
$
N/A
 

Summary information regarding stock options issued and outstanding as of April 30, 2015 is as follows:

   
Options
   
Weighted
Average
Share Price
 
Aggregate
intrinsic
value
 
Weighted
average
remaining
contractual
life (years)
 
Outstanding at  July 31, 2014
   
265,333
   
$
6.81
 
$
 
 
7.95
 
Granted
   
25,000
     
4.50
       
5.00
 
Exercised
   
-
     
-
           
Expired
   
(92,000
)
   
6.85
           
Outstanding at April 30, 2015
   
198,333
   
$
6.52
 
$
 
 
 
7.51
 

No non-vested stock options existed as of April 30, 2015.
 
Warrants

Summary information regarding common stock warrants issued and outstanding as of April 30, 2015, is as follows:
 
   
Warrants
   
Weighted
Average
Exercise Price
   
Aggregate
intrinsic
value
   
Weighted
average
remaining
contractual
life (years)
 
Outstanding at year ended July 31,2014
   
1,084,584
   
$
7.50
   
$
-
     
1.04
 
Granted
   
311,632
     
0.28
     
0.92
     
4.85
 
Exercised
   
-
     
-
                 
Expired
   
(417,917
)
   
-
                 
Outstanding at quarter ended April 30, 2015
   
978,299
   
$
5.20
   
$
0.92
     
2.08
 
 
Warrants granted to related party

During the year ended July 31, 2011, we entered into a consulting agreement with Geoserve Marketing, LLC (“Geoserve”), a company controlled by Michael Watts, who is the father-in-law of our former CEO Jeremy Driver and the brother of our current CEO. Under the terms of the agreement, we granted warrants to purchase 400,000 shares of common stock that have a market condition. If our common stock attains a five day average closing price of $22.50 per share, 200,000 warrants with an exercise price of $7.50 and an expiration date of February 15, 2016 shall be exercisable (“Warrant B”). If our common stock attains a five day average closing price of $45.00 per share, 200,000 warrants with an exercise price of $7.50 and an expiration date of February 15, 2016 shall be exercisable (“Warrant C”). The fair value of warrants that vest upon the attainment of a market condition must be estimated and amortized over the lower of the implicit or derived service period of the warrants. Previously recognized expense is not reversed in the event of a subsequent decline in the fair value of market condition equity based compensation. The fair value of the warrants and the derived service period were valued using a lattice model that values the liability of the warrants based on a probability weighted discounted cash flow model. This model is based on future projections of the various potential outcomes. Warrant B and Warrant C were amortized over the derived service periods of 2.08 years and 2.49 years, respectively. No expense related to these warrants was recognized during the nine months ended April 30, 2015, as the expense for the warrants was fully amortized in previously reported periods.

The following reflects the fair value at the end of the derived service for each of the warrants:
 
 
Warrant B
 
Warrant C
 
Fair value
 
$
266,017
   
$
206,245
 

The following table reflects information regarding Warrant B and Warrant C during the nine months ended April 30, 2015 and 2014:
 
 
2015
 
2014
 
Compensation expense recognized
 
$
-
   
$
6,754
 

Note 8 – Related Party Transactions

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

A company controlled by Michael Watts purchased a 5% working interest in one of our wells in Galveston Bay.  As of April 30, 2015 and July 31, 2014, this company owed us $100 and $80,468, respectively, in joint interest billings.

During 2011, we entered into a consulting contract with a company controlled by Michael Watts, as detailed in Note 7 – Capital Stock - Warrants.  The contract permits us to terminate the agreement after the first year with thirty days’ notice.  We recognized expense of $0 and $6,754 from this contract during the nine months ended April 30, 2015 and 2014, respectively.
 
During the three months ended October 31, 2013, a company controlled by one of our former officers, Carter E & P, LLC (“Carter”) operated several properties onshore in South Texas, including our producing properties located near the Victoria Barge Canal in Calhoun County, Texas. Although he was not a related party after September 1, 2013, he was a related party during the periods covered by this report. As of April 30, 2015 and July 31, 2014, there were no outstanding related party receivables from Carter.  Revenues generated, lease operating costs, and contractual overhead charges incurred during the time Carter was a related party were as follows:
 
   
Three months ended
April 30,
   
Nine months ended
April 30,
 
   
2015
   
2014
   
2015
   
2014
 
Revenues
 
$
-
   
$
-
   
$
     
$
39,274
 
Lease operating costs
 
$
-
   
$
-
   
$
     
$
23,259
 
Overhead costs incurred
 
$
-
   
$
-
   
$
     
$
4,687
 

In November 2013, we issued a promissory note for funds received from Mr. Kent Watts, our Chairman, of $100,000. Under the terms of the note, principal on the note was due after one year and incurred interest at 5% per annum payable on a monthly basis. In April 2014, the Company entered into a new debt agreement whereby Mr. Watts agreed to loan the Company up to $600,000 at an interest rate of 6.25%. The previous debt of $100,000 was rolled into this new note. Additionally, we borrowed $200,000 from Mr. Watts during April 2014 and $300,000 from Mr. Watts in May 2014. The total balance on the note was $600,000 as of April 30, 2015. Accrued interest is payable monthly beginning in May 2014, and beginning in August 2014 the principal is due in 36 monthly payments through July 2017. The note is secured by the Company’s assets owned by GBE, subject to any other lien holder's superior rights, if any. As part of the financing agreement with Shadow Tree, this note has been subordinated, and no payments will be made until the Shadow Tree debt has been repaid.

During December 2013, the Company has sold 191,667 shares of common stock to the nephew of the Chairman and Chief Executive Officer of the company and 619,960 shares of common stock to an entity in which Michael Watts has a minority interest (See Note 7).  The value of these transactions as of April 30, 2015 is $2,184,879 and is classified as a receivable for common stock within equity.

During the three months ended April 30, 2014, Kent P. Watts advanced HCN (prior to its acquisition by HEC) funds for working capital purposes to the Company. On December 3, 2013, HCN issued 3,963 shares of its Series A Preferred Stock to Kent P. Watts in order to cancel the majority of the outstanding balance HCN owed to Kent P. Watts at that time. (See Note 7 – Capital Stock – HCN Series A Preferred Stock). During the nine months ended as of April 30, 2015, the Company had current liabilities owed to Mr. Watts of approximately $78,600.

During the nine months ended April 30, 2015, the Company received approximately $2,722 from Mr. Michael Watts for a related party receivable previously outstanding for approximately the same amount as of July 31, 2014.

Note 9 – Fair Value Measurements

As defined in FASB ASC Topic 820, fair value is the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  This Topic requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements.  The statement requires fair value measurements be classified and disclosed in one of the following categories:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.  The Company considers active markets as those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2: Pricing inputs other than quoted market prices included in Level 1 that are based on observable market data and are directly or indirectly observable for substantially the full term of the asset or liability.  These include quoted market prices for similar assets or liabilities, quoted market prices for identical or similar assets in markets that are not active, adjusted quoted market prices, inputs from observable data such as interest rate and yield curves, volatilities or default rates observable at commonly quoted intervals, or inputs derived from observable market data by correlation or other means.

Level 3: Pricing inputs that are unobservable or less observable from objective sources.  Unobservable inputs should only be used to the extent observable inputs are not available.  These inputs maintain the concept of an exit price from the perspective of a market participant and should reflect assumptions of other market participants.  An entity should consider all market participant assumptions that are available without unreasonable cost and effort.  These are given the lowest priority and are generally used in internally developed methodologies to generate management's best estimate of the fair value when no observable market data is available.

Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement.  The Company's assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels.

Certain assets and liabilities are reported at fair value on a recurring or nonrecurring basis in the Company's consolidated balance sheets.  The following methods and assumptions were used to estimate the fair values:
 
Derivative Liabilities
 
The following table sets forth, by level within the fair value hierarchy, the Company's financial assets and liabilities that were accounted for at fair value on a recurring basis as of April 30, 2015:
 
April 30, 2015

Description
 
(Level 1)
   
(Level 2)
   
(Level 3)
   
Total Carrying
Value
 
Convertible Notes
  $      
$
-
   
$
1,648,407
   
$
1,648,407
 
Typenex Co-Warrants
 
$
-
   
$
-
   
$
243,478
   
$
243,478
 
Tainted Warrants – Georserve (Note 7)
  $      
$
-
   
$
48,575
   
$
48,575
 
Total
 
$
-
   
$
-
   
$
1,940,460
   
$
1,940,460
 

Note 10-Derivative Liabilities

Embedded Derivative Instruments

The Company determined that the following convertible notes (collectively “Convertible Notes”) issued during the three months ended April 30, 2015 contained an embedded derivative instrument as the conversion price was based on a variable that was not an input to the fair value of a “fixed-for-fixed” option as defined under FASB ASC Topic No. 815 - 40 (refer Note 7 for further information regarding the convertible notes):

· LG Capital Convertible Note
· Adar Bays, LLC Convertible Note
· JSJ Investments Inc. Convertible Note
· Typenex Co-Investment, LLC Convertible Note

The Company determined the fair values of the embedded derivatives using the lattice valuation model with the following assumptions:

   
Initial
   
April 30, 2015
 
Common stock issuable
   
744,835
     
1,771,432
 
Market value of common stock on measurement date (1)
 
$
0.91 – 1.07
   
$
1.20
 
Adjusted exercise price
 
$
0.52 – 2.25
   
$
0.26-$0.28
 
Risk free interest rate (2)
   
0.08% - 0.25
%
   
0.01%-0.06
%
Instrument lives in years
   
0.50 – 1.00
     
0.32 – 0.68
 
Expected volatility (3)
   
103%-114
%
   
126%-137
%
Expected dividend yields (4)
 
None
   
None
 

(1) The market value of common stock is the stock price at the close of trading on the date of issuance or at period-end, as applicable.

(2) The risk-free interest rate was determined by management using between the 0.5 and 5 - year Treasury Bill as of the respective offering or measurement date.

(3) The historical trading volatility was determined by the Company’s trading history.

(4) Management determined the dividend yield to be -0-% based upon its expectation that it will not pay dividends for the foreseeable future.
 
 Activity for embedded derivative instruments during the three and nine months ended April 30, 2015 was as follows:

   
Balance at
July 31,
2014
   
Initial Valuation
of Embedded
Derivative
Instruments
Issued During
the Period
   
Increase
(Decrease) in
Fair Value of
Derivative
Liabilities
   
Fair Value of
Derivative
Liabilities
on Repayment
of Debt
   
Balance at
April 30,
2015
 
LG Capital
 
$
-
   
$
80,433
   
$
192,313
   
$
(272,745
)
 
$
-
 
Adar Bays, LLC
   
-
     
109,170
     
163,576
     
(272,745
)
   
-
 
JSJ Investments, Inc.
   
-
     
110,825
     
382,064
     
-
     
492,889
 
Typenex Co-Investment
           
66,720
     
1,088,798
     
-
     
1,155,518
 
                                         
   
$
-
   
$
367,147
   
$
1,826,751.
   
$
(545,490
)
 
$
1,648,407
 

Warrants

As additional consideration for the loan evidenced by the Typenex Convertible Note, we granted Typenex a five year warrant (Typenex Warrants) to purchase shares of our common stock equal to $87,500 divided by the Market Price. The Market Price is defined as  a Conversion Factor (70%-80%) multiplied by the average of the five (5) lowest Closing Bid Prices in the twenty (20) Trading Days immediately preceding the applicable Conversion. The warrants have an initial exercise price of $2.25 per share, and are exercisable for 38,889 shares of commono stock.

In addition, the Typenex Warrants contain anti-dilution provisions that provide for a reduction in the exercise price of such warrants in the event that future common stock (or securities convertible into or exercisable for common stock) is issued (or becomes contractually issuable) at a price per share (a “Lower Price”) that is less than the exercise price of such warrant at the relevant time. The amount of any such adjustment is determined in accordance with the provisions of the relevant warrant agreement and depends upon the number of shares of common stock issued (or deemed issued) at the Lower Price and the extent to which the Lower Price is less than the exercise price of the warrant at the relevant time. In addition, the number of shares issuable upon exercise of some of these warrants will be increased inversely proportional to any decrease in the exercise price, thus preserving the aggregate exercise price of the warrants both before and after any such adjustment.  We have determined that these provisions could result in modification of the warrants exercise price based on a variable that is not an input to the fair value of a “fixed-for-fixed” option as defined under FASB ASC Topic No. 815 - 40.

Tainted Warrants

On February 17, 2015, the Warrant B and Warrant C that were previously  issued to Georserve (see Note 7) were considered tainted derivative instruments due to the issuances of various convertibles notes during the three month ended April 30, 2014. Those convertible notes contain variable conversion price and therefore, we cannot conclude that we will have sufficient authorized unissued shares to share settle all the warrants and convertible notes. Accordingly, the Company recorded a derivative liability for the aggregate fair value of the Warrant B and Warrant C.

The fair values of these warrants were recognized as derivative warrant instruments at issuance or when they become issuable and are measured at fair value at each reporting period. The Company determined the fair values of these warrants using a lattice valuation model.
 
Activity for derivative warrant instruments during the three and nine months ended April 30, 2015 was as follows:

   
Balance at
July 31
2014
   
Initial Valuation
   
Increase
(Decrease) in
Fair Value of
Derivative
Liabilities
   
Balance at
April 30,
2015
 
Tainted Warrant-Georserve (Note 7)
   
-
     
17,541
     
31,034
     
48,575
 
Typenex Co-Warrants
 
$
-
   
$
91,925
   
$
151,553
   
$
243,478
 
   
$
-
   
$
109,466
   
$
182,587
   
$
292,053
 

The Company determined the fair values of the warrant derivatives using the lattice valuation model with the following assumptions:

   
Initial
   
April 30, 2015
 
Common stock issuable
   
705,556
     
978,299
 
Market value of common stock on measurement date (1)
 
$
0.92
   
$
1.20
 
Adjusted exercise price
 
$
2.25
   
$
0.28
 
Risk free interest rate (3)
   
1.57
%
   
1.43
%
Instrument lives in years
   
5
     
4.85
 
Expected volatility (4)
   
112
%
   
114
%
Expected dividend yields (5)
 
None
   
None
 

(1) The market value of common stock is the stock price at the close of trading on the date of issuance or at period-end, as applicable.
 
(2) Upon the issuance of Vis Vires convertible note on March 31, 2015, it was assumed that the anti-provision was triggered as the note conversion price of $0.28 was below the then-current warrant exercise price of $2.25. The adjusted exercise price was lowered to the note conversion price.
 
(3) The risk-free interest rate was determined by management using the 5 - year Treasury Bill as of the respective offering or measurement date.

(4) The historical trading volatility was determined by the Company’s trading history.

(5) Management determined the dividend yield to be -0-% based upon its expectation that it will not pay dividends for the foreseeable future.
 
On issuance dates, the derivative liability with an aggregate fair value of $454,903 which we recorded as a debt discount and amortized over the terms of the instruments.  The initial fair value of the tainted warrants was offset to equity.

On April 24, 2015, the Company repaid the principle amount of the LG Capital and Adar Bays convertible notes, resulting in a change of $513,157. The change was recorded as a loss from derivatives and the related unamortized discount was expensed immediately.

As of April 30, 2015, the aggregated balance of derivative liability was $1,940,460 and the unamortized discount was $214,031.

Note 11 - Commitments and Contingencies

Legal

We are subject to legal proceedings, claims and liabilities which arise in the ordinary course of business. We accrue for losses associated with legal claims when such losses are probable and can be reasonably estimated. These accruals are adjusted as additional information becomes available or circumstances change. Legal fees are charged to expense as they are incurred.

As of April 30, 2015, we were party to the following legal proceedings:

Civ. Action No. 4:15-cv-00727, Hydrocarb Energy Corporation, et al. v. Vincent Pasquale Scaturro; In the United States District Court for the Southern District of Texas Houston Division. Hydrocarb Energy Corporation ("HEC") is Plaintiff in this action, and currently has a claim of breach of contract against Mr. Scaturro and an application for preliminary and permanent injunction as a result of Mr. Scaturro’s violation of a Lock Up Leak-Out Agreement executed by the parties on or about December 20, 2014.  There is currently a Temporary Restraining Order in place enjoining Mr. Scaturro from trading more than 500 shares of HEC stock per day.
 
Environmental

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

There is soil contamination at a tank facility owned by GBE. Depending on the technique used to perform the remediation, we estimate the cost range to be between $150,000 and $900,000. We cannot determine a most likely scenario, thus we have recognized the lower end of the range. We have submitted a remediation plan to the appropriate authorities and have not yet received a response. As of April 30, 2015, $150,000 has been recognized and is included in the balance sheet caption “Accounts payable and accrued expenses.”

Letters of Credit

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

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

   
April 30, 2015
 
Prepaid letter of credit fees
 
$
101,250
 
Amortization
   
(84,875
)
Net prepaid letter of credit fees
 
$
16,375
 

Note 12 – Going Concern

The accompanying condensed 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. The Company has not generated any significant revenues from ongoing operations and incurred net losses since inception. These matters raise substantial doubt about the Company’s ability to continue as a going concern. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset amounts or the classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

Management’s principal objective is to maximize shareholder value by, among other things, increasing production by developing its acreage, increasing profit margins by evaluating and optimizing its production, and executing its business plan to increase property values, prove its reserves, and expand its asset base.   While management currently has no plans to discontinue or revise its business plan, recent volatility and decrease in crude oil prices may cause management to cut back on its development or acquisition plans, or otherwise revisit its business and/or its capital expenditure plan.  Continued volatility and decreases in crude oil prices may accelerate such cut back or revisions.  To combat price volatility in crude oil process and further diversify the business, management has increased its focus on the development of HEC.

Note 13 - Subsequent Events

Effective June 10, 2015, the Credit Agreement )the “Credit Agreement”) entered into as borrower, along with Shadow Tree Capital Management LLC, as agent (the “Agent”), and certain lenders party thereto )the “Lenders”) was amended.  Pursuant to the original 2014 Credit Agreement, the Lenders loan us $4 million, which was represented by Term Loan Notes in an aggregate amount of $4,545,454 (the “Notes”), representing as original issue discount of 12%. As part of the amended agreement, the lenders agreed to loan to us an additional $475,632.  The proceeds may be used for the following:  pay for costs of operating Borrower’s business that do not violate the terms of the Agreement, pay transaction costs, including Lender fees, broker fees, legal costs, and other professional fees with respect to the closing of the transaction contemplated by this Agreement, fund the costs of resuming, increasing and sustaining oil and gas production, including well work and infrastructure improvements, at the Galveston Bay Fields.

On June 10, 2015, with the approval of the Board of Directors of the Company (i.e., Mr. Watts personally, and Mr. Chris Herndon), Mr. Watts exchanged all rights he had to the 8,188 shares of Series A 7% Convertible Voting Preferred Stock (which were required to have a face value of $3,275,200) See Note 2 – HCN Acquisition), and accrued and unpaid dividends which would have been due thereunder, assuming such Series A 7% Convertible Voting Preferred Stock was correctly designated and issued at the time of the HCN acquisition, totaling, $327,879, into 32 (“Units”), each consisting of (a) 25,000 shares of the restricted common stock of the Company (the “Shares”); and (b) $100,000 in face amount of Convertible Subordinated Promissory Notes (each a “Note”). Specifically, Mr. Watts received an aggregate of 800,000 shares of common stock and a Convertible Promissory Note with an aggregate principal amount of $3.2 million and a maturity date of June 10, 2018 (the “Watts Note”) in connection with the Exchange Agreement.
 
The Watts Note accrues interest quarterly in arrears, at an annualized percentage interest rate equal to the average quarterly closing spot price of West Texas Intermediate Crude oil divided by ten, plus two (the “WTI Interest Rate”), which resets on a quarterly basis, provided that if the average quarterly closing spot price is less than $50 in any quarter, the applicable interest rate for the following quarter is 0% per annum. For example, if the average quarterly closing spot price was $60 for the prior quarter, the applicable interest rate for the next quarter would be 8% per annum ($60 / 10 = 6 + 2 = 8%). The Watts Note accrues interest, quarterly in arrears, which accrued interest is added to the principal balance of the Watts Note until the earlier of (a) the date the Watts Note is converted into Series B Convertible Preferred Stock (as discussed below); and (b) January 31, 2016 (provided that after January 31, 2016, interest is payable quarterly in arrears in cash). The Watts Note may be prepaid at any time prior to maturity, subject to a 15% prepayment penalty. At any time prior to the earlier of (a) the payment in full of the Watts Note and (b) the Conversion Date (defined below), the Watts Note and all accrued interest thereon is convertible into common stock of the Company at the option of the holder at a conversion price of $4 per share. Notwithstanding the above, on the date, if ever, as the Company has filed a designation of Series B Convertible Preferred Stock (described below) with the Secretary of State of Nevada (the “Conversion Date”), the Watts Note, and any and all accrued and unpaid interest thereon, automatically converts into shares of Series B Convertible Preferred Stock at a conversion price of $1,000 per Series B Convertible Preferred Stock share (with any remaining amount payable in cash at the time of conversion). The Watts Note contains standard and customary events of default, subject where applicable to a ten day cure right, and accrues interest at the rate of 12% per annum in the event of an occurrence of an event of default, provided that the holder may with written notice, upon the occurrence of an event of default, demand the entire outstanding balance of the Watts Note be immediately paid in full. The payment of the Watts Note is subordinate in all cases to the amounts owed by the Company to its senior lenders under that certain Amended and Restated Credit Agreement, originally dated as of August 15, 2014 and amended and restated as of June 10, 2015 (the “Credit Agreement”).

Series B Convertible Preferred Stock

The proposed Series B Convertible Preferred Stock, which is subject to the approval at our 2015 annual meeting of stockholders of (a) an amendment to our Articles of Incorporation, to authorize our Board of Directors to designate series of preferred stock with such rights and privileges as it may determine in its sole authority; or (b) an amendment to our Articles of Incorporation to amend our Articles of Incorporation to provide for the designation of a series of Series B Convertible Preferred Stock, has the rights and privileges described below. No Series B Convertible Preferred Stock will be issued by us, until such time, if ever, as such Series B Convertible Preferred Stock is approved by the Board of Directors (in the event the stockholders approve the amendment described in (a) above, but not the amendment described in (b) above) or the stockholders (in the event the stockholders approve the amendment described in (b) above). Shortly after this filing, we plan to file an updated Schedule 14A proxy statement setting forth, among other things, the terms and conditions of the amendments described in (a) and (b) above, and requesting stockholder approval at our annual meeting for the approval of such amendments, each of which will require the affirmative vote of stockholders holding at least a majority of our outstanding voting shares.

We plan to designate a total of 35,000 shares of Series B Convertible Preferred Stock, subject to stockholder approval. The Series B Convertible Preferred Stock has a face value of $1,000, and accrues a quarterly dividend (based on each calendar quarter), beginning on the first day of the first full month following the initial issuance date of the Series B Convertible Preferred Stock, equal to the WTI Interest Rate multiplied by the face value of each share of Series B Convertible Preferred Stock ($1,000 per share). Until the end of the third calendar quarter following the initial issuance date of the Series B Convertible Preferred Stock (the “Accrual Period”), dividends accrue and are paid in additional shares of Series B Convertible Preferred Stock based on the face value of the Series B Convertible Preferred Stock (provided that any dividends representing less than the face value accrue until the next period (if they then total the face value of one share of Series B Convertible Preferred Stock) or the end of the Accrual Period when they are payable in cash). Any dividends not paid when due accrue interest at the rate of 12% per annum until paid in full.

The Series B Convertible Preferred Stock has the right to participate in dividends and other non-stock distributions of the Company as if such Series B Convertible Preferred Stock had previously been converted into common stock. The Series B Convertible Preferred Stock contains a liquidation preference equal to its face value, which takes priority over the securities of the Company other than, the Series A Preferred Stock, amounts owed by the Company under the Credit Agreement, as well as any future debt used to refinance, repay or supplement the Credit Agreement, capital leases, senior debt in place as of the original issuance date of the Series B Convertible Preferred Stock and any other securities which the Company may determine to provide first priority interests to in the event of a liquidation of the Company, provided that the Series B Convertible Preferred Stock shall always have a liquidation preference over the common stock.

Each Series B Convertible Preferred Stock share is convertible, at any time, at the option of the holder, into 250 shares of common stock, and all accrued and unpaid dividends are convertible into common stock of the Company at the option of the holder at any time, at the rate of $4 per share. Each Series B Convertible Preferred Stock share votes together with the common stock on all shareholder matters, and not as a separate class, and has the right to vote 250 voting shares on all shareholder matters. The Series B Convertible Preferred Stock and any and all accrued and unpaid dividends thereon also automatically convert, upon the Company’s common stock (as adjusted for stock splits and similar events) closing at or above $7 per share for a period of at least thirty consecutive trading days, into shares of common stock in an amount equal to (i) the number of shares of Series B Convertible Preferred Stock held by each holder multiplied by the face value of the Series B Convertible Preferred Stock ($1,000 per share), plus (ii) any and all accrued dividends, divided by the conversion price ($4 per share). The Series B Convertible Preferred Stock contains no preemptive rights. The Series B Convertible Preferred Stock has no redemption rights, provided the Company is able, pursuant to the terms of the Series B Convertible Preferred Stock to negotiate, from time to time, mutually agreeable redemption terms with any or all of the Series B Convertible Preferred Stock holders (which terms and conditions need not be consistent from holder to holder).
 
So long as any shares of Series B Convertible Preferred Stock are outstanding, the Company cannot, without first obtaining the approval of the holders of a majority in interest of the Series B Convertible Preferred Stock, voting together as a single class (a) effect an exchange, reclassification, or cancellation of all or a part of the Series B Convertible Preferred Stock (except in connection with a recapitalization which effects the conversion price of the Series B Convertible Preferred Stock and/or a combination in which the holders of the Series B Convertible Preferred Stock have the right to participate on an as-converted basis); (b) effect an exchange, or create a right of exchange, of all or part of the shares of another class of shares into shares of Series B Convertible Preferred Stock (except in connection with a recapitalization which effects the conversion price of the Series B Convertible Preferred Stock and/or a combination in which the holders of the Series B Convertible Preferred Stock have the right to participate on an as-converted basis); (c) alter or change the rights, preferences or privileges of the shares of Series B Convertible Preferred Stock so as to affect adversely the shares of such series; or (d) amend or waive any provision of the Company’s Articles of Incorporation or Bylaws relative to the Series B Convertible Preferred Stock so as to affect adversely the shares of Series B Convertible Preferred Stock.

Finally, Mr. Watts has agreed that in the event the Company should raise at least $10.5 million through a planned offering of the Units (not including his exchange of the rights to the Series A Preferred for Units), he will convert the $600,000 promissory note he is owed into Units or Series B Convertible Preferred Stock, in his discretion and as applicable, and the Company will be responsible for repaying any remaining amount (accrued interest for example) in cash.
 
CAUTIONARY STATEMENT ON FORWARD-LOOKING INFORMATION

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

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

As used in this Quarterly Report: (i) the terms “we”, “us”, “our”, “Hydrocarb”, “HEC”, “Penasco”, “Galveston Bay”, “SPE”, “NEI” and the “Company” mean Hydrocarb Energy Corp and its wholly owned subsidiaries Penasco Petroleum Inc., Galveston Bay, LLC, SPE Navigation I, LLC, and Namibia Exploration, Inc. Hydrocarb Corporation (“HCN”), Hydrocarb Texas Corporation, Hydrocarb Energy DRC Corporation, Hydrocarb Namibia Energy (Pty) Limited and Hydrocarb Guinea SARL plus our 95% ownership interest of Otaiba Hydrocarb LLC, unless the context otherwise requires; (ii) “SEC” refers to the Securities and Exchange Commission; (iii) “Securities Act” refers to the Securities Act of 1933, as amended; (iv) “Exchange Act” refers to the Securities Exchange Act of 1934, as amended; and (v) all dollar amounts refer to United States dollars unless otherwise indicated.

The following discussion of our plan of operations, results of operations and financial condition as at and for the nine months ended April 30, 2015 should be read in conjunction with our unaudited consolidated interim financial statements and related notes for the nine months ended April 30, 2015, included in this Quarterly Report, as well as our Annual Report on Form 10-K for the year ended July 31, 2014.

Results of Operations

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

Three months ended April 30, 2015 compared to the three months ended April 30, 2014:

Statements of operations:

   
Three Months Ended April 30,
   
Increase/
   
%
 
   
2015
   
2014
   
(Decrease)
   
Change
 
                 
Revenues
 
$
1,139,278
   
$
1,057,550
     
81,728
     
8
%
                                 
Operating expenses
                               
Lease operating expense
   
1,043,956
     
1,559,339
     
(515,383
)
   
-33
%
Depreciation, depletion, and amortization
   
385,058
     
179,678
     
205,380
     
114
%
Accretion
   
229,560
     
242,608
     
(13,048
)
   
-5
%
Consulting fees - related party
   
-
     
-
     
-
         
General and administrative expense
   
749,154
     
645,496
     
103,658
     
16
%
Total operating expenses
   
2,407,728
     
2,627,121
     
(219,393
)
   
-8
%
                                 
Loss from operations
   
(1,268,450
)
   
(1,569,571
)
   
301,121
     
19
%
                                 
Consulting and other income (expense)
   
14,126
     
712
     
13,414
     
1,884
%
Gain or Loss on derivatives
   
(1,468,016
)
   
-
      (1,468,016 )     -100 %
Interest income (expense), net
   
(697,291
)
   
(20,905
)
   
(675,441
)
   
-3,236
%
Foreign currency transaction gain (loss)
   
(36,951
)
   
(3,380
)
   
(33,571
)    
-993
%
                                 
Net loss before income taxes
   
(3,456,582
)
   
(1,593,144
)
   
(1,863,437
)
   
-117
%
                                 
Income tax provision
   
-
     
-
     
-
         
                                 
Net loss
   
(3,456,582
)
   
(1,593,144
)
   
(1,863,437
)
   
-117
%
                                 
Less:  Net loss attributable to noncontrolling interests
   
-
     
(1,602
)
   
1,602
     
100
%
                                 
Net loss attributable to Hydrocarb Corporation
   
(3,456,582
)
   
(1,591,542
)
   
(1,865,039
)
   
-110
%
                                 
Basic and diluted loss per common share:
 
$
(0.16
)
 
$
(0.08
)
               
                                 
Weighted average shares  outstanding  (basic and diluted)
   
21,270,879
     
20,963,759
                 
 
We recorded net loss of $3,456,581, or ($0.16) per basic and diluted common share, during the three months ended April 30, 2015, as compared to a net loss of $ 1,591,542, or ($0.08) per basic and diluted common share, during the three months ended April 30, 2014.

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

· Revenues decreased due to lower sales prices. Production volume was higher as the workover and recompletion wells were primarily completed.  This is reflected in the production volume.
· Lease operating expenses decreased due to lower nonrecurring expenses.
· Depreciation, depletion, and amortization increased because of higher production in the current year versus production in the same quarter of the comparable period prior year.
· General and administrative expenses increased primarily due to increased legal fees for the period..
· Consulting and other income for the three months ended April 30, 2015 primarily represents income earned for production handling. Expenses incurred in the comparable prior period included write-offs of previously recognized consulting income. No such write-offs existed during the current reporting period.

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

Nine months ended April 30, 2015 compared to the nine months ended April 30, 2014:

   
Nine Months End April 30,
   
Increase/
   
%
 
   
2015
   
2014
   
(Decrease)
   
Change
 
                 
Revenues
 
$
2,991,055
   
$
3,887,493
     
(896,438
)
   
-23
%
                                 
Operating expenses
                               
Lease operating expense
   
3,254,801
     
3,487,798
     
(232,997
)
   
-7
%
Depreciation, depletion, and amortization
   
771,480
     
673,357
     
98,123
     
15
%
Accretion
   
790,550
     
731,093
     
59,457
     
8
%
Consulting fees - related party
   
-
     
6,754
     
(6,754
)
   
-100
%
General and administrative expense
   
2,672,914
     
3,383,820
     
(710,906
)
   
-21
%
Total operating expenses
   
7,489,745
     
8,282,822
     
(793,077
)
   
-10
%
                                 
Loss from operations
   
(4,498,690
)
   
(4,395,329
)
   
(103,361
)
   
- 2
%
                                 
Consulting and other income (expense)
   
20,905
     
68,912
     
(48,007
)
   
-70
%
Gain or Loss on derivatives
   
(1,468,016
)
   
-
      (1,468,016     -100 %
Interest income (expense), net
   
(1,204,795
)
   
(98,033
)
   
(1,106,762
)
   
- 1,128
%
Foreign currency transaction gain (loss)
   
(38,593
)
   
(34,006
)
   
(4,587
)    
-13
%
                                 
Net loss before income taxes
   
(7,189,188
)
   
(4,458,456
)
   
(2,730,732
)
   
- 61
%
                                 
Income tax provision
   
-
     
(4,599
)
   
4,599
     
100
%
                                 
Net loss
   
(7,189,188
)
   
(4,463,055
)
   
(2,726,133
)
   
- 61
%
                                 
Less:  Net loss attributable to noncontrolling interests
   
(1,305
)
   
(4,962
)
   
3,657
     
74
%
                                 
Net loss attributable to Hydrocarb Corporation
   
(7,187,883
)
   
(4,458,093
)
   
(2,729,790
)
   
- 61
%
Basic and diluted loss per common share:
 
$
(0.34
)
 
$
(0.34
)
               
                                 
Weighted average shares  outstanding  (basic and diluted)
   
21,184,600
     
13,111,626
                 
 
We recorded net loss of $7,187,883, or ($0.36)per basic and diluted common share, during the nine months ended April 30, 2015, as compared to a net loss of 4,458,093, or ($0.34)per basic and diluted common share, during the nine months ended April 30, 2014.

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

· Revenues decreased due to lower sales prices in fiscal 2015. Lease operating expenses decreased due to lower nonrecurring expenses.
· Depreciation, depletion, and amortization increased because of increased production in the current year versus production in the same quarter of the comparable period prior year.
· General and administrative expenses decreased primarily as a result of decreased compensation expense related to stock options.
· Interest expense increased due to the addition of the Shadowtree Capital financing which was entered into in August of 2014.
· Consulting and other income for the nine months ended April 30, 2015 primarily represents income earned for production handling. Expenses incurred in the comparable prior period included write-offs of previously recognized consulting income. No such write-offs existed during the current reporting period.

Liquidity, Capital Resources and Going Concern

The following table sets forth our cash and working capital as of April 30, 2015 and July 31, 2014, respectively:

   
April 30, 2015
   
July 31, 2014
 
Cash and cash equivalents
 
$
90,261
   
$
144,258
 
Working capital (deficit)
 
$
(5,939,054
)
 
$
(3,566,332
)

At April 30, 2015, we had $90,261 of cash on hand and a working capital deficit of $5,939,054. The Company has accumulated losses since inception. These factors raise substantial doubt about the Company’s ability to continue as a going concern. It is the intent of the Company is to maximize shareholder value by, among other things, increasing production by developing its acreage, increasing profit margins by evaluating and optimizing its production, and executing its business plan to increase property values, prove its reserves, and expand its asset base. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Net Cash Provided by Operating Activities

During the nine months ended April 30, 2015, operating activities used $1,887,995 in comparison to cash used of $825,798 during the nine months ended April 30, 2014. The main operating activity using cash for the nine months ended April 30, 2015, was a net loss of $7,189,188, offset by $790,704 of accounts payable and accrued expenses and $396,475 of share based compensation; $771,480 of depreciation depletion and amortization, $790,550 of accretion, $820,448 of amortization of debt discount, and $205,131 of amortization of debt issuance cost.
 
Net Cash Used in Investing Activities

During the nine months ended April 30, 2015, investing activities used cash of $2,377,869 compared to using cash of $522,731 during the nine months ended April 30, 2014.  The main uses of cash for investing activities were purchases of oil and gas properties.
 
Net Cash Provided by Financing Activities

During the nine months ended April 30, 2015, financing activities provided cash of $4,211,867 in comparison to providing $1,785,745 in cash during the nine months ended April 30, 2014.  The main reasons for cash being provided by financing activities for the nine months ended April 30, 2015, were proceeds from borrowing and the main reasons for cash being provided by financing activities for the nine months ended April 30, 2014, was also proceeds from borrowing.

Operation Plans and Focus

In Galveston Bay, Texas we plan to continue enhancing the production from our four productive fields. Our development program includes primarily reworking, infrastructure improvements, and recompletions, as well as drilling, as to exploit the known reserves in at least 18 wells. Internal estimates show the projects, if successful, can almost quadruple current production enhancing cash flow significantly. Due to the fact that a large proportion of current operating costs in Galveston Bay are fixed it is expected that as production grows an increasing percentage of the revenue will contribute to positive cash flow. We plan to fund these projects as long as working capital and cash-flow permits and pending success of previous projects. If we are able to secure either bank or equity financing in the near future, this development plan can be accelerated.

In Namibia, Africa, we plan to interpret the newly acquired aerial gravity magnetic survey data and develop the acquisition plan for new 2D seismic data over the concession. This will include seeking a new partner that will, at least partially, carry us through the seismic acquisition program. 3D seismic will later be utilized for those identified structures which appear most prospective. Drilling of the first well is several years away. In the meanwhile, our goals are to increase the value and decrease the risk profile of our concession acreage in Namibia.

In September 2014 our CEO traveled to Abu Dhabi, United Arab Emirates (“U.A.E.”) and met with the board of directors of our subsidiary Otaiba Hydrocarb LLC. His goal was to proceed with oil company registration work that would allow the company to receive bids on oilfield services work with the hopes of developing a profitable business as has been the plan since the subsidiary was established. Instead of being able to proceed with the business plan, the partner in the UAE made it clear that they wanted more control over management of the subsidiary while still requiring us to fund ongoing expenses. This created an impasse between our partners and us. Together with consideration for the severe drop in oil prices, the board of directors made the decision to cease operations in the UAE in favor of our focus for oilfield services to be developed domestically. Thus, during the quarter ended April 30, 2015, the decision was made to close the office in the UAE and not to continue its operations, thereby reducing cash expense obligations that we have had in the past but no longer have. All expenses of operating there have been realized on an ongoing basis so the accounting effect of this shutdown is nil and immaterial.

Our plan of operations over the next twelve months is to increase cash flow upon one or more of the following occurring:
1. Continue to receive payments on the two receivables for HEC common stock;
2. Raise capital by farming down a portion of our Owambo Basin concession in Namibia to an industry partner;
3. Release restricted cash from the State Bonding requirement, as shut-in wells are brought back into production and/or as wells are plugged;
4. Continue to enhance production from our four production oil and gas fields in Galveston Bay; and
5. Raising capital through the issuance of additional equity or debt securities (similar to the transactions completed during February and March 2015, as described below).

Our plan of operations over the next twelve months will always be subject to available capital which will be determined by the success of projects that are currently in progress or will begin soon. It is even possible that given a high degree success in recently initiated projects and upcoming projects we could actually exceed our planned operations and have more internally-derived funds available for capital expenditures for the next six months. As management, we will determine the best use of our capital given the circumstances at the time.

Various conditions outside of our control may detract from our ability to raise the capital needed to execute our plan of operations, including the price of oil as well as the overall market conditions in the international and domestic economies. Any of these factors could have a material adverse impact upon our ability to raise capital or obtain financing and, as a result, upon our short-term or long-term liquidity.

Convertible Notes, Credit Agreement and Recent Events

As described above in Note 6 – Notes Payable – Convertible Notes Payable, in the financial statements included in Part I, Item 1 of this report, we sold the LG Convertible Note in the amount of $105,000, the Adar Bays Convertible Note in the amount of $105,000, the KBM Convertible Note in the amount of $350,000, the JSJ Convertible Note in the amount of $137,000, the Vis Vires Convertible Note in the amount of $414,500 and the Typenex Convertible Note in the amount of $350,000, and we also granted Typenex the Warrant described above during the period, which convertible notes and terms thereof are described in greater detail in Note 6.

As described above in Note 13 – Subsequent Events, in the financial statements included in Part I, Item 1 of this report, on June 10, 2015, we entered into an Exchange Agreement with Kent P. Watts, our CEO, pursuant to which Mr. Watts exchanged all shares of Series A Convertible Preferred Stock which he was due and all rights to accrued and unpaid dividends thereon for 32 Units, consisting of an aggregate of 800,000 shares of the Company’s restricted common stock and a Convertible Promissory Note in the aggregate amount of $3.2 million.
 
Effective June 10, 2015, we entered into an Amended and Restated Credit Agreement (the “Restated Credit Agreement”) as borrower, along with Shadow Tree Capital Management, LLC, as agent (the “Agent”), and Shadow Tree Funding Vehicle A—Hydrocarb LLC and Quintium Private Opportunities Fund, LP, as lenders (collectively, the “Lenders”), which amended and restated in its entirety the Credit Agreement originally entered into between us, the Agent and the Lenders dated as of August 15, 2014 (as disclosed in our Current Report on Form 8-K filed with the SEC on August 31, 2015) and previously amended on February 17, 2015 (as amended as of the date of the Restated Credit Agreement and prior to the amendments affected by the Restated Credit Agreement, the “Original Credit Agreement”).

The Restated Credit Agreement, increased the amount of interest due on additional loans made pursuant to the terms of the Restated Credit Agreement (provided that no additional loans were made under the credit agreement prior to the additional loans made in connection with the Restated Credit Agreement as discussed below) to 16% per annum (from 14% per annum pursuant to the prior terms); accelerated the maturity date of amounts borrowed from the Lenders under the credit agreement to November 30, 2015 (previously amounts borrowed were due August 15, 2016); provided for the Lenders to make additional loans of $475,632 (less an aggregate of $73,023 in fees and expenses, not including placement and other fees totaling 6% of the amount borrowed) as of the date of the Restated Credit Agreement, which loans have been made to date; removed the right of the Company to request further loans under the credit agreement; provided for the payment to the Lenders of an exit fee in the amount of 4% of the amount repaid under the Restated Credit Agreement, if repaid in full prior to July 31, 2015, and 5% of such repaid amount if repaid after July 31, 2015; provided for the immediate issuance of an aggregate of 32,500 shares of the Company’s restricted common stock to the Lenders and the termination of any other requirements of the Company to issue additional shares to the Lenders pursuant to the terms of the credit agreement (previously 32,500 shares were due on the 18 month anniversary of the original closing and 25,000 shares were due on the 21 month anniversary of the original closing); required us to make all contractually required payments to Linc Energy LLC and make all necessary payments to and take or cause to be taken all other commercially reasonable actions to cause the Redfish Reef field to be both producing and distributing meaningful quantities of oil and gas no later than July 15, 2015, subject to circumstances beyond our control; modified certain of the covenants described in the Original Credit Agreement; waived, effective as of the date of the Restated Credit Agreement all previously defaults which the Lenders had notice of under the Original Credit Agreement; and effected various non-material revisions and updates to the Original Credit Agreement.

All of the above are described in greater detail in the Current Reports on Form 8-K filed with the Commission on March 11, 2015 and June 19, 2015.

On May 29, 2015, the Company entered into a revolving line of credit agreement with Christian Smith & Jewell, the Company’s legal counsel.  The line of credit established a revolving line of credit in the amount of up to $350,000 for legal fees due to the law firm, including $200,000 previously accrued.  Advances of credit under the line of credit are in the discretion of the law firm.  Amounts subject to the line of credit are evidenced by individual convertible promissory notes, which have customary events of default, accrue interest at the rate of 3% per annum (12% upon an event of default), are due on demand, and are convertible (along with accrued and unpaid interest) into shares of the Company’s common stock at a conversion price of $1.17 per share.  Amounts due can be paid at any time without penalty, provided the Company gives at least 30 days prior notice of its intention to repay amounts owed.  The notes each contain a 4.99% ownership limitation.  In connection with the entry into the line of credit, the Company issued the law firm a convertible promissory note in the amount of $200,000.

Critical Accounting Policies

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

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

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

Oil and Natural Gas Properties

We account for our oil and natural gas producing activities using the full cost method of accounting as prescribed by the United States Securities and Exchange Commission (SEC). Under this method, subject to a limitation based on estimated value, all costs incurred in the acquisition, exploration, and development of proved oil and natural gas properties, including internal costs directly associated with acquisition, exploration, and development activities, the costs of abandoned properties, dry holes, geophysical costs, and annual lease rentals are capitalized within a cost center. Costs of production and general and administrative corporate costs unrelated to acquisition, exploration, and development activities are expensed as incurred.
 
Costs associated with unevaluated properties are capitalized as oil and natural gas properties but are excluded from the amortization base during the evaluation period. When we determine whether the property has proved recoverable reserves or not, or if there is an impairment, the costs are transferred into the amortization base and thereby become subject to amortization.

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

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

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

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

Asset Retirement Obligations

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

Stock-Based Compensation

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

We account for non-employee share-based awards based upon ASC 505-50, Equity-Based Payments to Non-Employees. ASC 505-50 requires the costs of goods and services received in exchange for an award of equity instruments to be recognized using the fair value of the goods and services or the fair value of the equity award, whichever is more reliably measurable. The fair value of the equity award is determined on the measurement date, which is the earlier of the date that a performance commitment is reached or the date that performance is complete. Generally, our awards do not entail performance commitments. When an award vests over time such that performance occurs over multiple reporting periods, we estimate the fair value of the award as of the end of each reporting period and recognize an appropriate portion of the cost based on the fair value on that date. When the award vests, we adjust the cost previously recognized so that the cost ultimately recognized is equivalent to the fair value on the date the performance is complete.

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

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

Changes in Internal Control over Financial Reporting

We regularly review our system of internal control over financial reporting to ensure we maintain an effective internal control environment.  There were no changes in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
 
Part II Other Information

Item 1. Legal Proceedings

Although we may, from time to time, be involved in litigation and claims arising out of our operations in the normal corse of business, we are not currently a party to any material legal proceeding, except as discussed below.Civ. Action No. 4:15-cv-00727, Hydrocarb Energy Corporation, et al. v. Vincent Pasquale Scaturro; In the United States District Court for the Southern District of Texas Houston Division. Hydrocarb Energy Corporation ("HEC") is Plaintiff in this action, and currently has a claim of breach of contract against Mr. Scaturro and an application for preliminary and permanent injunction as a result of Mr. Scaturro’s violation of a Lock Up Leak-Out Agreement executed by the parties on or about December 20, 2014.  There is currently a Temporary Restraining Order in place enjoining Mr. Scaturro from trading more than 500 shares of HEC stock per day.

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

It has come to our attention that our December 2013 designation of Series A Preferred Stock, was likely not effective pursuant to the terms of our Articles of Incorporation, as amended and applicable Nevada law, and as such, is invalid.

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

In connection with certain due diligence subsequently undertaken by the Company, it has come to the attention of management, that although the Company previously believed, on advice of prior counsel, that the Board of Directors of the Company had the authority under the Company’s Articles of Incorporation, to unilaterally authorize preferred stock, that under applicable Nevada law, unless such preferred stock is specifically authorized in a Nevada corporation’s articles no preferred stock can be designated or issued. As such, our Board of Directors did not have authority under the Articles of Incorporation, as amended, and applicable Nevada law to designate the Series A Preferred or to file such designation with the Secretary of State of Nevada. Consequently, we now believe that the Series A Preferred is not validly issued or outstanding and the filing of the Series A Preferred designation was invalid and had no legal effect.
 
Notwithstanding the above, the documentation relating to the designation of the Series A Preferred was filed with and accepted by the Secretary of State of Nevada and the Company had previously been treating the Series A Preferred as validly issued and outstanding. For example, during the year ended July 31, 2014, the holder of the Series A Preferred Stock purportedly earned dividends of $150,548 on such securities. As of July 31, 2014, these dividends have not been accrued as liabilities since they were not declared by the Company.

Although the Company took action in good faith, based on the advice of prior counsel, in connection with the designation of the Series A Preferred, following the date of this filing, the Company plans to promptly take steps to hold a shareholders meeting to seek shareholder approval to amend the Articles of Incorporation to properly authorize preferred stock and provide the Board of Directors the ability in their discretion to designate such preferred stock, and may further request shareholder approval and ratification of the specific terms of the terms of the prior Series A Preferred. Assuming shareholder approval of the authorization of preferred stock, and the Board of Director’s ability to designate such preferred stock, and/or the actual terms of the Series A Preferred, the Company will re-file the Series A Preferred designation with the Secretary of State of Nevada.

Notwithstanding the above, as described under Note 13 – Subsequent Events, of the financial statements included in Part I, Item 1, above, on June 10, 2015, Mr. Watts exchanged his right to receive Series A Preferred for 32 units each consisting of (a) 25,000 shares of the restricted common stock of the Company; and (b) $100,000 in face amount of Convertible Subordinated Promissory Notes, and as such, no longer holds any rights to the Series A Preferred.

Notwithstanding the above, due to the fact that we now believe that the Series A Preferred was invalid, we could be forced to amend and restate our prior SEC filings and prior financial statements to clarify the fact that such Series A Preferred stock was never validly outstanding or issued. Furthermore, the fact that certain of our corporate actions were not affected properly, the perception in the marketplace that such corporate actions were not affected properly, or uncertainties associated therewith, could raise questions about our corporate governance and controls and procedures and result in the trading value of our common stock, if any, being lower than companies without similar issues.

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

As described under Note 6 – Notes Payable of the financial statements included in Part I, Item 1, above, we sold various convertible promissory notes in February and March 2015. The conversion prices of the convertible notes vary from between 50% to 80% of the market value of our common stock, subject in many cases to anti-dilution and other rights. As a result, any conversion of the convertible notes and sale of shares of common stock issuable in connection with the conversion thereof will likely cause the value of our common stock, if any, to decline in value, as described in greater detail under the Risk Factors below. Notwithstanding the above, we plan to repay the convertible notes in full before any conversions take place.

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

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

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

The issuance of common stock upon conversion of the convertible notes will cause immediate and substantial dilution.

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

Our existing stockholders will experience substantial dilution of their investment upon any conversion of the convertible notes. The convertible notes are convertible into shares of common stock at a conversion price equal to a discount to the market value of our common stock as described above. As a result, the number of shares issuable could prove to be significantly greater in the event of a decrease in the trading price of our common stock, which decrease would cause substantial dilution to our existing stockholders. As sequential conversions and sales take place, the price of our common stock may decline, and if so, the holders of the convertible notes would be entitled to receive an increasing number of shares, which could then be sold, triggering further price declines and conversions for even larger numbers of shares, which would cause additional dilution to our existing stockholders and would likely cause the value of our common stock to decline.

The continuously adjustable conversion price feature of our convertible notes may encourage the holders of the convertible notes to sell short our common stock, which could have a depressive effect on the price of our common stock.

The convertible notes are convertible into shares of our common stock at a discount to the market value of our common stock. The significant downward pressure on the price of our common stock as the holders of the convertible notes convert and sell material amounts of our common stock could encourage investors to short sell our common stock. This could place further downward pressure on the price of our common stock. In addition, not only the sale of shares issued upon conversion of the convertible notes, but also the mere perception that these sales could occur, may adversely affect the market price of our common stock. Notwithstanding the above, we plan to repay the convertible notes in full before any conversions take place.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During the nine months ended April 30, 2015, we issued an aggregate of 100,000 shares of common stock to consultants for services rendered. We valued these transactions at approximately $266,722.

As described above in Note 6 – Notes Payable – Convertible Notes Payable, in the financial statements included in Part I, Item 1 of this report, we sold the LG Convertible Note in the amount of $105,000, the Adar Bays Convertible Note in the amount of $105,000, the KBM Convertible Note in the amount of $350,000, the JSJ Convertible Note in the amount of $137,000, the Vis Vires Convertible Note in the amount of $414,500 and the Typenex Convertible Note in the amount of $350,000, and we also granted Typenex the Warrant described above.

As described above in Note 13 – Subsequent Events, in the financial statements included in Part I, Item 1 of this report, on June 10, 2015, agreed to issue Mr. Watts 32 Units, consisting of an aggregate of 800,000 shares of the Company’s restricted common stock and a Convertible Promissory Note in the aggregate amount of $3.2 million.

As described above Note 13 – Subsequent Events, in the financial statements included in Part I, Item 1 of this report, we agreed to issue 32,500 shares of restricted common stock of the Company to the Lenders pursuant to the Restated Credit Agreement on June 10, 2015.

On May 29, 2015, the Company entered into a revolving line of credit agreement with Christian Smith & Jewell, the Company’s legal counsel.  The line of credit established a revolving line of credit in the amount of up to $350,000 for legal fees due to the law firm, including $200,000 previously accrued.  Advances of credit under the line of credit are in the discretion of the law firm.  Amounts subject to the line of credit are evidenced by individual convertible promissory notes, which have customary events of default, accrue interest at the rate of 3% per annum (12% upon an event of default), are due on demand, and are convertible (along with accrued and unpaid interest) into shares of the Company’s common stock at a conversion price of $1.17 per share.  Amounts due can be paid at any time without penalty, provided the Company gives at least 30 days prior notice of its intention to repay amounts owed.  The notes each contain a 4.99% ownership limitation.  In connection with the entry into the line of credit, the Company issued the law firm a convertible promissory note in the amount of $200,000.

We claim an exemption from registration for the issuances and grant described above pursuant to Section 4(a)(2) and/or Rule 506 of Regulation D of the Securities Act of 1933, as amended (the “Securities Act”), since the foregoing issuances and grant did not involve a public offering, the recipients were (a) “accredited investors”; and/or (b) had access to similar documentation and information as would be required in a Registration Statement under the Securities Act, the recipients acquired the securities for investment only and not with a view towards, or for resale in connection with, the public sale or distribution thereof. The securities were offered without any general solicitation by us or our representatives. No underwriters or agents were involved in the foregoing issuances and grant and we paid no underwriting discounts or commissions. The securities sold are subject to transfer restrictions, and the certificates evidencing the securities contain an appropriate legend stating that such securities have not been registered under the Securities Act and may not be offered or sold absent registration or pursuant to an exemption therefrom. The securities were not registered under the Securities Act and such securities may not be offered or sold in the United States absent registration or an exemption from registration under the Securities Act and any applicable state securities laws.
 
Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits
 
See the Exhibit Index following the signature page to this Quarterly Report on Form 10-Q for a list of exhibits filed or furnished with this report, which Exhibit Index is incorporated herein by reference.
 
35

 
Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

HYDROCARB ENERGY CORP.
 
/s/ Kent P. Watts
 
Kent P. Watts
 
Chief Executive Officer, Executive Chairman and Director
 
(Principal Executive Officer)
 
Date:  June 22, 2015
 
 
36

 
EXHIBIT INDEX

Exhibit No.
Description of Exhibit
10.1
Securities Purchase Agreement between Hydrocarb Energy Corp. and LG Capital Funding, LLC (February 17, 2015) (Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)
10.2
8% Convertible Redeemable Note ($105,000 – LG Capital Funding, LLC)(February 17, 2015) (Filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)
10.3
Securities Purchase Agreement between Hydrocarb Energy Corp. and Adar Bays, LLC (February 17, 2015) (Filed as Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)
10.4
8% Convertible Redeemable Note ($105,000 – Adar Bays, LLC)(February 17, 2015) (Filed as Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)
10.5
Securities Purchase Agreement between Hydrocarb Energy Corp. and KBM Worldwide, Inc. (February 17, 2015) (Filed as Exhibit 10.5 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)
10.5
Convertible Promissory Note ($350,000 – KBM Worldwide, Inc.)(February 17, 2015) (Filed as Exhibit 10.6 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)
10.6
10% Convertible Promissory Note ($137,000 – JSJ Investments Inc.)(February 23, 2015) (Filed as Exhibit 10.7 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)
10.7
Securities Purchase Agreement between Hydrocarb Energy Corp. and Typenex Co-Investment, LLC (March 5, 2015) (Filed as Exhibit 10.8 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)
10.8
Secured Convertible Promissory Note ($350,000 – Typenex Co-Investment, LLC.)(March 5, 2015) (Filed as Exhibit 10.9 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)
10.9
Secured Convertible Promissory Note ($350,000 – Typenex Co-Investment, LLC.)(March 5, 2015) (Filed as Exhibit 10.10 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)
10.10
Warrant to Purchase Shares of Common Stock (March 5, 2015 - Typenex Co-Investment, LLC) (Filed as Exhibit 10.11 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)
10.11
Stock Pledge Agreement between Typenex Co-Investment, LLC and CW Navigation, Inc. (March 5, 2015) (Filed as Exhibit 10.11 to the Company’s Current Report on Form 8-K filed with the Commission on March 11, 2015 (File No. 000-53313) and incorporated herein by reference)

10.12
Executive Agreement with Kent P. Watts (March 9, 2015)(Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on March 17, 2015 (File No. 000-53313) and incorporated herein by reference)
10.13
Convertible Promissory Note dated March 31, 2015 by Hydrocarb Energy Corporation in favor of Vis Vires Group, Inc. in the principal amount of $414,500 (Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on June 19, 2015 (File No. 000-53313) and incorporated herein by reference)
10.14
Securities Purchase Agreement dated March 31, 2015 between Hydrocarb Energy Corporation and Vis Vires Group, Inc. (Filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Commission on June 19, 2015 (File No. 000-53313) and incorporated herein by reference)
10.15
Exchange Agreement between Hydrocarb Energy Corporation and Kent P. Watts (June 10, 2015) (Filed as Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the Commission on June 19, 2015 (File No. 000-53313) and incorporated herein by reference)
10.16
Convertible Promissory Note ($3,200,000) owed to Kent P. Watts (Filed as Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the Commission on June 19, 2015 (File No. 000-53313) and incorporated herein by reference)
10.17
Amended and Restated Credit Agreement dated as of June 10, 2015, by and among Hydrocarb Energy Corporation, as borrower, Shadow Tree Capital Management, LLC, as agent, and the Lenders thereto (Filed as Exhibit 10.5 to the Company’s Current Report on Form 8-K filed with the Commission on June 19, 2015 (File No. 000-53313) and incorporated herein by reference)
10.18
First Amendment to Stock Grant Agreement between Hydrocarb Energy Corporation and the Lenders dated June 10, 2015 (Filed as Exhibit 10.6 to the Company’s Current Report on Form 8-K filed with the Commission on June 19, 2015 (File No. 000-53313) and incorporated herein by reference)
10.19
$365,724 Term Loan Note dated June 10, 2015 payable by Hydrocarb Energy Corporation to Shadow Tree Funding Vehicle A-Hydrocarb LLC (Filed as Exhibit 10.7 to the Company’s Current Report on Form 8-K filed with the Commission on June 19, 2015 (File No. 000-53313) and incorporated herein by reference)
10.20
$118,908 Term Loan Note dated June 10, 2015 payable by Hydrocarb Energy Corporation to Quintium Private Opportunity Fund, LP (Filed as Exhibit 10.8 to the Company’s Current Report on Form 8-K filed with the Commission on June 19, 2015 (File No. 000-53313) and incorporated herein by reference)
Certification of Principal Executive required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification of Principal Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification of Principal Executive and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and Section 1350 of 18 U.S.C. 63.
99.1*
Form of Certificate of Designation of Hydrocarb Energy Corporation Establishing the Designation, Preferences, Limitations and Relative Rights of Its Series B Convertible Preferred Stock (Filed as Exhibit 99.1 to the Company’s Current Report on Form 8-K filed with the Commission on June 19, 2015 (File No. 000-53313) and incorporated herein by reference)

*Filed herewith
**Furnished herewith.
# XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
 
 
 
38




Exhibit 31.1
 
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Kent P. Watts, certify that:

1. I have reviewed this Quarterly report on Form 10-Q of Hydrocarb Energy Corp.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the consolidated financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in the report;

4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have significant role in the registrant's internal control over financial reporting.

Date: June  22, 2015
 
By:
/s/ Kent P. Watts
 
Kent P. Watts
 
Chief Executive Officer and a director
 
(Principal Executive Officer)
 
 




Exhibit 31.2
 
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Christine P. Spencer, certify that:

1. I have reviewed this Quarterly report on Form 10-Q of Hydrocarb Energy Corp.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the consolidated financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in the report;

4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have significant role in the registrant's internal control over financial reporting.

Date:
June  22, 2015
   
By:
/s/ Christine P. Spencer
 
Christine P. Spencer
 
Chief Accounting Officer
 
(Principal Accounting Officer)
 
 




Exhibit 32.1
 
CERTIFICATIONS PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2001
(18 U.S.C SECTION 1350)

In connection with the Quarterly Report of Hydrocarb Energy Corp, on Form 10-Q for the quarter ended April 30, 2015, as filed with the Securities and Exchange Commission (the "Report"), Kent P. Watts, Chief Executive Officer and Christine P. Spencer, Chief Accounting Officer of Hydrocarb Energy Corp., do hereby certify, pursuant to 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350), that to his or her knowledge:

(1)        The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)            The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date:
June  22, 2015
 
By:
/s/ Kent P. Watts
Kent P. Watts
Chief Executive Officer and a director
(Principal Executive Officer)

By:
/s/ Christine P. Spencer
Christine P. Spencer
Chief Accounting Officer
(Principal Accounting Officer)

A signed original of this written statement required by Section 906 or other document authenticating, acknowledging, or otherwise adopting the signatures that appear in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.